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The (in)appropriate benchmark when beliefs are not the only state variable

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  • Godfrey Keller

Abstract

In models of learning by experimentation, there is a natural benchmark of myopia when the only intertemporal link is the agent`s subjective belief (signal independence). An alternative benchmark using a passive learner has been proposed when there is a further intertemporal link that directly affects payoffs (signal dependence). The purpose of this note is to suggest that the use of this particular benchmark is flawed for two reasons: first, passive learning does not disentangle the effects of knowing that beliefs might change as well as other state variables, and we offer another benchmark using a naive learner that does, and so necessarily reduces to myopia in the signal independent case; secondly, and maybe more tellingly, passive learning does not do what it is supposed to do, namely help measure the gains from active experimentation, since the payoffs of a passive learner can be markedly lower than those of a naive learner.

Suggested Citation

  • Godfrey Keller, 2005. "The (in)appropriate benchmark when beliefs are not the only state variable," Economics Series Working Papers 223, University of Oxford, Department of Economics.
    • Handle: RePEc:oxf:wpaper:223
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    References listed on IDEAS

    as
    1. Trefler, Daniel, 1993. "The Ignorant Monopolist: Optimal Learning with Endogenous Information," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 34(3), pages 565-581, August.
    2. Manjira Datta & Leonard J. Mirman & Edward E. Schlee, 2002. "Optimal Experimentation in Signal Dependent Decision Problems," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 43(2), pages 577-608, May.
    3. Lazear, Edward P, 1986. "Retail Pricing and Clearance Sales," American Economic Review, American Economic Association, vol. 76(1), pages 14-32, March.
    4. Freixas, Xavier, 1981. "Optimal growth with experimentation," Journal of Economic Theory, Elsevier, vol. 24(2), pages 296-309, April.
    5. Edward E. Schlee & Manjira Datta & Leonard J. Mirman, 2000. "Learning with noiseless information and payoff-relevant signals," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 16(1), pages 63-75.
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