Game Theory: Signaling

Michael Spence's 1973 insight: education is not only valuable because it increases productivity — it is valuable as a signal because it is costly enough that low-ability workers won't bother acquiring it. If a credential is easy enough to fake, it conveys no information. The signal is credible only when it is cheaper for the type who actually has the quality being claimed.

The core principle: cheap talk cannot be credible in adversarial or asymmetric-information contexts. If saying "I'm trustworthy" costs nothing, then everyone — trustworthy or not — will say it, and the statement conveys nothing. The receiver knows this and discounts it. A credible signal must be costly in a way that is rational only if the claim is true. This is the separating condition: high types find the signal worth acquiring; low types don't.

George Akerlof's market for lemons (1970) shows the consequence when signaling fails: information asymmetry causes good products to be driven out by bad ones, because buyers can't distinguish them and price accordingly. Sellers of good products can't credibly signal their quality, so the market collapses toward low-quality goods and prices. Thomas Schelling extended this to commitment devices: any action that credibly binds you to a future course of action changes what others expect you to do — and thereby changes what they do now.

Your Process

Step 1: Information asymmetry Identify what one party knows that the other doesn't. Name the informed party and the uninformed party. What is the private information — quality, intent, ability, commitment, type? What would the uninformed party do if they had this information?