Rational Inattention: A Review

Abstract

We review the recent literature on rational inattention, identify the main theoretical mechanisms, and explain how it helps us understand a variety of phenomena across fields of economics. The theory of rational inattention assumes that agents cannot process all available information, but they can choose which exact pieces of information to attend to. Several important results in economics have been built around imperfect information. Nowadays, many more forms of information than ever before are available due to new technologies, and yet we are able to digest little of it. Which form of imperfect information we possess and act upon is thus largely determined by which information we choose to pay attention to. These choices are driven by current economic conditions and imply behavior that features numerous empirically supported departures from standard models. Combining these insights about human limitations with the optimizing approach of neoclassical economics yields a new, generally applicable model.

JEL Classification: D8