Observational Learning with a Budget

--We consider a model of Bayesian observational learning in which a sequence of agents receives a private signal about an underlying binary state of the world. Each agent makes a decision based on its own signal and its observations of previous agents. A central planner seeks to improve the accuracy of these signals by allocating a limited budget to enhance signal quality across agents. We formulate and analyze the budget allocation problem and propose two optimal allocation strategies. At least one of these strategies is shown to maximize the probability of achieving a correct information cascade. I NTRODUCTION Consider that an item, which could either be of a "good" or a "bad" quality, is up for sale in a market where agents arrive sequentially and decide whether to buy the item, with their choice serving as a recommendation for later agents. While the quality of the item is unknown to the agents, every agent has its own prior knowledge of the item's quality in the form of its private belief. Each agent then makes a payoff optimal decision based on its own prior knowledge and by observing the choices of its predecessors. Such models of "observational learning" were first studied by [1]-[3] under a Bayesian learning framework wherein each agent's prior knowledge is in the form of a privately observed signal about the pay-off-relevant state of the world, which in this case is the item's quality, and is generated from a commonly known probability distribution. A salient feature of such models is the emergence of information cascades or herding, i.e., at some point, it is optimal for an agent to ignore its own private signal and follow the actions of the past agents. Subsequent agents then follow suit due to their homogeneity.