BATCH 2012-2014

ECONOMICS BOOK REVIEW NAME OF THE BOOK: HIDDEN ORDER- THE ECONOMICS OF EVERYDAY LIFE

RUSH HOUR BLUES AND RATIONAL BABIES

Author in the beginning of the book presents very beautifully the idea that Economics lie on the assumption of rationality. It assumes that every individual has set goals and would tend to choose the correct way to achieve them. He supports this idea by taking the an extremely simple example of an infant crying to cure his hunger. In an example of investing time and effort in studying alternatives when buying a car or voting, it is to be realized that the payoff of the former investment will be high in case of the decision of buying a car. Voting is characterized as rational ignorance ie. I is rational to be ignorant when information costs more than its worth. A very usual example has been dealt with in order to explain that what is apparent might not be equal. In a grocery store everyone can tell which line is shorter, but the relevant length is not in space but in time. Estimating which line gets you out faster requires a little mental effort, because standing behind ten people with very few items in their carts is better than standing behind seven with their carts full. Though the later line is shorter it is a better option. The author deals with how deals with how rationality even occurs without applying mind by quoting the example of genes. Genes cannot think, yet they behave as if they have carefully calculated how to maximize their survival in future generations. This example appears too abstract to explain the subject. He even mentions about the omissions of many possible details which could have been included to enhance discussions and critical analysis.

ACTIONS SPEAK LOUDER THAN WORDS

The author says that, how much, is enough depends on what is worth and what it costs. He says that the consumption decisions one makes, the goods one considers buying, are those appropriate of ones income. There exist no needs, but wants, nothing including life is infinitely valuable, so trade-offs are a must. Economic value is simply value to individuals as judged by them and revealed in their action this has been beautifully explained by the example of the value of a crust of bread in the hands of a starving man and that of a syringe of heroine in the hands of an addict. Posing the example of diamonds worth being more than that of water, where we can easily do without the former but the later is essential for

life the author explains price. It is derived that the price equals both cost of production and value to the user, both of which must therefore be equal to each other.

THINKING ON PAPER: THE GEOMETRY OF CHOICE

In this chapter I found that the author has dealt with logical approaches and has taken into use economic concepts to explain terms like price, value, cost etc. Though in the beginning, he talks about David Ricardos work which is uninteresting and hard to relate for the readers who do not know much about him. The author explains by the example of two grocery stores the terms value and price. The value of something is what we are just willing to give up for it. Two things are of the same value if gaining one and losing another leaves us neither better nor worse. This explains the concept of indifference well. The indifference curve explains what is meant by value and budget line helps to understand the meaning of price. The price of a good is the amount of something else one must give up to get it whereas the cost is opportunity cost, which is the cost of anything, whether one buys or produces it, it is what one has to give up in order to get it. He explains subsidy with the example of potato subsidy. Measured in money, subsidy is a wash. Measured in human welfare, it is a net loss, as it changes human incentives in a way that makes every consumer worse off.

WHAT WOULD YOU GIVE TO GET OFF A DESERT ISLAND

Through this section of the book it was very easy for me to understand the concept of marginal value and demand. It is concluded that rational consumer buys the quantity for which marginal value equals price. The quantity he buys at a price is a point on his demand curve. Since he buys a quantity at which marginal value equals price, it is a point on his marginal value curve.

BRICKS WITHOUT CLAY : PRODUCTION IN A ONE-INPUT WORLD

According to Friedman theory of multiplying benefits makes one think that a single dime spent in the city can help enrich everyones life because it passes on to many people who spend it again before it gets out of the city. The mayor thought the same way while estimating that GMs $20 million expenditure on payrolls and purchases in the city will mean that the company will mean that the company will add $100 million to the incomes of the residents. The mayor might be confusing revenue with profit while making the estimation. For firms with either multiple or single inputs to production the logic of simple production can be divided into three steps i.e. Choosing what to produce considering the implicit profits that are reaped from the production. Deciding how much to produce. Combining the decisions of many individual producers. Producers that are very good at producing a good A or very bad at producing any other good will produce the good A even at a lower price. For a producer a backward bending is analogous to the curiosity of the theory of a Giffen Good-a good whose demand curve slopes in the wrong direction implying that consumers buy more of the good when the price rises. The backward bending supply curve for labour suggests that as the wages increase the number of hours worked will increase until a certain point after which they keep decreasing.

PTOLEMAIC TRADE THEORY, OR CAN WE BRING THE NEW YORK TIMES INTO THE TWENTIETH CENTURY?
In most popular economic discussions the following three propositions can be found. High costs or low quality is the reason why Japan and America have a trade deficit. To improve the trade balance America needs to impose tariffs while the Japanese dont. A trade surplus is good while a trade deficit is bad for both the countries. Friedman further explains how declining marginal values motivate two parties to exchange goods and how this exchange of goods makes both the parties better off. One can concur that an exchange of goods makes sense when one of the parties is very good at producing the good and has plenty of it, and the other party is not good at producing it. This argument is defined as the principle of comparative advantage. Exchanges and bargains only work when both the parties are sure that the exchange will bring them profit. Friedman further explains that a balance has to be struck in case of a bilateral monopolistic bargain making both parties feel that they are gaining some value from the trade and the surplus is being shared fairly. Both parties try to convince one another of the value they offer by the trade but there is a chance of one getting ripped off in the process. Feeling that the other party is ripping

you off does not essentially mean that they are charging more than the real price; instead it means that the price that you are paying is not worth the good.

PUTTING IT TOGETHER: PRICE THEORY IN A SIMPLE ECONOMY

The author explains the concept of equilibrium taking the example of an imaginary commodity called widgets. When the price of the commodity is higher than the equilibrium price the producers want to sell more than what the consumers demand. When the price goes below the equilibrium price the consumers want to buy more than what the producers want to sell. According to the concept of marginal value the consumers do not mind paying a price more than the market price because they cannot buy as many widgets as they want hence causing the price to rise again and reach the equilibrium price. Confusion can be avoided by coherently differentiating between the changes in demand and change in the quantity demanded and the same applies to supply and the quantity supplied. An increase in the demand causes the demand curve to shift out and raises prices. Elasticity governs the effect of price and quantity of shifts in supply and demand curves. Who pays Taxes? To answer the question author considers two situation where in the government imposes tax on the producer or the consumer. If the taxes are imposed on the producer there is an increase in price of the good, the increase in price does not mean that the producer is getting a higher price for the same good; instead the extra amount goes to the government as tax hence in the process the price paid by the consumer goes up and the price received by the producer decreases, both of these together constitute the tax that is paid to the government. When the tax is imposed on the consumer the consumer gives up the same amount to get the widget. Hence Friedman concludes that no matter who hands the tax over to the government the tax is really distributed amongst the producers and the consumers. After knowing that both the consumer and producer pay taxes one might ask what is the real cost of taxes or, as author puts it, how much worse off it makes them. The relation between revenue and excess burden depends on the shape of the demand curve. The steeper the demand curve (more inelastic demand is), the less the given tax reduces quantity and thus lower the ratio of excess burden to revenue. Elasticity of both supply and demand are usually greater in the long run than in the short run. Friedman further uses price theory to explain how imposing taxes on landlords and providing subsidies to tenants can make them worse or better off.

THE BIG PICTURE

After discussing a system involving a single good one can generalise the concept to get a picture of the entire economy. An economy is an interdependent system wherein both the consumer and the producer

preferences define how much of a good will be produced and at what price will the consumer buy it. In order to put it together the author starts with individual preferences and productive capabilities and find complete set of equilibrium prices and quantities. In real world situations the production of one good requires another good hence the price of any good is dependent on the price of the required goods. In contrast to partial equilibrium author describes this as a general equilibrium that exists in interdependent economies.

BOSSES WORKERS AND OTHER COMPLICATIONS

In this chapter author discusses about the existence of the firms, the steps taken by the firms during production and marginal production. This chapter opens with a statement which tells about the importance of a supervisor or a manager in a firm stating that the obvious way to coordinate the work of lots of people is to have one at the top giving orders. And the author defined the firm as a miniature of command economy where employers give orders to supervisors who give orders to workers. The capitalist system of coordination by trade seems to be largely populated by indigestible lumps of socialism called corporations which raised three puzzles. 1) Why corporation exist? 2) How corporations are controlled? 3) How the existence of corporations can be incorporated in the economic theory? The author explains the need of corporation existence is to achieve the organization goal in which set of principles and rules where incorporated. And he also explained what changes the firms will consider when the firms are in lose by giving an example about his job in UCLA. In the theory of the firm the author explains about the production cost and cost curve which gives a description of what quantity of output can be produced with the given input and the total cost of production as of function of quantity produced. He also explained about the marginal cost and average cost and how these cost shows effect on profits. And these

things will help to calculate the supply curve of the firms. And this supply curve of the firm helps to find the supply curve of the industry. The shape of the graphs of these cost curves depends on the shifting balance between economies and diseconomies of scale. Based on the equation MRP=P the author explained weather the firm should continue with the product or to shutdown the firm. This situation comes depending on how the small firms are competing with the large firms. He also explains, the entrance of new firms to the industry. He says that these new firms are entering to industry because of the attractive profits. But in a long run these firms are shutting down because of the negative profits.

MONOPOLY FOR FUN AND PROFIT

MONOPOLY: The original meaning of the word monopoly is an exclusive right to sell. Natural monopoly: Occurs when because of economic scale, a firm large enough to produce the total output of the industry has a lower average cost than any smaller firm. If the average cost of production of large firms is lower than the small firms then it is worth less to small firms to enter into market. Artificial monopoly: Over a wide range of production if both the big and small firms produce the products at same cost this is called Artificial monopoly. And in this situation economies and diseconomies of scale roughly balance. The author had mentioned other type of monopoly in which the monopolies are sold by government as a way of raising money or given to people the government liked. In this chapter the author mainly discussed about price discrimination. And divided the way of pricing a product in to two ways :-

Price takers: Those firms which decide the price of the product based on the market price. Eg: rice, wheat and vegetables etc. Price searchers: Those firms which can sell their products on a considerable range of prices. Eg: automobiles, biscuits etc. Price discrimination: This is one of the methods implemented by monopolies to increase their profits. In this method a single product is given two prices based on the quality of the product. This method helped the firms to reach one of the determinants of the demand willingness to pay for a product. But it also has some disadvantages:1) It will lead to problem in distinguishing customers who will buy the

goods at a high price from those who will not.

2) It also prevents resale. It does no good to offer the product at low

price to poor customers if they turn around and resell it to rich ones.

HARD PROBLEMS: GAME THEORY, STRATEGIC BEHAVIOUR, AND OLIGOPOLY

In the last two chapters the author discusses about the firms, production, total cost curves, marginal cost curves and average cost curves but he did not discussed about the strategic behaviour which is one of the important factor that will help a firm or industry to achieve their goals . In this chapter the author discussed about strategic behaviour. In the market many players exists and each firm will have its own strategy. The author says that these firms wont change their strategies until no further changes will make them better off. He also says that equilibrium will reach when each player has chosen a strategy that is optimal for him. He also discussed about the games economists play to understand the behaviour that has the structure of the game. This includes most of the subject matter of economics, political science, international relations,

interpersonal relations and sociology. And he considered monopolistic competition and oligopoly as two quite ways of analyzing situations somewhere between monopoly and perfect competition.

TIME
In this chapter the Author speaks about the change in prices with respect to time. The price of a good would depend on when you buying it. Every Decision is evaluated on its Current effect and Future Effect. A Firm trying to decide whether to produce a good would convert all future gains & losses into present values and adds them. If the sum is positive it decides to produce and if the sum is negative (loss) it decides not to produce. It compares the alternatives in terms of the present value of all gains and losses and chooses the one which it is highest. i.e.. Only if(Income > Market Interest Rate* Investment).

SAVINGS INVESTMENT AND INTEREST RATES

The Individual Consumer has a flow of income, an internal discount rate, a utility function, and an internal rate at which he can borrow or lend. His objective is a pattern of consumption over his lifetime that maximizes the present value of utility. Someone who expects a high income in early in his career and a low income later (a professional Athlete) saves money in the early years, lends at a interest, and collects and consumes later. Someone in the opposite situation (MBA Student), Borrows money when he is young and Pays it back, with interest, when he is older. So one of the things determining the net demand for loans, is the pattern of lifetime earnings and expenditure opportunities. A Second factor is the internal discount rate. If some cultural change makes people more concerned about their future, their saving will go up and borrowings will come down. If everyone decides to enjoy today whatever the consequences, the borrowings would go up and earning down. If all lending and borrowing were of this sort, total borrowing would be equal to total savings; but you cannot borrow a Rupee until someone saves one. If demand for loan rises and supply falls, the interest rate goes up until quantity demanded and quantity supplied are equal.

In addition to individual borrowing and lending, there are also firms borrowing in order to invest.. If interest rates are high then firms invest only in projects with higher returns, the lower the interest rate, the larger the number of projects that yield a positive net present value. One way of producing future goods from present goods is by building factories; another way is to put present goods somewhere same & wait .

CHANCE
Sunk costs are the costs that have already been incurred and cannot be recovered. A firm will enter an industry only if the price it expects to receive is enough to cover all costs; including constructing a factory or designing a new product- costs are not sunk until they are incurred. If Price is insufficient to cover sunk costs, it is not worth replacing old factories when they wear out, so the number of factories will gradually decline and the price will gradually rise. Eventually price will be equal to average total cost. A Speculator buys things when he thinks they are cheap and sells them when he thinks they are expensive. A Speculator makes a fortune on other persons Misfortune. In order to make money, the speculator must sell as well as buy. If he buys when good is plentiful, he does indeed tend to increase the price then; but if he sell when it is scarce, he increases the supply and decreases the price just when additional grain is most useful. Speculators if successful, smooth out price movements, buying goods when they are below their long run price and selling them when they are above it, raising the price toward equilibrium in one case & lowering it toward equilibrium in the other. Buying when prices are low raises low prices; selling when prices are high lowers high prices. Thus Successful speculators decrease price fluctuations. The Rational Gambler You are betting on whether a coin will come up heads or tails. Your problem is to decide what bets to take. This is an example of declining marginal Utility. Buying Information You are trying to decide between 2 goods as to which to buy. You expect you will like 1 of the cars better than the other, but unfortunately do not

know which. By paying some search cost you reduce the uncertainty, improving the average outcome of your decision.

WHO GETS HOW MUCH WHY? When a Psychiatrist wants to get his audiences attention, he talks about sex. Economics speak about the income distribution. In both the cases the audiences interest is prurient, puritanical and personal. You read in a paper that the bottom 20% of house old receive less than 5% of all the income, while the top 20% receive more than 40%.That sounds like a world of radical inequality. But there are atleast 2 things wrong with the figures. The first is that they do not distinguish between differences in peoples lives and the differences where in their lives people are. Some people are retired people living comfortably on their savings in a home they own, or college students with part time jobs. One thing about which every1 agrees is that he is paid less than he should be. Being paid less means receiving less than your fair share of the worlds goods- and if i am getting less than fair share, someone else must be getting more than his. This raises 2 obvious questions: What determines how much each one gets? And what determines how much each of us ought to get? An employer is deciding whether to hire another worker. He calculates how much more output he could produce as a result. As long the market value of the increased output is larger than what he must pay the worker, he hires and profit goes up. He stops hiring at the point where one more worker is worth exactly what he costs. A Worker free to choose how many hours he wants to work will work up to the point where his wage equals the marginal value of leisure.

SUMMING PEOPLE UP
They keep coming to us with questions: Should we have a tariff?, Should we have rent control? Economists said they dont know anything about should go and talk to a philosopher. But our self-described economic imperialist cannot leave it at that. He thinks that economics can define a concept, efficiency, "that is an important part of what I suspect most of you mean by 'good'". As soon becomes apparent, he uses his notion of efficiency to pre-empt much of the job of ordinary morality.

"Simple," apparently, means "readily graspable by Mr. Friedman"; and to our author, nearly all rational behaviour reduces to the pursuit of cash. He himself notes that "[m]oney is no more the only thing with value than yardsticks are the only thing with length", but it soon transpires that the warning is pro forma. Indeed, the very sentence following the warning is: "Life, health, wisdom, all has value provided someone is willing to give up money to get them." How reassuring! Conventional economists hope to avoid the need for controversial ethical judgments in this way: Suppose some change makes at least one person better off and no one worse off. Then, salvation is at hand: while making no interpersonal comparisons of utility we can nevertheless say an improvement has taken place. But improvements of this kind, called Pareto superior moves, are few and far between. Usually every change will make someone worse off; and, if so, the Pareto criterion cannot be used. Our author has thus set himself a difficult task. He recognizes the limitations, if not outright failure, of the conventional Pareto approach. Nevertheless, he proposes not to give up: he does not wish to abandon questions of good and bad to the philosophers.

WHAT IS EFFICIENT ?
His answer has at least the virtue of simplicity. We count up the dollar gains and losses of a proposal, and adopt it if a net gain will ensue. More specifically, Friedman's plan makes use of the concepts of consumer's and producer's surplus. Oddly enough, this proposal falls victim to exactly the same difficulty that besets the potential-Pareto rule. The gains and losses go to different people: how, then, can an economist judge whether, "society" is better off? Further, estimates in dollars of gains and losses cannot be taken as measures of utility, since the utility of money may differ from person to person. Friedman recognizes these problems with his standard. As our author elsewhere notes, a policy can sometimes benefit one country without producing any gain for the world's economy. In a discussion of tariffs, he sums up: "So if the United States is a price searcher in international markets, the outcome without tariffs is efficient if all interests are considered but inefficient if only American interests are". And if our goal is to maximize total surplus, should we not encourage a large population increase? The more people, the more potential gains in surplus. Or are we supposed to be maximizing surplus over a constant population? But the problems Friedman recognizes himself are quite enough. He has not offered the slightest reason to think that efficiency, in his sense, is a good at all, let alone an important part of what we mean by good. The mistake in most discussions of natural monopoly is the assumption that the problem is monopoly. The problem is a particular kind of production function: one for which minimum average cost occurs at a quantity too high to permit perfect competition.

HOW TO GUM UP THE WORKS ?

In this chapter he started with the topic of PARADOX OF PRICE CONTROL. He explained this with the example of gasoline price. One way of making sure that u will get enough gasoline is by getting up early in the morning and arrived at the station. But the result is a long line because every people will do that. Having to wait in line raises the cost of gasoline adding a no pecuniary cost in time to the cost he is already paying in money. The result is a cost increased pecuniary plus no pecuniary way, higher than the uncontrolled price. In the next thing he is talking about RATIONING which means if the production is cut down by 20%, then consumers should be given ration tickets that permits to buy only 80% of last year. Efficiently allocating schemes must be implemented and Distribution versus Allocation. In which he says Allocation is what goods go where. Distribution is who gets how much. He says that we should distribute the limited resources in such a way that everyone should able to get equal benefits. According to the author, the redistribution methods like liability rules, price control results in improper allocation of resources with the exception of rents because in short run supply is inelastic. In order to protect consumers, licensing and certifications are granted so that consumers on the basis of that can decide which is good or bad. The author talks about how to cut taxes and increase revenue. He replaces progressive and regressive rate system with flat rate system because in that they can utilize their leisure time and can earn more income and pay better taxes.

MARKET FAILURE
The author focuses on market failures because they fail to produce the efficient outcome by citing rational action of every member of the group that makes it worse off. He describes the form of market failure as public-good problem. The solution to this is to produce public goods privately in number of ways .For example-by unanimous contract i.e. getting all the receivers together and deciding. The other is by privileged minority which means by forming small sub groups from the receivers who can be persuaded to bear the cost. Also by making public goods private temporarily and by combining two public goods. The other alternative is to let the govt. produce and pay for it from taxes. He connects the externalities (net cost or benefits ones action imposes on others) with cost and benefits. If cost is greater than the benefits, it will not lead to any work but if vice-a-versa is the case, it will. He emphasizes that efficiency can be controlled by imposing regulations and externality by proprietary community in which neighbours affect the decision and merger in which one company can control the cost and resources of the other company.

As Coases points out that externality can be treated by negotiations with both the parties involved as he talks about airport noise reduction or pollution problems but this solution depends on ability to measure the damage. Externalities can be implemented by contract / merge. Consider sharecropping both landlord and farmer contributes input and share the profits, same with publisher and author. The two kinds of mistake associated with externality according to the author are failure to distinguish benefits from external benefits and to include both positive and negative externalities which have been explained by in context of population growth, driving rules etc. which shows that the externality is pecuniary (positive effects=negative effects). He highlights the adverse selection behaviour of the users to go on searching unless and until they find the required satisfaction. The barter system has also been explained with respect to the customers in monetary terms because they have what the other want and vice-a-versa. Market failures should be seen as unfairness rather than inefficiency.

LAW AND SAUSAGE: THE POLITICAL MARKET PLACE

The author considers government action as an outcome of a political market place. In that market as in others rational individuals add to pursue their own ends. It has been the dominant view among economists that most tariffs hurt the nations that imposes them as well as the nations they are imposed against and that most nations, most of the time could be better off abolishing all tariff and moving to complete free trade. The author argues that tariffs cannot be an economic improvement as the result of competitive industry is efficient, a tariff alters that result taxing the conversion of commodities and reducing the quantities of the commodities used and produced, but this does not apply in a monopoly environment and tariff can reap more benefits in this case. The author goes on to explain the economics of politics. Democracy in present scenario can be considered as a trade. Politicians expect to reelected where as people trade their votes to get better benefits and development. Most of the time in the market for legislation the politician seeks to maximise his own utility, subject to the constraint that he can sell legislation for only as long as he can keep getting elected.

RATIONAL CRIMINALS AND INTENTIONAL ACCIDENTS : THE ECONOMICS OF LAW AND LAWBREAKING

The author even ventures to find the economics of crime. The economic approach to crime starts from one simple assumption that the criminals are rational. A rational mugger prefers defenceless old lady over younger ones. The author observes that the essential objective in any conflict is neither to defeat your enemy nor to make it impossible for him to defeat you but merely to make it no longer in his interest to do whatever it is that you object to. Considering broader version of market for political influence, market for illegal drugs, stolen goods market for sex (legal & illegal). Economics apply to illegal as well as legal market when one input to production is estimated, substitutes become more variable. The author deduces that increased enforcement raises the street price of drugs. We can have three different explanations for drug related violence. One implies that marginal increase in enforcement will decrease violence; two that they will increase violence if demand is inelastic, decrease it if demand is elastic. All imply that legalizing drugs would eliminate drugrelated crime. Dealing with the cost of crime the author is of the opinion that even though left appears to be merely a transfer he goes on to prove that it is not a transfer but a net cost. The author opinions that a better solution to the accident low is to charge by the result ie If I cause an accident then I must pay the cause. Externalities are internalised .I have an incentive to engage in an efficient level of accident prevention of every margin. Hence we have switched from safety regulation to civil liability for damages. A different approach is to make each party fully liable for the entire cause if the accident not to the other party but to the state. This approach may prove faulty because if both parties face lines for their role in the accident i.e a good reason not to report it.

THE ECONOMICS OF LOVE AND MARRIAGE

The author chooses to deal with the economics of marriage market with pinch of humour. He talks about gains from division of labour, specialisation etc. The author debates on the issue why one should marry his/her lover. It makes sense because love is associated with sex, and parents prefer rearing their own children to rearing other peoples. Also love reduces the conflicts of interest that lead to costly bargaining. Equilibrium on the marriage market is in part a problem of supply and

demand, but in part also a problem of sorting different people according to different tastes and attitudes.