Welfare Analysis of Imperfect Information Equilibria

Most analyses of equilibrium with imperfect information have assumed that individuals know the distribution of possibilities in the market. When individuals do not know the distribution, marginal cost pricing is not generally optimal. In a two-price example it is shown that individuals with correct Dirichlet priors tend to search too little when they adjust their beliefs in response to observations. In a fairly general static partial equilibrium model, the derivatives of social welfare with respect to pricing and advertising are related to market characteristics. Different situations are described where there are social gains from increases or decreases in both the price and the level of selling effort.