Prices and knowledge: A market-process perspective

118 Prices and knowledgechapter 3 to be two different informational roles that prices mayperform. On the one hand, prices may serve as knowledge surrogatesin the sense that individuals optimizing with respect to them act as ifthey knew more than they actually do. Prices thus serve to reduce theamount of information people need to have for them to makedecisions that are correct from the standpoint of the economy as awhole. On the other hand, prices may serve as sources from whichindividuals may try to infer knowledge about the traded good.Much work has tried to determine whether prices perform theseroles effectively, that is, whether they are informationally efficient.Grossman and Stiglitz’s conclusion, like that of other economists, isthat, in most realistic situations, prices are not informationallyefficient, because of different types of externalities. (This, of course,raised the issue of what a relevant standard of efficiency ought to be,an issue previously brought up by Harold Demsetz.)2. Also interested in the informational role of prices, and ofmarkets in general, are theorists adopting a bounded-rationalityframework. Their main dissatisfaction with the equilibriumapproach, as chapter 4 showed, is in its use of optimizing individualsfacing costly information as a framework for the analysis ofinformational problems. Bounded-rationality theory emphasizes thatthe cognitive limitations of individuals are more serious, and thatthese limitations make optimizing behaviour impossible. However, atthis stage of its development, the bounded-rationality analysis of theinformational role of prices, at least as found in Simon’s writings,does not differ significantly from that of equilibrium theory. Pricesappear in Simon’s work as useful summaries (knowledge surrogates)that allow individuals to make reasonably good decisions in spite oftheir bounded rationality.Chapter 4 also tried to show that bounded-rationality theory,though it has pointed correctly at weaknesses of the omniscient,optimizing agent of equilibrium theorizing, still tends tounderestimate the knowledge problem by emphasizing only certainlimitations of human beings as information processors. Thisunderestimation is related to Simon’s adoption of a special notionof complexity and a theory of cognition that, as was shown, arehighly questionable and have received serious criticism. Thelimitations of the bounded-rationality approach as it now standsshould be noticed, particularly because it is often perceived as theonly alternative to the economics of information for the analysis ofinformational issues.