Neoclassical
economists assume decision making agents operate under perfect information.
However imperfect information is the norm than exception of life (Hayek, 1945; Akerlof, 1998 and Stiglitz, 2001). Actually
the problem is more serious than imperfect information, as the problem is
imperfect knowledge. If human beings are rational beings, wrong decisions are
only result of imperfect information or wrong information. However multipurpose
rational mind is not what human posses and irrationality is the norm of life
than exception (Cosmides and Tooby, 1994a, 1994b, 1996, 1987). Orthodox Economist
think students fail in exam because they have bad teacher, who give them wrong
information, but Conlisk (1996, page 672) stated
Though we teach that
agents act as if unboundedly rational, we use gallons of red ink to inform
students that they do not.
Lack of perfect rationality is
well documented in wider literature of psychology, cognition, evolutionary
psychology, institutional economics, experimental economics, behavioral
economics and soon. See Cimoli, et al. (2006), Arrow (1969), Hodgson (2007); Nelson
(2006), Williamson (1971, 1976, 1979, 1991, 1993, 1998, 2000, 2005), Hodgson
(1998), Macher and Richman (2006), Smith (1991), Loomes (1998), Pagano (1999), Simon
(1962, 1985), Vanberg (2002, 2004), Rutherford (1995), Cosmides and Tooby
(1994a, 1994b, 1996, 1987), Nelson and Nelson (2002), Conlisk (1996), Rabin
(1998), Camerer and Loewenstein (2004), Selten (1999), Goldberg (1990), Kahneman
and Tversky (1982), Gigerenzer (1991), Clark (1918) Neale and Bazerman (1985), Cachon
and Camerer (1996), Camerer et al. (1993), Akerlof and Yellen (1985), Aumann
(1985), Grether (1990), Neelin et al. (1988) and Weg and Zwick (1991).
Fortunately models with imperfect
information may not be bad model for world with imperfect knowledge, when used
with care. What knowledge
enables us is to extract more conclusions from less information. The more
knowledge we have, the more we can act from less information. The less
knowledge we have the more information do we need to act on information (Mezgebo,
2014). Mind can be better understood as modular thinker or thinker which uses
models or schemes (Piaget, 1936 and Pinker, 1997). The benefit of model is to infer more from
less information at hand. As accuracy of the model declines the more
information will be needed to act up on information. So knowledge problem is
serious form of information problem and as result imperfect information models
will be reliable proxy for knowledge problem as long as they did not
underestimate level of information problem. However impact of imperfect
information and impact of imperfect knowledge will have different channels of
cause and effect. That is why it is better to use the imperfect information
models with care. Now let’s turn to the problem at hand.
Imperfect information is observed,
when people do not have perfect information about course of events. Asymmetric
information is observed, when all concerned bodies are not having balanced share
of information (Stiglitz, 2001). Say a
farmer may not know what the market price will be at harvest time and
definitely his/her knowledge on weather condition could be very vague at best.
As result s/he does have imperfect information or imperfect knowledge. When
decisions are done under imperfect information or imperfect knowledge, it is
hardly possible to assume they are the best decisions that can be made. The
best example of asymmetric information is repair shops and health sector. The
expert knows more than the customer and in this case you cannot assume the
doctor and the repairman will never use his/her knowledge and information to
cut better deal for him/her, while costing the society dearly. Under such
reality it is hardly possible to accept market will result in best possible
resource allocation to the society. The million dollar question is: does
imperfect information of the real world make the conclusion of perfect
information model of neoclassical useless fairytale[1]?
One point raised by proponents of
free market economy is that given people have to use some of their resource for
information collection than for production, the level of output under risk will
be lower than what can be under perfect market. But still market is constrained
optimal. The point is that, if any organization can collect information, the
market can do it better. In simple words nothing changes in conclusion of perfect
market, except for welfare loss needed to avoid ignorance (Stigler, 1961). Stigler
(1961, page 224) insisted
Ignorance is like
subzero weather: by a sufficient expenditure its effects upon people can be
kept within tolerable or even comfortable bounds, but it would be wholly
uneconomic entirely to eliminate all its effects. And just as an analysis of
man’s shelter and apparel would be somewhat incomplete if cold weather is
ignored, so also our understanding of economic life will be incomplete if we do
not systematically take of account the cold winds of ignorance
The substance of the idea, as
summarized by Stiglitz (2001), is that if we include the cost of information and
accumulation of knowledge, perfect market is constrained optimal. The cost of the
economy will increase by cost of information and accumulation of knowledge; but
still market economy will provide the most possible higher welfare that can be
generated from given resources. Imperfect market will not generate the best
possible allocation of resources, which can be generated from perfect market
only, but it will result in the next best allocation of resource. The point is
that market is always efficient and this includes in dealing with problem of
knowledge and information.
However this proposition is
missing three important points. The first part of the problem is the fact that
information is non rival good and market allocation of non rival good is highly
unreliable (Stiglitz, 2001). The most important cost of information and also
knowledge is producing it and the cost of sharing it is very negligible in
magnitude. We should notice public goods and services are non rival and non
excludable in character (Musgrave & Musgrave, 1980). So let’s take the two
possibilities to share or not to share information. Either information becomes
public good or not depends on how far it is shared. If information is shared it
will create free riders as any public good (Stiglitz, 2001). Since market is
inefficient supplier of public goods and services, as shown above, it will be
self evident fact that market will not be optimal supplier of information.
If information is kept hidden,
there are two possibilities. One possibility is information could be under
supplied in the market, because most people lack information which is owned by
others. As result their decision will not be based on the best possible
information and will not be the best decision possible. This could happen if
the incentive for information collection does not encourage many people to
collect information. We should notice the same information can be collected and
supplied in cost effective manner by central body and as result market will not
be optimal supplier of information. If incentives are very high to benefit from
information and everyone is collecting private information, there could be over
spending on information too (Stiglitz, 2001). The same information is collected
again and again by different agents and this could not be the best possible
information collection process. Small scale farmers may fail in first category of
under informed agents and security traders in second category of over spending
agents.
Now let’s focus on second part of the problem. Information
is convened not only by direct communication but also by action (Stiglitz, 2001).
If information is kept private and other agents still can make it public by
observing action, this will create free rider problem. When a big trader, who
is known to invest on information, start buying grain, all small traders will
follow his/her lead to benefit from his/her investment by being a free riders.
So if s/he wants to make more profit, not only s/he has to hide the information
but also s/he has to manipulate his/her behavior to give distorted signal to
the competitors and free riders.
Far worst the well informed decision making agent does not
have to hide the information or may not need to distort his action at all, but
the agent should not be interested to share it. Given there is difference
between knowledge and information, there could be still serious problem of
understanding his/her knowledge. The small traders may understand his/her
action but they may not be able to figure out what s/he knows. When everybody
is dependent on everybody in such manner chaos is order of life and mass
psychology will dictate the market dynamics to be chaotic and unstable. This
will create distortion in the information and knowledge system itself. Market
is not only inefficient supplier of information but is serious source of
information distortion and mass absurdity.
Let me use simple example to
explain it. Think about two cars, which are travelling in opposite sides of one
road. If their drivers have perfect information about the intention of other
driver, one will take left and the other to avoid collusion will take right.
The self interest of each driver, to avoid collusion, will result in efficient
use of the road. However the perfect information scenario assumed above is
unrealistic. Normally drivers will have highly imperfect information and have
to evaluate the intent of other driver from his/her action. If everyone is not
promoting his/her own welfare, or is not trying to move faster in the road, one
can stop and wait for the first car to pass and choice his/her path then after.
This will reduce the efficiency of transportation, but will lead to low
collusion. When people are promoting their own welfare, free competition
between drivers to use the road will end in collusion, in most cases. Collusion
free driving under such reality is an exception than norm. The problem is that
not only each driver does not know the intention of other driver, but also
action and reaction of each driver will create more confusion in the system.
Have you ever try to pass over narrow path when another person is coming from
the other side. Imagine how chaotic the system becomes! Competition to use the
road will crate chaos of misunderstanding. Every good intention will be lost in
translation to make collusion highly likely. This is why promotion of self
interest under imperfect information will not only result in Pareto sup-optimal
resource allocation, but it will also create more imperfection of information
and knowledge in the system.
This is why market economy is not only facing imperfect
information, but is also creating additional imperfection of information. Distortion
can also come from wrong presentation of contract. Say worker will over sell him/her
self, firms will over estimate the benefit and under estimate the cost of their
goods and services and soon.
The third source of the problem is much serious and dangerous.
The market process which promotes selfishness is catalyst of such moral decay.
After all a doctor may do what is best for patient, a mechanic may do what is
best for the car owner, a worker may speak honestly and firms may be ethical
enough to be frank and trustworthy. When all life becomes about competition and
‘virtue of selfishness[2]’, the
market will be catalyst for distortion of information and knowledge. In this
reality, can we say market competition will give us ideal reality and the best
possible organization possible? Definitely no! This is why information
economists like Stiglitz (2001, page 7 and 12) stress the fact that
Perfect competition - model was not robust – even slight departures
from the underlying assumption of perfect information had large consequences…. In
the standard paradigm, the competitive general equilibrium model, there were no
shocks, no unanticipated events: at the beginning of time, the full equilibrium
was solved, and everything from then on was an unfolding over time of what had
been planned in each of the contingencies.
So it is right to conclude that
“Under the imperfect information paradigm, markets are almost never Pareto
efficient” (Stiglitz, 2001, page 15). However we should remember let alone perfect
market and especially the virtuous market, even devil need to have a devil
advocate. The above analysis is not complete because there is learning
happening over time and there is collective rationality which often can over
perform individual rationality and sometimes destroy humanity under wrong mass
psychology. In simple words the above analysis ignores one important fact that
signaling can be also supplied from right institutions.
The idea is people learn from
their action and will refine facts from fiction. I may hire wrong worker but
who has best interest to get it right? The answer is me, not government or
other institution. As long as there is correct signaling of mistakes, market
can do it better. For example in experimental market, agents are given
fragmented information of the whole system. In this case all the information is
available in the economic space, but everyone has small portion of the complete
information. Then they are allowed to buy and sell so they can make profit. In
dynamic manner market price will summarize their information to give them right
signal. If you think price should be high but it turns out to be low, you learn
from it. In dynamic manner the market will take you toward rationality or
outcome that would be expected by well informed central planer. Such simple
markets are often observed to attain not perfection but optimality in terms of
discovering the right market price (Plott, 1981, 1986; Plott and Sunder, 1988; Smith
and Williams, 1981; Roberson and Smith, 1982; Smith, 1962, 1964, 1967, 1982,
1990, 1991; Easley and Ledyard, 1983; Conlisk, 1983; Bray, 1982; Knez et al.,
1985; Friedman, 1984 and Gode and Sunder, 1993). The point of those experiments
is that when right signaling institutions like double auction are used and when
agents do not have to be burdened with predicting the action and intention of
other agents, market will create market rationality using bounded rationality
of the decision making agents.
We should notice those
experiments did prove the need to have societal view of rationality, beyond
individual view of rationality which dominates the dominant schools of psychology.
After all we do learn from mistakes as long as there are corrective
institutions at work. Natural science is science not because Newton is Angel,
or Einstein is perfectly rational, it is science because the scientific system
and culture works in long run. The rationality of science does not emanate from
human rationality, it emanates from the system which organizes the thinking and
experimenting agents. The strength of evolution does not emanate from far sight
rationality of genes or their phenotype but from its cumulative selection for
fitness that lead to path dependent accumulation of fitness. The same fitness
selection is observed to work in market with right kind of institution. However
those experiments did not really replicate the problem as we see it.
First they ignore the fact that
information may not be collected efficiently. Their focus was on how market can
assemble information from different agents by using profit. However they assume
all information is in the system. If I know more than the market, I will bet
against the market or other decision making agents. In making profit I will
supply the information to the market. The market does not know my information
in detail, but it will incorporate my information in its decision making
process. Say I know there is more demand than supply, as result market price
has to be higher. If market price is kept low, I will buy and store the
commodity. This will push price up because I increase demand. This process will
stop when my information is reflected in the price of the market. While I am
rewarded for my foresight, other agents who used to follow (influence) the
market dominantly will learn their mistake by facing loss[3]. However
this will not solve all problems of imperfect information and imperfect
knowledge.
In real world information has to
be collected and the question was do people have incentive to collect optimal
amount of information in least cost possible? If there is less than optimal and
distorted information in the system, there is no grantee the market will
generate efficient price discovery[4].
Actually the same experimental studies cited above did observe the fact that
when agents have to predict other people’s behavior, the market system will
have bubbles and busts and very low level of efficiency. Far worst the
experiments cannot show and did not show that every decision made by the
subjects of the experiment is rational and optimal, as assumed in neoclassical
text books. Future experiments need to study this dynamics from better angle to
give us better picture which can replace the endless bickering of Greek
mythology which dominates most economics.
The experimental studies did
however show institutional design matter to attain optimality (Plott, 1986; Smith,
1964, 1967, 1982, 1990; Gode and Sunder, 1993; Roberson and Smith, 1982 and
Easley and Ledyard, 1983). Under wrong signaling by wrong institution you can
send people to hell or under right signaling by right institutions you can send
them to heaven. In simple words, institutional design does matter for
collective optimality. The question therefore is what kind of institutional
design can make otherwise perfect market with imperfect information constrained
Pareto optimal.
The answer we have until this
point includes complete and efficient credit, information, insurance and future
markets (Stiglitz, 1981). To understand
this let’s make it simple to understand from practical point of view. Farmers
have to choice which input to use and which output to produce, without knowing
how much output they can get from each effort. Different inputs have different
productivity under different weather conditions, which are behind the control
of the farmer. For example, fertilizer can give different level of output based
on moisture content of the soil, which depends on natural weather conditions.
At the same time differ grains has different resistance to different shocks.
That is why there is high output uncertainty in farming. Unfortunately, given
necessity nature of most agricultural products which lead to low price
elasticity of demand, random change in output will generate more than
proportional change in price[5]. Means
production decisions have to be done in face of high output and price risk. If
market forces can supply optimal information to decision making agents, market
based allocation of resources will be, still, constrained optimal decision. But
given the fact that information is public good, market forces has tendency to
under supply it. As result, farmers have to make production decision with less
than optimal information. This is why optimal and cost effective information
has to be supplied by information markets, which does not have to be
competitive market (Stigler, 1961). The efficient market hypothesis of Read
(2013) implies that information can be assembled by market forces efficiently and
by implication it lead to conclusion that collecting information does not pay. However
from where does the market get the information if information does not pay at
all is unanswered question? It is another badly cooked Greek mythology of
economists. The idea do give good presentation of the good information
processing capacity of market but to say it is efficient is to hide beyond lie
not to see the bubbles and busts of market and market absurdity which is daily
news of this world. Ones we separate information from knowledge, in addition to
incentive problem of information collection, the theory will become another badly
under cooked bread which tests ugly. The bad cook, which is Read (2013), did
destroy the nutrition which is definitely inside the grain that is supposed to
be bread.
Even if there is enough
information in the market, market allocation needs additional institutions to
be constrained Pareto optimal. First the information has to be squeezed in to simple
values that can be easily understood by decision making agents. This is where
the nutrition of Read (2013) becomes useful. Spot information will be
summarized to spot prices by spot market as explained above. However future
information has to be analyzed efficiently to make the best prediction
possible. Future markets are needed to squeeze all information in the economy
in to simple to understand future prices (Mishkin, 2004).
If Teff future of one quintal
with strike date of 3 month is sold at strike price of 1000 birr. It means
buyer and seller are agreeing to exchange 1 quintal Teff after 3 months for
1000 birr. If someone has information that shows that Teff spot price is going
to be 900 after 3 month, s/he has to sell future at strike price of 1000 birr.
After 3 months s/he will buy the grain in spot market for 900 birr and will
honor its future contract at 1000 birr. As result s/he will make a profit of
100 birr. When most people, with information that spot price is going to be 900
birr after 3 months, start future selling, future price will decline to ward
900 birr. Viewed from different angle, if a person believes that spot price
after 3 months is going to be 1100, s/he will buy in future market for strike
price of 1000 birr. After 3 months s/he will pay 1000 birr for one quintal Teff
based on its future contract and will sell it at 1100 birr in spot market, to
earn a profit of 100 birr. At current time when many people with such
expectation, start buying to the future, future price will increase to ward
1100 birr. One way or another decision making agents have incentive to squeeze
whatever information they have in to future prices. This is why future trading
is needed to make sure that decisions are done based on all possible
information and all information is squeezed into few prices that decision
making agents can understand. This will benefit not only those which
participate on such activity but also those who watch future prices to get the
best prediction possible about future prices. When there is efficient and well
functioning future market with adequate information it will give us the best
prediction possible of future prices. A farmer than using his/her limited
information to make production decision for grain that will be sold after
months at who know the price, they can use the best prediction possible (Mishkin,
2004). If decision is done in the best information possible what can be changed
then after (Read, 2013)?
Read’s (2013) efficient market hypothesis
is wrong in many grounds. First we can understand part of his problem from type
I and type II errors of decisions. Science is conservative and it often rejects
good ideas in trying to protect itself from countless wrong ideas. Science
often faces high type I error as result. Highly competitive market is highly
progressive and will try to milk a lot of information to make best prediction.
As result type I error often is not serious problem. But it reacts to every
junk of information as result it is very unstable system. It faces serious type
II errors. There is too much unnecessary information and imperfect knowledge. In
addition when knowledge is incomplete and uncertainty very high, information
and knowledge of your follow human beings and the market itself will become
useful guide under mass psychology and market reinforcement. Not because market
or follow traders are right all the time, this is because decisions are done at
market level at competitive system and the entire market takes them seriously
in carrot and stick process that follows. Investors may run away and banks may reject
to lend when the market valuation turn to be bad. The market as its dominance
rises, it has tendency to fulfill its own prophecy but it does not grantee market
is always right. This is why bubble and bust are daily reality of competitive markets
and it is highly likely good firms often are forced to exist market because of
security market failures which wrongly rate them low. Keynes after all is quoted
in saying (Wikiquote, 2017)[6]
The ignorance of even the best-informed
investor about the more remote future is much greater than his knowledge, and
he cannot but be influenced to a degree which would seem wildly
disproportionate to anyone who really knew the future, and be forced to seek a
clue mainly here to trends further ahead. But if this is true of the
best-informed, the vast majority of those who are concerned with the buying and
selling of securities know almost nothing whatever about what they are doing.
They do not possess even the rudiments of what is required for a valid
judgement, and are the prey of hopes and fears easily aroused by transient
events and as easily dispelled.
However the problem does not end
there. In one side market with functional and efficient information market will
never supply perfect information. Some information is not perfectly available
like weather condition and other information is too costly to collect compared
to the benefit it can generate. In other side future markets may not be highly
efficient under such reality of imperfect information. Experimental studies using
future markets did show the fact that the market has tendency to create bubbles
and booms or cyclical instability (see Smith, 1962, 1964, 1967, 1982, 1990,
1991). This can be seen from the fact that future prices are highly unstable
and will create serious bases risk as result (Mishkin, 2004). Basis risk is
difference between future spot price and the prediction of future trading about
it in form of future price. If teff price is predicted by future market to be
1000 after 3 months, and after 3 months the spot market price turn out to be
1300 birr, those who sell to the future will loss 300 and future buyers will
gain 300 birr. Basis risk is risk of future market failing to predict future
spot price. Future markets in practice do reduce spot risk at cost of increased
bases risk. If all information is not used and if the system also creates
instability, there is risk that has to be managed efficiently.
That is why insurance markets
must be functional to allocate risk from risk averse individuals toward risk
takers, for price. If a farmer can produce a Teff valued at 10, 000 birr from
input cost of 8, 000 birr, there will be a profit of 2, 000 birr. However if
the farmer is risk averse and needs a risk premium of 3, 000 birr to assume the
risk on his/her 8, 000 birr, s/he will not engage in the productive activity. As result value of output
will decline by 10, 000 birr. Now let’s say there is someone who can give the
farmer full insurance of 10, 000 birr for premium of 1, 000 birr. So to achieve
the best possible allocation of resource, the farmer needs to buy insurance for
1, 000 birr to produce and earn net profit of 1, 000 birr. This could be
functional option trading or some sort of insurance scheme. Option trading
gives you right to exercise a future contract when it is favorable to you
without duty when it is not favorable to do so (Mishkin, 2004). You have no
basis risk of participating in future market if you buy option, except you have
to pay risk premium in buying option. The option seller (writer) is betting on
the assumption you will not exercise the option and s/he will have your payment
of risk premium as income as risk taker. This is one way to efficiently trade
risk between risk averse and risk taker individuals. Production risk and other
risks can be also handled by efficient insurance schemes. That is why for
market allocation to be constrained Pareto optimal under risk, there must be
functional insurance market or similar institution. We should understand the markets
that we have in form of future and option trading are functional but far from Pareto
optimal (see Mishkin, 2004). As result the conditions stated for existence of efficient
market hypothesis cannot be satisfied in real world.
Finally, there must be function
finical intermediaries or banks, too. People must able to stabilize their investment
and consumption in face of stochastic nature of their income, spending and
wealth. In general even if there is risk in a market, but there are
1.
adequate information in the market from highly information
market
2.
Highly functional future market
3.
Highly functional insurance market or related institutions
4.
Highly functional intermediaries (banks)
Market allocation will be the
next best possible (constrained Pareto optimal) resource allocation and there
is no need to change things to improve it farther. As functionality declines market
allocation do need additional institutions to make it work better. Say telling
doctors serving people is our duty, so to frame their mind, is needed at least.
Under complete set of highly functional markets which are preferably perfect, decisions
will be done based on the best possible information and all risks will be
efficiently managed by financial markets (insurance and banks). Under such
reality there is nothing that the state or other institutions can do to improve
farmers’ decision than to respect market allocation.
The challenge is the same
problems which make grain markets inefficient will in turn reduce efficiency of
above institutions to make the entire system Pareto suboptimal and sometimes
dysfunctional (Mishkin, 2004). Those problems are the primo facto for those who
cry let the state free and this is where they start telling their Greek
mythology that explain how self scarifying Santa known as functional state give
fire to humanity by stealing it from the Gods of Olympus and as result is seriously
hunted by the Zeus of our world who want to kick the ladder of development from
rest of the oppressed people.
Akerlof (1998), for example,
insist that under asymmetric information missing markets are to be expected. If
there is asymmetric information on quality of products that can lead to adverse
selection problem the market may fail to exist despite the fact that demand and
supply coexist and there is price range which is beneficial for both buyer and
seller. This is because since adverse selection will increase the risk to above
average risk, high premium will be asked for that, but this will push the less
risky farther out of the market pushing the risk up and the premium up and finally
this vicious circle will eliminate the market. How spot market, future market,
option market, insurance market, financial intermediaries and other
institutions under competitive system will not be perfectly efficient can be
explained by the same logic of imperfect and asymmetric information used to
explain their genesis above (see Mishkin, 2004 and Stiglitz, 2001 for review).
This is why under imperfect and
asymmetric information to expect fully functional markets, let alone perfect market
or extremely efficient market, is highly unpractical. Imperfect information and
asymmetric information which leads to moral hazard and adverse selection
problem is the reason why most financial institutions come to picture. However
imperfect information and asymmetric information will also reduce their
capacity to solve all financial problems too. In general market forces by
themselves will not solve the information problem and alternative institutions
including state has to come to picture to find solution for problems faced by
humanity. If there is location where the invisible hand, with its full set of
functional institutions, becomes useless fairytale, this location is to be
found in under developed rural areas of developing economies.
This is
why market, as institution, is very important, but not perfect institution to
serve as perfect recipe for every developmental problem. Even it is surprising
to notice that humanity in 21st century is debating if market makes
mistake or not? One thing common among philosophers, social scientists and
practitioners is that in order to show what they believe is perfect, normally
will end up proving what they believe is wrong. This is unfortunate reality
that we have, where the practical good becomes the archenemy of none
existing perfection. In market
economics in order to show that the market is perfect, they make it easy for
others to prove that the market is imperfect and to demand for its replacement.
There is
no doubt that market is the most effective institution in allocation of
resource, compared to any alternative institution in most cases. However it is
tool which has to be used when it serves us and which has to be managed,
perfected and discarded when it is our interest to do so. Market like state is
our servant not our master, unless we start worshiping them like the
intellectual slaves of the mad king or fire stealing ladder sharing mythical heroes of the let state free moment. All
is just Greek mythology, but you have to collect the nutrient inside and cook
it better.
[1]
It is important to note this part is highly dependent on Stiglitz (2001)
[2]
Read Rand (1964) for unapologetic defense for selfishness.
[3] The same
result of improved rationality through computer learning is documented by Clark
and Karmiloff-Smith (1993) too. However contradictory evidence is given by Rabin
(1998) in stating economist did not care about irrationality assuming learning
will improve out come and in markets were experts with adequate experience will
act as rational agent. How experiments which checks weather knowledge of
statistics improves decision making or not does not show any support for
experts’ better judgment or the idea of the that people learn in the real
world. Moreover studies show that people do still make mistakes in environment
that they are familiar. Experts are over confidence compared to layman when they
make right or wrong prediction. When their information is not adequate to make
any prediction, experts have tendency to make predictions and to be very
confident about it.
However Rabin (1998) seems
to be stack in his classic school of psychology rejecting the real world as
reality smiles on his foolishness. Is over confidence itself out of check and
balance? To say people are not perfectly rational forever is not the same as to
say they will never learn at all. But Rabin (1998) himself did notice people
who are expert on their field of study do make mistakes, but it is absurd to
think Rabin will never learn forever. As long as there is competition such over
confident will be also refined cannot be rejected to justify the learning
process having tendency to move toward rationality (Aumann, 1985). But those
results do have critic too. For example Camerer and Loewenstein (2004) pointed
an idea that since repetitive transactions are not common in real life,
experimental outcomes are not applicable to real life. However the solution is
we should devise institutions like double auction markets to make them
repetitive and efficient. Game theory analysis by Blume (1982), Plott and
Sunder (1988) and actual market analysis of Timmerman (1994) also found that
although learning improves performance there are multiple optimal solutions and
not necessarily rational expectation equilibrium. But we are not expecting
perfection like neoclassical economics but only tendency to move in the right
direction.
[4] For extreme
and unpractical defense of market efficiency under efficient market hypothesis
see Read (2013).
[5] Stiglitz
(1981) point out that as long as price elasticity is between 0.5 and 1, price
instability will be coupled with income stability. Means price variability will
stabilize income and farmers will not face high risk due to production and
price risk. What it means is either farmers produce more or less their income
will be stable around average. The problem is farmers will not have incentive
to produce more because it does not pay to do so. To imply production and
marketing risk does not matter under such reality is absurd.
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