A report on issues related to poverty & inequality in India

SUBMITTED TO MR. MIHIR K. MAHAPATRA

SUBMITTED BYGROUP - 2 DEVENDRA BHANSALI DIPANKAR CHAKRAVRTY NARASIMHAN KESHAVAN RAJKUMAR SINGH VIPIN BAJAJ 11015 11016 11032 11043 11060

PREFACE
The Armchair Economist: Economics and Everyday Life is a
economics book written by noted professor of economics Sir Steven Landsburg. The book is a collection of routine examples illustrating important economic and financial theories.The underlying theme of the book, as Landsburg states on the first page, is that most of economics can be summarized in four words: People respond to incentives. In the first few chapters, Author tried to explain the Responsiveness towards Incentives with quite a many examples such as Accidents, safety legislations, etc. He also tried to explain the rationality issues with the economists slogan-De gustibus nonest disputandumthere's no accounting for tastes. With this apparently innocuous observation, Landsburg discusses some unexpected effects of various policies such as automobile safety legislation and environmental policies. Part Two entitled "Good and Evil" provides some insight as to how the pure economist thinks. Dr. Landsburg correctly points out that public policymaking is inherently fiawed because it is not based on any fundamental principles relating to what constitutes good or fair. Dr. Landsburg also explains the Coase Theorem of property rights using the example of a doctor whose patients are upset by the noisy candy-making machines that are operated in the building next door. The rest of the book includes expositions on a wide range of topics, including budget deficit, unemployment, economic growth, and cost-benefit analysis. What we, the group liked about the book is that the comprehension part. As, it is very easy to comprehend and the authors way of explaining the things is quite commendable. As the author remarked at the start of one of the most enjoyable chapters-"Economic theory predicts that you are not enjoying this book as much as you thought you would." The point turns out to be this: the fact that you have chosen to read it is a sign that you have probably overvalued it in relation to all the other books you could have read instead. Landsburg has written a very clear introduction to the thinking of a particular kind of economist: those of the so-called Chicago school of which he is himself a member. Where their thinking is confused, the book is confused; where it is clear, so is the book. But we did enjoy it, and would recommend it.

THE AUTHOR
Steven E. Landsburg is a Professor of Economics at the University of Rochester, where students recently elected him Professor of the Year. He is the author of The Armchair Economist, Fair Play, More Sex is Safer Sex, The Big Questions, two textbooks in economics, a forthcoming textbook on general relativity and cosmology, and over 30 journal articles in mathematics, economics and philosophy. His current research is in the area of quantum game theory. He writes the monthly Everyday Economics column in Slate magazine, and has written regularly for Forbes and occasionally for the New York Times, the Wall Street Journal and the Washington Post. He appeared as a commentator on the PBS/Turner Broadcasting series Damn Right, and has made over 200 appearances on radio and television broadcasts over the past few years.

The Armchair Economist: Economics and Everyday Life

The Author tried to amalgamate the general concepts of Economics with the daily activities. Heres a brief summary of, what the author wants to express and what we learnt. The first chapter is about the critical role played by incentives in economic behavior. Dr. Landsburg explains that the introduction of a regulation causes a consumer to change his behavior. He says that economics can be summarized as people respond to incentives. The author says that if the prices are allowed to rise freely, customers will reduce their consumption. It clearly depicts the relationship between quantity demanded and price of the product as explained by Law of Demand. As per this principle, the incentives provided to the drivers in the form of seat-belts, padded dashboards, collapsible steering columns, dual-breaking systems and penetrationresistant windshield did not result in a decline in vehicular accident-related deaths as lawmakers had anticipated. While the use of safety belts helped to prevent some deaths, this phenomenon was offset by the propensity of drivers to drive less carefully because the incentive to drive with prudence in the absence of seatbelt protection had disappeared. The seat-belt regulation did reduce the number of driver deaths by making it easier to survive an accident. But it also increased the number of driver deaths due to reckless behavior and the number of pedestrian deaths. There were more accidents and fewer driver deaths per accident, but the total number of driver deaths remained essentially unchanged. At the end of the day, incentives do matter. One cannot underestimate the power of incentives Chapter Two explores talks about rational chaos. For example, why don't rock concert promoters raise ticket prices in the face of a sellout? The answer here is simple. Rock concert tickets sell out in advance even if the promoters increase the price of the tickets. But the promoters dont increase the price. The rationality of this decision is argued and the probable reasons for not increasing the ticket prices are as follows: The long queues for the concert are a good advertisement to the show. Therefore, the promoters do not increase the ticket price. But the author argues that the high selling price of the tickets is also a good advertisement to the rock shows. The other reason for not increasing the ticket prices is that the promoters want a teenage audience who buy rock memorabilia whereas adults dont buy those. Therefore it is necessary to keep the ticket prices affordable.

Describing the decisions made by individuals as rational and finding the reasons why the particular behavior is rational is one of the basic principles in microeconomics.

Chapter Three, "Truth or Consequences," provides some timely insight into the relationship between asymmetric information and insurance pricing. The author contends that a deficit of information on consumer prudence leads an insurance company to charge premiums that are commensurate with an average risk level. The risk averters, who know how they behave, feel they are paying too high a price and forego insurance. This leaves a pool of insured parties that is dominated by risk takers. This increases average risk and results in a higher premium charged by the insurance company. As the next level of risk averters conclude that the new premium charged is too high, they too forego insurance, the average risk level rises once again, and the cycle of rising rates continues. Ultimately, the pool of insured parties would be so risky that the insurance company would incur large losses that would jeopardize its financial solvency. Insurers seek to ameliorate the asymmetric information problem and the associated dilemma of moral hazard by providing rate incentives to parties who reveal information about any behavior that affirms the inclination towards prudence. For example, getting a car alarm is one type of signal a risk averter can give to the insurance company in order to facilitate the provision of cost effective insurance. Then, the author talks about the Indifference principle. As per authors argument, the gain is certainly not busboys. Because the wages of the busboy is inversely proportional to the tip. The restaurant owner does not benefitted even after decreasing the busboys wages. As the total cost of food falls by the amount of tip given by the diner, the owner cant afford to keep the same menu prices. Therefore, the menu prices shrink. Thus, the benefit of the tip is returned to the diner. The Indifference Principle guarantees that all economic gains accrue to the owners of fixed resources. Only the owner of a resource in fixed supply can avoid the consequences of the Indifference Principle. Part Two entitled "Good and Evil" provides some insight as to how the pure economist thinks. Policy makers believe in list of pros and cons. They need moral philosophy to guide the decisions. Dr. Landsburg correctly points out that public policy-making is inherently flawed because it is not based on any fundamental principles relating to what constitutes good or fair. He argues that taxes are almost always an evil, in as much as they contribute to economic inefficiency and create dead weight losses. Yet, there is overwhelming political support for taxes, especially progressive taxes, as a good because some redistribution of income can be achieved. That begs the question as to whether redistribution of income is inherently moral. Since rational self-interest underpins the idea of capitalism, the market-driven

economist's response to this query would differ from the popular notion of equalizing wealth.

ECONOMICS IN THE COURTROOM

In law and economics, the Coase theorem, attributed to Ronald Coase, describes the economic efficiency of an economic allocation or outcome in the presence of externalities. The theorem states that if trade in an externality is possible and there are no transactions costs, bargaining will lead to an efficient outcome regardless of the initial allocation of property rights. In practice, obstacles to bargaining or poorly defined property rights can prevent Coasian bargaining. Dr. Landsburg explains the Coase Theorem of property rights using the example of a doctor whose patients are upset by the noisy candy-making machines that are operated in the building next door. Bridgman made candy in the kitchen of his London home. In 1879, Dr. Sturges built a new consulting room at the end of his garden, adjacent to Bridgman's kitchen. Only after the construction was complete did the doctor discover that Bridgman's machinery made noiseso much noise that the consulting room was unusable. Sturges brought suit in an attempt to shut down Bridgman's business. But, the judge ruled for Sturges. When negotiations between the doctor and the candy-maker are possible, it is shown that resources are most efficiently allocated when they are directed to their most profitable use. A judge is unable to identify and thus direct resources to their most profitable use. This can only be decided by the owners of the resources. In the event that the doctor's business is more profitable than making candy, the doctor should pay the candy-maker a fee that is sufficiently large enough to motivate him to cease making candy and allow the doctor to enjoy a prosperous practice.Economists are usually far more concerned about the allocation of resources than they are about transfers of income between individuals. That is, it does not affect what gets produced, or the means of production. There is a flip side to the Coase theorem, which can be dealt as : When circumstances prevent negotiations, entitlementsliability rules, property rights, and so forthdo matter. For certain cases the court's decision matters, and the efficient decision depends on the particulars of the case. Dr. Landsburg continues to argue in this chapter on the benefits of the price system. He presents a cogent argument as to how signals by consumers and producers are best reflected in the price-setting mechanism of a free market. Adam Smith would be very happy with the explanation of the invisible hand concept presented herein. His conclusion is that inefficiency exists when

markets are missing. This is a truism for economists. Unfortunately, the merits of a free-market system in which prices convey information about wants and needs is an idea that is woefully misunderstood by the public at large.

Consider air pollution. If a market existed for clean air, local residents and polluting factories could set the appropriate price for clean air and the optimal amount to be maintained. Because this market does not exist, the exact benefits and costs associated with clean air cannot be assessed and regulation is promulgated to provide for less pollution. Unfortunately, as Dr. Landsburg explains, regulation further distorts the supply and demand equation, and the result is a wholly unsatisfactory one for all parties.

THE MYTHS
In third Part, the Author explained of certain myths that are quite prevalent in public. As, he pointed out quite rightly, at the rate of one dollar per second, it would take over one hundred thousand years to pay off the national debt. Such facts titillate, but they do not enlighten.

MYTHS ABOUT WHAT THE NUMBERS MEAN

Myth 1: Interest on past debt is a burden. Interest payments on past debt are included in the calculation of the deficit, which implies that these payments add to the taxpayers' burden. Myth 2: A dollar spent is a dollar spent. That is, a dollar spent in erecting a government office building (which uses up steel, glass, labor, etc.) is the equivalent of a dollar paid out by Social Security (which makes one person richer and another poorer without actually consuming anything) which is not correct. Myth 3: Inflation doesn't count. In fact, inflation is an enormous boon to any debtor, including the government. Myth 4: Promises don't count.

MYTHS ABOUT INTEREST RATES

Myth 5: The "Goliath" Myth. According to this theory, the country is populated by little "Davids," competing against the "Goliath" of tine federal government, which annually consumes $200 billion that would otherwise be available to Davids seeking to finance their cars and their houses. This competition for a limited supply of money drives up interest rates to the point where David can't even afford to finance a slingshot.

Myth 6: The Myth of Dick and Jane.

MYTHS ABOUT THE BURDEN OF THE DEBT

Myth 7: Our grandchildren will inherit our debts. Our grandchildren will inherit not only our debts but also our savings accounts, which include the additional wealth that we save by paying lower taxes in the present. Myth 8: The Myth of Crowding Out. This is similar in form to the Goliath myth, except that this one concerns physical resources rather than money. Myth 9: Deficits hurt our trade position. The author also explained about how we misinterpret Statistics and he explained it with the help of some examples. Economy wide unemployment can be a sign that times are getting worse or a sign that times are getting better. The same is true at the level of the individual. The author explained it by a example that when Peter chooses to work 80 hours a week and get rich while Paul chooses to work 3 hours a week and get comfortable in other ways, who is to say which choice is the wiser?. In economics, morality, or for that matter personal instincts say we should approve more of one than of the other. Unemployment or a low level of employment, can be a voluntary choice and a good one. It is easy for observers to falsely convince themselves that Peter must have been wiser or more fortunate than Paul, because Peter's income is more conspicuous than Paul's leisure. Statistics is a plain truth but we interpret it wrongly most of times. A doctor probably have different opinions about the average size of his waiting room crowd. Perhaps it's because you are just more aware of people when they are coughing on you and there are no empty chairs. More likely it's because you and your doctor are measuring different things. More justified when he says There are always more no of people who know the clinic is crowded. Another examples can be a Statistical illusion of poverty and Finding a table in Non smokers section. In fourth part, The author highlights the importance to investors of assessing risk versus return. While this important tradeoff is a fundamental principle of financial valuation to professional investors and academics, many are unaware that a higher expected return comes at the expense of a higher risk potential for any given security. His advice to the reader is to focus on constructing a well-diversified portfolio and forget about the celebrations of a given stock provided by one's friendly broker. We thought that his comments regarding the efficient market hypothesis were grossly simplified. Still, the author can be forgiven this deficiency if you keep in

mind that the intended audience probably wouldn't want more of an explanation of market efficiency anyway. Economic theory predicts that you are not enjoying this book as much as you thought you would. This is a special case of a more general proposition: Most things in life don't turn out as well as you thought they would. While psychologists, poets, and philosophers have often remarked it as a necessary consequence of informed, rational decision making. The author elaborated it by the example of selection of a book. Choosing a book is a process fraught with risk and uncertainty. Fortunately, your lifetime of experience as a reader is a valuable guide. It enables you to form some expectation of each book's quality. Your expectations are sometimes very wrong, but on average they are far better than random guesses. Some books are better than you expect them to be and others are worse, but it is unlikely that you err in one direction much more often than the other. If you consistently either overestimated or underestimated quality, you would eventually discover your own bias and correct for it. So it is reasonable to assume that your expectations are too low about as often as they are too high. This means that if you chose this book randomly off the shelf, it would be as likely to exceed your expectations as to fall short of them. But you didn't choose it randomly off the shelf. Rational consumer that you are, you chose it because it was one of the few available books that you expected to be among the very best. Unfortunately, that makes it one of the few available books whose quality you are most likely to have overestimated. Under the circumstances, to read it is to court disappointment. THE IOWA CAR CROP The author quoted very beautifully that A thing of beauty is a joy forever and nothing is more beautiful than a succinct and flawless argument. A few lines of reasoning can change the way we see the world. The author talk about his friends David Friedman one of the most beautiful arguments. While the argument might not be original, David's version is so clear, so concise, so incontrovertible, and so delightfully surprising and moreover the argument concerns international trade. David Friedman said that there are two technologies for producing automobiles in America. One is to manufacture them in Detroit, and the other is to grow them in Iowa. When you have two ways to make a car, the road to efficiency is to use both in optimal proportions. The last thing you should want to do is to artificially hobble one of your production technologies. Iowa trades Wheat for Cars with Japan. Policies rooted in superstition do not frequently bear efficient fruit- Imported cars traded in from IOWA are less American than cars manufactured in Detroit. If we have two paths then we should pave a way that includes the benefits of both.

Finally, The Author talks about the Economics of Scientific Method and questions whether Albert Einsteins theory of relativity is credible or not. In 1915, Albert Einstein announced his general theory of relativity and some of its remarkable implications. The theory "predicted" an aberration in the orbit of Mercury that had been long observed but never explained. It also predicted something new and unexpected, concerning the way light is bent by the sun's gravitational field. In 1919, an expedition led by Sir Arthur Eddington confirmed the light-bending prediction and made Einstein an international celebrity. Both the explanation of Mercury's orbit and the successful prediction of light bending were spectacular confirmations of Einstein's theory. But only the light bendingbecause it was unexpectedmade headlines. The Author questions the reader- Does novelty matter? The "novelty doesn't matter" camp argues that a theory should be judged on its own merits, independent of how it was discovered. The author goes on the extent to explain it by a example as Consider a simple analogy. Of the socks in your left-hand drawer, one-half are black. Of the socks in your right-hand drawer, none is black. If you choose a sock from the left-hand drawer, what is the probability it is black? Surely one-half. Now suppose that while blindfolded, you reach into a randomly chosen drawer and remove a sock. Your spouse, who has been watching, then informs you that you chose from the left-hand drawer. What is the probability that the sock is black? Still one half. All that matters is where the sock came from, not what you knew when you were choosing it. The scientist choosing among possible theories bears some resemblance to a man choosing a sock. In his left-hand drawer are theories that conform to a particular set of facts, and one-half of these theories are true. In his right hand drawer are theories that are refuted by the facts, and none of these theories is true. The scientists who describe their theories based on novelty produce true theories. There are two ways to produce a theory: Theorize first and then produce Look first and then produce. If scientists theorize first, their work is expensive, too few theories survive, and not enough good bridges get built. If scientists look first, there is no way to tell the good theories from the bad ones and too many bad bridges get built and then fall down. The author divided scientists into two groups-

 Lookers and Theorizers.Theorizers generally are the ones who produce novel predictions. Theorizers who produce a novel prediction get a pay for $100,000. The ones who fail get $20,000 Lookers get a guaranteed pay of $50,000. This is done to keep the BAD away from the GOOD. The government must fund the researches that have no social value whatsoever. Thus the research institutes will be efficient in producing successful theories by making way for the good scientists.

Science of Economics v/s the Religion of Ecology

Economics is a way of thinking, with an influence on its practitioners that transcends the demands of formal logic. Economists are extraordinary in their openness to alternative preferences, life-styles, and opinions. The author explained it by examples likeRecycling of paper- eliminates the incentive for paper companies to plant more trees and can cause forests to shrink. If you want large forests, your best strategy might be to use paper as wastefully as possible. Also, by Removing pesticides which will lead to rise in prices of the vegetables and fruits. Less people will consume them. More people will tend to spoil their health. Finally, to sum it up, In authors words, Economics in the narrowest sense is a science free of values. But economics is also a way of thinking, with an influence on its practitioners that transcends the demands of formal logic. With the diversity of human interests as its subject matter, the discipline of economics is fertile ground for the growth of values like tolerance and pluralism.

Conclusion
The Armchair Economist: Economics and Everyday Life is rich with straightforward but powerful illustrations of key tenets of economics and finance. An understanding of economics is indispensable to understanding how financial markets work and how consumers and firms behave and this book makes critical ideas easy to digest and fun to read about. The book is entertaining and often witty, and written in a conversational, easy-to-read style. The book is very good at presenting often unintuitive and novel ways of looking at things. This is an invaluable book for pointing out common fallacies in arguments about deficits, inflation, unemployment, and other major political issues. At the same time, however, we think that thr author occasional misses significant relevant issues, most glaringly in the final chapter on environmentalism. For example, author describes a case where Jack wants a woodland at the expense of Jill's parking space and vice versa, and argues that the desires are exactly symmetrical. While environmentalists claim that the wilderness should take precedence "because a decision to pave is 'irrevocable'", Author says "a decision _not_ to pave is _equally_ irrevocable" because "Unless we pave today, my opportunity to park tomorrow is lost as irretrievably as tomorrow itself will be lost". While this is correct, this misses the environmentalist's point that it is much easier to convert woodland to parking lot than to do the reverse. The environmentalist fears taking actions that are irrevocable in the sense that they cannot be undone in the future. Author's perspective throughout the book seems to me to ignore the possibility of actions taken which may have consequences which may adversely affect the very existence of mankind. Another example in the same chapter is when he suggests that the best way for environmentalists to support the existence of cattle is to eat beef: "If you want ranchers to keep a lot of cattle, you should eat a lot of beef". This presumes that environmentalists care about the number of cattle in existence, irrespective of their living conditions. Nonetheless, we recommend this book for the content clarity and for the examples of economic and financial principles in an entertaining way.