Information economics

Last updated

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

Related Research Articles

In economics, industrial organization or industrial economy is a field that builds on the theory of the firm by examining the structure of firms and markets. Industrial organization adds real-world complications to the perfectly competitive model, complications such as transaction costs, limited information, and barriers to entry of new firms that may be associated with imperfect competition. It analyzes determinants of firm and market organization and behavior as between competition and monopoly, including from government actions.

Behavioral economics studies the effects of psychological, cognitive, emotional, cultural and social factors on the economic decisions of individuals and institutions and how those decisions vary from those implied by classical theory.

George Akerlof American economist and Koshland Professor of Economics

George Arthur Akerlof is an American economist who is a University Professor at the McCourt School of Public Policy at Georgetown University and Koshland Professor of Economics Emeritus at the University of California, Berkeley. He won the 2001 Nobel Memorial Prize in Economic Sciences.

The Market for Lemons 1970 paper by the economist George Akerlof

"The Market for Lemons: Quality Uncertainty and the Market Mechanism" is a well-known 1970 paper by economist George Akerlof which examines how the quality of goods traded in a market can degrade in the presence of information asymmetry between buyers and sellers, leaving only "lemons" behind. In American slang, a lemon is a car that is found to be defective only after it has been bought.

Monetary economics is the branch of economics that studies the different competing theories of money: it provides a framework for analyzing money and considers its functions, and it considers how money, for example fiat currency, can gain acceptance purely because of its convenience as a public good. The discipline has historically prefigured, and remains integrally linked to, macroeconomics. This branch also examines the effects of monetary systems, including regulation of money and associated financial institutions and international aspects.

Socioeconomics is the social science that studies how economic activity affects and is shaped by social processes. In general it analyzes how societies progress, stagnate, or regress because of their local or regional economy, or the global economy. Societies are divided into 3 groups: social, cultural and economic.

Experimental economics is the application of experimental methods to study economic questions. Data collected in experiments are used to estimate effect size, test the validity of economic theories, and illuminate market mechanisms. Economic experiments usually use cash to motivate subjects, in order to mimic real-world incentives. Experiments are used to help understand how and why markets and other exchange systems function as they do. Experimental economics have also expanded to understand institutions and the law.

Equity (economics) fairness in economics

Equity or economic equality is the concept or idea of fairness in economics, particularly in regard to taxation or welfare economics. More specifically, it may refer to equal life chances regardless of identity, to provide all citizens with a basic and equal minimum of income, goods, and services or to increase funds and commitment for redistribution.

Computational economics is a research discipline at the interface of computer science, economics, and management science. This subject encompasses computational modeling of economic systems, whether agent-based, general-equilibrium, macroeconomic, or rational-expectations, computational econometrics and statistics, computational finance, computational tools for the design of automated internet markets, programming tool specifically designed for computational economics and the teaching of computational economics. Some of these areas are unique, while others extend traditional areas of economics by solving problems that are tedious to study without computers and associated numerical methods.

Government failure, in the context of public economics, is an economic inefficiency caused by a government intervention, if the inefficiency would not exist in a true free market. It can be viewed in contrast to a market failure, which is an economic inefficiency that results from the free market itself, and can potentially be corrected through government regulation. The idea of government failure is associated with the policy argument that, even if particular markets may not meet the standard conditions of perfect competition required to ensure social optimality, government intervention may make matters worse rather than better.

Philosophy and economics, also philosophy of economics, studies topics such as rational choice, the appraisal of economic outcomes, institutions and processes, and the ontology of economic phenomena and the possibilities of acquiring knowledge of them.

<i>Quarterly Journal of Economics</i> journal

The Quarterly Journal of Economics is a peer-reviewed academic journal published by the Oxford University Press. Its current editors-in-chief are Pol Antràs, Robert J. Barro, Lawrence F. Katz, and Andrei Shleifer. It is the oldest professional journal of economics in the English language, and covers all aspects of the field—from the journal's traditional emphasis on microtheory, to both empirical and theoretical macroeconomics. According to the Journal Citation Reports, the journal has a 2015 impact factor of 6.662, ranking it first out of 347 journals in the category "Economics".

Market (economics) Mechanisms whereby supply and demand confront each other and deals are made, involving places, processes and institutions in which exchanges occur.

A market is one of the many varieties of systems, institutions, procedures, social relations and infrastructures whereby parties engage in exchange. While parties may exchange goods and services by barter, most markets rely on sellers offering their goods or services in exchange for money from buyers. It can be said that a market is the process by which the prices of goods and services are established. Markets facilitate trade and enable the distribution and resource allocation in a society. Markets allow any trade-able item to be evaluated and priced. A market emerges more or less spontaneously or may be constructed deliberately by human interaction in order to enable the exchange of rights of services and goods. Markets generally supplant gift economies and are often held in place through rules and customs, such as a booth fee, competitive pricing, and source of goods for sale.

Agent-based computational economics (ACE) is the area of computational economics that studies economic processes, including whole economies, as dynamic systems of interacting agents. As such, it falls in the paradigm of complex adaptive systems. In corresponding agent-based models, the "agents" are "computational objects modeled as interacting according to rules" over space and time, not real people. The rules are formulated to model behavior and social interactions based on incentives and information. Such rules could also be the result of optimization, realized through use of AI methods.

Cultural economics is the branch of economics that studies the relation of culture to economic outcomes. Here, 'culture' is defined by shared beliefs and preferences of respective groups. Programmatic issues include whether and how much culture matters as to economic outcomes and what its relation is to institutions. As a growing field in behavioral economics, the role of culture in economic behavior is increasingly being demonstrate to cause significant differentials in decision-making and the management and valuation of assets.

Public economics is the study of government policy through the lens of economic efficiency and equity. Public economics builds on the theory of welfare economics and is ultimately used as a tool to improve social welfare.

Mathematical economics is the application of mathematical methods to represent theories and analyze problems in economics. By convention, these applied methods are beyond simple geometry, such as differential and integral calculus, difference and differential equations, matrix algebra, mathematical programming, and other computational methods. Proponents of this approach claim that it allows the formulation of theoretical relationships with rigor, generality, and simplicity.

Rural economics is the study of rural economies, including:

References

  1. ↑ • Beth Allen, 1990. "Information as an Economic Commodity," American Economic Review, 80(2), pp. 268–273.
      • Kenneth J. Arrow, 1999. "Information and the Organization of Industry," ch. 1, in Graciela Chichilnisky Markets, Information, and Uncertainty. Cambridge University Press, pp. 20–21.
       • _____, 1996. "The Economics of Information: An Exposition," Empirica, 23(2), pp.  119–128.
       • _____, 1984. Collected Papers of Kenneth J. Arrow, v. 4, The Economics of Information. Description and chapter-preview links.
       • Jean-Jacques Laffont, 1989. The Economics of Uncertainty and Information, MIT Press. Description Archived 2012-01-25 at the Wayback Machine and chapter-preview links.
  2. ↑ Kenneth J. Arrow, 1996. "The Economics of Information: An Exposition," Empirica, 23(2), pp. 120–21.
  3. ↑ Charles Wilson, 2008. "adverse selection," The New Palgrave Dictionary of Economics , 2nd Edition. Abstract.
  4. ↑ • John O. Ledyard, 2008. "market failure," The New Palgrave Dictionary of Economics, 2nd Ed. Abstract.
       • Armen A. Alchian and Harold Demsetz, 1972. "Production, Information Costs, and Economic Organization," American Economic Review, 62(5), pp. 777–795.
       • Sanford J. Grossman and Joseph E. Stiglitz, 1980. "On the Impossibility of Informationally Efficient Markets," American Economic Review, 70(3), pp. 393–408 Archived 2012-04-04 at the Wayback Machine .
       • Stiglitz, Joseph E. (2008). "Information". In David R. Henderson (ed.). Concise Encyclopedia of Economics (2nd ed.). Indianapolis: Library of Economics and Liberty. ISBN   978-0865976658. OCLC   237794267.
       • _____, 1987. "The Causes and Consequences of the Dependence of Quality on Prices," Journal of Economic Literature, 25(1), pp.1–48.
       • _____, 2000. "The Contributions of the Economics of Information to Twentieth Century Economics," Quarterly Journal of Economics, 115(4) , pp. 1441–1478.
       • _____, 2002. "Information and the Change in the Paradigm in Economics," American Economic Review, 92(3), pp. 460–501 [ dead link ]. from Nobel Prize Lecture Archived 2011-05-10 at the Wayback Machine , December 8, 2001.
  5. ↑ Jan Mycielski, 1992. "Games with Perfect Information," Handbook of Game Theory with Economic Applications, v. 1, Elsevier, ch. 3, pp. 41–70.
  6. ↑ • Adam Brandenburger, 2008. "epistemic game theory: complete information," The New Palgrave Dictionary of Economics, 2nd Edition. Abstract.
       • Sylvain Sorin, 1992. "Repeated Games with Complete Information," Handbook of Game Theory with Economic Applications, v. 1, Elsevier, ch. 4, pp. 71–107.
  7. ↑ • Aviad Heifetz. 2008. "epistemic game theory: incomplete information,"The New Palgrave Dictionary of Economics, 2nd Edition. Abstract.
       • Robert J. Aumann and Aviad Heifetz, 2002. "Incomplete Information," Handbook of Game Theory with Economic Applications, v. 3, Elsevier, ch. 43, pp. 1665–1686.
       • Shmuel Zamir, 1992. "Repeated Games of Incomplete Information: Zero-Sum," Handbook of Game Theory with Economic Applications, v. 1, Elsevier, ch. 5, pp. 109–154.
       • Françoise Forges, 1992. "Repeated Games of Incomplete Information: Non-Zero-Sum," Handbook of Game Theory with Economic Applications, v. 1, Elsevier, ch. 6, pp. 155–177.
  8. ↑ • S. S. Lippman, and J. J. McCall, 2001. "Information, Economics of," International Encyclopedia of the Social & Behavioral Sciences , pp.  7480–7486.
       • Eric Rasmusen, 2007. Games and Information, 4th ed. Description and chapter-preview links.
       • Charles R. Plott and Vernon L. Smith, 2008. Handbook of Experimental Economics Results, v. 1, Elsevier, Part 2: Market Economics of Uncertainty and Information and Part 4: Games, respectively, chapters 34–40 & 45–66 preview links.
       • Karl-Gustaf Löfgren, Torsten Persson, and Jörgen W. Weibull, 2002. "Markets with Asymmetric Information: The Contributions of George Akerlof, Michael Spence and Joseph Stiglitz," Scandinavian Journal of Economics, 104(2), pp. 195–211 Archived 2012-04-25 at the Wayback Machine .
  9. ↑ • Roger B. Myerson, 2008. "mechanism design," The New Palgrave Dictionary of Economics, 2nd Edition. Abstract.
       • _____, 2008. "revelation," principle," The New Palgrave Dictionary of Economics, 2nd Edition. Abstract.
       • _____, 2008. "Perspectives on Mechanism Design in Economic Theory," American Economic Review, 98(3), pp. 586–603 Archived 2012-05-25 at the Wayback Machine . Revised from Nobel-prize lecture.
       • Noam Nisan and Amir Ronen, 2001. "Algorithmic Mechanism Design," Games and Economic Behavior, 35(1–2), pp. 166–196.
  10. ↑ • F. A. Hayek, 1945. "The Use of Knowledge in Society," American Economic Review, 35(4), pp. 519–530.
       • _____, 1948. Individualism and Economic Order, Chicago. Description and chapter-preview links.
  11. ↑ Sytse Douma & Hein Schreuder (2013) "Economic Approaches to Organizations", 5th edition, London: Pearson
  12. ↑ George Akerlof, 1970. "The Market for 'Lemons': Quality Uncertainty and the Market Mechanism," Quarterly Journal of Economics, 84(3), pp. 488–500 [ permanent dead link ].
  13. ↑ Bengt Holmstrom, 1979. "Moral Hazard and Observability,", Bell Journal of Economics, 10(1), pp. 74–91 Archived 2012-04-07 at the Wayback Machine .
  14. ↑ Michael A. Spence, 1973. "Job Market Signaling," Quarterly Journal of Economics, 83(3), pp. 355–377.
  15. ↑ Joseph E. Stiglitz, 1975. "The Theory of 'Screening', Education, and the Distribution of Income," American Economic Review,65(3), pp. 283–300.
  16. ↑ "The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel 2001". nobelprize.org. Retrieved 10 April 2018.

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.
This page is based on this Wikipedia article
Text is available under the CC BY-SA 4.0 license; additional terms may apply.
Images, videos and audio are available under their respective licenses.