Bayesian efficiency

Bayesian efficiency

Bayesian efficiency addresses an appropriate economic definition of Pareto efficiency where there is incomplete information.Palfrey, Thomas R.; Srivastava, Sanjay; Postlewaite, A. (1993) " [,M1 Bayesian Implementation.] " Pg. 13-14. ISBN 3718653141] 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. [Baltagi, Badi Hani. (2001) " [ A Companion to Theoretical Econometrics.] " Blackwell Publishing. ISBN 140510676X]


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