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Behavioral and Policy Implications of Rational Inattention

Periodic Reporting for period 4 - INATTENTION (Behavioral and Policy Implications of Rational Inattention)

Reporting period: 2020-10-01 to 2021-03-31

Our overarching goal was to improve our understanding of the implications of human inattention. We were especially interested in what inattention implies for the design of public policies. Nowadays, more and more information is available, yet it is often excessive and difficult to digest properly. Therefore, how we allocate our scarce attention is crucial. Should we choose to pay attention to news about politics or about inflation? Do we invest detailed attention in a relatively small selection of topics and ignore everything else, or do we instead scratch the surface of myriads of different topics? Importantly, what are the implications of our inattention for consumption and investment behaviour? Or for voting behaviour? In turn, how do politicians shape their platforms to attract inattentive voters? It turns out that less-than-perfect information about the world we live in can drive inefficiencies of democracy, emergence of polarization in the society, and discrimination against minorities.
One of the most important observations in behavioral economics has been the concept of mental accounting. However, the existing theories of mental accounting that Thaler and others developed are not directly based on the inability to process and record information, and thus they are likely to have different implications. This project aimed to build a theory of mental accounting directly on the idea that digesting large amounts of information data is not costless for people, i.e. in line with Thaler’s ideas. Further, we planned to develop a unified framework to study the implications of voters’ rational inattention (selective ignorance) to political issues, including popular demand for misguided policies, public good provision, and the complexity of announced platforms. In the remaining works within the broad agenda of this project, we studied implications of inattention for the optimal construction of quota, taxes, and choice menus. Overall, we set out to better understand the fundamentals of the behaviour of inattentive agents, and then to use the new insights to study important issues affected by inattention.
We developed new theories of the fundamental behaviour of inattentive agents, and then we applied the insights to the study of important issues including the functioning of democracy, discrimination, polarization, and poverty.
First, we have provided a deeper understanding of the concept of mental accounting. We developed a theory of how an agent makes basic multi-product consumption decisions in the presence of taste, consumption-opportunity, and price shocks that are costly to attend to. We established that the agent often simplifies her choices by restricting her attention to a few important considerations, which depend on the decision at hand and affect her consumption patterns in specific ways. If the agent's problem is to choose her consumption levels of many goods with different degrees of substitutability, then she may create mental budgets for product categories that contain more substitutable items (e.g. entertainment and food). In some situations, it is optimal to specify budgets in terms of consumption quantities, but when most products have an abundance of substitutes, specifying budgets in terms of nominal spending tends to be optimal. If the goods are complements, in contrast, then the agent may --- consistent with naive diversification --- choose a fixed, unconsidered mix of products. If the agent's problem is to choose one of multiple products to fulfil a given consumption need (e.g. for gasoline or for a bed), then it is often optimal for her to allocate a fixed sum for the need.
Second, we studied how voters' selective ignorance interacts with policy design by political candidates. Small groups and voters with extreme preferences are more influential than under full information, divisive issues attract the most attention, and public goods are underfunded.
We also studied theoretically and experimentally how flexible information acquisition drives polarization of individuals with the same preferences, but perhaps only slightly different prior beliefs.
Finally, we explored how some economic variables, including prices and portfolio structure, do not change continually, but instead stay fixed for spans of time, then jump to new values. This behavior is usually modeled by the introduction of an explicit adjustment cost. We show that such a pattern can also represent optimal allocation of the attention of agents who have limited capacities to process information. We showed this result analytically in a broad class of cases. In this section, we also studied how quotas can affect the allocation of attention of HR managers.
The results have been presented at more than fifty invited talks at conferences and university seminars, and in national media. The work has been published in top economic journals. Selected papers include:
Kőszegi, Botond, and Filip Matějka. "Choice simplification: A theory of mental budgeting and naive diversification." The Quarterly Journal of Economics 135.2 (2020): 1153-1207.
Jung, Junehyuk, Kim, Jeong Ho (John), Matějka, Filip, and Christopher A. Sims. "Discrete actions in information-constrained decision problems." The Review of Economic Studies, 86.6 (2019): 2643-2667.
Matějka, Filip, and Guido Tabellini. "Electoral competition with rationally inattentive voters." The Journal of the European Economic Association (2020).
We developed new theories that describe how inattentive agents perceive the world and what policies then emerge. We developed 1) a new theory of mental accounting, 2) a theoretical description of how voters’ inattention affects what policies are proposed by competing politicians, 3) a theoretical understanding of how simple and lumpy behaviour emerges.
First, we developed a theory of how an agent makes basic multi-product consumption decisions. The novelty is that we can explore the ways in which agents choose to simplify their choices by restricting their attention to a few important considerations. Informally put, we can describe what simple heuristics consumers choose to use. In some situations, it is optimal to specify budgets in terms of consumption, i.e. mental accounting, but in other situations the agents choose to fix a portfolio mix of consumption and only scale it up or down as a whole, i.e. naïve diversification. Now, we can better understand how fairly general cognitive limitations connect to various aspects of realistic behaviour. These aspects were not understood to be driven by one unifying mechanism before, and now we can better describe when a particular form of behaviour is likely to emerge.
Second, the novelty of the project on political economy is that we studied what pieces of information about proposed policies voters choose to acquire. It turns out that such choices have an impact on what policies politicians support, which can lead to socially suboptimal equilibria.
Finally, the progress beyond the state of the art in the third part is that we have studied when discrete or lumpy behaviour can be driven by information frictions, in addition to being driven by explicit costly adjustment. The crucial ingredient is a flexible choice of information. In some situations, agents choose to consider only a finite number of alternatives, and alternate between fairly extreme choices, while in others their behaviour changes gradually.