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Rational Inattention and Beyond

Paper Session

Saturday, Jan. 5, 2019 8:00 AM - 10:00 AM

Atlanta Marriott Marquis, M103
Hosted By: Econometric Society
  • Chair: John Leahy, University of Michigan

Rationally Inattentive Behavior: Characterizing and Generalizing Shannon Entropy

Andrew Caplin
,
New York University
Mark Dean
,
Columbia University
John Leahy
,
University of Michigan

Abstract

We provide a full behavioral characterization of the standard Shannon model of rational
inattention. The key axiom is “Invariance under Compression”, which identifies this model as capturing an ideal form of attention-constrained choice. We introduce tractable generalizations that allow for many of the known behavioral violations from this ideal, including asymmetries and complementarities in learning, context effects, and low responsiveness to incentives. We provide an even more general method of recovering attention costs from behavioral data. The data set in which we characterize all behavioral patterns is “state dependent”stochastic choice data.

Welfare Theorems for Inattentive Economies

George-Marios Angeletos
,
Massachusetts Institute of Technology
Karthik Sastry
,
Massachusetts Institute of Technology

Abstract

The canonical Arrow-Debreu model is augmented with a generalized form of rational inattention. We first demonstrate, in an example, how equilibrium prices in such economies may fail to reveal demand and supply to the outside observer, complicating welfare analysis. Next, we show more generally how the efficient outcomes can be understood as the solution to the problem of a mediator whose messages, shadow prices, are observed by the agents with endogenous idiosyncratic noise and can be interpreted by them only at the expense of cognitive effort. This suggests that there can be welfare gains from sending “simpler” messages or less volatile prices relative to a frictionless benchmark. We finally identify general restrictions on the cognitive structure that suffice for these welfare gains to be taken care by the “invisible hand” of the market mechanism---that is, for appropriate extensions of the two Welfare Theorems to hold despite the aforementioned complications.

An Attention-Based Theory of Mental Accounting

Botond Koszegi
,
Central European University
Filip Matejka
,
Charles University and Academy of Science

Abstract

We analyze how a decisionmaker with limited attention optimally attends to and responds to taste, price, and income shocks in simple consumption-savings models. We identify several ways in which the agent can be interpreted to engage in mental accounting, derive comparative statics on the strength of these patterns, and make additional predictions. When allocating consumption among goods with different degrees of substitutability in the face of taste or price shocks, the agent may create budgets for the more substitutable consumption categories. This tendency is stronger if the cost of attention is higher, and if there is more variety in available products. When managing her consumption from and transfers between an investment account and a checking account, the later of which she has an incentive to balance, the agent's marginal propensity to consume (MPC) out of shocks to the checking account is often greater than her MPC out of shocks to the investment account. Furthermore, to reduce the attention she must pay to her budgeting, the agent prefers to reduce spending risk, making her more averse to risk in the checking account than the investment account. As a result, she may optimally switch to a cheaper substitute product (such as a lower-grade gasoline) when a random price increase occurs.

A Theory of Narrow Thinking

Chen Lian
,
Massachusetts Institute of Technology

Abstract

I develop an approach, which I term narrow thinking, to break the decision-maker's ability to perfectly coordinate her multiple decisions. For a narrow thinker, different decisions are based on different, non-nested, information. The narrow thinker then makes each decision with an imperfect understanding of the others. Formally, it is as if the decision-maker is a collection of multiple selves playing an incomplete-information game. The friction effectively attenuates the degree of interaction across decisions and can translate into either over- or under-reaction depending on the environment. The narrow thinker violates the fungibility principle, and can exhibit mental accounting-type behavior. Narrow thinking also reconciles other seemingly disparate phenomena in a unified framework, such as excess sensitivity to temporary income shocks, the small wage elasticity of daily labor supply, temptation and comfort zones. Finally, I study an endogenous narrow thinking problem: the decision maker chooses optimally what information each decision is based upon, subject to a cognitive constraint.
Discussant(s)
Sandro Ambuel
,
University of Toronto
Jakub Steiner
,
CERGE-EI and the University of Zurich
Daniel Gottlieb
,
Washington University
Colin Raymond
,
Purdue University
JEL Classifications
  • E7 - Macro-Based Behavioral Economics
  • D8 - Information, Knowledge, and Uncertainty