How Wasteful is Signaling?

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.