Lecture 3 Unobserved choice sets

Lecture 3 Unobserved choice sets Rachel Griffith CES Lectures, April 2017 Introduction Unobserved choice sets Goeree (2008) GPS (2016) Final comments 1 / 32

1. The general problem of unobserved choice sets 2. Sovinsky Goeree (2008) Limited information and advertising in the US personal computer industry Econometrica 3. Gaynor, Propper and Seiler (2016) Free to Choose? Reform, Choice, and Consideration Sets in the National Health Service American Economic Review Introduction Unobserved choice sets Goeree (2008) GPS (2016) Final comments 2 / 32

Demand estimation relies of revealed preference Identification of demand parameters rests on revealed preference arguments: someone chooses A over B we infer that they prefer A to B to do this we need to know that they could have chosen B if they instead preferred B to A cited on the Wikipedia page on revealed preference: If there exist only an apple and an orange, and an orange is picked, then one can definitely say that an orange is revealed preferred to an apple. In the real world, when it is observed that a consumer purchased an orange, it is impossible to say what good or set of goods or behavioral options were discarded in preference of purchasing an orange. In this sense, preference is not revealed at all in the sense of ordinal utility. Koszegi and Rabin (2007, AER) Introduction Unobserved choice sets Goeree (2008) GPS (2016) Final comments 3 / 32

Rich theoretical literature suggesting choice sets are heterogenous and constrained Consumers might face constrained choices for many reasons, and these are likely to differ across consumers limited information, search, time constraints, potentially combined with firm behaviour (e.g. advertising) Eliaz and Spiegler (2011, REStud); De Los Santos et. al (2012, AER); Reutskaja, Camerer, and Rangel (2011, AER) limited or rational (in)attention Masatlioglu et al (2012, AER); Manzini and Mariotti (2014, Econometrica) self control problems and commitment Bernheim and Rangel (2009, QJE), DellaVigna (2009, JEL) Our ability to explore their empirical relevance is limited Introduction Unobserved choice sets Goeree (2008) GPS (2016) Final comments 4 / 32

Implications of heterogeneity in choice sets for demand estimation Heterogeneity in choice sets can be useful for identification if variation is exogenous and we observe the variation in choice sets or if we know and can model the process of choice set formation but more often it is problematic when it is unobserved (by the econometrician) or when choice set formation is endogenous Introduction Unobserved choice sets Goeree (2008) GPS (2016) Final comments 5 / 32

Simple example to gain intuition for the problem a consumer can either buy (Y i = 1) or not buy (Y i = 0) payoff to buying is U i1 ; payoff to not buying is U i0 some consumers have the option to buy (CSi don t (CSi = {0}) = {0, 1}) and others what we observe in the data 1 if U i1 U i0, and CSi = {0, 1} Y i = { U i1 < U i0 and CSi = {0, 1} 0 if or CSi = {0} Introduction Unobserved choice sets Goeree (2008) GPS (2016) Final comments 6 / 32

Simple example to gain intuition for the problem In this example the probability that i buys is: Pr (Y i = 1) = Pr [U i1 > U i0 CS i = {0, 1}] }{{} probability that buy given have choice probability that have choice {}}{ Pr [CS i = {0, 1}] revealed preference arguments allow us to infer preferences based on this part this part is a problem and causes bias in parameter estimates Introduction Unobserved choice sets Goeree (2008) GPS (2016) Final comments 7 / 32

Discrete choice demand model with heterogenous choice sets Market with j = 1,..., J products i = 1,..., I consumers t = 1..., T choice situations The choice i makes in t: Y it the sequence of choices i makes, Yi = (Y i1,..., Y it ) The true choice set of i in t: CS it unobserved to the econometrician the sequence of choice sets: CS i = (CS i1,..., CS it ) Introduction Unobserved choice sets Goeree (2008) GPS (2016) Final comments 8 / 32

Discrete choice demand model with heterogenous choice sets We are interested in the consequences of mistakenly assuming that i chooses from some larger choice set that contains options that were not in fact in their choice set denote this larger set Sit and the sequence of these: S i = (S i1,..., S it ) (for notational convenience assume St the same for all i) so that the sequence of these is: S = (S 1,..., S T ) Introduction Unobserved choice sets Goeree (2008) GPS (2016) Final comments 9 / 32

Discrete choice demand model with heterogenous choice sets Denote the preferences that govern choice by θ i and γ i Pr [Y i = j CS i = c, θ i ] probability of making a sequence of choices, Y i = j, given the consumer is matched to choice sequence, CS i revealed preference arguments allow us to make inference about consumer preferences based on this Pr [CS i = c γ i ] the process matching consumers to their (unobserved) choice sequence revealed preference arguments are not informative here Probability of making a sequence of choices, Y i = j, is Pr [Y i = j CS i = c, θ i ] Pr [CS i = c γ i ] Introduction Unobserved choice sets Goeree (2008) GPS (2016) Final comments 10 / 32

Discrete choice demand with heterogenous choice sets Let indirect utility from choosing i in t: U ijt = V ijt (X ijt, θ) + ε ijt assume ε ijt is distributed Type I Extreme Value conditional on the specific sequence of choice sets to which i is matched Thus for any choice set, c, that the consumer is matched to Pr [ Y i = j CS i = c, θ] = T exp (V ijt (X ijt, θ)) m CS it exp (V =ct imt (X ijt, θ)) t=1 Introduction Unobserved choice sets Goeree (2008) GPS (2016) Final comments 11 / 32

Bias If econometrician incorrectly specifies choice as larger set S = s: Pr [Y i = j S = s, θ] = This leads to bias T exp (V ijt (X ijt, θ)) m S t=s t exp (V imt (X ijt, θ)) t=1 { problem }} { Pr [ Y i = j S = s, θ] = Pr [ Y i = j CS i = c, θ] }{{} probability that buy given have choice Pr [ Y i CS i = c S = s, θ] = T t=1 exp ( ( V ijt Xijt, θ )) m CS m CS it =c exp ( ( V imt Xijt, θ )) it =c exp ( ( V imt Xijt, θ )) r S t =s t exp ( ( V irt Xijt, θ )) Introduction Unobserved choice sets Goeree (2008) GPS (2016) Final comments 12 / 32

Bias Estimation of θ based on too large choice set S = s will be biased if Pr [Y i CS i = c S = s, θ] is important this is the probability that, if i could actually choose from S, the choice they would make would be in their true choice set if all the products that i likes are in their choice set then this will be close to 1 and there will be no bias if when facing the bigger choice set S = s, i would make a choice not in CS i = c, then bias will be larger if we (mistakenly) include alternatives in estimation that i really likes, but were not available, then we will get larger bias The size of bias is increasing in the degree of differentiation the share of individuals with constrained choice set the extent of the constraint Introduction Unobserved choice sets Goeree (2008) GPS (2016) Final comments 13 / 32

Some approaches that do not correct the bias Add product (j) specific constants to the model this doesn t control for the bias term, which is individual specific Add random coefficients to the model relies on distribution of random coefficients being independent of the Xs we can clearly see that this won t hold by looking at the bias term Introduction Unobserved choice sets Goeree (2008) GPS (2016) Final comments 14 / 32

Approaches to dealing with this Collect data that indicates which products are in each consumer s choice sets Chamberlain (1980) fixed effect logit Approaches deriving from Manski (1977) Sovinsky Goeree (2008, Econometrica), van Nierop et al (2010, JMR), Draganska and Klapper (2011, JMR) jointly model both choice set formation and the purchase decision given a choice set use information on the matching process to integrate out unobserved choice set heterogeneity Introduction Unobserved choice sets Goeree (2008) GPS (2016) Final comments 15 / 32

Chamberlain (1980) s Fixed Effect Logit It is convenient to rewrite the bias { problem }} { Pr [ Y i = j S = s, θ] = Pr [ Y i = j CS i = c, θ] }{{} probability that buy given have choice Pr [ Y i CS i = c S = s, θ] = T t=1 exp ( ( V ijt Xijt, θ )) m CS m CS it =c exp ( ( V imt Xijt, θ )) it =c exp ( ( V imt Xijt, θ )) r S t =s t exp ( ( V irt Xijt, θ )) in this form Pr [ Y i = j S = s, θ] == T t=1 exp ( V ijt ( Xijt, θ ) ln(π i ) ) m S t =st exp ( V imt ( Xijt, θ )) this is a fixed-effect (in a non-linear context) Introduction Unobserved choice sets Goeree (2008) GPS (2016) Final comments 16 / 32

Chamberlain (1980) s Fixed Effect Logit Chamberlain s Fixed Effect Logit differences out the bias term Conditions on observed choice switches consider a market with products {a, b, c, d, e,...} if we observe i choosing a in period 1 and b in period 2, so Y i = (a, b) we know a and b are in i s true unobserved choice set i could have chosen either (a, b) or (b, a) the Fixed Effect Logit estimates the probability: Pr[Y i = (a, b) {(a, b), (b, a)}, θ ] individual-alternative specific effects difference out Relies on choice set stability Identifies only coefficients on time varying X s Introduction Unobserved choice sets Goeree (2008) GPS (2016) Final comments 17 / 32

Chamberlain (1980) s Fixed Effect Logit This enable us to point-identify preference parameters θ but we cannot point-identify elasticities ξ jj = β pp j 1 exp (βx j) exp (βx l ) l CS ξ jk = β pp k exp (βx k ) l CS exp (βx l ) elasticities are functions of the full choice set, CS i, which are not observable without imposing more structure/further assumptions about the choice set formation process Introduction Unobserved choice sets Goeree (2008) GPS (2016) Final comments 18 / 32

Approaches deriving from Manski (1977) Jointly model both the choice set formation process and the purchase decision given a choice set Manski (1977): the unconditional probability of i selecting choice sequence j can be written as: Pr[Y i = j θ, γ] = Pr[Y i = j CS i = c, θ] Pr[CS i = c γ], c C i where Ci is the collection of sets of possible choice sequences to which consumer type i can be matched By having information on the matching process between consumer types and choice sets, researchers can integrate out unobserved choice set heterogeneity in a matter analogous to that routinely done with unobserved preference heterogeneity Introduction Unobserved choice sets Goeree (2008) GPS (2016) Final comments 19 / 32

Sovinsky Goeree (2008) Considers the US personal computer market Consumers have limited consumer information, advertising influences the set of products from which consumers choose to purchase Specifies a model of the form: probability that have choice exp ( V ijt t(x ijt, θ) ) { }} { Pr[Y it = j t θ, γ] = c C r c exp ( V j irt (X ijt, θ) ) φ ilt (γ) (1 φ ikt (γ)) l c k / c }{{} probability that buy given have choice where C j t is the collection of all the choice sets that include product j Introduction Unobserved choice sets Goeree (2008) GPS (2016) Final comments 20 / 32

Sovinsky Goeree (2008) The consideration of each product is assumed to be independent from the consideration of the other products Pr [CS it = c γ] = φ ilt (γ) (1 φ ikt (γ)) it l c k / c the number of PCs is large (over 2,000), so the non-parametric estimation of all the φ s is not feasible; Sovinksy Goeree s assumes that φ ilt (γ) = exp (W ilt (γ)) 1 + exp (W ilt (γ)) where W is advertising Introduction Unobserved choice sets Goeree (2008) GPS (2016) Final comments 21 / 32

Introduction Unobserved choice sets Goeree (2008) GPS (2016) Final comments 22 / 32

Issues potential for misspecification of choice set formation process even when correctly specified it is likely to suffer from a curse of dimensionality because the number of elements in Ci grows exponentially in the number of products J sold in the market if c is not in the support of the choice set distribution to which individual i can be matched to in period t there will still be some bias computing expectations over the universal set would not be a problem if we could estimate a truly flexible specification for φ that was able to accomodate Pr it [CSit = c γ] = 0 whenever necessary the problem arises because we are not usually able to estimate a truly flexible model for φ, and we need to make additional assumptions Introduction Unobserved choice sets Goeree (2008) GPS (2016) Final comments 23 / 32

Gaynor, Propper and Seiler Expanding choice in healthcare is a popular reform supporters believe it will increase competition and raise quality opponents argue that patients either can t make choices or will make poor choices, so competition will lead to wasteful use of resources, focus on the wrong attributes of care or harm the poor and less educated Model demand for coronary artery bypass graft before and after a reform that gave patients choice pre-reform they had constrained choice (their physician decided) post-reform they had increased choice (constrains and incentives for physicians relaxed) Introduction Unobserved choice sets Goeree (2008) GPS (2016) Final comments 24 / 32

Gaynor, Propper and Seiler They do not know precisely the nature of the constraint pre-reform they model demand post reform and recover the contraint by comparing the predicted choices using the model applied in the pre-reform period, and attribute the differences in predicted and actual choices to the constraint They find that introducing choice led to patients requiring heart bypass surgery became more responsive to the quality of care; this gave hospitals a greater incentive to improve quality (and they provide some reduced form evidence on this) Introduction Unobserved choice sets Goeree (2008) GPS (2016) Final comments 25 / 32

Hospital Choice Patient s utility U ij = β wi W jt + β zi Z jt + f (D ij ) + ξ j + ɛ ij i: patient, j: hospital W : wait time, Z: quality, D: distance Physician utility V ij = g(d ij ) + ζ j + v ij physician utility determined by contracts, financial incentives and other unobservable factors captured by hospital fixed effects, distance related variables and an indicator for whether the hospital was located in the same administrative region (PCT) as the referring physician the reform relaxed these incentives Introduction Unobserved choice sets Goeree (2008) GPS (2016) Final comments 26 / 32

Hospital Choice Physician offers hospital k to patient if J: all hospitals, λ i 0 V ik max j J (V ij ) λ i All hospitals within a distance of λi in utility space are included in the choice set (offered to the patient) λ i captures extent to which physician cares about patient utility λ i = 0 = patients preferences have no influence on the choice λ i > 0 = physician might include multiple hospitals in the choice set, how many depends on the value of λ i GPS estimate λ i, and allow it to vary across patient characteristics Introduction Unobserved choice sets Goeree (2008) GPS (2016) Final comments 27 / 32

Identification How do they separately identify patient and physican preferences they identify them separately because they observe a change in the process by which choice sets are formed due to the reform patients preferences are identified from the post-reform period, where choice is freed up physician s preferences are identified from the pre-reform period if patient choice pre-reform was unconstrained (and if patient preferences are stable over time) then the post-reform estimates should predict hospital choice before the reform (if patients had choice) if instead post-reform preferences do not predict referral patterns in the pre-reform time period, it has to be the case that the way in which referrals were made changed over time Introduction Unobserved choice sets Goeree (2008) GPS (2016) Final comments 28 / 32

Introduction Unobserved choice sets Goeree (2008) GPS (2016) Final comments 29 / 32

Welfare Difficult to measure welfare effects for a number of reasons want to find the impact of removing restriction; find surplus in constrained world (just physician s utility function) and in unconstrained world (physician s and patients) problem is they don t observe choice set in constrained world, and need that to measure surplus; they simulate choice sets there is no price mechanism so surplus expressed in utils; can t translate to monetary terms; instead translate to distance (find equivalent to 15km reduction in travel costs) Introduction Unobserved choice sets Goeree (2008) GPS (2016) Final comments 30 / 32

Comparison of Gaynor Propper Seiler and Goeree Goeree (2008) models the probability of inclusion into the choice set; implies that the inclusion probabilities are independent separately for each product in GPS a very attractive hospital can lead to a smaller choice sets by pushing other hospitals out of the choice set Goeree (2008) allows positive probability that no product is in the choice set in GPS this is not allowed, the physician has to offer the patient at least one hospital Why don t GPS include expected patient utility directly in the physician s utility function? this is defined over all possible choice set permutations, e.g. if 29 possible options is (2 29 1)=536,870,911 Introduction Unobserved choice sets Goeree (2008) GPS (2016) Final comments 31 / 32

Summary Unobserved and endogenous choice sets are a potentially big problem We have some econometric tools to deal with them, but they are limited in application Exciting on-going research and an area with opportunities for new research with Greg Crawford and Alessandro Iaria we are developing more general methods based on extending the differencing idea of Chamberlain s fixed effect model Introduction Unobserved choice sets Goeree (2008) GPS (2016) Final comments 32 / 32