Economic Modeling in the Post Great Recession Era

CHAPTER 3 Information Past Imperfect, Present Incomplete, Future Uncertain

Capt. Bart Mancuso: How did you know that his next turn would be to starboard?

Jack Ryan: I didn’t. I had a 50/50 chance. I needed a break. Sorry.

Capt. Bart Mancuso: That’s all right, Mr. Ryan. My Morse is so rusty; I could be sending him dimensions on Playmate of the Month.

This simple exchange from the movie The Hunt for Red October illustrates the need to make decisions without complete, perfect information and the need to communicate what we think is the correct message under uncertainty.

The reality of the world we live in is that there are many possible outcomes with less-than-perfect information in decision making. This is the focus of this chapter.¹ Three regularities in decision theory add to the richness, or some would say complications, to economic decision making. First, decision makers tend to focus more on losses than gains. Second, persons focus more on changes in their utility states than they focus on absolute utilities. Finally, the estimation of subjective probabilities is severely biased by anchoring, recency, and other decision-making patterns.

Two stories from WWII highlight the role of information and its importance. At the start of WWII, both Great Britain and Germany had functioning radar systems. For Great Britain the use of radar was the key to victory in the air battles we term the Battle of Britain, as radar allowed the British to deploy their limited fighter force in ...