Imperfect Information

5 Key excerpts on "Imperfect Information"

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  eBook - ePub

  Handbook of Monetary Economics vols 3A+3B Set

  • Benjamin M. Friedman, Michael Woodford(Authors)
  • 2010(Publication Date)
  • North Holland

    (Publisher)

  (12). Here it follows because a linearization of the optimality conditions is equivalent to a quadratic approximation of the objective function. 7 This property has been used at least since Simon (1956) to make problems of incomplete information easier, and we will often (but not always) rely on it. The Imperfect Information equilibrium is defined as the values of y t and p t such that Eqs. (13), (14) and (18) hold. To complete the model, the only ingredient that needs to be added is a specification of how firms form expectations. 8 3 Foundations Of Imperfect-Information and Aggregate-Supply Models If the firm has neither limits to its rationality nor any constraints on its ability to process information, then more information is better. The firm can always freely dispose of the information, and in general the ability to make more accurate forecasts will allow it to make decisions that yield higher expected profits. 9 To justify why people do not have full information therefore requires the presence of some information or rationality cost, k. 10 The cost can be real resources or utility losses, may be variable or fixed, and may even be implicit in the form of shadow multipliers on an information constraint. Section 6, on the microfoundations of Imperfect Information, is devoted to models of these costs. In this section, we discuss the choices that these information costs generate. 3.1 What to choose and plan? With full information, we can think of the firm as either choosing the quantity of output to produce or the price to set. Choosing one of them instantly determines the other via the demand function. For instance, if the firm chooses its price, then using its information on aggregate output and the price level, it knows exactly the amount of output it will produce. With Imperfect Information, these two options are no longer equivalent

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  eBook - PDF

  21st Century Economics: A Reference Handbook

  • Rhona C. Free(Author)
  • 2010(Publication Date)
  • SAGE Publications, Inc

    (Publisher)

  Unlike other goods, information cannot be sampled or returned for a refund: Once the decision has been made to learn something, it is virtually impossible to reverse it after obtaining information. It is of course possible to for-get information. Forgetting, however, will not reimburse one for the efforts expended to obtain information. Information asymmetry, the third property listed above, will be the primary focus of this chapter. The idea that peo-ple have different knowledge seems almost obvious. Its implications for market equilibrium, however, had not been recognized for a long time. It was usually assumed that in competitive markets, knowledge heterogeneity will be small and will not affect the equilibrium in any signifi-cant way. Contrary to this common belief, Akerlof and Yellen (1985) showed that even small deviations can have significant effects. George Stigler is often regarded as the father of econom-ics of information for it was he who focused economists' attention on the role of information in economic decision making. Stigler (1961) analyzed the dispersion of prices and noted that while it is often convenient to assume that all agents are endowed with perfect information about prefer-ences and technologies, the very existence of price dispersion contradicts this simple view. He explained the persistence of such dispersion by the presence of search costs: Obtaining information requires time, which is a valuable resource. He then suggested that in equilibrium, the marginal benefit of the search for information must equal its marginal cost. While Stigler's (1961) paper was a breakthrough that gave birth to a new field in economics, it treated infor-mation in very much the same way that the economists were treating other goods. Information, however, is dif-ferent in many respects. It is these differences, and infor-mation asymmetry in particular, that will be the focus of our attention. 729

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  Government Failure versus Market Failure

  Microeconomics Policy Research and Government Performance

  • Clifford Winston(Author)
  • 2007(Publication Date)
  • Brookings Institution Press and AEI

    (Publisher)

  C ompetitive markets are an essential step toward efficient resource allocation, but efficiency also requires that buyers and sellers be fully informed and that their actions do not affect the welfare of others. Market participants can adjust their behav-ior to reduce the social cost of Imperfect Information and of consumption and production externalities, but information and externality policies may raise social welfare further. In theory, these so-called social regulations seek to protect public health, safety, and the environment by encouraging con-sumers and producers to take account of the effect of their actions on oth-ers’ utility. 1 In practice, the economic policy issue is to determine the most efficient way to compel socially desirable behavior. Imperfect Information If consumers are uninformed or misinformed about the quality of a prod-uct, they may derive less utility from it than they expected. Consumers’ 4 Social Regulation: Imperfect Information and Externalities  1. The liability system administered by the courts also, in theory, seeks to reduce the cost of exter-nalities by encouraging firms and consumers to behave in a more socially efficient manner. The Economics of Liability Symposium in the Summer 1991 Journal of Economic Perspectives provides an overview of the system. choices could be distorted by false advertising, by firms’ failures to disclose relevant information about their products and services, and by a lack of information to assess accurately the safety of potentially risky products. Similarly, workers may become injured or ill because they lack information about the health risks they may encounter in their workplace. The federal government attempts to minimize the welfare losses caused by Imperfect Information by empowering regulatory agencies to direct firms to provide complete and accurate information about their products and workplaces and to ensure that consumer products and workplaces meet reasonable safety standards.

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  Strategy and Politics

  An Introduction to Game Theory

  • Emerson Niou, Peter C. Ordeshook(Authors)
  • 2015(Publication Date)
  • Routledge

    (Publisher)

  7 Games with Incomplete Information

  7.1 Incomplete Information

  Thus far, we have assumed that any uncertainty we choose to incorporate into our models has nature as its source. More importantly, if nature’s moves are revealed to one person, we have thus far assumed that they are revealed to everyone, so that there are no informational asymmetries—no one has any private information, aside, possibly, from the choices they make as the situation unfolds. More generally, though, many important political processes can be modeled only if we assume that decision makers have private information, such as the details of their own preferences or their capabilities. A great many examples and subsidiary questions come to mind:

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  A Political Theory Primer

  • Peter C. Ordeshook(Author)
  • 2020(Publication Date)
  • Routledge

    (Publisher)

  5 Games With Incomplete Information

  5.1 Incomplete Information

  Thus far we have assumed that any uncertainty we choose to incorporate into our models has nature’s random moves as its source. More importantly, if nature’s moves are revealed to one person, we assume that they are revealed to everyone, so that there are no informational asymmetries—no one has any private information, aside, possibly, from the choices they make as the situation unfolds. More generally, though, many important political processes can be modeled only if we assume that decision makers have private information, such as the details of their own preferences or their capabilities. A great many examples and subsidiary questions come easily to mind:

  What costs are terrorists willing to incur after hijacking a plane, and how willing should a government be to make concessions or to risk sacrificing hostages?

  What are a weapon system’s capabilities that might not be observable or measurable by other countries, and how does this asymmetry in information affect the willingness of countries to engage in arms control negotiations?

  How can a congressional committee monitor and regulate an executive agency when it knows that the agency will have better information about the program’s performance than Congress once that program goes into effect?

  How should we approach a negotiation if we don’t know an adversary’s willingness to compromise or how it values time? When some voters are informed about a legislator’s actions and others are not, what weight will the legislator give to the informed versus the uninformed members of his constituency? With respect to the important issue of strategic deterrence, will a country be willing to actually implement its threat to launch a mutually costly counterattack if attacked?

  These examples have one common element: One person knows something that another does not know—costs, capabilities, policy position, program performance, and so on. Thus, it appears that parts of the extensive forms that we might create to represent these situations will be unknown to different persons and, therefore, that answering these questions will require tools in addition to the ones that previous chapters offer. Indeed, we will have to augment our tools, because the asymmetric information in our examples opens the door to new and more complicated forms of “he-thinks-that-I- think” regresses and to more complicated forms of strategic interaction.

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