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Information cascades avoidable when inneficient? (NOTE: Theres a PDF file that can be downloaded from this website. I only read chapter 2 and a portion of chapter 3 from this 37 page article

In class we have seen that information cascades do not always result in a social optimal situation. One example of this was the game where there is a bucket with 3 balls two of which are one color and one of which is another color. Each person in his turn gets to pick one ball and given the ball he saw, and the guess’s of all the people before him decide which color of balls has a majority. We have seen that in the very possible, though an unlikely situation, that everyone will guess wrong. This occurs when the first two people happen to take out the ball that belongs to the minority group. This is clearly not social optimal. Let us consider the same game, in which every person who guesses correctly is given 5$, and 0$ if he guesses incorrectly, and a 100 people play the game. Since consumers are generally risk averse, It is easy to see that the if the 10000 people agreed, to split the money they earn in the end, and have the first 100 people state the color they see, instead of relying on any information they have received previously they will be better off (If the first 100 people state the color they see the next 9,900 people will almost certainly know which color is of a majority) . The original situation is not optimal since since the long run choices made are on average inferior to those made when all information is aggregated optimally.

In the above paragraph I have used a simple, not very realistic example. However, such situations often occur. In class we discussed many “real” examples of information cascades. I pose the question of why information cascades start so easily even though they are often inefficient? There is no clear answer to this. Although one can show that under certain assumptions (weather these assumptions are hold true in the real word is debatable), cascades will always arise and are unavoidable. Clearly though, we see that information cascades do happen, and are sometimes inefficient.


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