Godfrey I. Ihedimma
The Contributions of the Economics of Information to Twentieth Century Economics
Updated: Sep 25, 2018
This is a reviewed article which was initially published by Stiglitz, J. in 2000. His work centred on the the problems lack of information caused consumers and how it affected their choices.
In recent times, there is the discovery that information could be viewed as any other commodity [though different from others], thus having a price, a supply as well as a demand as this would be existent in the market for information, thus the branch of economics – Information Economics.
Stiglitz (2000) opines that;
In the field of economics, perhaps the most important break with the past - one that leaves open huge areas for future work - lies in the economics of information.
Other concerns in this field is the imperfection of information, asymmetries of information and how this has shaped economic thinking in the present time. From the eighteenth and nineteenth century antecedents, most of the economists of the time perceived the problems associated with information availability, though not under the connotation of same. Adam Smith identified that firms raise interest rates, thus making some [best] borrowers drop out of the market for loanable funds. If they knew perfectly the risks concomitant with each borrower, each borrower would be charged a somewhat appropriate risk. This is same of other economists of the time such that the authors observed the consequence of this deficit as well as their importance but failed to elucidate the implications or tracing the source of these observations to problems of information.
It is now recognised that information is imperfect, obtaining information can be costly, there are important asymmetries of information, and the extent of information asymmetries is affected by actions of firms and individuals.
The Arrow-Debreu Model assumed complete markets, these markets are state contingent and no problems of enforcement. Efforts have been dispensed over time at loosening the underlying assumptions, focusing on creating as in an instance, the impossibility of having markets in contingencies which would not have been thought of. More so, if information were perfect, enforcing contracts would be relatively simple. The twentieth century antecedents points at a standard competitive equilibrium model could be viewed as solving information problems especially scarcity as no one had to know the preferences of all individuals to achieve pareto-efficient resource allocations. Information economics is seen today as an intellectual revolution as information is now perceived as a sort of good with same nature as a public good, possessing non-rivalry and non-excludability. In addressing the selection problem, if the government had knowledge of everyone’s ability, designing an income tax system to maximise the public’s welfare would not be much of a problem. For this, the process through which individuals reveal information about themselves through their choice is referred to as self-selection.
In the context of incentives and moral hazard, instances could be given of the insurance firms and risk coverage. If an individual is insured against certain risks, this would mean that he is hedged against certain occurrences and as such could take any action since it has been incentivised. But with perfect information, insurance firms could stipulate what actions could be taken as guided by the contract to avoid the problems of incentives, however, actions are at best, imperfectly observed. Principles laid down to address issues as such include exploring the incentive pay issues as it involves a broader payment structure in tandem with monitoring. However, is turned out that dangers loomed while focusing incentives on easily observable variables as education. This though is liable to drive attention away from variables like education to ability and cognitive skills.
This recognition deeply affects the understanding of wisdom inherited from the past, such as the fundamental welfare theorem and some of the basic characterisation of a market economy, and provides explanations of economic and social phenomena that otherwise would be hard to understand.
In application, information economics has vagaries of empirical applications. The implications of this study as reviewed is seen in the area of adverse signalling for which as in the case of shares issuing firms their prices fall when they issue shares and rise when they buy back. But then, testing this theory in specific contexts is not enough as there are alternatives in which the conclusions similar to the prior, are also obtained. If the securities are [imperfect] substitutes for each other, they would have a downward sloping demand curve, thus, a rise in the supply of shares would lead to the fall in price of shares. This would mean that the test of the information-theoretic assumption would be predicate upon differentiating responses on the basis of variances in information. Information also reveals why those who spend longer years schooling earn higher, but then, standard human capital models also predicts same. But there are points of divergence between the predictions of both theories. Instances are given in cases where students may possess information which exceeds the increase in the productivity concomitant with the learning per year as the returns which accrue to the fourth year of college is virtually significantly above the returns to previous years. Under the same tenets, the human capital theories advocates that the relevance of what the student studies in relation to his actual job should matter a lot, but then, in reality, it does not.
Information economies is also applicative in the area of credit rationing, governance as well as the limitations in the use of equity finance. The central problem of economics is indeed information or its lack – the utilization of knowledge not accorded anyone in totality. This allowed much of economics to border on how the price system created solutions to the resource allocation problems as opposed to how the market responded to new flow of information and the extent of response.
The above article is a review piece of the article below. Ideas contained therein are also credited to the authors cited within in base article.
Stiglitz, Joseph E. (2000). The Contributions of the Economics of Information to Twentieth Century Economics. The Quarterly Journal of Economics, 115(4); 1441-1478