Revealed Preference, Rational Inattention, and Costly Information Acquisition

Abstract

Apparently mistaken decisions are ubiquitous. To what extent does this reflect irrationality, as opposed to a rational trade-off between the costs of information acquisition and the expected benefits of learning? We develop a revealed preference test that characterizes all patterns of choice "mistakes" consistent with a general model of optimal costly information acquisition and identify the extent to which information costs can be recovered from choice data.Limits on attention impact choice. Shoppers may buy unnecessarily expensive products due to their failure to notice whether or not sales tax is included in stated prices (Chetty, Looney, and Kroft 2009). Buyers of secondhand cars focus their attention on the leftmost digit of the odometer (Lacetera, Pope, and Sydnor 2012). Purchasers limit their attention to a relatively small number of websites when buying over the Internet (De Los Santos, Hortaçsu, and Wildenbeest 2012).While apparently mistaken decisions are ubiquitous, this does not imply that decision makers are irrational. The standard theory of choice asserts only that individuals act optimally, given what they know. At least since the work of Hayek (1945) and Stigler (1961), there has been a focus on the optimization of knowledge itself, with decision makers trading off the cost of learning against improved decision quality. As the universality of knowledge constraints has been increasingly recognized, so the range of information cost functions used to model them has expanded. Verrecchia (1982) models choice of variance of a normal signal; Sims (2003) an unrestricted choice of information structure with costs based on Shannon entropy; and Reis (2006) the binary choice of whether or not to become fully informed. 1 1 See, for example, van Nieuwerburgh and Veldkamp (2009) and Woodford (2012) for other informational cost functions.

Stopping on Nine: Evidence of Heuristic Managerial Decision‐Making in Major League Baseball Pitcher Substitutions

“…Baseball managers use heuristics at times but appear to substitute more consistent decision‐making in high‐stakes situations. These results are more consistent with rational inattention by managers than suboptimal decision‐making per se (Caplin and Dean ). Thus, I find evidence similar to recent examples (e.g., Brown and Yang ) that document apparent decision making anomalies that do not significantly affect final outcomes.…”

How can neuroscience inform economics?

“…Unfortunately, such costs are not generally well understood, and the precise form of the cost function can have an important impact on predicted economic behavior [33]. One approach is to treat these costs as unknown [34], which limits the predictive power of such models. Another is to select a particular attention cost function, usually based on Shannon mutual information -a concept borrowed from information theory, and use this to make predictions.…”

Stochastic Complementarity

“…However, the recent wave of abstract works on stochastic choice (e.g. Aguiar, Boccardi and Dean [1], Brady and Rehbeck [10], Caplin and Dean [12], Echenique, Saito and Tserenjigmid [16], Gül, Natenzon and Pesendorfer [18], Manzini and Mariotti [20] among others) has highlighted a wide variety of possible 'choice errors' and choice procedures, and so a number of reasons why agents' behaviour might fail to be described by a logit model, and indeed even by the much larger class of RUMs. We take Behavioural Insights Unit established in 2012 as part of the New South Wales Premier and Cabinet's office.…”