Working Paper: NBER ID: w16911
Authors: Xavier Gabaix
Abstract: This paper defines and analyzes a "sparse max" operator, which is a less than fully attentive and rational version of the traditional max operator. The agent builds (as economists do) a simplified model of the world which is sparse, considering only the variables of first-order importance. His stylized model and his resulting choices both derive from constrained optimization. Still, the sparse max remains tractable to compute. Moreover, the induced outcomes reflect basic psychological forces governing limited attention. \n\nThe sparse max yields a behavioral version of two basic chapters of the microeconomics textbook: consumer demand and competitive equilibrium. We obtain a behavioral version of Marshallian and Hicksian demand, the Slutsky matrix, the Edgeworth box, Roy's identity etc. The Slutsky matrix is no longer symmetric: non-salient prices are associated with anomalously small demand elasticities. Because the consumer exhibits nominal illusion, in the Edgeworth box, the offer curve is a two-dimensional surface rather than a one-dimensional curve. As a result, different aggregate price levels correspond to materially distinct competitive equilibria, in a similar spirit to a Phillips curve. This framework provides a way to assess which parts of basic microeconomics are robust, and which are not, to the assumption of perfect maximization.
Keywords: bounded rationality; sparsity; consumer behavior; competitive equilibrium
JEL Codes: D03; D42; D8; E31; G1
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| limited attention (D91) | decision-making processes (D70) |
| limited attention (D91) | nominal illusion (E41) |
| nominal illusion (E41) | consumer demand (D12) |
| limited attention (D91) | consumer demand (D12) |
| bounded rationality (D01) | asymmetric Slutsky matrix (D11) |
| perceived price levels (E30) | competitive equilibria (D50) |
| bounded rationality (D01) | preferences regarding tax policy (H29) |
| nominal illusion (E41) | preferences regarding tax policy (H29) |
| limited attention (D91) | preferences regarding tax policy (H29) |
| inattention (D91) | consumer behavior (D19) |