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An Economic Approach to the Psychology of Change: Amnesia, Inertia, and Impulsiveness

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  • David Hirshleifer
  • Ivo Welch

Abstract

This paper models how imperfect memory affects the optimal continuity of policies. We examine the choices of a player (individual or firm) who observes previous actions but cannot remember the rationale for these actions. In a stable environment, the player optimally responds to memory loss with excess inertia, defined as a higher probability of following old policies than would occur under full recall. In a volatile environment, the player can exhibit excess impulsiveness (i.e., be more prone to follow new information signals). The model provides a memory-loss explanation for some documented psychological biases, implies that inertia and organizational routines should be more important instable environments than in volatile ones, and provides other empirical implications relating memory and environmental variables to the continuity of decisions.

Suggested Citation

  • David Hirshleifer & Ivo Welch, 2001. "An Economic Approach to the Psychology of Change: Amnesia, Inertia, and Impulsiveness," Yale School of Management Working Papers ysm185, Yale School of Management, revised 01 Aug 2009.
  • Handle: RePEc:ysm:somwrk:ysm185
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    File URL: http://icfpub.som.yale.edu/publications/2556
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    More about this item

    Keywords

    Memory; Inertia; Amnesia; Behavioral Economics;
    All these keywords.

    JEL classification:

    • D7 - Microeconomics - - Analysis of Collective Decision-Making
    • L2 - Industrial Organization - - Firm Objectives, Organization, and Behavior
    • D8 - Microeconomics - - Information, Knowledge, and Uncertainty

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