How Wasteful is Signaling?

TL;DR

This paper quantifies the wastefulness of signaling in economic environments, deriving a simple formula for waste ratio in isoelastic cases and exploring its effects beyond.

Contribution

It introduces a formula for the waste ratio in signaling, revealing its dependence on benefit and cost elasticities, applicable to both isoelastic and non-isoelastic environments.

Findings

The waste ratio in isoelastic environments is $eta/(eta+\sigma)$.

The waste ratio is constant across types and independent of cost convexity.

Directional effects of elasticities extend to non-isoelastic environments.

Abstract

Signaling is wasteful. But how wasteful? We study the fraction of surplus dissipated in a separating equilibrium. For isoelastic environments, this waste ratio has a simple formula: $\beta/(\beta+\sigma)$, where $\beta$ is the benefit elasticity (reward to higher perception) and $\sigma$ is the elasticity of higher types' relative cost advantage. The ratio is constant across types and is independent of other parameters, including convexity of cost in the signal. We show that the directional effects of $\beta$ and $\sigma$ on waste extend to non-isoelastic environments.