The economics of information PDF Strydom

The economics of information developed rapidly from the early 1960s following two pioneering publications by Stigler (1961) and Machlup (1962). The first was based on an application of conventional utility maximization analysis combined with search theory. The second was primarily concerned with the so-called 'knowledge industries', with the dissemination of knowledge as the focal point of interest. The general equilibrium framework underlying the first approach created important logical problems and Austrian economics set off on a different route where the dissemination of knowledge featured prominently (Hayek, 1945), but the exposition was supported by a dynamic framework with uncertainty where market participants faced an unknowable future (Shackle, 1958). Moreover, this exposition was based on a particular view of markets as a process (Kirzner, 1973) where individuals added value to the information in terms of a subjectivist approach (Lachmann, 1986).

Information and equilibrium economics

The general equilibrium models fall into two categories. One deals with event uncertainty (Hirshleifer and Riley, 1979) or the exogenous data of the economic system where individuals overcome uncertainty through information-generating activities. The other is more closely associated with Stigler's analysis where disequilibrium emerges because of market uncertainty and where search theory plays an important part (Rothschild, 1973), while uncertainty about the exogenous features of the economic system is assumed away. The analysis focused heavily, but not exclusively, on prices as the main element of market information. In this exposition market participants are supposed to adopt a decision rule such as a fixed sample size or a sequential procedure whereby they engage in price search activity. The literature finally opted in favor of a sequential search procedure to ensure optimal outcomes. This reasoning clearly demonstrates the intellectual framework of the equilibrium approach, namely its bias in favor of equilibrating processes, in the sense that the pursuit of information through search or the dissemination of information through any process is regarded as a disequilibrium-correcting activity (Hirshlcilcr and Riley, 1979). Fundamentally, these models of economic behavior were characterized by the overriding feature of equilibrating forces which overruled disequilibrating processes. Disequilibrium analyses

The economics of inloinmlion IfiJ

were nevertheless suggested by several authors, in thr sense that tin- senrxh ing procedure did not generate sufficient information to attain mai I > i. qulllh rium (Rothschild, 1973), but the deterministic nature ol tlmse mud* It «lis qualifies them as meaningful instruments in explaining human 1» lm\ i<n

Equilibrium economics has particular methodological lentim ■* *im h no not very helpful in understanding the economics of information 11.. . i.,» lures are evident in terms of the static nature of the analysis which moans dial lime is effectively eliminated. In equilibrium economics the future and thr present collapse into a single dimension of logical time where what Is Imp pening now will also happen in the future. The exposition is churacten/rd by instantaneous adjustments because market participants have the eorreel in lor mation about equilibrium prices and quantities which is supplied without cost. The analysis is concerned with a world with no uncertainty, which means that speculative gains and losses which characterize the real world arc-absent. Equilibrium economics has nothing to say about non-equilibrium situations, since no trading is allowed at non-equilibrium prices. Within this static intellectual framework, where uncertainty is absent, information dissemination through the market process or Machlupian 'knowledge industries' has no meaning. We can address the problem of information economics meaningfully if we discard the intellectual framework of equilibrium economics. Information only has meaning in a world of uncertainty.

Information and knowledge

I inguistically, knowledge refers to the sum of what is known, while informa lion is associated with items of knowledge. Machlup (1962) drew attention to the act of informing and the state of knowing. We could, therefore, follow Lachmann (1986) and distinguish between the stock of knowledge and the Mow of information. In a changing world, the flow of information is not only important in the sense that one may alter one's plans according to the latest information, but one should constantly assess one's stock of knowledge for revision.

Information and markets

The application of the static market concept of equilibrium economics to the problems of information economics has met with criticism, as indicated by Rothschild (1973). Moreover, this exposition usually defended markets within a paradigm of efficiency with particular optimum conditions which could not be satisfied in the real world and therefore neoclassical economics elaborated on the possibility of market failure. The markets of equilibrium economic* could be considered as mental systems associated with human behavioi in an Imperfect world as if they were dealing with a perfectly working system Information cannot play a meaningful role in this paradigm.

Austrian economics introduced a dynamic market framework in terms of market processes (Kirzner, 1973) where private plans are important while market pressures and market spillovers (Lachmann, 1986) generate dynamic adjustments in an uncertain world with a time dimension (Torr, 1988). Within this dynamic framework markets are social institutions which disseminate information (Strydom, 1990). In the efficiency framework of equilibrium economics, markets are restricted to performing an allocative role, but, in the dynamic exposition where uncertainty prevails, markets disseminate information. Individual plans which Lachmann (1986) defined as a web of thought which accompanies and guides observable action, feature prominently in the exposition. A plan may be put into practice or it may be modified because of new information and in other instances the information may change to such a degree that a particular plan may be abandoned. This series of changes in individual plans generated by the flow of market information was identified as the market process by Kirzner (1973) and Lachmann (1986) extended this dynamic analysis by elaborating on the different types of processes.

The subjectivist approach

The concept of change and the formulation of a dynamic process with a time dimension which dispenses with the static framework of equilibrium economics signals the importance of the subjectivist approach, since these dynamic processes in time are uniquely related to the actions of human beings. Analysing these actions introduces the subjectivist approach (Kirzner, 1960), the essence of which is that human beings apply their reason to prevailing and known circumstances to perceive a preferred state of affairs, and in doing so they become active within a time dimension, going from the present to the future; that is, they have private plans to attain the preferred state of affairs. The present is analysed and understood in terms of our stock of knowledge which is updated and altered by the flow of new information and, following the process of updating, the individuals change their plans. The perceived preferred state of affairs introduces the importance of the future. The future cannot be analysed systematically in terms of our present stock of knowledge, but expectations play an important part in generating a dynamic framework comprising the future and the past. Expectations about the future can be derived by applying our imagination (Shackle, 1958) to conceive certain states ol aflairs which are different from the past. The subjectivist view of expectations is important because it introduces a dynamic relation between the past and the future

By applying our imagination to the future we are able to plan, and the divergence ol human plans is the basis for dynamics. By applying one's imagination the human mind conceives a future state of affairs which is preferred to that ot the present and this new state is achieved by means of a

Tlw economics of information 16.5

systematic plan, setting out a programme of action to attain Ihe goal. We are not merely concerned with the individual plans in isolation because actions lakcn by others have an important bearing on the plans of market participants. The plans of a particular person will partly depend on his actions and partly on his expectations regarding the likely actions of other market participants. Information is of crucial importance because changing circumstances are identified through information. As soon as new information becomes available expectations regarding the future change and new plans are drawn up to guide the actions of market participants. In such a dynamic framework it becomes important to be informed, that is to know the latest information. ()ne could ensure a competitive advantage by becoming informed ahead of others and working according to a new revised plan of action.

The individual plans which guide the actions of a particular person are based on private information, which brings us to another dimension of the subjectivist approach in the economics of information. The significance of private information has been recognized explicitly by Lachmann (1986) in Ihe sense that individuals interpret the information. Interpretation is a function of the human mind and it is always private and subjective. Machlupian 'knowledge industries' are active in the distribution and transmission of information and this flow of knowledge is interpreted by individuals; they change their plans in terms of their latest assessment and expectation of the future and their actions which follow become part and parcel of market processes through which information is disseminated within markets and through spillover effects from one market to the other. The interpretation ol information is a focal point of the analysis in the economics of information,

We have already emphasized the importance of the divergence in human plans as a basis for dynamic analysis. This is a different approach from that of rational expectations, where expectations are introduced within a static framework according to which utility and profit-maximizing economic agents employ all useful available information as envisaged by ihe relevant economic theory. This is in sharp contrast with the analysis in information economics where diverging human plans are possible because of different interpretations of the information and/or diverging expectations. As demonstrated by Torr (1988), the rational expectations approach does not acknowl edge diverging expectations, which means that uncertainty and speculative market behavior are excluded from the analysis; therefore, the exposition falls back on the same mental processes of static analysis, as opposed to the dynamic processes envisaged by the economics of information.

See also:

Chapter 25: Prices and knowledge; Chapter 17: Risk and uncertainty


Hayek, F.A. (1945), 'The use of knowledge in society', American Economic Review, 35. 519-30.

Hirshleifer, J. and J.G. Riley (1979), 'The analytics of uncertainty and information : an expository survey', Journal of Economic Literature, 17, 1375-1421.

Kirzner, I.M. (1960), The Economic Point of View : An Essay in the History of Economic Thought, Princeton: Van Nostrand.

Kirzner, I.M. (1973), Competition and Entrepreneurship, Chicago: University of Chicago Press.

Lachmann, L.M. (1986), The Market as an Economic Process, Oxford: Basil Blackwell.

Machlup, F. (1962), Production and Distribution of Knowledge in the United States, Princeton: Princeton University Press.

Rothschild, M. (1973), 'Models of market organisation with imperfect information: a survey', Journal of Political Economy, 81, 1283-1308.

Shackle, G.L.S. (1958), Time in Economics, Amsterdam: North-Holland.

Stigler, G.J. (1961), 'The economics of information', Journal of Political Economy, 69, 213— 25.

Strydom, P.D.F. (1990), 'Markets, information and liberty', South African Journal of Economics, 58, 377-90.

Torr, C. (1988), Equilibrium, Expectations and Information: A Study of General Theory and Modern Classical Economics, Oxford: Basil Blackwell.

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