Prices and knowledge: A market-process perspective

Equilibrium prices and information 33On the other hand, Grossman and Stiglitz argue, the situationin which no one collects information is not an equilibrium either:in this case a given individual will find it profitable to gathercostly information because, owing to the price-taking assumptionof the perfectly competitive model, he believes his activity willnot affect the equilibrium price. (Therefore, his information willnot become freely available to other traders, allowing him anadvantage.) However, as soon as many individuals start collectinginformation, the equilibrium price is affected and aggregates theirinformation perfectly. This, again, provides an incentive forindividuals to stop gathering costly information and to obtain itcostlessly from the price. 10 As a result, Grossman argues, abreakdown of markets occurs ‘when price systems reveal toomuch information’ (ibid.: 574). 11The source of the paradoxes of the price system described byGrossman and Stiglitz is a problem of externalities. As Grossman(1981:557) has pointed out, when prices are taken as sources ofinformation they create ‘an externality by which a givenindividual’s information gets transmitted to all other traders’. In thecase of costly information, uninformed traders will free-ride on theinformation-gathering activity of informed traders. The latter,unable to reap the full rewards of their (costly) activity, will tend, asin standard externality analysis, to seek information in a nonoptimalfashion.‘Noisy’ pricesAnother possibility is that prices do not aggregate informationperfectly (i.e. they are, to use Grossman and Stiglitz’s terminology,‘noisy’). As exemplified below, it is not possible for individuals toobtain all the necessary information from such prices. In this case,Grossman and Stiglitz argue, it may become worth while for tradersto engage in costly information-gathering activities, and anequilibrium is possible. Still, in this case—the only one capable ofsustaining an equilibrium—Hayek’s argument, as interpreted byGrossman and Stiglitz, breaks down: when the price system is‘noisy’, ‘some traders want very much to know why prices are, forexample, unusually high. It is not enough for traders to observe onlyprices’ (Grossman 1976:585). Hayek’s argument that a higher priceis sufficient to lead agents to react in an efficient way appears to bewrong.