Information usage in the formation of price expectations: theory and econometric tests

Mark S. McNulty

ISU General Staff Papers from Iowa State University, Department of Economics

Abstract: Assume that economic agents form expectations rationally by forecasting future prices with the stochastic expectation of price, conditional upon an observed set of information. If information used in forming expectations is considered a scarce resource, profit maximizing agents will acquire additional information until the marginal cost of that activity equals the marginal benefit. Agents engaged in purely productive activities are considered, and it is assumed that there is no opportunity for speculation. The benefits of information usage are shown to depend upon the parameters of the market in which the agent is participating. In certain situations, the information used by one agent may create both positive and negative externalities in the market;If information is considered a costly resource, then one does not expect agents to use all that is available, even if expectations are formed rationally. The applicability of different econometric tests of the hypothesis of rationality are discussed in light of this fact. Special attention is given to estimation and hypothesis testing when the error in the model is serially correlated;An empirical analysis of expectation formation in the chicken broiler market is conducted. The results imply that short run production decisions in this industry do not satisfy the rational expectations model. It is suggested that the value of information to broiler producers is relatively small in the short run because of an inability to make substantial short-run changes in the level of production. A cobweb model of expectation formation performed well in describing producer behavior.

Date: 1985-01-01
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