Optimal Irrational Behavior
James Feigenbaum (),
Frank Caliendo () and
Emin Gahramanov ()
No 200901, Working Papers from Utah State University, Department of Economics and Finance
Contrary to the usual presumption that welfare is maximized if consumers behave rationally, we show in a two-period overlapping generations model that there always exists a rule of thumb that can weakly improve upon the lifecycle/permanent-income rule in general equilibrium with irrational households. The market-clearing mechanism introduces a pecuniary externality that individual rational households do not consider when making decisions, but a publically shared rule of thumb can exploit this effect. For typical calibrations, the improvement of the welfare of irrational households is robust to the introduction of rational agents. Generalizing to a more realistic lifecycle model, we find in particular that the Save More Tomorrow(TM) (SMarT) Plan can confer higher lifetime utility than the permanent-income rule in general equilibrium.
Keywords: consumption; saving; coordination; lifecycle/permanent-income hypothesis; SMarT Plan; general equilibrium; rules of thumb; pecuniary externality (search for similar items in EconPapers)
JEL-codes: C61 D11 E21 (search for similar items in EconPapers)
Pages: 39 pages
New Economics Papers: this item is included in nep-cba, nep-dge, nep-mac and nep-upt
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Journal Article: Optimal irrational behavior (2011)
Working Paper: Optimal irrational behavior (2009)
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Persistent link: https://EconPapers.repec.org/RePEc:uth:wpaper:200901
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