Output Decisions by a Firm: An Example of a Dual Control Problem with Information Externalities

Abstract

This chapter focuses on the output decisions by a firm. Many economists attempt to explore the consequences of replacing the assumption of perfect and complete information by that of imperfect and/or incomplete information in modeling macro- as well as micro-economic phenomena. This chapter presents a model that is dynamic not only in terms of information variables, for example, estimates of the state of the world parameters that are changing with time, but also in terms of other endogenous variables (state variables) that are changing with time as well. It examines, in the context of a particular market situation, the nature and amount of information processing that is demanded of economic agents to reach optimal output decisions. This is done without assuming that an equilibrium has been reached in learning. This microeconomic model is then used, as a vehicle of discussion, to illustrate a kind of information externalities that could be present in some market situations. It is argued that it is much more realistic for economic agents to purse some decision policies which are suboptimal, yet which do not demand as much in terms of effort in reaching the decision.