Solved Exercise for Precis writing 1400 Words Precis for Class 9, 10, 11, 12 and Government Exams.

Precis Exercise 

The Royal Swedish Academy of Sciences, which awards the Nobel Prize in economics, continues to spring surprises. Not that the selection communities goes against the intention of Alfred Nobel which was to award those who make the most important discoveries. The prizes so far have gone to economists who made ‘important contributions. The surprise comes because the word ‘important’ means the thing to many people.

Economics despite its pretensions to being an accurate science and clothing itself in mathematical finery serves many constituencies. It is not simply a means to unravel the mysteries of social phenomena but also an ideological construct that can serve special interests. Consequently, what is important is not a unique attribute because apart from the technical virtuosity, it is the idea behind them that assumes significance in determining the importance. Only two weeks ago, the Wall Street Journal’ asked about 40 economists who in their opinion deserved the Prize this year. Of the 60 names, William Vickrey (82 Professor Emeritus at the Colombia University) and James Mirlees (60, Professor of Economics, Cambridge University) were not in the top ten and perhaps did not even figure in the rest. What is interesting is that, in the top 10, two other Columbia University professors figured. The actual prize winner, though it is tragic beyond measure that Professor Vickrey should have died within three days after being awarded the Prize. Predicting the awardees is like telling which horse will win the Royal Derby when all of them are of the outstanding pedigree with good racing records. All that can be said is that the winner will be a competent economist whose contributions are important to many if not in everybody’s reckoning.

After a few years of flirting with the Chicago school with its blind belief in the working of the free enterprise system, the Nobel selectors have come to realise that the ideal is not the real and that economists must provide ways and means to take the reality as far as possible to the ideal. This year’s Nobelists are some of the best Applied Economists with their feet planted firmly in the ground. This does not mean Mirlees and Vickrey are rebellious misfits in the currently dominant economic paradigm. On the contrary, they are very much within the orthodox neoclassical tradition but are, as the Hungarian economist Janos Kornai used the phrase in a different context, of the Enlightened Orthodox’ variety. Enlightened because they do not equate reality with the imaginary neo-classical world which believes that if you leave everything free, the operation of markets will sort out all economic problems.

Economies function because individuals com them have needs and capacities. They make decisions or not to do certain acts which have consequences for their own and others’ welfare. In an ideal world — SUCH for example postulated by Adam Smith in 1776 where the invisible hand’ operates — the individual self-interest society’s self-interest is the same. Hence the decision those individuals take result in the maximum possible welfare for all. The implied assumption is that information about the individual’s motivations, preferences and capacities are known to everyone with certainty. Obviously, this cannot be true. Hence in recent times, economists have analysed the ways in which imperfect, inadequate and costly information affects economic behaviour and consequently market equilibrium. If markets fail, the State must enter the picture. But then what can be done to make the State’s intervention efficient?

The pioneering work of Vickrey and Mirlees addresses (a) theoretical analysis of what information and incentives do to make the economy efficient; and (b) makes practical suggestions of how to circumvent informational barriers through effective government intervention. Their mathematical background shows clearly in the way they have rigorously analysed concepts which could have been submerged into vague trivialities, and their concern for social good — expressed almost in terms of Benthamite Utilitarianism — make them take clear normative positions.

The Canadian-born, U.S. educated Vickrey, despite making many theoretical innovations, was never content with displaying technical virtuosity for its own sake. He believed that theoretical underpinning was essential for policy-oriented analysis, and if he did not find any such support for his practical work, he went ahead to formulate the necessary theory first. Like the great John Stuart Mill, Vickrey quietly enshrined his theoretical insights in his applied work without pursuing them fully. For example, Vickrey’s early work in Public Finance done in 1940s led him to study the theoretical basis of an income tax system which will balance equity and efficiency.

The insights contained in this 1945 paper were developed by Mirlees more than 25 years later that culminated in the fertile field of “Optimal tax theory. Similar is his work in the broad field of Public Choice theory (e.g The economics of auctions and bidding, self-policing imputation sets in Game theory and demand revealing procedures) elaborated to provide fascinating insights two decades later. At the same time, his investigations into reforming the progressive tax system done in the 1940s wherein he had suggested cumulative averaging assessment, a taxable tax credit for government interest, rationalisation of undistributed profits tax, became key areas of discussion many years later. His basic thesis is that, if we introduce progression independently in income, expenditure, wealth and inheritance taxes, it would contribute neither to efficiency nor equity. As he claimed, it is “desirable to combine them into an overall progressive structure”. He was also a member of the Carl Shoup mission of the early post-war years that laid the foundation for the successful Japanese tax system

Other areas where he made original contributions are transportation and public utility pricing. By looking at responsive pricing, urban congestion, airline reservation markets, fare collection methods etc. in a cogent analytical way without losing sight of reality, he was able to combine theory with practical requirements. On the whole, his view was that the State should play an ‘honest’ part in the economy and economists contribute to ‘laying out the technical possibilities and describing the consequences of various alternatives.

James Mirlees’s work is precisely in this direction. The comprehensive handbook he wrote along with I.M.D. Little, Project Appraisal and Planning for Developing Countries, set up criteria based on the desirability of efficiency in production and using the concepts of accounting prices originally developed by Jan Tinbegen.

At the theoretical level, Mirlees’s work on the ‘Optimal tax problem tries to formally describe unavoidable questions that come up in public finance such as the balance between direct and indirect taxes, progressive and proportional taxes, income and expenditure as the tax base and with the trade-off between efficiency and equity in the fiscal system. This led to many profound cones regarding the role of information like the consequences of asymmetric information, moral hazard, adverse principal-agent divergence, self-selection and we grapple with important uncertainties of economics.

“Moral hazard is a phrase used to describe the ac of individuals in maximising their satisfaction to detriment of others in situations where they do, not he the full consequences. Principal-agent tells us about the situation where the interest of the owner or the government differs from subordinates — manager or the tax collector – with consequences for the behaviour of the latter to the detriment of the interests of the former. All these are written in a terse mathematical form and not easily summarised example. But we can see how relevant they are if we take a practical example.

The recent Telecom Policy change which saw acrimonious debates, court cases and the former Communications minister’s questionable actions is a good illustration of the issues. To start with, the government sets the rules, but the firm has private information which the government instrumentality cannot observe perfectly. This is asymmetric information with one party not fully knowledgeable about what is going on. It is also not sure what the government will do and thus has to operate under conditions of uncertainty. So it takes advantage of the Principal (government policy) – Agent (Minister) divergence of interests. The firm also indulges in Moral Hazard by taking action that would hurt other firms and consumers. When such are difficulties, the task of the honest policymaker is to devise an incentive scheme that would force everyone to act fairly. If such practical problems are to be tackled, the underlying theory must be strong. William Vickrey and James Mirlees have been doing just that all these years. (1400 words)

Solved Precis

The Premise of the 1996 Nobel Prize for Economics Though earlier, the Academy awarded the Prize to those that favoured the free market system, it now prefers honour those who believe in the ability of all the different systems, to produce the best combinations that will meet the needs of society. Put differently, the Academy supports the modern belief that the States are responsible for correcting the flaws that may arise in their economies.

The choice of Vickrey and Mirlees for the latest prize supports this trend. Their work makes a theoretical analysis of what the information about the motivations, preferences and capacities, of an individual, and the incentive to the individual do, to make the economy efficient. The work also gives practical suggestions on how to overcome the secrecy that surrounds the motivations and preferences, by effective government intervention.

Vickrey’s basic belief was that the State should play an honest part in the economy. His early studies in Public Finance helped him create the theoretical basis for an income tax system which balanced equity and efficiency. He felt that increases in income, expenditure and taxes would contribute to neither efficiency nor equity. He also made original contributions in other areas of the economy, like transportation and public utility pricing. A feature of his work was his tendency to give theoretical explanations to all practical possibilities.

Mirlees, who also worked in a similar way, devised criteria for evaluating development projects based on production efficiency. Adapting one of Vickrey’s earlier works, he developed the theories of ‘Optimal Tax’ which describe such issues as the balance between direct and indirect taxes and explains the relationship between equity and efficiency in the tax system. His work led to important conclusions, like, the concepts of ‘Moral Hazard’ and *Principal-Agent’ divergence, which deal with the important uncertainties of economics.

“Moral Hazard’ explains the tendency to maximise one’s benefits without regard for the welfare of others. The tendency is unfair because its undesirable consequences are borne, not by the agency that initiates it, but by others, “Principal-Agent’ divergence, on the other hand, discusses the situation in which there is a clash between the interests of owners and their managers.

The misdemeanour involving the Communication Minister, with regard to the new Telecom Policy, ill how these ideas work? One of the firms bidding un Policy, wanting to breach the ministry’s confidential secure success, decided to take advantage of the diver between the interests of the Principal, the government and those of the Agent — the minister, by bribing the minister. The firm also indulged in “Moral Hazard’ by against the other bidder’s interests. Such cases may be avoided by conceiving useful methods to ensure fairness by all the parties concerned. However, the methods may be successful only if their basic theories are strong. (462 words)