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Optimal irrational behavior in continuous time

James Feigenbaum () and Frank Caliendo ()

Journal of Economic Dynamics and Control, 2010, vol. 34, issue 10, 1907-1922

Abstract: Feigenbaum et al. (2009) showed in a two-period overlapping generations model that households can improve upon the rational, competitive equilibrium while maintaining competitive factor markets if agents coordinate upon an irrational consumption/saving rule. We generalize their findings to continuous time. The optimal consumption rule with coordination implies a U-shaped lifecycle consumption profile. Rational agents living in a standard competitive equilibrium would need a 4% increase of consumption in every period across the lifecycle to reach the level of utility that can be achieved under coordination. Most of this gain can be achieved with a linear saving rule.

Keywords: Consumption; Saving; Coordination; General; equilibrium; Rules; of; thumb; Pecuniary; externality; Overlapping; generations; Optimal; irrational; behavior (search for similar items in EconPapers)
Date: 2010
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Handle: RePEc:eee:dyncon:v:34:y:2010:i:10:p:1907-1922