Logit, CES, and Rational Inattention

Andrei Matveenko

doi:10.2139/ssrn.2990774

Logit, CES, and Rational Inattention

Abstract

We study fundamental links between two popular approaches to consumer choice: the multinomial logit model of individual discrete choice and the CES utility function, which describes a multiple choice of a representative consumer. We base our analysis on the rational inattention (RI) model and show that the demand system of RI agents, each of which chooses a single option, coincides with the demand system of a fictitious representative agent with CES utility function. Thus, the multiple choice of the representative agent may be explained by the heterogeneity in signals received by the RI agents. We obtain a new interpretation for the elasticity of substitution and the weighting coeficients of the CES utility function. Specifically, we provide a correspondence between parameters of the CES utility function, prior knowledge and marginal cost of information.

Original language	English
Number of pages	22
DOIs	https://doi.org/10.2139/ssrn.2990774
Publication status	Published - 22 Jun 2017

Series	RePEc (Research Papers in Economics)
Number	593

Keywords

Faculty of Social Sciences
discrete choice
rational inattention
CES utility function
multinomial logit
representative consumer
demand system

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10.2139/ssrn.2990774

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abstract = "We study fundamental links between two popular approaches to consumer choice: the multinomial logit model of individual discrete choice and the CES utility function, which describes a multiple choice of a representative consumer. We base our analysis on the rational inattention (RI) model and show that the demand system of RI agents, each of which chooses a single option, coincides with the demand system of a fictitious representative agent with CES utility function. Thus, the multiple choice of the representative agent may be explained by the heterogeneity in signals received by the RI agents. We obtain a new interpretation for the elasticity of substitution and the weighting coeficients of the CES utility function. Specifically, we provide a correspondence between parameters of the CES utility function, prior knowledge and marginal cost of information.",

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AB - We study fundamental links between two popular approaches to consumer choice: the multinomial logit model of individual discrete choice and the CES utility function, which describes a multiple choice of a representative consumer. We base our analysis on the rational inattention (RI) model and show that the demand system of RI agents, each of which chooses a single option, coincides with the demand system of a fictitious representative agent with CES utility function. Thus, the multiple choice of the representative agent may be explained by the heterogeneity in signals received by the RI agents. We obtain a new interpretation for the elasticity of substitution and the weighting coeficients of the CES utility function. Specifically, we provide a correspondence between parameters of the CES utility function, prior knowledge and marginal cost of information.

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KW - representative consumer

KW - demand system

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M3 - Working paper

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BT - Logit, CES, and Rational Inattention

ER -

Logit, CES, and Rational Inattention

Abstract

Keywords

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