Rationally Inattentive Statistical Discrimination: Arrow Meets Phelps

Abstract: When information acquisition is costly but flexible, a principal may rationally acquire information that favors one group over another. The former group faces incentives to invest in becoming productive, while the latter is discouraged from such investments. The principal, in turn, ignores the productivity difference between groups unless the underinvested group surprises him with a genuinely outstanding outcome. We give conditions under which the discriminatory equilibrium is most preferred by the principal, despite all groups being ex-ante identical. Our results inform the discussion of affirmative action, implicit bias, and occupational segregation and stereotypes.