Ch. 1 shows the reader how to model asymmetric information and knowledge in theoretical economics. It also introduces the concept of higher‐order knowledge. For the analysis of bubbles it is important to draw a distinction between mutual knowledge, e.g. all traders know that the price is too high, and common knowledge, i.e. they all know this and that all know and so on. Prices are determined in equilibrium. The two most commonly used equilibrium concepts in market settings with asymmetric information are the competitive Rational Expectations Equilibrium (REE) concept and the strategic...

Ch. 1 shows the reader how to model asymmetric information and knowledge in theoretical economics. It also introduces the concept of higher‐order knowledge. For the analysis of bubbles it is important to draw a distinction between mutual knowledge, e.g. all traders know that the price is too high, and common knowledge, i.e. they all know this and that all know and so on. Prices are determined in equilibrium. The two most commonly used equilibrium concepts in market settings with asymmetric information are the competitive Rational Expectations Equilibrium (REE) concept and the strategic Bayesian Nash Equilibrium concept. The chapter compares and contrasts both equilibrium concepts and also highlights their conceptual problems. This chapter also introduces and contrasts the two efficiency concepts: informational efficiency and allocative efficiency.