KLAUS KULTTI () (Department of Economics, University of Helsinki, P.O. Box 17, Arkadiankatu 7, 00014, Finland) PAAVO MIETTINEN () (Finnish Doctoral Programme in Economics, University of Helsinki, P.O. Box 17, Arkadiankatu 7, 00014, Finland; Department of Economics, University of Helsinki, P.O. Box 17, Arkadiankatu 7, 00014, Finland)
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We consider a standard sequential decision to adopt/buy a good in a herding environment. The setup is same as in Sgroi (2002). Contrary to the basic herding case we introduce a cost that the agents have to pay for the information about their predecessors' actions. All agents receive informative signals as in the standard herding models but do not view the actions taken by their predecessors unless they pay the observation costs. In this set up the first and the second agents rely on their own signals when they make the decision to adopt/buy the good. Only the third agent is willing to buy the information on all of the preceding agents' actions. All agents following the third agent buy information on only one agent's action and decide to adopt/buy the good after updating their beliefs. What follows is that the two first agents' actions determine whether the rest of the agents will adopt/buy the good or not when information about the predecessors' actions is cheap enough. If the cost of the information about the predecessors' actions is very expensive then all the agents will act according to their own signals. If observing is free one gets the standard results. In essence we identify a discontinuity in the basic herding model since the herding arises deterministically when a small observation cost is introduced.
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