Between non-best response and limited reasoning – Experimental evidence on inertia using process data

The project explores why price decisions in economic settings often display inertia – and which cognitive limitations may lie behind this. Experiments offer new insights that may come as a surprise.

Inertia in economic decisions describes the phenomenon whereby people tend to adapt their actions to new economic conditions gradually rather than immediately. Traditional macroeconomic theories attribute this inertia to rigid factors such as the costs of price adjustments and cumbersome information flows. Experimental evidence provides another reason: people do not act as rationally as many economic models assume. They often do not react thoughtfully to available information or fail to strategically anticipate the prices set by others.

The DFG project Inertia, led by Prof. Dr. Johann Graf Lambsdorff, assumes that this discrepancy between theory and experimental evidence can be explained by limited cognitive abilities. “These limit the ability to solve complex tasks,” explains the holder of the Chair of Economic Theory at the university. To investigate this, the researchers are developing a pricing game in which the decisions of the participants are interdependent, similar to competing companies. A price increase by one company invites imitation, while a price reduction by the competition is responded to with a price reduction of one's own. Participants determine their prices under simple or complex conditions and with varying degrees of information. “This allows us to observe how cognitive load affects the inertia of price adjustment by limiting participants' ability to respond reflectively or anticipate strategically the choices by others,” explains Prof. Dr. Graf Lambsdorff.

At several points during the experiment, the researchers collect and analyze so-called process data, i.e., data on the participants' thought processes. This data provides insights into the causes of inertia, i.e., whether it is primarily caused by unreflective reactions or a lack of strategic foresight. Artificial intelligence is used to evaluate the written explanations provided by the participants. The project aims to identify cognitive limitations that lead to inertia in order to bridge the gap between macroeconomic theory and experimental evidence.

In addition, the researchers hope that their findings will lead to more effective communication of economic policy. “The results could help central banks develop communication strategies that take into account the cognitive limitations of economic actors,” says Prof. Dr. Graf Lambsdorff. This could potentially lead to more effective policy interventions and a better understanding of responses to macroeconomic shocks or policy measures.

The illustration was created with the help of ChatGPT.