Efficiency Under Endogenous Information Choice: A Price-Setting Application

Abstract

Abstract Do private incentives to acquire information reflect the full social value of such information? We show that the answer to this question is typically negative in a canonical business cycle setting, where firms set prices under imperfect information about aggregate productivity. The wedge between private and social values of information is related to market power and ex-post inefficiencies in the use of information. The first reduces the private value of information (relative to its social value), while the second raises it. The overall sign of the inefficiency in information acquisition is therefore ambiguous. Implementing the informationally constrained efficient outcome requires a combination of fiscal and monetary policies—specifically, counter-cyclical revenue subsides as well as a monetary policy rule that targets a counter-cyclical aggregate price level.