Rules of Thumb and Attention Elasticities: Evidence from Under- and Overreaction to Taxes

William Morrison, Dmitry Taubinsky

NBER Working Paper No. 26180
Issued in August 2019
NBER Program(s):Law and Economics Program, Labor Studies Program, Public Economics Program, Political Economy Program

This paper develops a methodology for testing whether attention costs are a source of consumers' misreaction to opaque prices. We show that costly attention models make a series of predictions about how individual differences in misreaction respond to stakes. We then test and confirm these predictions in an experiment on consumers’ online shopping decisions in the presence of shrouded sales taxes that are exogenously varied within consumer over time. The empirical results point to a model in which consumers use heterogeneous rules of thumb to compute the opaque tax when the stakes are low, but use costly mental effort to increase their accuracy when the stakes increase. In particular, some consumers systematically underreact to sales taxes while others systematically overreact. But when the stakes increase, consumers who tend to underreact become more sensitive to sales taxes, while consumers who tend to overreact becomes less sensitive to sales taxes. We establish the results both by using simple reduced-form tests as well as by developing novel econometric techniques for quantifying individual differences. The results are inconsistent with models in which attention is exogenous and models in which all consumers are either fully attentive to the tax or ignore it completely.

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Document Object Identifier (DOI): 10.3386/w26180

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