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Rationality of limited rationality : some aggregate implications

Author

Listed:
  • Uri M. Possen

    (Department of Economics, Cornell University, USA)

  • Mikko Puhakka

    (Department of Economics, University of Lapland, Finland)

Abstract

In this paper we let economic agents choose whether to become fully rational or stay boundedly rational. Boundedly rational agents are less sophisticated in their information processing abilities. It is costly to acquire information needed to become fully rational, and thus not all agents are willing to incur those costs. We then explore the aggregate effects of endogenizing the decision whether the agent should or should not become fully rational in handling information. Since fully and boundedly rational individuals make different saving and consumption decisions, their interaction has a direct impact on the size of capital stock, aggregate savings and the volatility of output. E.g. we are able to show that in many circumstances our model will imply a smoother consumption than would be observed in a model with only fully rational Consumers.

Suggested Citation

  • Uri M. Possen & Mikko Puhakka, 1994. "Rationality of limited rationality : some aggregate implications," Finnish Economic Papers, Finnish Economic Association, vol. 7(2), pages 83-93, Autumn.
  • Handle: RePEc:fep:journl:v:7:y:1994:i:2:p:83-93
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    References listed on IDEAS

    as
    1. Haltiwanger, John & Waldman, Michael, 1985. "Rational Expectations and the Limits of Rationality: An Analysis of Heterogeneity," American Economic Review, American Economic Association, vol. 75(3), pages 326-340, June.
    2. J. Bradford De Long & Andrei Shleifer & Lawrence H. Summers & Robert J. Waldmann, 1989. "The Size and Incidence of the Losses from Noise Trading," Journal of Finance, American Finance Association, vol. 44(3), pages 681-696, July.
    3. Russell, Thomas & Thaler, Richard, 1985. "The Relevance of Quasi Rationality in Competitive Markets," American Economic Review, American Economic Association, vol. 75(5), pages 1071-1082, December.
    4. De Long, J Bradford, et al, 1991. "The Survival of Noise Traders in Financial Markets," The Journal of Business, University of Chicago Press, vol. 64(1), pages 1-19, January.
    5. Gali, Jordi, 1990. "Finite horizons, life-cycle savings, and time-series evidence on consumption," Journal of Monetary Economics, Elsevier, vol. 26(3), pages 433-452, December.
    Full references (including those not matched with items on IDEAS)

    More about this item

    JEL classification:

    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • E22 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Investment; Capital; Intangible Capital; Capacity

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