Optimal Irrational Behavior in Continuous Time

Document Type

Article

Journal/Book Title/Conference

Journal of Economic Dynamics and Control

Volume

34

Publication Date

2010

First Page

1907

Last Page

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.

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