Bayesian efficiency
Encyclopedia
Bayesian efficiency addresses an appropriate economic definition of Pareto efficiency
where there is incomplete information. Under Pareto efficiency, an allocation of a resource is Pareto efficient if there is no other allocation of that resource that makes no one worse off while making some agents strictly better off. A limitation with the concept of Pareto efficiency is that it assumes that knowledge about other market participants is available to all participants in that every player knows the payoffs and strategies available to other players so as to have incomplete information. Often, the players have types that are hidden from the other player.
The lack of complete information raises a question of when the efficiency calculation should be made. Should the efficiency check be made at the ex ante stage before the agent sees their types, at the interim stage after the agent sees their types, or at the ex post stage where the agent will have complete information about their types? Another issue is incentive. If a resource allocation rule is efficient but there is no incentive to abide by that rule or accept that rule, then the revelation principle
asserts that there is no mechanism by which this allocation rule can be realized.
Bayesian efficiency overcomes problems of the Pareto efficiency
by accounting for incomplete information, by addressing the timing of the evaluation (ex ante efficient, interim efficient, or post ante efficient), and by adding an incentive qualifier so that the allocation rule is incentive compatible.
Pareto efficiency
Pareto efficiency, or Pareto optimality, is a concept in economics with applications in engineering and social sciences. The term is named after Vilfredo Pareto, an Italian economist who used the concept in his studies of economic efficiency and income distribution.Given an initial allocation of...
where there is incomplete information. Under Pareto efficiency, an allocation of a resource is Pareto efficient if there is no other allocation of that resource that makes no one worse off while making some agents strictly better off. A limitation with the concept of Pareto efficiency is that it assumes that knowledge about other market participants is available to all participants in that every player knows the payoffs and strategies available to other players so as to have incomplete information. Often, the players have types that are hidden from the other player.
The lack of complete information raises a question of when the efficiency calculation should be made. Should the efficiency check be made at the ex ante stage before the agent sees their types, at the interim stage after the agent sees their types, or at the ex post stage where the agent will have complete information about their types? Another issue is incentive. If a resource allocation rule is efficient but there is no incentive to abide by that rule or accept that rule, then the revelation principle
Revelation principle
The revelation principle of economics can be stated as, "To any Bayesian Nash equilibrium of a game of incomplete information, there exists a payoff-equivalent revelation mechanism that has an equilibrium where the players truthfully report their types."...
asserts that there is no mechanism by which this allocation rule can be realized.
Bayesian efficiency overcomes problems of the Pareto efficiency
Pareto efficiency
Pareto efficiency, or Pareto optimality, is a concept in economics with applications in engineering and social sciences. The term is named after Vilfredo Pareto, an Italian economist who used the concept in his studies of economic efficiency and income distribution.Given an initial allocation of...
by accounting for incomplete information, by addressing the timing of the evaluation (ex ante efficient, interim efficient, or post ante efficient), and by adding an incentive qualifier so that the allocation rule is incentive compatible.