Sunday, September 21, 2008

Prices and Information

By Christopher Espinal

We often assume that markets are efficient. In matter of fact we often assume that markets are efficient, because the underlying assumptions assist market interaction and market clearing.

However, recent studies have shown that information is not “complete” and therefore markets are not as efficient as we may think.

This critique of the underlying assumption of perfect information has become the center of a movement to a new form economics called New Information Economics, as named by economists Joseph Stiglitz and George Ackerloff.

Their efforts to alter the models offered by the neoclassical school may have some validity information asymmetry always exists everywhere, but we don’t necessarily have to consider
information as an institution that assists markets like contract laws. The New Information Economics models consider at the most basic transaction level, a consumer and a producer, one of whom holds more information than the other. In other words, asymmetric information is a central concern and can lead to non-equilibrium, or a point where markets don’t clear.

As an alternative to that alternative, we can consider information an input good subject to market conditions just like any other private good. Hence, when you decide to make a
trade or purchase, we consider the costs or price of information. If information is much too costly, less trades in the market will happen.

The most important example is that when we consider purchasing an item, we usually go with a well known brand that signals its high quality. This also means that we will pay a premium
to use a well known product that fits our demand for information.

Subjecting information to the demand curve has important implications. It means that information, like any other good, has a different opportunity cost for different people because
the readiness and ability to pay varies.

Car aficionados will pay a smaller price on information for vehicles since they know so much about vehicles. Purchasing a customized car will be no big deal for those who understand
the science since the price on information is low. For example, the less time in understanding a vehicle than a newbie. Thus, more Car aficionados are likely to enter the used car market.

On the other hand, a newbie who engages in the market must either take a risk, pay for a third party appraisal, or simply purchasing a new car fresh out of the factory. A new car would eliminate asymmetric information relating to potential defects or overused parts.

However, the price of information is falling because of the internet. Following this example, we have, which reveals information regarding used cars on the market. On Ebay, people look through the description section before purchasing an item and read reviews by previous customers. If you want to purchase a video game but aren’t sure about the system specifications you can visit this awesome website, Can You Run It, which matches your system to the video game’s requirements.

These solutions to asymmetric information are very important because the more information available, the more trades will happen in that market. Thus, it seems from this approach to
asymmetric information that markets are still efficient – but apart from the standard explanation, information serves as an implicit good in every market.

Furthermore, when the government decides to step in to solve problems of information asymmetry, as Stiglitz and Ackerloff would prefer, one can view this intervention as an information subsidy. They are artificially lowering the costs of information. Like every other bureaucracy, one must understand the side effects, such as distortions of incentives as a
result of subsidies.

For example, if an overseeing institution such as the SEC imposes laws on information distribution for public companies, although they are “subsidizing” information for shareholders,
that artificial drop in the price of information will cause an artificial increase in the price of a good elsewhere. Often, an example of a resulting artificial price increase will occur in the price of providing that additional information. To accommodate the example, Investment Banks not only require Global Research or Business Analysts to provide and analyze information on public companies, but must also hire Supervisor Analysts to read stock material for compliance with SEC laws.

At the end of the day, everything is a game of tradeoffs. Should we cause other prices to increase so that this price can lower? Will that devised optimal point result in greater efficiencies in the market, greater growth, and a more developed society? Should every person have a right to perfect information as if it were a public good? At what cost on everything else?

These are complex questions for a seemingly simple idea.

Christopher Espinal is an economics student at the University of Chicago. He can be reached at

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