In Economics, what is Signalling?

The concept of signalling in the field of economics has to do with the transfer of information from one party to another, often in order to achieve some sort of mutual satisfaction or arrangement. When explaining the way that signalling occurs, the party that is transmitting the information is often referred to as the agent. The party that receives and evaluates the information is usually understood to be the principal.

One of the classic illustrations of how signalling works involves an individual who is seeking employment. In order to attract the attention of an employer, the prospective employee may choose to engage in signalling as a means of gaining the attention of the employer. This segment of the process often begins with the crafting of the resume. If the information on the resume generates sufficient interest, then the employer will often schedule an interview and seek to broaden his or her knowledge base about the prospective employee.

At the interview, the prospect assumes the role of agent and seeks to build on the rapport already established through the resume. This will involve emphasizing certain facts that are relevant to the position and the general goals of the company. Essentially, the agent is taking true data and presenting it in the most attractive manner possible.

In turn, the employer assumes the role of principal and receives the information. As the information is received, principals assimilate and evaluate the data. At the end of this process, the principal can extend an offer of employment to one agent, as well as inform other agents that there is no need for further information and the position is now filled.

One of the key components of ethical signalling is that only true and correct information is provided by an agent to a principal. While the agent may choose to downplay some data while spotlighting other information that he or she believes is of more interest to the principal, honesty is essential if the conveyance or signal of information is to be considered successful.

Signalling is understood to be part of a broader process that is often referred to as contract theory. Concerned with achieving a balance between rewards and competency employed in a process, the activity of signalling is very important in order to employ contract theory to the advantage of all parties involved.