Asymmetric Information

Abstract

The Arrow-Debreu model is the basic model in which the two classical welfare theorems of economics are expressed. Under quite general assumptions, it can be shown that, first, a competitive equilibrium allocation, or Walrasian allocation, is Pareto efficient (Pareto optimal); second, under somewhat different assumptions, any Pareto efficient allocation will be a competitive equilibrium allocation after some suitable redistribution of initial endowments. Implicitly or explicitly, the statement of the first welfare theorem assumes that all economic agents have the same information about all economic variables. This is not to say that uncertainty is ruled out; there may be uncertainty as long as all agents are identically uncertain. If this assumption of symmetric information is violated, the competitive outcome will no longer be guaranteed to be Pareto efficient. The introduction of asymmetric information into various economic problems has given us new insight into how market failures might arise and whether there may be governmental, or other non-market, corrections which can improve welfare. Several examples illustrating this are given below.