Editing Economics (section)

=== Uncertainty and game theory ===
{{Main|Information economics|Game theory|Financial economics}}

[[Uncertainty]] in economics is an unknown prospect of gain or loss, whether quantifiable as [[Risk#Risk and uncertainty|risk]] or not. Without it, household behaviour would be unaffected by uncertain employment and income prospects, [[financial market|financial]] and [[capital market]]s would reduce to exchange of a single [[financial instrument|instrument]] in each market period, and there would be no [[communication]]s industry.<ref>{{cite encyclopedia |author-link1=Mark J. Machina |last1=Machina |first1=Mark J. |title=The New Palgrave Dictionary of Economics |pages=190–197 |author-link2=Michael Rothschild |last2=Rothschild |first2=Michael |date=2008 |edition=2nd |editor-first1=Steven N. |editor-last1=Durlauf |editor-first2=Lawrence E. |editor-last2=Blume |chapter-url=http://www.dictionaryofeconomics.com/article?id=pde2008_R000152 |doi=10.1057/9780230226203.1442 |isbn=978-0-333-78676-5 |chapter=Risk |publisher=Palgrave Macmillan UK |access-date=2 March 2011 |archive-date=11 October 2017 |archive-url=https://web.archive.org/web/20171011071806/http://www.dictionaryofeconomics.com/article?id=pde2008_R000152 |url-status=live }}</ref> Given its different forms, there are various ways of representing uncertainty and modelling economic agents' responses to it.<ref>{{cite encyclopedia |last=Wakker |first=Peter P. |date=2008 |edition=second |editor-first1=Steven N. |editor-last1=Durlauf |editor-first2=Lawrence E. |editor-last2=Blume |chapter-url=http://www.dictionaryofeconomics.com/article?id=pde2008_U000005 |doi=10.1057/9780230226203.1753 |title=The New Palgrave Dictionary of Economics |pages=428–439 |isbn=978-0-333-78676-5 |chapter=Uncertainty |publisher=Palgrave Macmillan UK |access-date=2 March 2011 |archive-date=30 December 2010 |archive-url=https://web.archive.org/web/20101230071633/http://www.dictionaryofeconomics.com/article?id=pde2008_U000005 |url-status=live }}</ref>

[[Game theory]] is a branch of [[applied mathematics]] that considers [[Strategy#Strategies in game theory|strategic interactions]] between agents, one kind of uncertainty. It provides a mathematical [[microfoundation|foundation]] of [[industrial organisation]], discussed above, to model different types of firm behaviour, for example in a solipsistic industry (few sellers), but equally applicable to wage negotiations, [[Bargaining#Game theory|bargaining]], [[Contract theory|contract design]], and any situation where individual agents are few enough to have perceptible effects on each other. In [[behavioural economics]], it has been used to model the strategies [[Agent (economics)|agents]] choose when interacting with others whose interests are at least partially adverse to their own.<ref>{{unbulleted list citebundle|{{harvp|Samuelson|Nordhaus|2010|loc=ch. 11, "Uncertainty and Game Theory" and [end] Glossary of Terms, "Economics of information", "Game theory", and "Regulation"}}.|{{cite book |last=Camerer |first=Colin F. |author-link=Colin F. Camerer |date=2003 |title=Behavioral Game Theory: Experiments in Strategic Interaction |url=https://books.google.com/books?id=cr_Xg7cRvdcC&pg=PP1 |chapter=Chapter 1: Introduction |chapter-url=http://assets.press.princeton.edu/chapters/i7517.pdf |publisher=Princeton University Press |isbn=978-1-4008-4088-5}}}}</ref>

In this, it generalises maximisation approaches developed to analyse market actors such as in the [[supply and demand]] model and allows for incomplete information of actors. The field dates from the 1944 classic ''[[Theory of Games and Economic Behavior]]'' by [[John von Neumann]] and [[Oskar Morgenstern]]. It has significant applications seemingly outside of economics in such diverse subjects as the formulation of [[nuclear strategies]], [[Game theory#Philosophy|ethics]], [[Game theory#Political science|political science]], and [[evolutionary biology]].<ref>{{cite encyclopedia |title=Game Theory |dictionary=The New Palgrave Dictionary of Economics |url=http://www.dictionaryofeconomics.com/article?id=pde2008_G000007 |access-date=2 March 2011 |last=Aumann |first=R. J. |date=2008 |author-link=Robert Aumann |editor-last1=Durlauf |editor-first1=Steven N. |edition=2nd |archive-url=https://web.archive.org/web/20101229164520/http://www.dictionaryofeconomics.com/article?id=pde2008_G000007 |archive-date=29 December 2010 |editor-first2=Lawrence E. |editor-last2=Blume |url-status=live}}</ref>

[[Risk aversion]] may stimulate activity that in well-functioning markets smooths out risk and communicates information about risk, as in markets for [[insurance]], commodity [[futures market|futures contracts]], and [[financial instruments]]. [[Financial economics]] or simply [[finance]] describes the allocation of financial resources. It also analyses the pricing of financial instruments, the [[capital structure|financial structure]] of companies, the efficiency and fragility of [[financial market]]s,<ref>{{cite journal |author-link1=Ben Bernanke |last1=Bernanke |first1=Ben |author-link2=Mark Gertler (economist) |first2=Mark |last2=Gertler |date=February 1990 |title=Financial Fragility and Economic Performance |journal=Quarterly Journal of Economics |volume=105 |issue=1 |pages=87–114 |jstor=2937820 |doi=10.2307/2937820 |s2cid=155048192 |url=http://www.nber.org/papers/w2318.pdf |access-date=3 September 2019 |archive-date=26 November 2019 |archive-url=https://web.archive.org/web/20191126210951/https://www.nber.org/papers/w2318.pdf |url-status=live }}</ref> [[Financial crisis|financial crises]], and related government policy or [[Financial regulation|regulation]].<ref>{{cite encyclopedia |title=The New Palgrave Dictionary of Economics |editor-first1=Steven N. |editor-last1=Durlauf |editor-first2=Lawrence E. |editor-last2=Blume |edition=2nd |date=2008}}</ref><ref>{{cite encyclopedia |author-link=Stephen Ross (economist) |last=Ross |first=Stephen A. |title=Finance |url=http://www.dictionaryofeconomics.com/article?id=pde2008_F000071 }}</ref><ref>{{cite encyclopedia |last1=Burnside |first1=Craig |first2=Martin |last2=Eichenbaum |first3=Sergio |last3=Rebelo |title=Currency Crises Models |url=http://www.dictionaryofeconomics.com/article?id=pde2008_S000204 |access-date=2 March 2011 |archive-date=26 March 2012 |archive-url=https://web.archive.org/web/20120326015628/http://www.dictionaryofeconomics.com/article?id=pde2008_S000204 |url-status=live }}</ref><ref>{{cite encyclopedia |last=Kaminsky |first=Graciela Laura |title=Currency Crises |url=http://www.dictionaryofeconomics.com/article?id=pde2008_C000468 |access-date=2 March 2011 |archive-date=26 March 2012 |archive-url=https://web.archive.org/web/20120326015551/http://www.dictionaryofeconomics.com/article?id=pde2008_C000468 |url-status=live }}
</ref><ref>{{cite encyclopedia |last=Calomiris |first=Charles W. |title=Banking Crises |url=http://www.dictionaryofeconomics.com/article?id=pde2008_B000051 |access-date=2 March 2011 |archive-date=3 January 2015 |archive-url=https://web.archive.org/web/20150103021252/http://www.dictionaryofeconomics.com/article?id=pde2008_B000051 |url-status=live }}</ref>

Some market organisations may give rise to inefficiencies associated with uncertainty. Based on [[George Akerlof]]'s "[[Market for Lemons]]" article, the [[paradigm]] example is of a dodgy second-hand car market. Customers without knowledge of whether a car is a "lemon" depress its price below what a quality second-hand car would be.<ref>{{cite journal |last=Akerlof |first=George A. |date=August 1970 |title=The Market for 'Lemons': Quality Uncertainty and the Market Mechanism |journal=Quarterly Journal of Economics |volume=84 |issue=3 |pages=488–500 |jstor=1879431 |doi=10.2307/1879431 |s2cid=6738765 |url=http://hydrogen.its.ucdavis.edu/eec/education/EEC-classes/eeclimate/class-readings/akerlof-the%20market%20for%20lemons.pdf |archive-url=https://web.archive.org/web/20110818045155/http://hydrogen.its.ucdavis.edu/eec/education/EEC-classes/eeclimate/class-readings/akerlof-the%20market%20for%20lemons.pdf |archive-date=18 August 2011}}</ref> [[Information asymmetry]] arises here, if the seller has more relevant information than the buyer but no incentive to disclose it. Related problems in insurance are [[adverse selection]], such that those at most risk are most likely to insure (say reckless drivers), and [[moral hazard]], such that insurance results in riskier behaviour (say more reckless driving).<ref name="sciencedirect">{{cite encyclopedia |last1=Lippman |first1=S.S. |title=International Encyclopedia of the Social & Behavioral Sciences |pages=7480–7486 |first2=J.J. |last2=McCall |date=2001 |publisher=Elsevier |doi=10.1016/B0-08-043076-7/02244-0|isbn=978-0-08-043076-8 |chapter=Information, Economics of }}</ref>

Both problems may raise insurance costs and reduce efficiency by driving otherwise willing transactors from the market ("[[incomplete markets]]"). Moreover, attempting to reduce one problem, say adverse selection by mandating insurance, may add to another, say moral hazard. [[Information economics]], which studies such problems, has relevance in subjects such as insurance, [[contract theory|contract law]], [[mechanism design]], [[monetary economics]], and [[health economics|health care]].<ref name="sciencedirect" /> Applied subjects include market and legal remedies to spread or reduce risk, such as warranties, government-mandated partial insurance, [[restructuring]] or [[bankruptcy law]], inspection, and [[Regulatory economics|regulation]] for quality and information disclosure.<ref>{{harvp|Samuelson|Nordhaus|2010|loc=ch. 11, "Uncertainty and Game Theory" and [end] Glossary of Terms, "Economics of information", "Game theory", and "Regulation"}}</ref><ref>{{cite book |title=The New Palgrave Dictionary of Economics |editor-first1=Steven N. |editor-last1=Durlauf |editor-first2=Lawrence E. |editor-last2=Blume |publisher=Palgrave Macmillan |edition=2nd |date=2008}}</ref><ref>{{cite encyclopedia |last=Wilson |first=Charles |title=Adverse Selection |url=http://www.dictionaryofeconomics.com/article?id=pde2008_A000040 |access-date=2 March 2011 |archive-date=16 October 2017 |archive-url=https://web.archive.org/web/20171016225939/http://www.dictionaryofeconomics.com/article?id=pde2008_A000040 |url-status=live }}</ref><ref>{{cite encyclopedia |last=Kotowitz |first=Y. |title=Moral Hazard |url=http://www.dictionaryofeconomics.com/article?id=pde2008_M000259 |access-date=2 March 2011 |archive-date=17 October 2017 |archive-url=https://web.archive.org/web/20171017041859/http://www.dictionaryofeconomics.com/article?id=pde2008_M000259 |url-status=live }}
</ref><ref>{{cite encyclopedia |author-link=Roger B. Myerson |last=Myerson |first=Roger B. |title=Revelation Principle |url=http://www.dictionaryofeconomics.com/article?id=pde2008_R000137 |access-date=2 March 2011 |archive-date=29 December 2010 |archive-url=https://web.archive.org/web/20101229164407/http://www.dictionaryofeconomics.com/article?id=pde2008_R000137 |url-status=live }}</ref>