Information economics

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.[1]

One application considers information embodied in certain types of commodities that are "expensive to produce but cheap to reproduce."[2] 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."[2] 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.[2]

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.[3] 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[4] and their implications for contract theory, including market failure as a possibility.[5]

Information economics is formally related to game theory as two different types of games that may apply, including games with perfect information,[6] complete information,[7] and incomplete information.[8] Experimental and game-theory methods have been developed to model and test theories of information economics,[9] including potential public-policy applications such as mechanism design to elicit information-sharing and otherwise welfare-enhancing behavior.[10]

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 employee about the job. However, one employee may have more information about what the role would entail then the other.[11] 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.[11]