A Cognitive Basis for Context-Dependent Utility

This paper provides a new way to understand the concept of a utility function. By looking into the cognitive processes of information acquisition, I demonstrate how a utility function can be derived from deeper first principles. Crucially, assuming that humans possess only a minimal set of cognitive tools ordinal comparison and proportion (or frequency-of-occurrence) estimation, I show that the resulting utility of an object is isomorphic to the perceived rank of its magnitude within a reference set. By construction, the resultant utility is adaptive, and thus is evolutionarily advantageous. With perfect cognitive tools, this adaptive utility minimizes mistakes in binary choices. Cognitive imperfections may lead to suboptimal choices, as small objects tend to be overvalued and large objects tend to be undervalued. The proposed parsimonious model has features that are strongly consistent with empirical observation. This new analytical approach offers a bridge between modern economics, psychology, and neuroscience. Journal of Economic Literature classification numbers: D03