Information economics

Information economics is a branch of Economics that studies how information affects economic decisions. Information is special because it is so easy to spread, but so hard to control. It is easy to create, but hard to trust. And it influences many of our decisions. However, this special nature of information complicates many standard economic theories.

Information economics focuses on three areas: the study of Information asymmetries, the economics of information goods, and the economics of information technology.

Contents

1 Information Asymmetry

1.1 Signaling
1.2 Screening

Information Asymmetry

Information Asymmetry deals with the study of decisions in transactions where one party has more or better information than the other. This creates an imbalance in power in transactions which can sometimes cause the transactions to go awry. Examples of this problem are Adverse selection and Moral hazard. A classic example of this is George Akerlof's The Market for Lemons. There are two primary solutions to this problem, signalling and screening.

Signaling

Michael Spence originally proposed the idea of Signaling. He proposed that in a situation with information asymemetry, it is possible to for people to signal their type, thus believably 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 easier 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 possed the skill that they were trying to signal (a capacity for learning).

Screening

Joseph E. Stiglitz pioneered the theory of Screening. 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 choice depends on the private information of the other party.

Information Goods

Buying and selling information is not the same as buying and selling normal goods. First of all, information is non-rivaled, which means that buying information doesn't mean that some else cannot buy it. Secondly, information has almost zero marginal cost, which means that once you have the first copy, it doesn't cost anything to make a second copy. This makes it easy to sell over and over.

Bundling

One method of taking advantage of information goods is bundling. That is the strategy of grouping multiple items together and selling them as a group. Bundling allows sellers to better predict the demand for the bundle. While it is difficult to know which items in the group an individual person wants, they are likely to value some of the items enough to purchase the bundle, even if they don't value any of the items enough to buy it separately. However, this only works when it doesn't cost much to sell extra items in a bundle that are unwanted. Information goods fit this profile since it doesn't cost anything to make extra copies.

More Information

In 2001, the Bank of Sweden Prize in Economic Sciences in Memory of Alfred Nobel was awarded to George Akerlof, Michael Spence, and Joseph E. Stiglitz for their contributions to the theory of the economics of information.