Prices and knowledge: A market-process perspective

Equilibrium prices and information 53arguments, described above, they judge the price system‘informationally inefficient’, even though they assume away severaltypical ‘imperfections’ usually attributed to markets in reality (such as,for example ‘incomplete’ markets). Since Arrow’s (1962) paper it hasbeen common to argue that, because information has attributes of apublic good and there are increasing returns to its uses, a perfectlycompetitive economy will underinvest in its production. On the otherhand, Jack Hirshleifer (1971) has pointed out that, if secrecy ispossible, there may be overinvestment in information-gatheringactivities. Arrow (1984:143) offers an example of this possibility:each firm may secretly get the same information, either on nature oron each other, although it would of course consume less ofsociety’s resources if they were [sic] collected once anddisseminated to all.An awareness of these issues leads Grossman and Stiglitz (1976: 251)to affirm that ‘although it is easy to show that the market solution isnot, in general, efficient, it is difficult to ascertain whether there is toolittle or too much information acquisition’.Stiglitz seems to have taken some of Demsetz’s criticisms of theusual welfare approach (presented in chapter 2) into account whenarguing recently that ‘obviously, economies with perfect informationare likely to function better than economies with imperfectinformation: That is an irrelevant comparison’. The relevantquestion, he states, is whether the market is ‘constrained Paretoefficient, taking into account the imperfections of information andcosts of obtaining more information’ (Stiglitz 1987:13–14).However, this only takes care of what Demsetz terms the ‘fallacy ofthe free lunch’ —in this case, judging a situation inefficient becauseit does not include complete information, even though informationmay be costly. But Stiglitz’s (1987:14), and others’, conclusion thatsuch economies are ‘essentially never constrained Pareto efficient’suggests that they have in mind a better alternative that is not madeexplicit. This seems to be a variant of Demsetz’s ‘the grass is alwaysgreener’ fallacy which, in this case as in most welfare analysis,consists of assuming implicitly the existence of an alternativeinstitution (1) that can costlessly (or at least with advantage withrespect to markets) obtain the necessary knowledge and (2) that willhave the motivation to improve on market outcomes. Although herejects it explicitly, Stiglitz reintroduces implicitly the perfect