2012 Discussion Papers
School of Economics Discussion Paper 12/02
Back to the future: economic rationality and
maximum entropy prediction
University of Kent
An information-theoretic thought experiment is developed to clarify why the maximum entropy methodology is appropriate for predicting the equilibrium state of economic systems. As a ﬁrst step, object allocation problems, modeled as knapsack problems, are shown to be equivalent to congestion games under weak assumptions. This proves the existence of ﬁnite improvement paths linking initial conditions and Nash equilibria. The existence of these improvement paths is precisely what enables the use of maximum entropy to make predictions concerning the equilibrium state. Finally an illustration of this predictive power is provided through an application to the Schelling model of segregation.
JEL Classification: C02; C11; C63; D80
Keywords: Information entropy; knapsack problem; potential function; Schelling segregation
This paper integrates and extends two previous papers released under the title `Ignorance is bliss: rationality, information and equilibrium' and `Back to the Future: A Simple Solution to Schelling Segregation', respectively School of Economics Discussion Papers 11/03 and 11/04.
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