Slutsky matrix norms: The size, classification, and comparative statics of bounded rationality

Abstract Given any observed demand behavior —by means of a demand function—, we quantify by how much it departs from rationality. The measure of the gap is the smallest Frobenius norm of the correcting matrix function that would yield a Slutsky matrix with its standard rationality properties (symmetry, singularity, and negative semidefiniteness). As a result, we are able to suggest a useful classification of departures from rationality, corresponding to three anomalies: inattentiveness to changes in purchasing power, money illusion, and violations of the compensated law of demand. Errors in comparative-statics predictions from assuming rationality are decomposed as the sum of a behavioral error (due to the agent) and a specification error (due to the modeller). Illustrations are provided using several bounded rationality models.

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