Abstract
Differences in cognitive sophistication and effort are at the root of behavioral heterogeneity in economics. To explain this heterogeneity, behavioral models assume that certain choices indicate higher cognitive effort. A fundamental problem with this approach is that observing a choice does not reveal how the choice is made, and hence choice data is insufficient to establish the link between cognitive effort and behavior. We show that deliberation times provide the missing link, in the form of an individually-measurable correlate of cognitive effort. We present a model of heterogeneous cognitive depth, incorporating stylized facts from the psychophysical literature, which makes predictions on the relation between choices, cognitive effort, incentives, and deliberation times. We confirm the predicted relations experimentally in different kinds of games. However, we also show that imputing cognitive depth from choices alone can lead to erroneous conclusions when the features leading to iterative thinking are not salient.
Highlights
Economic agents form different expectations and react differently even when confronted with the same information, leading to substantial behavioral heterogeneity, which in turn has long been recognized as a fundamental aspect of economic interactions (e.g., Haltiwanger and Waldman 1985; Kirman 1992; Blundell and Stoker 2005; Von Gaudecker et al 2011)
This model provides empirically testable predictions regarding the relation of deliberation times, depth of reasoning as revealed by choices, and incentives
An immediate prediction is that higher observed depth of reasoning implies longer deliberation times
Summary
Economic agents form different expectations and react differently even when confronted with the same information, leading to substantial behavioral heterogeneity, which in turn has long been recognized as a fundamental aspect of economic interactions (e.g., Haltiwanger and Waldman 1985; Kirman 1992; Blundell and Stoker 2005; Von Gaudecker et al 2011). A key source of heterogeneity is the fact that cognitive capacities differ among individuals, as does the motivation to exert cognitive effort This observation has given rise to a rich theoretical literature on iterative. Stepwise reasoning processes, including level-k models (Stahl 1993; Nagel 1995; Stahl and Wilson 1995; Ho et al 1998) and models of cognitive hierarchies (Camerer et al 2004) Such models endow individuals with differing degrees of strategic sophistication or reasoning capabilities, and might hold the key to describe heterogeneity in observed behavior (for a recent survey, see Crawford et al 2013). A small but growing literature in macroeconomics has started to incorporate heterogeneity in cognitive depth and iterative thinking (Angeletos and Lian 2017), leading to promising insights on the effects of monetary policy (Farhi and Werning 2019) or low interest rates (García-Schmidt and Woodford 2019)
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