Introduction

There is a standard model of economic behavior, the Arrow-Debreu general equilibrium model of perfect competition. While this model may not be entirely adequate as a description of economic reality, it is most useful as a standard of comparison. For in equilibrium in this model, subject to the careful qualifications of Pareto optimality, peoples' lives are as pleasurable as they possibly can be, given their tastes and productive capabilities. Consequently, to understand why peoples' lives are not as pleasurable as they might be (in the Pareto sense), it is necessary only to know why the real world fails to correspond to the Arrow-Debreu Utopia.

In the real world, contrary to the assumptions of Arrow and Debreu, information is neither complete nor costless. On the contrary, given the cost of information and the need for it, people typically make predictions about the behavior of the economy and the behavior of individuals based upon a limited number of easily observable characteristics. We say that such a prediction is based upon an indicator; an econometrician would call it a prediction using the method of instrumental variables. This paper shows the distortions caused to examples of the A-D (Arrow-Debreu) model by the introduction of indicators.

There are two types of examples of the use of indicators in the models that follow. One sort of indicator owes its existence to the potentially useful economic information provided.