hidden order

7/30/2019 Hidden Order

1/16

BATCH 2012-2014

ECONOMICS BOOK REVIEW

NAME OF THE BOOK:

HIDDEN ORDER- THE ECONOMICS

OF EVERYDAY LIFE


2/16

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 theirsurvival 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, thegoods 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


3/16

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 understandthe 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


4/16

According to Friedman theory of multiplying benefits makes one think thata single dime spent in the city can help enrich everyones life because itpasses on to many people who spend it again before it gets out of thecity. The mayor thought the same way while estimating that GMs $20million expenditure on payrolls and purchases in the city will mean that

the company will mean that the company will add $100 million to theincomes of the residents. The mayor might be confusing revenue withprofit while making the estimation.

For firms with either multiple or single inputs to production the logic ofsimple production can be divided into three steps i.e.

Choosing what to produce considering the implicit profitsthat 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 Aeven at a lower price.

For a producer a backward bending is analogous to the curiosity of thetheory of a Giffen Good-a good whose demand curve slopes in thewrong direction implying that consumers buy more of the good when theprice rises. The backward bending supply curve for labour suggests thatas the wages increase the number of hours worked will increase until acertain 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 propositionscan be found.

High costs or low quality is the reason why Japan andAmerica have a trade deficit.

To improve the trade balance America needs to imposetariffs while the Japanese dont.

A trade surplus is good while a trade deficit is bad for boththe countries.

Friedman further explains how declining marginal values motivatetwo parties to exchange goods and how this exchange of goods makesboth the parties better off. One can concur that an exchange of goodsmakes sense when one of the parties is very good at producing the goodand has plenty of it, and the other party is not good at producing it. Thisargument is defined as the principle of comparative advantage.Exchanges and bargains only work when both the parties are sure thatthe exchange will bring them profit. Friedman further explains that abalance has to be struck in case of a bilateral monopolistic bargainmaking both parties feel that they are gaining some value from the tradeand 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 onegetting ripped off in the process. Feeling that the other party is ripping


5/16

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

PUTTING IT TOGETHER: PRICE THEORY IN A SIMPLE

ECONOMY

The author explains the concept ofequilibrium taking the example of animaginary commodity called widgets. When the price of the commodity ishigher than the equilibrium price the producers want to sell more thanwhat the consumers demand. When the price goes below the equilibriumprice the consumers want to buy more than what the producers want tosell. According to the concept of marginal value the consumers do notmind paying a price more than the market price because they cannot buyas many widgets as they want hence causing the price to rise again andreach the equilibrium price.

Confusion can be avoided by coherently differentiating between thechanges in demand and change in the quantity demanded and the sameapplies to supplyand the quantity supplied. An increase in the demandcauses the demand curve to shift out and raises prices. Elasticitygovernsthe effect of price and quantity of shifts in supply and demand curves.

Who pays Taxes? To answer the question author considers two situationwhere in the government imposes tax on the producer or the consumer. Ifthe taxes are imposed on the producer there is an increase in price of thegood, the increase in price does not mean that the producer is getting ahigher price for the same good; instead the extra amount goes to the

government as tax hence in the process the price paid by the consumergoes up and the price received by the producer decreases, both of thesetogether constitute the tax that is paid to the government. When the taxis imposed on the consumer the consumer gives up the same amount toget the widget. Hence Friedman concludes that no matter who hands thetax over to the government the tax is really distributed amongst theproducers and the consumers.

After knowing that both the consumer and producer pay taxes one mightask what is the real cost of taxes or, as author puts it, how much worseoff it makes them. The relation between revenue and excess burdendepends on the shape of the demand curve. The steeper the demand

curve (more inelastic demand is), the less the given tax reduces quantityand thus lower the ratio of excess burden to revenue. Elasticity of bothsupply and demand are usually greater in the long run than in the shortrun. Friedman further uses price theory to explain how imposing taxes onlandlords and providing subsidies to tenants can make them worse orbetter off.

THE BIG PICTURE

After discussing a system involving a single good one can generalise theconcept to get a picture of the entire economy. An economy is an

interdependent system wherein both the consumer and the producer


6/16

preferences define how much of a good will be produced and at whatprice will the consumer buy it.

In order to put it together the author starts with individual preferencesand productive capabilities and find complete set of equilibrium pricesand quantities.

In real world situations the production of one good requires another goodhence the price of any good is dependent on the price of the requiredgoods. In contrast topartial equilibrium author describes this as a generalequilibrium that exists in interdependent economies.

BOSSES WORKERS AND OTHER COMPLICATIONS

In this chapter author discusses about the existence of the firms, thesteps 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 largelypopulated 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 theorganization 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


7/16

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 producethe 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 :-


8/16

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 aconsiderable 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 somedisadvantages:-

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,


9/16

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 itdecides 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, autility 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 theinternal 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.


10/16

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. IfPrice 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 tendto 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


11/16

know which. By paying some search costyou 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 thingswrong 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 tothe 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?, Shouldwe have rent control? Economists said they dont know anything aboutshould go and talk to a philosopher. But our self-described economicimperialist cannot leave it at that. He thinks that economics can define aconcept, efficiency, "that is an important part of what I suspect most of

you mean by 'good'". As soon becomes apparent, he uses his notion ofefficiency to pre-empt much of the job of ordinary morality.


12/16

"Simple," apparently, means "readily graspable by Mr. Friedman"; and toour author, nearly all rational behaviour reduces to the pursuit of cash. Hehimself notes that "[m]oney is no more the only thing with value thanyardsticks are the only thing with length", but it soon transpires that thewarning is pro forma. Indeed, the very sentence following the warning is:

"Life, health, wisdom, all has value provided someone is willing to give upmoney to get them." How reassuring!

Conventional economists hope to avoid the need for controversial ethicaljudgments in this way: Suppose some change makes at least one personbetter off and no one worse off. Then, salvation is at hand: while makingno interpersonal comparisons of utility we can nevertheless say animprovement has taken place. But improvements of this kind, calledPareto superior moves, are few and far between. Usually every changewill make someone worse off; and, if so, the Pareto criterion cannot beused.

Our author has thus set himself a difficult task. He recognizes thelimitations, if not outright failure, of the conventional Pareto approach.Nevertheless, he proposes not to give up: he does not wish to abandonquestions of good and bad to the philosophers.

WHAT IS EFFICIENT ?

His answer has at least the virtue of simplicity. We count up the dollargains and losses of a proposal, and adopt it if a net gain will ensue. Morespecifically, Friedman's plan makes use of the concepts of consumer'sand producer's surplus.

Oddly enough, this proposal falls victim to exactly the same difficulty thatbesets the potential-Pareto rule. The gains and losses go to differentpeople: how, then, can an economist judge whether, "society" is betteroff? Further, estimates in dollars of gains and losses cannot be taken asmeasures of utility, since the utility of money may differ from person toperson.

Friedman recognizes these problems with his standard. As our authorelsewhere notes, a policy can sometimes benefit one country withoutproducing any gain for the world's economy. In a discussion of tariffs, hesums up: "So if the United States is a price searcher in internationalmarkets, 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 alarge population increase? The more people, the more potential gains insurplus. Or are we supposed to be maximizing surplus over a constantpopulation?

But the problems Friedman recognizes himself are quite enough. He hasnot offered the slightest reason to think that efficiency, in his sense, is agood at all, let alone an important part of what we mean by good. Themistake in most discussions of natural monopoly is the assumption thatthe problem is monopoly. The problem is a particular kind of production

function: one for which minimum average cost occurs at a quantity toohigh to permit perfect competition.


13/16

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 makingsure that u will get enough gasoline is by getting up early in the morningand arrived at the station. But the result is a long line because everypeople will do that. Having to wait in line raises the cost of gasolineadding a no pecuniary cost in time to the cost he is already paying inmoney. 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 theproduction is cut down by 20%, then consumers should be given rationtickets that permits to buy only 80% of last year. Efficiently allocatingschemes must be implemented and Distribution versus Allocation. Inwhich he says Allocation is what goods go where. Distribution is who getshow 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 inwhich one company can control the cost and resources of the other company.


14/16

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 beseen 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 thenations 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 inpresent scenario can be considered as a trade. Politicians expect to re-

elected 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


15/16

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 drug-

related 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 chargeby 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


16/16

demand, but in part also a problem of sorting different people according

to different tastes and attitudes.

hidden order

Documents