Economics and Public Policy
Start
Course Focus
General understanding of Economic Terms
Figure out how understanding of economics helps people earn money
Understanding the Economics of Welfare (Poverty, Development, Pollution)
How does the Finance Minister make decisions? Whats is the rationale behind economic policy decisions and what are the implication of politics?
When Economics Matters?
Scarcity
Historically it was not important, it was linked with political economy until adam smith institutionalized the study of economics
Limited resources are where we need Economics. Abundance doesn't create conflict.
Choice
Economics is useful when choices are available for the interacting agents
Economics can help people understand the results of choices
Competition
Ideally in the perfect world there is perfect competition between firms
In the real world we deviate from free market behavior in the form of monopolies, government intervention
How to Think like an Economist?
Optimizing choices under constraints
Rational actors: acts to maximize gain and minimize losses (Not always the case in reality)
Efficiency: Prefer the maximum utility/resource often at the cost of fairness (Utilitarian View) Maximize without making others worse off (Pareto/Welfare view)
What influences Economics?
Institutions: Formal or Informal systems that organise social, political and economic relations,are reproduced through routine actions, and shape behaviour thus affecting developmental outcomes.
Power and Control: Institutions can exercise power over groups leading to deviation from rationality and efficiency
Key Terms in Economics from Dasgupta
Understanding Supply, Demand, Markets, Market Failures
Understanding different streams of thoughts: Keynesianism (Role of the State) Neoclassicalism (What we typically study) etc.
Economics v. Political economy
Political Economy (pre Adam Smith) politics and economy was completely intertwined in studies
Economics: Shifted focus to purely the economic systems and theorize about that
Macro vs micro Economics
Micro: Looks at a smaller scale - Households, Firms, Local Markets, etc
Marco: Looks at a larger scale - Global Economics, State Economics
In practice, the interactions have to be considered for a good study as the separation is artificial
Opportunity Costs
Opportunity cost is the benefit that one forgoes by making a choice
Equilibirum is the best case when there is perfect competition
Circular Flow of Interactions descibe the flow of resources
Model are also used to analyse, establish causality etc
Economic Growth and Inequality
Hockey Stick Diagram
Different rate of growth, increasing with time
Time vs GDP based growth per capita
Inequality of Growth
Growth Pattern across different people have been observed
Capitalism as a driver for inequality
The Skyscraper Diagram
Average Income Distribution in PPP$ (a measure of how much money you make) in the population (y, z axis) vs country (x axis)
PPP$ is a theoretical exchange rate based on the cost of a comparable basket of goods
Width = population
Rich Poor Ratio as a measure of Inequality
1000 years ago, things were uniform. Even in 1980s skyscrapers were not abrubt as the rich poor disparity was less
Private market influences inequality
Migration Distress and Trends in Covid 19 Crisis: Increasing Inequality in India, Richer People spend a lot more for essentials and non essentials
Countries that took off earlier have reached a rich but inequal distribution while younger developing countries are still at low flatlands
Income Measures
GDP = Total sum of goods and services produced in the country and measured per unit population but is not a good measure of wellbeing
PPP$ is a uniform fiscal value system
Noth
Economic Growth
No uniform in nature, Britain was early 1650s. India and China had its burst in growth in the late 20 century
Improvement in lifequality did not happen until independence
Measures of Growth
%GDP growth rate, YoY/MoM percentage change over a unit period
Compounded Annual Growth Rate is used when there are large variation over longer periods (used mainly for sectors not overall)
Growth is often done on log scale to clarity in representation of exponential growth
The Capitalist Revolution
Attributes of the revolution
Impact on Technology: Agents/Firms have an incentive to innovate and develop new technologies
Specialization: Division of Labor and assembly lines increase productivity (Adam Smiths Pin Factory)
Did Capitalism cause the hockey stick curve?
Natural experiments to investigate causality
Division of East and West Germany: Two economic systems in a similar environments has different growth capitalist>socialist
Newer experiments try to incorporate Randomized Controlled Trials
not all capitalists have been successful
Different conditions are required for capitalistic dynamism that leads to growth
Economic Conditions
Secure private property
Competitive markets
Meritocratic evironment
Political Conditions
Government provides infrastructure, education, healthcare, defense
Supporting Laws and Regulation
Taxation and other interventions
Needs
Private incentives for cost reducing innnovations
Public Policy that supports the condition
Public policy to provide essential goods and services
Capitalism and Democracy
Democracy gives equal power to all people
Advent of democracy reduced inequality by reducing share of top 1%
Capitalism and Environment
The poriuction has local (local habitat destruction, pollution) and global impacts (global warming)
Previously rediced to negative externalities but is changing
Updated Circular Flow model takes the role of the Bioshphere into context
Sustainability is needed to be taken into account
Technological advances to reduce cost driven by internalization of previous negative externatilies can help the environment
Democracy and Environment
Democracy may not been effective tools for sustainability
National focus can undervalue the global picture (Australia is not involved in global movement while doing good internally)
Democratic Citizens can choose to make decision in favor of future generations
Social Interactions
Economics happens in a socio-political context of institutions and needs to be studied accordingly
It it embedded in the biosphere and interacts with it
Depleting GW levels in villages near Bengaluru
GW is a common good and is non excudable but if you can overuse and reduce the amount available to others
It is succeptible to the Tragedy of Commons, can drive overconsumption harming everyone
Observed in the villages in Arkavathy Basin
77% of borewells have failed, depspite higher dependency on borewells. Self interest at the cost of public interest
Context
Insititutions play a key role in determining economic outcomes
Self-interest can bring good (innovation)
External effects arise when one's action affect others
Social Dilemma
Self-interested actions lead to sub-optimal outcomes
Tragedy of the Commons (Hardin) = cost is shared so the net short term cost to the agent is small driving exploitation
Free-riding utlizing public resources without cost/contribution
Solving Social Dilemmas
Social Preference: To care about the community consequences of actions (eg. support duing wars/ disasters)
Government Public Policies (Quotas for Fishing, Water Tarrif, Pollution Permits)
Local Institutions: Community creates institutions to regulate behavior (Village stand pipe over private pipes, Cauvery Family by Farmers)
Game Theory
Cost Benefit Analysis in case of interations between multiple agents
Social Interaction: A situation where action of one affect own and others outcomes
Strategic Interaction: A social Interaction where agents are aware of how the actiosn effect others
Strategy: Actions taken with the awarenedd og the mutual dependence of outcomes
Components of a Game
Players
Feasible Strategies
Information
Payoffs
Dominant Strategy
Action that yield maximum payoff for a player irrespective of what others do
Domainant Strategey Equilibrium where al players play the dominant hand
When self interest guides to the pareto optimal solution, its the invisible hand effect
Nash Equilibirum: Optimal strategy given the strategy of the other players
Does Invisible Hand Work?
Prisoners Dilemma: Independent Dominant Strategy (Nash) Equilibrium is different from pareto optimal
Farmer Example: Integrated Pest Control (Environment Friendly, best if both use) Terminator (Use of One will affect other badly, If both use it has externalities)
A Game where domaninat strategy equiloibtium is lower for each player and lower in total
Assumptions and Solution
Player only care about their own payoffs: Introduce social prefences
No consequences of actions: repeated games, social norms, peer punishment (Tit for Tat)
No Coordination (Introduce Insitutions and Policies)
Public Goods Game
Public Goods (non-rival and non-excludable)
Multiple players
Explains free-riding (the dominant strategy is not to contribute)
Repeated Games can solve problems
Social Norms, Reciprocity, Consequences of Selfishness in future, Peer Punishments
Social Preferences
People are concerned with what is happening to others place values on how out actions affect other people as well
Data collection
Survey Questions (subjective answers)
Statistical Studies of economic behavior (cannot control the environment)
Lab experiments: Control Treatment and compare, also replicable
Field Experiments: Realistic and more contextual
How social preferences affect games
Altruism: Willingness to help others
Reciprocity: Desire to help those tho helped you and harm others
Inequality Aversion: Disliking outcomes which are inequal
Negotiation
Coordination Game: Multiple nash equilibria (where cooperation is better, when you know what the other is doing) (Can promote negotiation)
Bargaining
When there are multiple nash equilibria but are not equally rewarding for the players there is a conflict of interest
Solfware Engineer Game: Coordination to use the same software is good, but one nash eq. is better for one
Other factors will affects the game: power dynamics and history
Global Climate Change Game
Business and Usual (BUA) vs Restriction (Aim to reach Restrict/Restrict)
Essentially a Hawk Dove game (Both want the other to restrict)
Negotiations are complex
Public Policy to change the game
Sustainable consumer lifestyles
Governement Stimulation for innovations and clean tech (can promote increase in demand: Jevon's Paradox)
Change in Norms
Even Cost Sharing of externalities
Efficiency and Fairness
Public Policy
Allocation: outcome of economic interactions
Policy aims to ensure efficiency and fairness
Example: Solving Tragedy of the commons
Make cows common property? (Who takes cares - free rider)
Enclosure to create private property (unfair)
Economics has a different idea of efficiency and fairness and there are pluralitistic approaches to these. Equity != equality
Ultimatum Game
Sequential Game the split can be accepted or rejected
Self referential playes accept all offers (some thing is better than nothing)
Other referential players reject the offer when it violates their norm of fairness
Trade-off of efficiency and fairness (rejection is inefficient, accepting is unfair)
The Pareto Criterion
Condition is pareto efficent if there is mutually benefit where no alternative has a better condition for one without a worse condition for others
Fairness is an subjective evaluation and conception of justice
Criterion: an allocation be pareto efficient
Pareto Dominant:No one prefers strategy over other, and atleast one strictly prefers it
Pareto Efficient: no improvement for one without worse for other
Pareto indominant: There is a policy that is preferred and increses for atleast one without affecting others
Compensation through public policy can affect the pareto efficiency
Defining Fairness
Allocations can be unjust based on:
Substantive judgement of fairness (the nature of the distribution itself)
procedural judgement of fairness (by the nature of the origin of the inequality and the morality of the process)
Outcomes of Public Policy
Its the result of the interaction of government actions and privately chosen actions of individuals
Policies can influence outcomes through:
Prohibitions and directive (mandatory enforced rules)
Incentives (Voluntary choices to inprove payoff)
Information provisions
Nash equilibrium != Pareto Optimal
Solve tragedy of commons using overgrazing tax: the nash equilbrium at (!restrict,!restrict) is shifted to (restrict, restrict) due to reduced payoff
Tax avoidance game
Government: High Tax, Low Tax
Firm: Pay tax, Tax Evation through loopholes
Nash Equilibrium is (HIgh Tax, Loopholes)
Policy shouldnt change prefernece in unintended ways and the final outcome is a nash equilibrium
Models of Individual Choice
What makes a model good
Clear
Identifies important relationships
Predicts Accurately
Useful
Improves communication
Ceteris paribus: Holds other factors constant
Opportunity Costs
Economic Cost:
Monetary Cost +
Subjective Costs
Decision is based on Economic Cost which includes bost opportunity cost and out-of -pocket cost
Accountant Profit is limiting for the decision making as it doesnt
Questionnaires can be used estimate costs of opportunities
Opportunity Cost: Net Benefit of the next best alternative
Production function
We need to factor in different conditions to understand the output for a better perspective
Production Function: How inputs translate into outputs holding all other factors constant
Example: Production Q(Labor L, Capital K)
In the kitchen, K = Stoves, L = Staff
Differences in Short Run (K is constant) and Long Run (K is variable)
Rate of Production (Slope) increase with input = marginal
Diminishing Returns: Reducing Marginal product with increase in input
Eg: One stove many cooks, Small farm more workers
Feasible Set
Opposite of Production function
Production possibility frontier, with the same conditions whats the maximum we can produce (Free time vs grade)
Anything within the feasibility frontier is possible anything beyond it is not practical (Essentialy describes a tradeoff)
On the boundary the conditions are pareto efficient
Slope of the feasiblity frontier (Marginal rate of transformation) represents the tradeoff (opportunity costs faced)
Preferences
Utility is a measure of satisfaction
Indifference curves shows differrent amount of different commodities that the agent is indifferent between (no preference)
Slope of indifference curve (marginal rate of substitution) represents tradeoffs the individual is willing to make
Properties
Slope Downward (Tradeoff)
Higher Indiffernce curve= higher utility
Smoothness
Non-intersecting
diminishing MRS
Optimization
Budget constaints: Sum_i(P_i * Q_i) = Budget
Can intersect with indifference curve
Tangential Indifference cuve is optimal
For two products, slope of constraint = -Px/Py, MRS is given by Sum(del_Utility) = 0 => MU_xQ_x + MU_yQ*y=> MRS = --MU_x/MU_y
At optimal, MU_y/MU_x = P_y/P_x
Progress
Can change the production function therefore chaning the feasibility frontier
Same production with more free time (eg tractors usage imporves production)
Two fold effect in case of normal goods
Income effect: More Income= Quality of life better => more free tie and consumption
Substitution efffect: Opportinty cost of free time increases
The net effect depends on relative strength according to individual preference
Public Policy
Jason Hickel (People believe we need growth because they start from the assumption of scarcity. There is no scarcity, there is inequality)
Decline in real wages over time while labor productivity has increased. A marxist observation. Rishing Labor exploitation
Function and personal distribution of income
Factor payments/income method: GDP = Sum of factor payments by all firms = wages+interest+rent+profit = total income
Gini Index in increasing, Wages is decreasing but Correlation is not causation. What are the confounders? Through regresion analysis, the paper by Francese and Mulas-Granados attributes it to wage dispersion (rich get more percent not the absolute value) not falling ware share
When we measure income, theoretically we want to study the functional distribution (among factors of production) but we end up looking at the personal distribution when looking at inequality.
Draw from constraint optimization to analyse how settings can influence decisions along the fraction of independence
Reservation options: A fallback option, what alternative available to you
Factors to consider
Constraints
Biological Constraints: Minimum utility required for required for survival (such as food/wage)
Technological Constraints: Feasibliity frontiers
Institutions: the (formal and informal) laws and social customs governing the way people interact in society. (Role of Power in economics)
Rules of the Game: determine the ability of the players to obtain a high payoff i.e. their bargaining power. Master has control over slaves, dictator over public etc. as opposed to independent free trade.
Bargaining power = extent of a person’s advantage in securing a larger share of the economic rents made possible by an interaction. (Eg. Ultimatum Game: Proposer has more bargaining power)
Farmers production function: grain producted per unit time use, Feasibility Grain consumed per unit free time
Real life example: Pre 1973 West Bengal, high income inequality. Operation Barga by Left Front: protection from eviction as long as rent is paid and 3/4 of the crop can be kept. Not Pareto efficient but decreased inequality and farm productivity.
The Conceptual Models: Angela and Bruno (Two farmer with different relations) and the gradient of the bargaining power
Angela as an independent farmer (Independent farmers witj access to land)
Same as constrained choice, maximizes utility when MRS=MRT Indifference and feasibility frontier tangentially intersect
Rule of Force: Bruno does not farm but takes some of Angelas harvest by force (Slavery and coerced Labor)
The lowest possible indifference curve is Biological constraint for Angela, Feasibility Frontier is combined for Angela and Bruno. There is a technical feasible set between biological and technological constraint, the optimal solution will be again when MRT joint = MRS for Angela any movement reduced the amount that Bruno gets.
Property Rights and Rule of Law: Laws protect Angela from coercion but bruno own the land (sharecropping, employed workers)
Legal system protect angela but no ownership.Reservation indifference curve. When there is reservaton option, Angela can just opt for that. But there is an indifference curve that has the same amount of utility as the reservation option.. The new region is the economically feasible set. (Bruno has no reservation option)
Why care about pareto efficiency? A economic framework. At MRS= MRT, all things are optimal. all movement at this point is efficient. Room for negotiation
Economic rent: All benefits recieved aboce the the reservation option
Property rights, rule of law and voting rights (20th century capitalist democracy)
Union and Lobbing as option. More representative of the current scenario. Bargaining changes the indifferece curve to higher utilities (same pay for less work) but such a movement is harmful to Bruno. Bruno will bargain to raise work to bring new curves to MRS MRT
Biology+Tech=>Technically Feasible Outcome(+Preferences+Reservation Option)=>Economically Feasible Option(+Bargaining Power+Preferences)=>Allocation Outcome
Other Factors at Play: Endowments
The facts about an individual that may affect his or her income. This includes physical wealth (land, housing, or stocks) and human capital (level and quality of schooling, special training, work experience).
Differences in endowments, as well as institutions, may in turn affect bargaining power – for example by producing different reservation options.
How did Bruno get the land? Why was brune able to overpower Angela
Measures of Inequality
Gini Coefficient
Better than Rich/Poor Ratio
0.5*Average pairwise differences/Average Income
Typically used on the basis of income but can be on the basis of welface or wealth
Loretz Curve
Axis ordered from poorest to richest (Cumulative Share of Capital vs Cumulative Share of population) y=x is perfect equality. The gini coefficient can be calculated Area of Triangle/Area of whole half
Barga reduced Gini and shifted triangel towards center
Redistributive Policies
Market Income-Taxes+Support for Poor = Disposable Income
These policies if progressive can reduce Gini coeffcient (Gini based on market Income and disposable income can be compared)
Firm and Markets (A theoretical approach)
Important Concepts
Surplus = Willingness to pay - Actual paid (can be monetized)
Economies of Scale
Output scales faster than Input
Large industries are more efficient and profitable
Firm is a business organization that
1) Employs people
2) Purchase inputs to produce market goods and services
3) Set prices greater than cost of production
Cost function
Total cost of production as a function of quantity produced Q = Fixed cost+Variable cost(Q)
Average cost = Production cost per unit quantity = slope from origin to cost function
Marginal Cost: Cost of producinng another unit of product slope
AC and MC meet at AC minimum (Always true, mathematically proven) Intersection of C(Q)/Q and dC(Q)/dQ is at x where d(C(Q)/Q)/dQ=0
Demand Curve
Quantity bought at each price through market review data or willingness to pay surveys
Economic Profit
Total Revenue - Total Cost (including opportunity cost)
Profit = PQ - C(Q) = Q(P-AC)
Isoprofit Curve
Price vs Quantity curves that give the same amount of profit
Zero economic profit = Breakeven (Not accounting loss)
As profit increases, minimum cost to sustain that increases
MC line intersects at minimum
Profit Maximization
Firm's feasibility Frontier = Demand Curve MRT
Indifference Curve = Isoprofit Curve MRS
MRT = MRS
Marginal Revenue: change in revenue per unit added (decreases prince but increasing quantity)
Maximization at MR=MC. MC,MR vs Q curve looks like Demand Supply curve and intersection is teh maximum profit point
Accounting and Opportunity costs are taken together in economics
Division of Labor in Capitalistic system
Power is decetralized in markets (autonomous and voluntary)
Economic power in the had of owners and managers
Firms producing differentiated products
Gains from Trade
Consumer Surplus = willingness to pay - paid
Producer Surplus = Revenue - marginal cost
Total Surplus = the area on the left betwee intersected lines
Considering only firm, and MRT of Isoprofit curve = MRS of demand curve gives is not pareto efficient in terms of surplus. MR=MC gives a pareto efficient outcome that maximizes total surplus
Differentiated products lead to loyalty. Bargaining edge can be used to upsell price.
Deadweight Loss = Loss of total surplus relative to a pareto efficient outcome (unexploited gains from trade)
Price Elasticity of Demand
Responsiveness to quantity demanded
Elasticity = %change Q/% change in P
|x|<1 = inelastic x=1 = unitary |x|>1 = elastic
Related to MR, Elastic = High MR, Inelastic = low or -ve MR
markup: profit margin as proportion of price, inversely proportional to elasticity of demand (More Inelastic, more profit margin)
Taxation
Tax on goods, reduces demand (like tax on unhealthy foods)
Taxation on inelastic goods leads to more tax revenue
Market power
Few substitutes = inelastic demand
High market power, ability to set prices, inelastic demand
Limits on market power (competition policies) prevent collusion to raise prices
Gain monopoly rent by raising prices and cause deadweight loss
natural monopoliess establish via cheaper than other firms
Shifting Demand Curve
innovation, prevent competition through patents
Advertising: creating brand loyalty
Perfect Competition (Firms as price makers not price taker)
Price Setting in a competition
Has a lot of social and political history: Free markets and Lassiez Faire economics eg. Power of market by Milton Friedman
"faith" in the market:
- Classical (Adam Smith)
- Neo Classical (Alfred Marshall)
- Criticism (Karl Marx)
- Role of State (John Maynard Keynes)-repuditates Say's Law (Supply creates its own demand)
Impersonal Economies that believe in the power of free market and pareto efficiency
Post 1950: economies are State+Market+Community
Competitive Equilibirum:
Demand Curve: measure of willingess to pay
Supply Curve: Willingness to accept the price
Equilibirum Price: Intersection of Supply and Demand assumes no intervention and no market power (no price setter)
Price Taking firms: Demand Curve is flat at price. Thus profit can only be maximized at MC = P (MR) when slope of isoprofit = 0 Surpply curve becomes the MC curve
Sum of all firm supply curve is the the market supply curve = marginal cost curve
All are price taker (buyers and sellers) Fraction of surplus depends on the elasticity of the goods.All contracts are complere and no externalities.
There is no deadweight loss, all gains from trade are exploited.
Caveats: Fairness is not necessasry suplus is not equal. Elasticity determines outcome.
Changes in the curve
Exogenous shocks: Technology/popularity
Market entry: If existing firms are earning economic rent and costs of entry are not too high
Taxes: Government Interventions (Distortion of free market), shift depending on who is taxed and a reduction in surplus is seen. Supply curve shifts left, Less for the same price, surplus reduces and some goes to govt Less elastic groud pays the tax burden
Failure of Markets
Importance of Price
Faith in the Market: Price captures true value of interactions between economic agents. Gains of trade and welfare can be captured by price
It is hard to assign economic costs to everything. Price needs to be put for transactions. Policy decision need analysis of costs and benfits.
Market Failure: In reality, resource allocation might be pareto inefficient
Market Failures
Collective Welfare: Total Welfare of the community firms+consumers
Pollution externalities: Firm might be operating at MR=MC but produces waste that reduces the welfare for consumers through pollution. Need additional incentive to invest in reducing externalities. Eg. Downstream use by farmer could lead to +ve: less fertilizer needed and -ve: health issue
Conditions for proper market functioning (if missing, markets fail)
Private property: rights to the thing to be bought and sold
Intitutions such a s Givt to enforece the rights
Social norms that respect property rights
Ability to write complete and enforcable contract that can be evealuted lawfully
Causes of Failure
External Effects
an effect of an economic acction taht is not specified as a benefit or liability in the contract
Marginal private Cost (MPC) = MC to decition maker
Marginal External Cost (MEC) = cost imposed on the society
Marginal Social Cost (MSC) = MPC+MSC (total cost to society)
MPC=price: Pareto Inefficient
MSC = Price: Pareto Efficient
Bargaining, and transactions between agents can be solve this. Bargain a reduction in pollution by offering compensation
Bargaining
legally assign rights to externality eg. right to clean air
Private bargaining can be done to reach pareto efficient outcome if there are no transation cost
Better than govt intervention beacuse of complete information
But transaction costs can be obstable in reality
For Firm, Minimum Acceptable offer = Lost Profit, For Society, Maximum compensation is the reservation option = Gross Social Gain. Final compensation is decided though the relative bargaining power
Limits
Impediment to collective actionL how to split gains in the collective
Missing information and wrong assessment of costs
Enforcement: Difficulty of assessment
Fund Limits
Government Intervention
Cap on Production at Socially optimal amount (Hard to determine and enforce)
Pigouvuan Tax (Tax/subsidy on firms generating externalities to correct for inefficiency) Taxes reduce the effective price to the socially optimal quantity
Enforcing compensation
Firms need to play community for produced externalities for the production = Area between MSC and MPC
Better than govt intervention as the money goes directly to the people
Limits:
Missing Information: Govt may be unaware of things
Difficulty in measuting costs
Corporate Lobbying to Government
Assymmetric information (Lack of or non verifiable information can lead to enefficient allocations)
Incomplete contracts (Main cause of externalities, not all important factors are written into the contract in an enforceable way)
Solution
Private bargaining
Government policies
Should all goods be allocated by markets
Some goods are not something that should be left to the markets
Repugnant Markets: Markets for Goods and Services that violate ethical/social norms like slavery
Modified Markets can be created: Kidney Matching
Merit Goods: Goods that should be provided to all irrespective of price such as education
Categories of market failure
Public Goods (Markets fail to distribute)
Free Riding is a problem
Pricing doesnt work: MC = 0
Externalities even under exclusion
Asymmetric Transaction
Landlord (knows the house) vs Tenant (does not know the house)
Landlord (does not knows the tenant quality) vs Tenant (knows themselves)
Hidden Action -> Leads to Moral Hazard
Moral Hazard: One party does something that affects the other party but the other party cant control it thriugh the contract due to lack of information (Employer doesnt know if the laborers are being fully efficient)
Car insurance: Insurance might lead to more risk and not all risks are contractable eg. driving speed. Leads to principar agent problem. In principal agent problem one party (the principal) would like another party (the agent) to act in some way, or have some attribute that is in the interest of the principal, and that cannot be enforced or guaranteed in a binding contract.
Banks: Credit market failures due to poorborrowers being credit constraints. Also banks go bankrupt becuase of govt intervention that incentivised risk taking.
Hidden Attributes -> Adverse Selection
Adverse Selection: problem faces by parties to an exchange in which the terms offered by one party will cause some exchange partners to drop out Eg. Second Hand Cars, attributes are not fully known leads to incorrect pricing
Example health insurance: More unhealthy people (preexisting conditions) tend to buy insurance (adverse selection), but this raises prices. thus excluding healthier individuals who would buy the insurance. India middle class exception: awareness has led to more insurance buys but leads to moral hazard due to private costs for a unlikely scenario
Royalty to Paddy farmers
Paddy farmers have no profit for paddy farming and so incentives are provided to star in paddy farming. There is an economic cost and benefit to the farmer but there is a social benefit (food deficits). There is no commisar, and is left to the markets but incentives are provided.
Ecological significance is also there. Similar to Downstream users pay for protecting forests upstream. The idea is that is payment for ecological services. These needs to be considered to consider the feasibility
Payment for ecosystem services (PES) is a method to change the livelihood for people to improve environment through pareto efficient transactions.
A large number of people woul benefit from paddy ecosystems they pay the paddy farmers through the govt