Optimal Irrational Behavior in Continuous Time
Journal of Economic Dynamics and Control
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.
Feigenbaum, James A. and Frank N. Caliendo, (2010), “Optimal Irrational Behavior in Continuous Time,” Journal of Economic Dynamics and Control 34: 1907-1922