A memory based model of bounded rationality
By: Sendhil Mullainathan
Contributors: Massachusetts Institute of Technology. Dept. of Economics
Series: Working paper series / Massachusetts Institute of Technology, Dept. of Economics -- working paper 01-28; Working paper (Massachusetts Institute of Technology. Dept. of Economics) -- no. 01-28.
Publisher: Massachusetts Institute of Technology, Dept. of Economics
Published: 2000
Place of publication: Cambridge, MA
Language: eng
Number of pages: 42
Description: How do memory limitations affect economic behavior? I develop a model of memory grounded in psychology and biology research to investigate this question. Using this model, I study the case where people apply Bayes rule to the history they recall as if it were the true history. The resulting beliefs exhibit over-reaction on average. They also exhibit under-reaction with the model providing enough structure to allow predictions about which effect dominates when. I then apply this general framework to an otherwise standard model of consumption. It predicts the broad structure of consumption predictability as well as differences in marginal propensity to consume across different income streams. Most important, because it ties the extent of bias to a measurable aspect of the stochastic process being forecasted, the model makes novel, testable empirical predictions. Keywords: psychology, biology, Bayes rule, personal economic history, consumption.
Notes: Title from cover.

"September 2000." "September 20, 2000"--Abstract.

Includes bibliographical references (p. 34-37).

Abstract in HTML and working paper for download in PDF available via World Wide Web at the Social Science Research Network.

Supported in part by the Chiles Foundation.