Information economics

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Information economics or the economics of information is a branch of microeconomic theory that studies how information and information systems affect an economy and economic decisions. Information has special characteristics: It is easy to create but hard to trust. It is easy to spread but hard to control. It influences many decisions. These special characteristics (as compared with other types of goods) complicate many standard economic theories. [1]

Microeconomics is a branch of economics that studies the behaviour of individuals and firms in making decisions regarding the allocation of scarce resources and the interactions among these individuals and firms.

An economy is an area of the production, distribution, or trade, and consumption of goods and services by different agents. Understood in its broadest sense, 'The economy is defined as a social domain that emphasize the practices, discourses, and material expressions associated with the production, use, and management of resources'. Economic agents can be individuals, businesses, organizations, or governments. Economic transactions occur when two parties agree to the value or price of the transacted good or service, commonly expressed in a certain currency. However, monetary transactions only account for a small part of the economic domain.

Contents

The subject of "information economics" is treated under Journal of Economic Literature classification code JEL D8 – Information, Knowledge, and Uncertainty. The present article reflects topics included in that code. There are several subfields of information economics. Information as signal has been described as a kind of negative measure of uncertainty. [2] It includes complete and scientific knowledge as special cases. The first insights in information economics related to the economics of information goods.

Noise (electronics) random fluctuation in an electrical signal

In electronics, noise is an unwanted disturbance in an electrical signal. Noise generated by electronic devices varies greatly as it is produced by several different effects.

In metrology, measurement uncertainty is the expression of the statistical dispersion of the values attributed to a measured quantity. All measurements are subject to uncertainty and a measurement result is complete only when it is accompanied by a statement of the associated uncertainty, such as the standard deviation. By international agreement, this uncertainty has a probabilistic basis and reflects incomplete knowledge of the quantity value. It is a non-negative parameter.

Uncertainty situation which involves imperfect and/or unknown information

Uncertainty refers to epistemic situations involving imperfect or unknown information. It applies to predictions of future events, to physical measurements that are already made, or to the unknown. Uncertainty arises in partially observable and/or stochastic environments, as well as due to ignorance, indolence, or both. It arises in any number of fields, including insurance, philosophy, physics, statistics, economics, finance, psychology, sociology, engineering, metrology, meteorology, ecology and information science.

In recent decades, there have been influential advances in the study of information asymmetries [3] and their implications for contract theory, including market failure as a possibility. [4]

In contract theory and economics, information asymmetry deals with the study of decisions in transactions where one party has more or better information than the other. This asymmetry creates an imbalance of power in transactions, which can sometimes cause the transactions to go awry, a kind of market failure in the worst case. Examples of this problem are adverse selection, moral hazard, and monopolies of knowledge.

In economics, contract theory studies how economic actors can and do construct contractual arrangements, generally in the presence of asymmetric information. Because of its connections with both agency and incentives, contract theory is often categorized within a field known as Law and economics. One prominent application of it is the design of optimal schemes of managerial compensation. In the field of economics, the first formal treatment of this topic was given by Kenneth Arrow in the 1960s. In 2016, Oliver Hart and Bengt R. Holmström both received the Nobel Memorial Prize in Economic Sciences for their work on contract theory, covering many topics from CEO pay to privatizations.

In neoclassical economics, market failure is a situation in which the allocation of goods and services by a free market is not Pareto efficient, often leading to a net loss of economic value. Market failures can be viewed as scenarios where individuals' pursuit of pure self-interest leads to results that are not efficient– that can be improved upon from the societal point of view. The first known use of the term by economists was in 1958, but the concept has been traced back to the Victorian philosopher Henry Sidgwick. Market failures are often associated with public goods, time-inconsistent preferences, information asymmetries, non-competitive markets, principal–agent problems, or externalities.

Information economics is formally related to game theory as two different types of games that may apply, including games with perfect information, [5] complete information, [6] and incomplete information. [7] Experimental and game-theory methods have been developed to model and test theories of information economics, [8] including potential public-policy applications such as mechanism design to elicit information-sharing and otherwise welfare-enhancing behavior. [9]

Game theory is the study of mathematical models of strategic interaction between rational decision-makers. It has applications in all fields of social science, as well as in logic and computer science. Originally, it addressed zero-sum games, in which each participant's gains or losses are exactly balanced by those of the other participants. Today, game theory applies to a wide range of behavioral relations, and is now an umbrella term for the science of logical decision making in humans, animals, and computers.

Perfect information

In economics, perfect information is a feature of perfect competition. With perfect information in a market, all consumers and producers have perfect and instantaneous knowledge of all market prices, their own utility, and own cost functions.

In economics and game theory, complete information is an economic situation or game in which knowledge about other market participants or players is available to all participants. The utility functions, payoffs, strategies and "types" of players are thus common knowledge.

Value of information

The starting point for economic analysis is the observation that information has economic value because it allows individuals to make choices that yield higher expected payoffs or expected utility than they would obtain from choices made in the absence of information.

Value of information is the amount a decision maker would be willing to pay for information prior to making a decision.

Information, the price mechanism and organizations

Much of the literature in information economics was originally inspired by Friedrich Hayek's "The Use of Knowledge in Society" on the uses of the price mechanism in allowing information decentralization to order the effective use of resources. [10] Although Hayek's work was intended to discredit the effectiveness of central planning agencies over a free market system, his proposal that price mechanisms communicate information about scarcity of goods inspired Abba Lerner, Tjalling Koopmans, Leonid Hurwicz, George Stigler and others to further develop the field of information economics.[ citation needed ] Next to market coordination through the price mechanism, transactions can also be executed within organizations. The information requirements of the transaction are the prime determinant for the actual (mix of) coordination mechanism(s) that we will observe. [11]

Friedrich Hayek Austrian and British economist

Friedrich August von Hayek, often referred to by his initials F.A. Hayek, was an Anglo-Austrian economist and philosopher best known for his defence of classical liberalism. Hayek shared the 1974 Nobel Memorial Prize in Economic Sciences with Gunnar Myrdal for his "pioneering work in the theory of money and economic fluctuations and [...] penetrating analysis of the interdependence of economic, social and institutional phenomena". Hayek was also a major social theorist and political philosopher of the 20th century and his account of how changing prices communicate information that helps individuals co-ordinate their plans is widely regarded as an important achievement in economics, leading to his Nobel Prize.

"The Use of Knowledge in Society" is a scholarly article written by economist Friedrich Hayek, first published in the September 1945 issue of The American Economic Review.

In economics, a price mechanism is the manner in which the profits of goods or services affect the supply and demand of goods and services, principally by the price elasticity of demand. A price mechanism affects both buyers and sellers who negotiate prices. A price mechanism, part of a market mechanism, comprises various ways to match up buyers and sellers. Price mechanism is a mechanism where price plays a key role in directing the activities of producers, consumers, resource suppliers. An example of a price mechanism uses announced bid and ask prices. Generally speaking, when two parties wish to engage in trade, the purchaser will announce a price he is willing to pay and seller will announce a price he is willing to accept.

Information asymmetry

Information asymmetry means that the parties in the interaction have different information, e.g. one party has more or better information than the other. Expecting the other side to have better information can lead to a change in behavior. The less informed party may try to prevent the other from taking advantage of him. This change in behavior may cause inefficiency. Examples of this problem are adverse selection and moral hazard.

A classic paper on adverse selection is George Akerlof's The Market for Lemons. [12] There are two primary solutions to this problem, signalling and screening.

For moral hazard, contracting between principal and agent may be describable as a second best solution where payoffs alone are observable with information asymmetry. [13]

Signaling

Michael Spence originally proposed the idea of signaling. He proposed that in a situation with information asymmetry, it is possible for people to signal their type, thus credibly transferring information to the other party and resolving the asymmetry.

This idea was originally studied in the context of looking for a job. An employer is interested in hiring a new employee who is skilled in learning. Of course, all prospective employees will claim to be skilled at learning, but only they know if they really are. This is an information asymmetry.

Spence proposed that going to college can function as a credible signal of an ability to learn. Assuming that people who are skilled in learning can finish college more easily than people who are unskilled, then by attending college the skilled people signal their skill to prospective employers. This is true even if they didn't learn anything in school, and school was there solely as a signal. This works because the action they took (going to school) was easier for people who possessed the skill that they were trying to signal (a capacity for learning). [14]

Screening

Joseph E. Stiglitz pioneered the theory of screening. [15] In this way the underinformed party can induce the other party to reveal their information. They can provide a menu of choices in such a way that the optimal choice of the other party depends on their private information. By making a particular choice, the other party reveals that he has information that makes that choice optimal. For example, an amusement park wants to sell more expensive tickets to customers who value their time more and money less than other customers. Asking customers their willingness to pay will not work - everyone will claim to have low willingness to pay. But the park can offer a menu of priority and regular tickets, where priority allows skipping the line at rides and is more expensive. This will induce the customers with a higher value of time to buy the priority ticket and thereby reveal their type.

Information goods

Buying and selling information is not the same as buying and selling most other goods. There are three factors that make the economics of buying and selling information different from solid goods:

First of all, information is non-rivalrous, which means that consuming information does not exclude someone else from also consuming it. A related characteristic that alters information markets is that information has almost zero marginal cost. This means that once the first copy exists, it costs nothing or almost nothing to make a second copy. This makes it easy to sell over and over. However, it makes classic marginal cost pricing completely infeasible.

Second, exclusion is not a natural property of information goods, though it is possible to construct exclusion artificially. However, the nature of information is that if it is known, it is difficult to exclude others from its use. Since information is likely to be both non-rivalrous and non-excludable, it is frequently considered an example of a public good.

Third is that the information market does not exhibit high degrees of transparency. That is, to evaluate the information, the information must be known, so you have to invest in learning it to evaluate it. To evaluate a bit of software you have to learn to use it; to evaluate a movie you have to watch it.

The importance of these properties is explained by De Long and Froomkin in The Next Economy.

More information

In 2001, the Nobel prize in economics was awarded to George Akerlof, Michael Spence, and Joseph E. Stiglitz "for their analyses of markets with asymmetric information". [16]

See also

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The Market for Lemons 1970 paper by the economist George Akerlof

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References

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Further reading

Papers

Technology], 978-0134645957

Monographs

Dictionaries

"bubbles" by Markus K. Brunnermeier
"information aggregation and prices" by James Jordan.
"information cascades," by Sushil Bikhchandani, David Hirshleifer and Ivo Welch.
"information sharing among firms" by Xavier Vives.
"information technology and the world economy" by Dale W. Jorgenson and Khuong Vu.
"insider trading" by Andrew Metrick.
"learning and information aggregation in networks" by Douglas Gale and Shachar Kariv.
"mechanism design" by Roger B. Myerson.
"revelation principle" by Roger B. Myerson.
"monetary business cycles (imperfect information)" by Christian Hellwig.
"prediction markets" by Justin Wolfers and Eric Zitzewitz.
"social networks in labour markets" by Antoni Calvó-Armengol and Yannis M. Ioannides.
"strategic and extensive form games" by Martin J. Osborne.