The rigidity of choice. Processing uncertainty through Shannon's channel

This dissertation is a theoretical investigation of the effects of Shannon's information-processing constraints on people's behavior.;The first chapter is methodological and presents a technique to solve a dynamic model with information-processing limits. It studies the implications of these limits on the consumption and savings behavior of households through time. In the model, consumers rationally choose the scope of the information about wealth they want to process, constrained by Shannon channels. The model predicts that risk adverse people rationally choose to be well informed about wealth before implementing consumption plans. Numerical results show that consumers with processing constraints have asymmetric responses to shocks, with negative shocks producing more persistent effects than positive ones. This asymmetry results into more savings.;Motivated by these results, the second chapter uses this technology to explore consumption and labor choices of people with limited processing capacity. It argues that constraining people to choose consumption and labor under finite Shannon capacity produces results qualitatively in line with U.S. business cycle data. In a simple partial equilibrium setting, risk adverse consumers rationally keep consumption and labor unchanged until they collect enough information. I find that at high frequency consumption appears to be more sluggish than labor supply. However, when people decide to change consumption they do so by a large amount. This combination leads to higher variance of consumption with respect to labor supply. Furthermore, such a framework generates endogenously a wedge between marginal rate of substitution and marginal rate of transformation or wages. Such wedge is bigger and more volatile the lower information flow. These findings suggest that rational inattention offers a promising avenue to bridge the gap between theory and U.S. business cycle data.;There is a caveat for the two chapters. To emphasize the relative variance of consumption and labor, in the second chapter I have a difference parameterization of the discount factor. Although this choice makes a comparison between the two chapters hard for time paths of the main variables, it provides a neat departure from the full information equivalent of chapter two.