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Discrete adjustment to a changing environment: Experimental evidence

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  • Khaw, Mel Win
  • Stevens, Luminita
  • Woodford, Michael

Abstract

A laboratory experiment illustrates cognitive limitations in decision-making that may be relevant for modeling price-setting. Our subjects systematically depart from the optimal Bayesian response in several respects. Their responses are random, even conditioning on available information. Subjects adjust in discrete jumps rather than after each new piece of information, and by both large and small amounts, contrary to the predictions of an “Ss” model of optimal adjustment subject to a fixed cost. And they prefer to report “round numbers,” even when that requires additional effort. A model of inattentive adjustment is found to quantitatively outperform popular alternatives.

Suggested Citation

  • Khaw, Mel Win & Stevens, Luminita & Woodford, Michael, 2017. "Discrete adjustment to a changing environment: Experimental evidence," Journal of Monetary Economics, Elsevier, vol. 91(C), pages 88-103.
    • Handle: RePEc:eee:moneco:v:91:y:2017:i:c:p:88-103
    DOI: 10.1016/j.jmoneco.2017.09.001
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    More about this item

    Keywords

    Adjustment hazard; Generalized Ss model; Menu costs; Rational inattention;
    All these keywords.

    JEL classification:

    • C91 - Mathematical and Quantitative Methods - - Design of Experiments - - - Laboratory, Individual Behavior
    • D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations
    • E03 - Macroeconomics and Monetary Economics - - General - - - Behavioral Macroeconomics

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