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

This paper develops and implements a series of tests of costly attention models, in the context of consumer misreaction to opaque prices. We derive a series of predictions about how the sign and magnitude of misreaction varies with 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. We find that 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. The collection of empirical results implies that consumers use highly heterogeneous rules of thumb to compute the opaque tax when the stakes are low, but use costly mental effort to increase the accuracy of their assessment of the total price when the stakes increase. We establish the results both by using simple reduced-form tests as well as by developing new econometric techniques for quantifying individual differences. The results are inconsistent with models in which attention is exogenous, as well as models in which attention is endogenous and costly but prior perceptions are homogeneous