Rationalizations and Mistakes: Optimal Policy with Normative Ambiguity

Abstract

Behavior that appears to violate neoclassical assumptions can often be rationalized by incorporating an optimization cost into decision-makers' utility functions. Depending on the setting, these costs may reflect either an actual welfare loss for the decisionmakers who incur them or a convenient (but welfare irrelevant) modeling device. We consider how resolution of this normative ambiguity shapes optimal policy in a number of contexts, including default options, inertia in health insurance plan selection, take-up of social programs, programs that encourage moving to a new neighborhood, and tax salience.