I develop an approach, which I term narrow thinking, to break the decision-maker’s ability to perfectly coordinate her multiple decisions. For a narrow thinker, different decisions are based on different, non-nested, information. The narrow thinker then makes each decision with an imperfect understanding of the others. Formally, it is as if the decision-maker is a collection of multiple selves playing an incomplete-information game. The friction effectively attenuates the degree of interaction across decisions and can translate into either over- or under-reaction depending on the environment. Narrow thinking leads to a violation of the fungibility principle and a smooth model of mental accounting. Narrow thinking also reconciles other seemingly disparate phenomena in a unified framework, such as excess smoothness to taste shocks, the small wage elasticity of daily labor supply, and the label effect. Finally, I study an endogenous narrow thinking problem: the decision maker chooses optimally what information each decision is based upon, subject to a cognitive constraint.
That is the abstract of a new paper from Chen Lian, who is on the job market this year from MIT. (That is not his job market paper but it does have a revise and resubmit from Review of Economic Studies.)