In class, we discussed information cascade in terms of economic behavior of the mass. An information cascade is a situation in which every subsequent actor, based on the observations of others, makes the same choice independent of his/her private signal. This may result in erroneous mass behavior. Information cascade is similar to herding behavior of the crowds. Benign herding behaviors may be frequent in everyday decisions based on learning from the information of others.

For example, when a person decides which of two restaurants to dine in, the person may choose restaurant A. If this was earlier in the day, both restaurants may be empty, so the choice in the restaurants is at random. Later, when other people pass by in search of a place to eat, they will see that restaurant A has customers while B is empty. Most likely, they will choose A on the assumption that the restaurant having customers already makes it the better choice. Economically speaking, restaurant A will get more business that night than restaurant B.

Lisa Anderson and Charles Holt set up an experiment to prove this theory. Two marbles of one color, blue, will be placed in one of the cups (cup A) along with one marble of the other color, red. The other cup (cup B) will contain two red and one blue. Random cup is chosen for all the subjects. The subjects will pick a marble out of the cup, and guess which of the cup it is. After the first subject, the marble is replaced, and the second subject will pick a marble. It is found that after the first couple subjects have conformed prediction, subjects tend to conform to this prediction regardless of the color of their marble.

This is similar to what is going on with mp3 player market. Once the iPods became popular, and became a “conformity,” more people tend to buy the iPods, following the trend.

http://web.centre.edu/econed/informat.htm