Inattentive Economies

We study the efficiency of inattentive but otherwise frictionless economies by augmenting the Arrow-Debreu framework with a flexible form of rational inattention. If attention costs satisfy an invariance condition embedded in Sims’s mutual information specification, a version of the first welfare theorem holds no matter the degree of inattention. More generally, however, a cognitive externality may emerge, and welfare may be improved by regulating and simplifying markets. We discuss how these results qualify Hayek’s argument about the informational optimality of the price system, how they link the normative question of interest to a decision-theoretic literature on stochastic choice, and how they separate paternalistic and nonpaternalistic approaches to modeling inattention.