Nber Working Paper Series Which Models Can We Trust to Evaluate Consumer Decision Making? Comment on “choice Inconsistencies among the Elderly”

Neoclassical and psychological models of consumer behavior often make divergent predictions for the welfare effects of paternalistic policies, leaving wide scope for researchers’ choice of a model to influence their policy conclusions. We develop a framework to reduce this model uncertainty and apply it to administrative data on consumer decision making in Medicare Part D. Consumers’ choices for prescription drug insurance plans can be explained by Abaluck and Gruber’s (AER 2011) model of utility maximization with psychological biases or by a neoclassical version of their model that precludes such biases. We evaluate these competing hypotheses using nonparametric tests of utility maximization and a trio of model validation tests. We find that 79% of enrollment decisions in Medicare Part D from 2006-2010 satisfied basic axioms of consumer preference theory under the assumptions of full information, zero transaction cost, and no measurement error. The validation tests provide evidence against widespread psychological biases. In particular, we find that precluding psychological biases improves the structural model’s out-of-sample predictions for consumer behavior. Jonathan D. Ketcham Associate Professor Department of Marketing, Box 4106 W.P. Carey School of Business Arizona State University 300 E. Lemon Street Tempe, AZ 85287-4106 [email protected] Nicolai V. Kuminoff Department of Economics Arizona State University P.O. Box 879801 Tempe, AZ 85287 and NBER [email protected] Christopher A. Powers 7500 Security Boulevard Mailstop B2-29-04 Baltimore, MD 21244 [email protected]