The One Percent Solution, or The Value of Information Quandary


Assume for the moment that through some completely legal means I know with certainty the price of Apple stock at the NASDAQ closing bell. How much would you pay for that information?

Well, it depends. If the information refers to yesterday’s closing price, the value of that information is very low. But if:

  • the information refers to tomorrow’s closing price, and if
  • you trust me enough to act upon that information, and if
  • you have a lot of money to invest…

Well, THAT would be some pretty valuable information. Those three “ifs” represent three factors that help determine the value of information. A more general statement of those factors is:woman counting money

  • the ability to use that information to make a better decision
  • the perceptions of the users (do they trust the information enough to act upon it?)
  • the potential gain or loss resulting from a good or bad decision[1]

Knowing yesterday’s closing price for a stock has a low value because you can’t do anything with that information. Knowing tomorrow’s closing price has more value, particularly if the price will go up or down dramatically—and if you have some money to invest. As one group of researchers put it, “the economic value of new data and information is effectively zero until the information is used productively in an application that actually brings economic benefit to an end user[2].”

In the instance of weather information, “the value of a flood forecast is small if flooding is either highly unlikely or very likely in a geographic region, or if the effects of flooding are almost impossible to prepare for[3].” Why? Because, if flooding is unheard of in the area, residents are less likely to believe a flood forecast and act upon it. If flooding occurs frequently, residents are more likely to take action with or without a specific forecast of flooding. And if nothing can be done to reduce flood losses, then it doesn’t really help to know about the flood ahead of time

I’ve seen a number of instances where people estimate the value of information using a “rule of thumb” value of one percent of the value of the goods and services affected by that information. Without pointing fingers (or thumbs), I’ll just say, “If life were only that simple…”

I did some investigation and think I’ve found the source of that rule of thumb—Yale University economist William Nordhaus. In 1986, Dr. Nordhaus participated in a workshop on the value of weather information. In that workshop, he said, “…all of the studies I know of the value of perfect information find its value to be on the order of one percent of the value of output. [Nordhaus then provides examples of studies of the value of weather information to the production of wheat, cotton, and electricity.] From these kinds of studies, then, we find the value of information is not zero, but it is not enormous either[4].”

Seen in context, this looks more like an informal reflection than a general rule.

Not satisfied, I recently asked Dr. Norhaus about the continued use of his 1986 comment and he replied, “I remember the talk but had no idea [the comment] would go beyond its status as an informal reflection.”

So there you have it—an informal reflection and not a general rule.

The value of information is found in its use, like land cover data used in development and conservation planning, biological data used to manage fish populations, and economic data used to reduce the losses associated with coastal storms. Estimating the value of information requires looking forward to all of the different end uses and considering the role of the information in producing a better outcome.

This is a lot more trouble than applying a rule of thumb, but it keeps economists busy and away from polite society. Which is always a good thing.


 

[1] Macauley, Molly K. “Some dimensions of the value of weather information: general principles and a taxonomy of empirical approaches.” Report of the Workshop on the Social and Economic Impacts of Weather. National Center for Atmospheric Research, Boulder, CO, 1997.

[2] Williamson, Ray A., Henry R. Hertzfeld, and Joseph Cordes. “The socio-economic value of improved weather and climate information.” Space Policy Institute, The George Washington University (2002).

[3] Macauley, op cit.

[4] Nordhaus, William D. 1986. “The Value of Information,” in Richard Krasnow, ed., Policy Aspects of Climate Forecasting (Washington, DC, Resources for the Future), RFF Proceedings, March 4, 129-134.