Economic Agents as Imperfect Problem Solvers / Cosmin L. Ilut, Rosen Valchev.

Format:

Book

Author/Creator:

Ilut, Cosmin L.

Contributor:

National Bureau of Economic Research.

Valchev, Rosen.

Series:

Working Paper Series (National Bureau of Economic Research) no. w27820.

NBER working paper series no. w27820

Language:

English

Physical Description:

1 online resource: illustrations (black and white);

Place of Publication:

Cambridge, Mass. National Bureau of Economic Research 2020.

Summary:

We develop a tractable model of limited cognitive perception of the optimal policy function, with agents using costly reasoning effort to update beliefs about this optimal mapping of economic states into actions. A key result is that agents reason less (more) when observing usual (unusual) states, producing state- and history-dependent behavior. Our application is a standard incomplete markets model with ex-ante identical agents that hold no a-priori behavioral biases. The resulting ergodic distribution of actions and beliefs is characterized by "learning traps", where locally stable dynamics of wealth generate "familiar" regions of the state space within which behavior appears to follow past-experience-based heuristics. We show qualitatively and quantitatively how these traps have empirically desirable properties: the marginal propensity to consume is higher, hand-to-mouth status is more frequent and persistent, and there is more wealth inequality than in the standard model.

Notes:

Print version record

September 2020.