Abstract:
Observed evidence shows that economic choices do not reflect what many models predict. Individuals do not perfectly smooth consumption over time, they either consume or save too much. Rational inattention, defined as the limited ability to process information, or to pay attention, is able to show that consumption choices are complex to study. The amount of information available to the agents is potentially infinite and rational inattention claims that it is practically impossible to pay attention to all of it. Within a two-period model under limited processing capacity, when total wealth is defined as a random variable, consumption choices are not as accurate as the ones presented in any other model without information frictions. This happens because the agent does not know what is the unique optimal choice, but she/he assigns a probability to each combination of wealth and consumption. In the case of rational inattention, the decision rule corresponds to the optimal joint probability distribution function (PDF), which concretely coincides with the allocation of attention. Because for problems of this kind an analytic solution is not feasible, I consider an iteration procedure that simulates the joint PDF. I conclude the analysis by applying the procedure to a specific framework. The take-up rate of social transfers represents indeed the core of the second part of the study. I show that extra units of wealth do not necessarily improve consumption choices and attention allocation, because there are practical and subjective determinants that affect the ability of the agent to process new information.
