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Limited Rationality and Strategic Interaction: A Probabilistic Multi-Agent Model

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    Abstract

    We develop a multi-agent framework based on probabilistic cellular automata theory to describe off-equilibrium dynamics in the context of the economic problem of price adjustment in different strategic situations as investigated experimentally by Fehr and Tyran (2001) and (2008). It is found that the main experimental findings, namely suboptimal aggregate behavior in terms of sluggish adjustment after a fully anticipated money shock, can be reproduced and largely explained by the interaction of sophisticated and naive agents. Furthermore, a range of conceptual issues as e.g. the source of endogenous beliefs on the other players rationality is addressed within our multi-agent framework. We find that, if costs/payoffs act as driver of rational behavior, then endogenous beliefs and consequential aggregate behavior are driven by the particular off-equilibrium time-dependent payoff/cost profile rather than by total off- equilibrium payoffs/costs that naive agents face in the respective strategic situation.

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    Paper provided by Swiss National Bank, Study Center Gerzensee in its series Working Papers with number 11.08.

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    Length: 21 pages
    Date of creation: Aug 2011
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    Handle: RePEc:szg:worpap:1108

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    1. Droste, Edward & Kosfeld, Michael & Voorneveld, Mark, 2003. "Best-reply matching in games," Mathematical Social Sciences, Elsevier, Elsevier, vol. 46(3), pages 291-309, December.
    2. Russell Cooper & John Haltiwanger, 1993. "Evidence on Macroeconomic Complementarities," NBER Working Papers 4577, National Bureau of Economic Research, Inc.
    3. Droste, E.J.R. & Kosfeld, M. & Voorneveld, M., 1998. "A Myopic Adjustment Process Leading to Best-Reply Matching," Discussion Paper, Tilburg University, Center for Economic Research 1998-111, Tilburg University, Center for Economic Research.
    4. Vives, X., 1988. "Nash Equilibrium With Strategic Complementarities," UFAE and IAE Working Papers, Unitat de Fonaments de l'Anàlisi Econòmica (UAB) and Institut d'Anàlisi Econòmica (CSIC) 107-88, Unitat de Fonaments de l'Anàlisi Econòmica (UAB) and Institut d'Anàlisi Econòmica (CSIC).
    5. Douglas D. Davis & Korenok Oleg, 2010. "Nominal Price Shocks in Monopolistically Competitive Markets: An Experimental Analysis," Working Papers, VCU School of Business, Department of Economics 1003, VCU School of Business, Department of Economics, revised Jun 2011.
    6. Cooper, Russell W. & Johri, Alok, 1997. "Dynamic complementarities: A quantitative analysis," Journal of Monetary Economics, Elsevier, Elsevier, vol. 40(1), pages 97-119, September.
    7. Jean-Robert Tyran & Ernst Fehr, 2002. "Limited Rationality and Strategic Interaction - The Impact of the Strategic Environment on Nominal Inertia," University of St. Gallen Department of Economics working paper series 2002, Department of Economics, University of St. Gallen 2002-25, Department of Economics, University of St. Gallen.
    8. Haltiwanger, John & Waldman, Michael, 1985. "Rational Expectations and the Limits of Rationality: An Analysis of Heterogeneity," American Economic Review, American Economic Association, American Economic Association, vol. 75(3), pages 326-40, June.
    9. Ernst Fehr & Jean-Robert Tyran, 2001. "Does Money Illusion Matter?," American Economic Review, American Economic Association, American Economic Association, vol. 91(5), pages 1239-1262, December.
    10. Javier Rivas, 2008. "Learning within a Markovian Environment," Economics Working Papers, European University Institute ECO2008/13, European University Institute.
    11. Colin F. Camerer & Teck-Hua Ho & Juin-Kuan Chong, 2004. "A Cognitive Hierarchy Model of Games," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 119(3), pages 861-898, August.
    12. Milgrom, Paul & Roberts, John, 1990. "Rationalizability, Learning, and Equilibrium in Games with Strategic Complementarities," Econometrica, Econometric Society, Econometric Society, vol. 58(6), pages 1255-77, November.
    13. Cooper, Russell & John, Andrew, 1988. "Coordinating Coordination Failures in Keynesian Models," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 103(3), pages 441-63, August.
    14. Haltiwanger, John C & Waldman, Michael, 1989. "Limited Rationality and Strategic Complements: The Implications for Macroeconomics," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 104(3), pages 463-83, August.
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