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ALLOCATION EFFECT: The goal of imposing taxes to change the allocation of resources, that is, to discourage the production, consumption, or exchange or one type of good usually in favor of another. This is one of two reasons that governments impose taxes. The other reason is the revenue effect. Because people would rather not pay taxes, taxes create disincentives to produce, consume, and exchange. If society deems that less of a particular good, such as alcohol, pollution, or cigarettes are "bad," then a tax can reduce its production and consumption, and thus change the allocation of resources.

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EFFICIENT INFORMATION SEARCH:

A comparison between the cost of acquiring information and the benefit generated by the information such that it is not possible to increase welfare or well being by acquiring any more of any less information. Efficient information search is achieved by equating the marginal cost of search with the benefit of search. This efficiency is comparable to the profit-maximizing decision by a producer and the utility-maximizing decision by a consumer.
The efficient acquisition of information is analogous to the production or consumption of any good. Acquiring information is beneficial, but doing so incurs a cost. Information is produced. Information is consumed. Efficiency is achieved by equating the incremental opportunity cost incurred in the production or acquisition of information (marginal cost of search) with the increment benefit generated from the information (marginal benefit of search).

Like all efficiency decisions, equating the marginal cost of search and the marginal benefit of search means that the corresponding level of search effort attains the highest possible level of satisfaction. It is not possible to increase satisfaction by increasing or decreasing search effort.

Because information search uses scarce resources, the marginal cost of search is greater than zero and efficient information search always falls short of obtaining complete information. As such, no one knows everything and everyone is ignorant about something, often most everything. Ignorance is the rule rather than the exception.

Efficient information search, the decision to seek out or produce information, depends on the benefit generated from the information (marginal benefit of search) and the cost incurred in obtaining the information (marginal cost of search).

Marginal Benefit of Search

One half of the efficient search decision depends on the benefit generated by the information. This is embodied in the marginal benefit of search. Information search generates several different types of benefit:
  • Price Differentials: One benefit generated by search effort is uncovering lower prices. To the extent that price differentials exist for a product, search effort is more beneficial. If, for example, the price of Wacky Willy Stuffed Amigos varies from $4.95 to $5.00, search effort can generate only up to $0.05 in saving benefit. Alternatively, if the price ranges from $1.00 to $10.00, then search effort can generate up to $9.00 in saving.

  • Total Expense: Related to price differentials is the total expenditure on a good. More expensive goods are likely to have greater absolute price differentials that less expensive goods. For example, a 10% price differential for a $20,000 OmniMotors XL GT 9000 generates a larger absolute value ($2,000) and is potentially more beneficial than the same proportional differential on a $5.00 Wacky Willy Stuffed Amigo ($0.50).

  • Purchase Frequency: Because the overall saving is greater, goods purchased more frequently generate greater search effort benefits than those purchased less frequently. Saving $0.05 on the daily purchase of a cup of coffee, for example, generates greater total search benefit ($18.25) than saving $10 on a pair of shoes purchased once a year.

  • Price Fluctuations: Also related to price differentials is fluctuations in prices. A good with readily steady and consistent prices generates less search benefit than one that fluctuates more. Because the price of fresh peaches fluctuates between growing and non-growing seasons, search benefit is greater than for canned peaches with a more stable price.

  • Production Techniques: On the production side, variation in production techniques or technology also affects search benefit. Goods that employ a wide variety of techniques or are subject to technological advances provide greater search benefit. For example, searching for new ways to manufacture a cell phone, with constantly evolving technology, is bound to prove more beneficial that new ways to make a stuffed animal.

  • Satisfaction Differentials: Lastly, individual preferences generate differential search benefit. Some people are naturally more curious than others and obtain greater intrinsic satisfaction from information.
The incremental benefit generated by additional search effort is the marginal benefit of search. It is comparable to marginal revenue of short-run production analysis and marginal utility of consumer demand theory.

Marginal benefit of search decreases with an increase in search effort. For example, the first hour spent searching for the best price of Wacky Willy Stuffed Amigos might generate a range of different prices, from a high of $7 to a low of $5, resulting in a beneficial saving of $2. An additional hour of search might reveal a new low price of $4, for a marginal benefit of $1. Further search effort provides incrementally smaller benefits until no lower prices are revealed and the marginal benefit is zero.

Marginal Cost of Search

The other half of the efficient search decision is based on the cost incurred in the search. This is embodied in the marginal cost of search. Information search incurs the same types of cost as the production of most goods:
  • Labor: An important component of search cost is human search effort. The time a person spends making phone calls, reading through a newspaper, and driving around town is an important search cost. And of course, comparable to other goods, the production of information goods such as newspapers, television programs, and advertising all require labor effort.

  • Capital: The cost of using assorted capital -- buildings, vehicles, tools, and equipment -- is incurred for search effort as it is for the production of other goods. A car is used to drive from store to store. A telephone is used to call about prices. Printing presses are used to produce newspapers and magazines. Computers are used to access information over the Internet.

  • Land: The cost of land, especially the cost of raw materials, is the third search effort cost. The cost of gasoline to fuel vehicles, of the paper used in printed materials, of the coal used to generate electricity used to operated computers, are all information search cost components.

  • Entrepreneurship: Lastly, the normal profit incurred in the use of entrepreneurial services is as important for information search and production is for any other goods.
The incremental cost generated by additional search effort is the marginal cost of search. It is comparable to marginal cost of short-run production analysis.

Marginal cost of search increases with an increase in search effort, comparable to increasing marginal cost for any type of production. Additional search effort requires additional scarce resources with alternative uses and increasing opportunity cost. For example, the first hour of searching for the lowest price of Wacky Willy Stuffed Amigos might entail an inexpensive walk to a nearby drug store. The next hour might then require a more distant and expensive drive to a discount super center. Further searching requires additional increasingly cost resources.

Efficient Search

Efficient Search
Efficient Search


Efficient information search, that is, the production of information, can be illustrated with a standard "demand and supply" type diagram. The exhibit to the right presents the framework for this analysis. The vertical axis measures the cost and benefit of undertaking search effort. The horizontal axis then measures the amount of information search effort, in this case measured in hours.

Efficiency is achieved with a balance between benefit and cost, or more specifically, the marginal benefit of search and the marginal cost of search. Each is represented by its own curve.

  • Marginal Benefit of Search Curve: The marginal benefit of search is represented by the negatively-sloped marginal benefit curve. Click the [MBS] button to reveal this curve. The MBS curve is negatively-sloped like a standard market demand curve.

  • Marginal Cost of Search Curve: The marginal cost of search is represented by the positively-sloped marginal cost curve. Click the [MCS] button to reveal this curve. The MCS curve is positively-sloped like a standard market supply curve.
The intersection of the MBS curve and the MCS curve indicates the efficiently level of information search. Click the [Efficient] button to highlight this intersection. In this exhibit, the MBS and MCS curves intersect at a search level of 5 hours. That is, 5 hours of search balances the additional benefit obtained from extra search effort and the additional cost of the extra effort.

This can be summarized with the efficient information search rule.

MBS=MCS

Searching more than 5 hours means the cost of extra search exceeds the benefit. Extra search is not worthwhile. Searching less than 5 hours means the benefit of extra search exceeds the cost. Extra search is worthwhile.

Key to this analysis is that as long as search is costly, search effort will not increase to the level that forces the marginal benefit of search to zero, to the level in which no further benefit can be obtained. In other words people decided to stop short of complete information. They voluntarily choose to remain (somewhat) ignorant.

This result gives rise to what is termed the sixth rule of ignorance, which states that obtaining information is a costly activity that requires resources with alternative uses and thus no one knows everything and everyone is ignorant about something.

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Recommended Citation:

EFFICIENT INFORMATION SEARCH, AmosWEB Encyclonomic WEB*pedia, http://www.AmosWEB.com, AmosWEB LLC, 2000-2017. [Accessed: December 11, 2017].


Check Out These Related Terms...

     | marginal cost of search | marginal benefit of search | economics of information | information | information search | asymmetric information | adverse selection | moral hazard | marginal benefit of search | marginal cost of search | signalling | screening |


Or For A Little Background...

     | market | barter | scarcity | efficiency | sixth rule of ignorance | marginal cost | marginal revenue | marginal utility |


And For Further Study...

     | public choice | innovation | good types | market failures | financial markets | institutions | rational ignorance | rational abstention | risk | uncertainty | risk preferences | risk aversion | risk neutrality | risk loving | marginal utility of income |


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