Microeconomics providing new insights in K4D

A new generation of economists working in the field of microeconomics is shedding new light on the role of information in decision making. I quote from The Economist:

(E)conomists’ ideas on how to design markets can seem puzzling at first. One example is the question of how much detail an online car auctioneer should reveal about the condition of the vehicles on offer. Common sense would suggest some information—a car’s age and mileage—is essential, but that total transparency about other things (precise details on subpar paintwork) might deter buyers, lowering the auctioneer’s commissions. Academic theory suggests otherwise: in some types of auction more information always raises revenues. 

To test the idea, Steve Tadelis of the University of California at Berkeley (now also working for eBay) and Florian Zettelmeyer of Northwestern University set up a trial, randomly splitting 8,000 cars into two groups. The first group were auctioned with standard information, including age and mileage. The second had a detailed report on the car’s paintwork. The results were striking: cars in the second group had better chances of a sale and sold for higher prices. This effect was most pronounced for cars in poorer condition: the probability of a sale rose by 23%, with prices up by 5%. The extra information meant that buyers were able to spot the type of car they wanted. Competition for cars rose, even the scruffier ones. 

But more information is not always better. Studies show that shoppers overwhelmed by choice may simply walk away. Mr Tadelis tested whether it would be better to tailor eBay’s auctions to users’ experience level. The options for new users were narrowed, by removing sellers who are more difficult to assess (for example those who had less-than-perfect feedback on things like shipping times). When new users had a simpler list of sellers to choose from, the number of successful auctions rose and buyers were more likely to use eBay again. Tailoring the market meant gains for buyers, sellers and eBay. 

The desire to use theory to challenge conventional thinking is one reason economists are valuable to firms, says Susan Athey, of Stanford University and Microsoft. When Ms Athey arrived at the software giant in 2007 it faced what was seen as an unavoidable trade-off: online advertising was good for revenues, but too much would deter users. If advertisers gained, users would lose. But economic theory challenges this, showing that if firms are dealing with two groups (advertisers and users, say), making one better off often benefits the other too. 

Ms Athey and Microsoft’s computer scientists put that theory to work. One idea was to toughen the algorithm that determines whether an ad is shown. This means ads are displayed fewer times, so advertisers lose out in the short-term. But in the longer run, other forces come into play. More relevant ads improve the user experience, so user numbers rise. And better-targeted ads mean more users click on the advert, even if it is shown less often. Empirical evidence showed that although advertisers would respond only after some time, the eventual gain was worth the wait. Microsoft made the change.

Lets think about this in terms of the theme of this blog, Knowledge for Development. Information is a source of knowledge, but it is not knowledge. Knowledge is information understood or information embodied in understanding. Thus providing more information to a neophyte who will be overwhelmed by the information may actually decrease the knowledge that he/she absorbs.

The quotation above also makes vivid the fact that different members of a society use different kinds of knowledge for different purposes, but with strong interconnections. In the examples above, economists have one kind of knowledge based on theory. They create a different kind of knowledge in people making decisions for enterprises such as EBay and Microsoft which is used in improving the profitability of the enterprises (and improving customer service). The enterprises in turn -- in these examples -- help consumers gain knowledge relevant to their purchasing decisions.