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Optimal Irrational Behavior

James Feigenbaum (), Frank Caliendo () and Emin Gahramanov ()

No 200901, Working Papers from Utah State University, Department of Economics and Finance

Abstract: 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
Date: 2009-02-03
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) Downloads
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