INFORMATION ECONOMICS or the economics of information is a branch of microeconomic theory that studies how information affects 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. Information is a highly valuable resource in economics.
If consumers have information about the quality and price of a given commodity and also from to buy it, they can make their budgets stretch further than those who do not have such information. If producers have sufficient information about the input prices and technique of production that has to apply in the production process, they will surely maximise their profit to the highest point. Farmers having a knowledge of weather forecasting will be able to avoid costly mistakes.
Similarly government environmental regulation can be more efficient if it is based on good scientific knowledge. Although these facts about the value of information are well known to economic agents for a long time, yet formal economic modeling in the context of acquisition of information and its implications for resource allocation is not that age-old. But even then the study of information economics has become one of the major areas of research.
It is not easy to define information. The quantity of information obtained from various actions is not well defined and what information is obtained is not homogeneous among its users? The forms of economically useful information are simply too varied to permit the kinds of price-quantity characterisations that are used for various products.
Economists who wish to study information must take some care to specify what the informational environment is in a particular decision problem (this is also termed as the information set) and how that information might be changed through individual actions. This approach has resulted in a vast number of models of specific situations with little overall commonality among them.
Another complication is linked with some technical properties of information. Most information is durable and retains value after it has been used. Information has the characteristic of a pure public good. That is, the information is both non-rival in that others may use it at zero cost and nonexclusive in that no individual can prevent others from using the information. The classic example of these properties is a new scientific discovery. When some prehistoric people invented the wheel, others could use it without detracting from the value of the discovery and everyone who saw the wheel could copy it freely. Because this situation significantly reduces incentives for making scientific discoveries, many countries have adopted patent laws as a way of privatising information that would normally be public in nature.
These technical properties of information imply that market mechanisms may often operate imperfectly in allocating resources to information provision and acquisition. Standard models of supply and demand may therefore be of relatively limited use in understanding such activities. At a minimum, models have to be developed that accurately reflect the properties being assumed about the information environment.
In essence, therefore, information is valuable because it permits individuals to increase the expected utility of their decisions. They might, therefore, be willing to pay something to acquire additional information; information also has a number of special properties (such as differing costs of acquisition and some aspects of a public good) that suggest that inefficiencies linked with imperfect and asymmetric information may be quite prevalent; the presence of asymmetric information may affect a variety of market outcomes, many of which are illustrated in the context of insurance theory. In this case insurers may have less information about potential risks than do insurance purchasers.
Information asymmetry deals with the study of decisions in transactions where one party has more or better information than the other. This creates an imbalance in power in transactions which can sometimes cause the transactions to go awry.
Developing models of information acquisition utilises many concepts that are linked with uncertainty. In many respects lack of information does represent a problem involving uncertainty for a decision maker. In the absence of perfect information, any one may not be able to know exactly what the consequences of a particular action will be. Better information can reduce that uncertainty and therefore lead to better decisions that provide increased levels of utility.