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Limited Rationality and Strategic Interaction - The Impact of the Strategic Environment on Nominal Inertia

  • Jean-Robert Tyran

    ()

  • Ernst Fehr

    ()

The evidence from many experiments suggests that people are heterogeneous with regard to their abilities to make rational, forward looking, decisions. This raises the question when the rational types are decisive for aggregate outcomes and when the boundedly rational types shape aggregate results. We examine this question in the context of a long-standing and important economic problem – the adjustment of nominal prices after an anticipated money shock. Our experiments show that when agents’ actions are strategic substitutes adjustment to the new equilibrium is extremely quick whereas under strategic complementarity adjustment lasts very long and is associated with relatively large real effects. This adjustment difference occurs because price expectations are very flexible under substitutability and very sticky under complementarity. Our results suggest that strategic complementarity does not only provide incentives for the rational types to partly mimic the behavior of the boundedly rational types but it also renders people less rational and forward looking. In addition, under complementarity people attribute less rationality to the other players.

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Paper provided by Department of Economics, University of St. Gallen in its series University of St. Gallen Department of Economics working paper series 2002 with number 2002-25.

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Length: 49 pages
Date of creation: Nov 2002
Date of revision:
Handle: RePEc:usg:dp2002:2002-25
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