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Information economics
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]

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.

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]

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]

Contents
Value of information
Information, the price mechanism and organizations
Information asymmetry
Signaling
Screening
Information goods
Bundling
More information
See also
References
Further reading

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.

Information, the price mechanism and organizations

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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. 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]

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.
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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 (http://osaka.law.miami.
edu/~froomkin/articles/newecon.htm).

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. [16]

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."[17]

See also
Adverse selection Infonomics Screening
Contract theory Information economy Signaling
Game theory Moral hazard Single crossing condition
Indigo Era (economics) Product bundling

References
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Further reading
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Bakos, Yannis and Brynjolfsson, Erik 2000. "Bundling and Competition on the Internet: Aggregation Strategies for
Information Goods" Marketing Science Vol. 19, No. 1 pp. 6382.
Bakos, Yannis and Brynjolfsson, Erik 1999. "Bundling Information Goods: Pricing, Profits and Efficiency" Management
Science, Vol. 45, No. 12 pp. 16131630
Birchler, Urs, and Monika Btler, 2007. Information Economics. London, Routledge. ISBN 978-0-415-37346-3.
Description (https://books.google.com/books?id=alSXCzWQmKcC&dq=Birchler,+U.W.,+and+M.+B%C3%BCtler+(200
7).+%22Information+Economics%22&source=gbs_summary_s&cad=0) and chapter-arrow-page links, pp. vii (https://
books.google.com/books?id=alSXCzWQmKcC&pg=PR7)-xi. (https://books.google.com/books?id=alSXCzWQmKcC&
pg=PR11)
Brynjolfsson, Erik, and Saunders, Adam, 2009. "Wired for Innovation: How information technology is reshaping the
economy", [1] (http://mitpress.mit.edu/catalog/item/default.asp?ttype=2&tid=11848), ISBN 0-262-01366-5 ISBN 978-0-
262-01366-6
Douma, Sytse and Hein Schreuder, 2013. "Economic Approaches to Organizations". 5th edition. London: Pearson [2]
(http://catalogue.pearsoned.co.uk/educator/product/Economic-Approaches-to-Organisations/9780273735298.page)
ISBN 0273735292 ISBN 9780273735298
Maasoumi, Esfandiar, 1987. "Information theory," The New Palgrave: A Dictionary of Economics, v. 2, pp. 84651.
Mas-Colell, Andreu; Michael D. Whinston, and Jerry R. Green, 1995, Microeconomic Theory. Oxford University Press.
Chapters 13 and 14 discuss applications of adverse selection and moral hazard models to contract theory.
Milgrom, Paul R., 1981. "Good News and Bad News: Representation Theorems and Applications," Bell Journal of
Economics, 12(2), pp. 380391. (https://www.msu.edu/~conlinmi/teaching/EC860/voluntarydisclosure/milgrom1981be
lljournal.pdf)
Nelson, Phillip, 1970. "Information and Consumer Behavior," Journal of Political Economy, 78(2), p p. 311 (https://ww
w.jstor.org/pss/1830691)329.
_____, 1974. "Advertising as Information," Journal of Political Economy, 82(4), pp. 729754. (http://comm.psu.edu/ab
out/centers/don-davis-program-in-ethical-leadership/09adInfo.pdf)
The New Palgrave Dictionary of Economics, 2008. 2nd Edition, selected entries and abstract links:

"bubbles" (http://www.dictionaryofeconomics.com/article?id=pde2008_S000278&q=information
&topicid=&result_number=19) by Markus K. Brunnermeier
"information aggregation and prices" (http://www.dictionaryofeconomics.com/article?id=pde2008
_I000247&q=information&topicid=&result_number=1) by James Jordan.
"information cascades," (http://www.dictionaryofeconomics.com/article?id=pde2008_I000103&q
=information&topicid=&result_number=2) by Sushil Bikhchandani, David Hirshleifer and Ivo
Welch.
"information sharing among firms" (http://www.dictionaryofeconomics.com/article?id=pde2008_I
000250&q=information&topicid=&result_number=4) by Xavier Vives.
"information technology and the world economy" (http://www.dictionaryofeconomics.com/article?
id=pde2008_I000275&q=information&topicid=&result_number=10) by Dale W. Jorgenson and
Khuong Vu.
"insider trading" (http://www.dictionaryofeconomics.com/article?id=pde2008_I000122&q=inform
ation&topicid=&result_number=37) by Andrew Metrick.
"learning and information aggregation in networks" (http://www.dictionaryofeconomics.com/articl
e?id=pde2008_L000218&q=information&topicid=&result_number=8) by Douglas Gale and
Shachar Kariv.
"mechanism design" (http://www.dictionaryofeconomics.com/article?id=pde2008_M000132&edit
ion=current&q=mechanism%20design&topicid=&result_number=3) by Roger B. Myerson.
"revelation principle" (http://www.dictionaryofeconomics.com/article?id=pde2008_R000137&editi
on=current&q=moral&topicid=&result_number=1) by Roger B. Myerson.
"monetary business cycles (imperfect information)" (http://www.dictionaryofeconomics.com/articl
e?id=pde2008_M000375&q=information&topicid=&result_number=5) by Christian Hellwig.
"prediction markets" (http://www.dictionaryofeconomics.com/article?id=pde2008_P000340&q=in
formation&topicid=&result_number=20) by Justin Wolfers and Eric Zitzewitz.
"social networks in labour markets" (http://www.dictionaryofeconomics.com/article?id=pde2008_
S000471&q=information&topicid=&result_number=14) by Antoni Calv-Armengol and Yannis M.
Ioannides.

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17/12/2017 Information economics - Wikipedia

"strategic and extensive form games" (http://www.dictionaryofeconomics.com/article?id=pde200

8_S000523&edition=current&q=) by Martin J. Osborne.

Marilyn M. Parker, Robert J. Benson, H.E. Trainor, 1988, Information Economics: Linking Business Performance to
Information Technology (http://www.palgrave-journals.com/jit/journal/v5/n1/abs/jit199013a.html), 978-0134645957
Pissarides, C. A., 2001. "Search, Economics of," International Encyclopedia of the Social & Behavioral Sciences,
pp. 1376013768. Abstract. (http://www.sciencedirect.com/science?_ob=ArticleURL&_udi=B7MRM-4MT09VJ-32F&_r
doc=27&_hierId=151000134&_refWorkId=21&_explode=151000131,151000134&_fmt=high&_orig=na&_docanchor=
&_idxType=SC&view=c&_ct=28&_acct=C000050221&_version=1&_urlVersion=0&_userid=10&md5=c5208bb5af455
b336d71f75b6472a94c)
Rothschild, Michael and Joseph Stiglitz, 1976. "Equilibrium in Competitive Insurance Markets: An Essay on the
Economics of Imperfect Information," Quarterly Journal of Economics, 90(4), pp. 629649. (http://porter.ssc.upenn.ed
u/~hfang/teaching/socialinsurance/readings/fudan_hsbc/Rothschild_Stiglitz76(2.2).pdf)
Shapiro, Carl, and Hal R. Varian, 1999. Information Rules: A Strategic Guide to the Network Economy. Harvard
University Press. Description (http://hbr.org/product/information-rules-a-strategic-guide-to-the-network/an/863X-HBK-
ENG) and scroll to chapter-preview links. (https://books.google.com/books?id=aE_J4Iv_PVEC&dq=%22Information+
Rules:+A+Strategic+Guide+to+the+Network+Economy%22&printsec=frontcover&source=bn&hl=en&ei=DR4VTL--KIa
BlAek3I2qDA&sa=X&oi=book_result&ct=result&resnum=4&ved=0CCwQ6AEwAw#v=onepage&q&f=false)
Stigler, George J., 1961. The Economics of Information, Journal of Political Economy, 69(3), pp. 213225. (http://ho
me.uchicago.edu/~vlima/courses/econ200/spring01/stigler.pdf)
Stiglitz, Joseph E. and Andrew Weiss, 1981. "Credit Rationing in Markets with Imperfect Information," American
Economic Review, 71(3), pp. 393410. (http://leeds-faculty.colorado.edu/yungc/Doctoral%20Course/PhD%20papers/
stiglitz.pdf)
Theil, Henri, 1967. Economics and Information Theory. Amsterdam, North Holland.

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