Big Ideas

IN CONTEXT

FOCUS

Decision making

KEY THINKERS

Michael Spence (1943–)

Joseph Stiglitz (1943–)

BEFORE

1963 Kenneth Arrow addresses the problems of information economics, such as when one party to a transaction has better information than another.

1970 George Akerlof describes markets with information disparities in The Market for Lemons.

AFTER

1976 Michael Rothschild and Joseph Stiglitz pioneer “screening,” by which an uninformed party can induce another to impart information.

2001 Michael Spence, George Akerlof, and Joseph Stiglitz win a Nobel Prize for their work in information economics.

A new field of economics was developed in the 1970s, when US economist George Akerlof published his insights on how disparities of access to information might be overcome.

US economist Michael Spence said that, in practice, if Person 1 has more information than Person 2 in a transaction, Person 1 is likely to send a signal to allow Person 2 to make a more informed decision.

The example Spence gave was that of the job interview, where an employer has less information than the applicant about his or her potential productivity. The applicant provides a resume detailing educational achievements, which may have no relevance to the post applied for but do signal a willingness for hard work and application. In Spence’s view higher education, unlike vocational training, mostly has a signaling function, and prospective “good” employees will invest in more education to signal their higher potential productivity.

The opposite of this process, for example where an employer uses the interview to elicit information, is known as screening. Someone buying a used car, or considering granting a loan, will use screening questions to glean information before deciding. Signaling and screening are used in all forms of business transactions.

The subject area of a student’s degree and their knowledge of it are of secondary importance when applying for many jobs. Rather, their degree signals ability and a capacity for work.