Information economics or the economics of information is the branch of microeconomics that studies how information and information systems affect an economy and economic decisions.• 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 chapter-preview links.
One application considers information embodied in certain types of commercial products that are "expensive to produce but cheap to reproduce."Samuelson, Paul A., and William D. Nordhaus (2001). Economics, p.194. Examples include computer software (e.g., Microsoft Windows), pharmaceuticals and technical books. Once information is recorded "on paper, in a computer, or on a compact disc, it can be reproduced and used by a second person essentially for free." Without the basic research, initial production of high-information commodities may be too unprofitable to market, a type of market failure. Government subsidization of basic research has been suggested as a way to mitigate the problem.
The subject of "information economics" is treated under Journal of Economic Literature classification code JEL D8 – Information, Knowledge, and Uncertainty. This 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.Kenneth J. Arrow, 1996. "The Economics of Information: An Exposition," Empirica, 23(2), pp. 120–21. It includes complete and scientific knowledge as special cases. The first insights in information economics related to the economics of information goods.
Since the 1970s, there have been influential advances in the study of information asymmetriesCharles Wilson, 2008. "adverse selection," The New Palgrave Dictionary of Economics, 2nd Edition. and their implications for contract theory, including market failure as a possibility.• John O. Ledyard, 2008. "market failure," The New Palgrave Dictionary of Economics, 2nd Ed. • 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 . • • _____, 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. from Nobel Prize Lecture , December 8, 2001.
Game theory Information economics is formally related to game theory as two different types of games that may apply, including games with perfect information,Jan Mycielski, 1992. "Games with Perfect Information," Handbook of Game Theory with Economic Applications, v. 1, Elsevier, ch. 3, pp. 41–70. complete information,• 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. and incomplete information.• Aviad Heifetz. 2008. "epistemic game theory: incomplete information,"The New Palgrave Dictionary of Economics, 2nd Edition. • 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. Experimental and game-theory methods have been developed to model and test theories of information economics,• 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 . including potential public-policy applications such as mechanism design to elicit information-sharing and otherwise welfare-enhancing behavior.• Roger B. Myerson, 2008. "mechanism design," The New Palgrave Dictionary of Economics, 2nd Edition. • _____, 2008. "revelation," principle," The New Palgrave Dictionary of Economics, 2nd Edition. • _____, 2008. "Perspectives on Mechanism Design in Economic Theory," American Economic Review, 98(3), pp. 586–603 . Revised from Nobel-prize lecture. • Noam Nisan and Amir Ronen, 2001. "Algorithmic Mechanism Design," Games and Economic Behavior, 35(1–2), pp. 166–196.
An example of game theory in practice would be if two potential employees are going for the same promotion at work and are conversing with their employer about the job. However, one employee may have more information about what the role would entail than the other. Whilst the less informed employee may be willing to accept a lower pay rise for the new job, the other may have more knowledge on what the role's hours and commitment would take and would expect a higher pay. This is a clear use of incomplete information to give one person the advantage in a given scenario. If they talk about the promotion with each other in a process called colluding there may be the expectation that both will have equally informed knowledge about the job. However the employee with more information may mis-inform the other one about the value of the job for the work that is involved and make the promotion appear less appealing and hence not worth it. This brings into action the incentives behind information economics and highlights non-cooperative games.
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. Data valuation is an emerging discipline that seeks to understand and measure the economic characteristics of information and data.
Information, 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. • 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. 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. 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.Sytse Douma & Hein Schreuder (2013) "Economic Approaches to Organizations" , 5th edition, London: Pearson
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 selection (adverse or advantageous) and moral hazard.
Adverse selection occurs when one side of the partnership has information the other does not and this can occur deliberately or by accident due to poor communication. A classic paper on adverse selection is George Akerlof's The Market for Lemons.George Akerlof, 1970. "The Market for 'Lemons': Quality Uncertainty and the Market Mechanism," Quarterly Journal of Economics, 84(3), pp. 488–500.
The most common example of the Lemons Market is in the automobile industry. As suggested by Akerlof, there are four car types that a buyer could consider. This includes choosing either a new or used car, and choosing a good or bad car, or Lemon as it is more commonly known. When considering the market options there is possibility of purchasing a new lemon car as there is a used good car. The uncertainty that arises from the probability of purchasing a lemon due to asymmetric information can cause the buyer to have doubts about the car's quality and inherent outcome when purchased. This same dilemma exists in a multitude of markets where sellers have an incentive to not disclose information about their product if it is poor quality due to knowledge that the average standard across the industry from good products existing will boost their selling power. The asymmetrical information known about the car's quality can lead to a breakdown in the automobile industry's overall efficiency. This is due to two reasons. Firstly, uncertainty between the buyers and sellers and secondly in the broader market where only sellers with below average vehicles will be willing to sell due to the reduced quality being represented. There are two primary solutions for adverse selection; signaling and screening.
Moral hazard includes a partnership between a principal and agent and occurs when the agent may change their behaviour or actions after a contract has been finalised which can cause adverse consequences for the principal.
Moral hazard is present when there is a change in the agent's behaviour after taking out insurance cover to protect them. For example, if someone purchased car insurance for their vehicle and afterwards held their responsibility to a lower standard by going over the speed limit for example or generally driving recklessly. The 2008 financial crisis is another example, where Mortgage-backed securities were formed through the collation of subprime mortgages and sold to investors without disclosing the risk involved. For moral hazard, contracting between principal and agent may be describable as a second best solution where payoffs alone are observable with information asymmetry.Bengt Holmstrom, 1979. "Moral Hazard and Observability", Bell Journal of Economics, 10(1), pp. 74–91 . Insurance covers will often include a waiting period clause to refrain agents from changing their attitude.
Signaling