Or Paradox of Economy

ECONOMICS PARADOXES

Simran Soni-13292Suman Raj-13298BMS 2F

PARADOX?

The term Paradox is from the Greek word “paradoxon” that means contrary to expectations, existing belief or perceived opinion.

It is a statement that appears to be self-contradictory or silly but may include a latent truth. It is also used to illustrate an opinion or statement contrary to accepted traditional ideas. A paradox is often used to make a reader think over an idea in innovative way.

1. GIFFEN GOODS

• A good for which demand increases as the price increases, and falls when the price decreases. A Giffen good has an upward-sloping demand curve, which is contrary to the fundamental law of demand.

• A Giffen good is typically an inferior product that does not have easily available substitutes, as a result of which the income effect dominates the substitution effect. Giffen goods are quite rare, to the extent that there is some debate about their actual existence. The term is named after the economist Robert Giffen.

• A more recent – and perhaps better – example of a Giffen good is offered by a 2007 study by Harvard economists Robert Jensen and Nolan Miller. Jensen and Miller conducted a field experiment in two provinces in China – Hunan, where rice is a dietary staple, and Gansu, where wheat is the staple. Randomly selected households in both provinces were given vouchers that subsidized their purchase of the staple food.

• The economists found strong evidence of Giffen behavior exhibited by Hunan households with respect to rice. Lowering the price of rice through the subsidy caused reduced demand by households for rice, while increasing the price (by removing the subsidy) had the opposite effect. The evidence with regard to wheat in Gansu was weaker because two of the basic conditions for Giffen behavior were not fully observed, i.e. that the staple good should have limited substitution, and households should be so poor that they consume only staple foods.

ARROW’S IMPOSSIBILITY THEOREM

• A social-choice paradox illustrating the impossibility of having an ideal voting structure that is reflective of specific fairness criteria, such as Pareto efficiency. Arrow's impossibility theorem states that a clear order of preferences cannot be determined while adhering to mandatory principles of fair voting procedures.

• For example, the following shows the type of problem typical of an election. Consider the following example, where voters are asked to rank their preference of candidates A, B and C:

45 votes A > B > C (45 people prefer A over B and prefer B over C)

40 votes B > C > A (40 people prefer B over C and prefer C over A)

30 votes C > A > B (30 people prefer C over A and prefer A over B)

DOLLAR AUCTION

• The dollar auction is a non-zero sum sequential game designed by economist Martin Shubik to illustrate a paradox brought about by traditional rational choice theory in which players with perfect information in the game are compelled to make an ultimately irrational decision based completely on a sequence of rational choices made throughout the game

• The setup involves an auctioneer who volunteers to auction off Rs 100 with the following rule:

• the bill goes to the winner; however, the two highest bidders must pay the highest amount they bid.

• The winner can get the amount for a mere five rupees, but only if no one else enters into the bidding war. The second-highest bidder is the biggest loser by paying the top amount he or she bid without getting anything back.

• The game begins with one of the players bidding five rupees (the minimum), hoping to make a ninety-five-rupees profit.

EASTERLIN PARADOX• The Easterlin Paradox concerns whether we are happier and more

contented as our living standards improve.

• In the mid 1970s Richard Easterlin drew attention to studies that showed that, although successive generations are usually more affluent that their parents or grandparents, people seemed to be no happier with their lives? It is an interesting paradox to study when you are writing about measuring economic welfare and the standard of living.

1) Within a society, rich people tend to be much happier than poor people.2) But, rich societies tend not to be happier than poor societies (or not by much).3) As countries get richer, they do not get happier.

• Easterlin argued that life satisfaction does rise with average incomes but only up to a point. Beyond that the marginal gain in happiness declines.

• One of Easterlin’s conclusions was that relative income can weigh heavily on people’s minds.

• Faced with this choice what would you rather have?

You get Rs 5,000 and a friend gets Rs 3,000or

You get Rs 10,000 and a friend gets Rs 15,000

RESOURCE CURSE• A paradoxical situation in which countries with an abundance of non-

renewable resources experience stagnant growth or even economic contraction. The resource curse occurs as a country begins to focus all of its energies on a single industry, such as mining, and neglects other major sectors.

As a result, the nation becomes overly dependent on the price of commodities, and overall gross domestic product becomes extremely volatile. Additionally, government corruption often results when proper resource rights and an income distribution framework is not established in the society, resulting in unfair regulation of the industry.

• The resource curse is most often witnessed in emerging markets following a major natural resource discovery.

• A commonly cited example of the resource curse is the Dutch disease, a situation which occurred in the Netherlands following a large natural gas find. The steps of the Dutch disease include:1. A nation finds ample natural resource reserves2. Economic focus begins to target this high-income industry3. Skilled workers from other sectors transfer to the resource sector4. Higher wages make the national currency less competitive5. Other industries, especially the manufacturing sector, begin to suffer

Both, the Dutch disease and the resource curse have a paradoxical impact on the overall economy following the discovery of large natural resource reserves.

ICARUS PARADOX

• The term refers to the phenomenon of businesses failing abruptly after a period of apparent success, where this failure is brought about by the very elements that led to their initial success.

• Danny Miler undertook this study when he saw the trend of Fortune 100 in 1996. he observed that 66 no longer existed till 2006, 15 still existed but were no longer on list and only 19 remained on list.

• Overconfidence and complacency

• Natural tendency

• Competitor neglect

• Organisational pressure

• Dogma, ritual and specialisation

• Relationship becomes shackles

TRIFFIN DILEMMA

• The Triffin dilemma or paradox is the conflict of economic interests that arises between short-term domestic and long-term international objectives when a national currency also serves as a world reserve currency.

• The dilemma of choosing between these objectives was first identified in the 1960s by Belgian-American economist Robert Triffin. He pointed out that the country whose currency, being the global reserve currency, foreign nations wish to hold, must be willing to supply the world with an extra supply of its currency to fulfill world demand for these foreign exchange reserves, and thus cause a trade deficit.

Example: If US is in a recession and it is better for money supply to be increased in the US, the policies pursued would also cause excessive liquidity in the global market (weakening the value of everyone's reserve)

This paradox is attributed with the reason for 2008 meltdown.