Economic Perspectives I

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Information That Reduces Waste

We begin our discussion at the level of an individual homo economicus. In what form does she absorb information, and what sort of mechanism translates that information into higher productivity? "Why Information Should Influence Productivity" starts with the following hypothesis as a possible answer:

Hypothesis 1: More precise information improves decisions by reducing waste.

We envision agents consistent with the homo economicus template. They make choices in an uncertain environment, and reap the corresponding benefits. According to hypothesis 2, information alters an agent's internal state: it adds to her knowledge base in a way that brings her behavior closer to optimal.

How can we describe this "knowledge base" more precisely? And how does the agent use it to make better decisions? A common framework views the knowledge base as a probability distribution over several world states. New information alters it via a statistical rule called Bayesian updating. The updated distribution helps the agent make a choice that will take maximum advantage of the available resources. In other words, new information will reduce the waste of such resources, and add to the agent's payoff without reducing the payoffs of others.

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