Chapter 40 Common knowledge

Abstract

This chapter presents some of the implications for economic behavior of the hypotheses that events, actions, optimization, and rationality are common knowledge. The main conclusion is that an apparently innocuous assumption of common knowledge rules out speculation, betting, and agreeing to disagree. Knowledge and interactive knowledge are central elements in economic theory. Common knowledge is the limit of a potentially infinite chain of reasoning about knowledge. Public events are the most obvious candidates for common knowledge. But events that the agents create themselves, such as the rules of a game or contract, can also plausibly be seen as common knowledge. Certain beliefs about human nature might also be taken to be common knowledge. Economists are especially interested, for example, in the consequences of the hypothesis that it is common knowledge that all agents are optimizers. It often occurs that after lengthy conversations or observations, what people are going to do is common knowledge, although the reasons for their actions may be difficult to disentangle.

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