ECON239: Q&A Page

December 6, 2010

The basic supply and demand model of the labour market describes a spot market in which employers and workers show up each period and hiring takes place. While this may be a reasonable description of the markets for some goods and even for some casual labour markets, in general it is pretty unrealistic. Most real-world employment relationships involve a dynamic relationship between employers and employees. How each party acts today can affect what happens tomorrow and issues of risk, uncertainty and asymmetric information can play an important role. For example, uncertainty about whether an employee will be around to work for a given employer next period, may affect the employer's willingness to engage in an informal long term arrangement.
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 My question has to do with A3, in which section of the notes can i find what are the "economic institutions governing trade in rural areas"? Does this mean the Grameen Bank?

In general, these economic institutions include both formal and informal arrangements between people that affect transactions. Although, microfinance institutions (such as the Grameen Bank in Bangladesh) are a more formal example, the question is referring to institutional arrangements more generally and especially less formal ones. For example, informal labour contracts, lender-borrower arrangements or land transactions. 

November 29, 2010

>>  I am doing assignment 4. I want to ask whether the question A3 is
>> based our last class this semester, because I cannot figure out how to
>> do it with what we have learned.

This question has to do with the issue of "intermediate societies" discussed at the end of section on Rural Labour markets. See also the discussion in Ray p. 520-2.
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I am confused about the B1. In the part c, it says the number of workers who have migrated to urban sector is 2,3,4,5,6,7,8,9 millions. So this part is based on the competitive equilibrium? If so, how can 9 millions workers be transferred to the urban sector considering the number of people who has already been in the sector?

If there are 9 million workers in the urban sector and only x million formal jobs, the probability of one such worker getting such a job is x/9, etc.

November 25, 2010

I noticed in going through my notes we did not cover the last couple sections of Microfinance (somewhere after joint liability, we also did not cover the Grameen II model). Are we expected to cover this material ourselves or are we exempt from it on the exam? The fact that the joint liability problem appeared on Assignment #3 leads me to think the former, but I just wanted to make sure as I start to prepare study notes. Thanks in advance.

If we have time (which I doubt), I will go back to this at the end. However, I will not ask anything specifically about it on the final exam. The main point about joint liability is that it gives borrowers incentives to

(1) assortitatively match, which can reduce the adverse selection problem
(2) monitor and impose sanctions on each other, which can reduce the moral hazard problems

November 11, 2020

I have a question regarding B2c) on the third assignment: can both borrowers obtain $0 at the same time? 

or ar the possible outcomes just:

- Both parties obtain a gross profit of $360.

- One party obtains a gross profit of $360 and the other one obtains a gross profit of $0.

- One party obtains a gross profit of $0 and the other one obtains a gross profit of $360.

There are 4  possibilities including both getting zero. Hopefully that became clear in yesterday's lecture.

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1. For Ex Ante Moral Hazard:

(y- R) – c > p( y – R) Why minus c – what kind of cost is it?

The text is saying “expending effort”, on what though?

The idea is that the borrower can choose between a safe or a risky investment (e.g. buying some seeds). The safe investment also requires the borrower to incur some additional cost up front (it could be that he has to put in more effort which has an opportunity cost, or it could be that he has to buy some other input (e.g. insecticide) to make the investment safe). Note that he might have to pay such a cost in both cases, but the key assumption is that it is higher for the safe investment. In this case c is difference in the costs.

2. Increasing in interest rate does not necessarily increase profit, under the adverse selection and ex ante moral hazard conditions. Why?

Under adverse selection it is because increasing the interest rate may cause safer borrowers to drop out of the market whereas the riskier ones stay in. This is because, due to limited liability, riskier borrowers are willing to pay a higher interest rate than safe borrowers. With ex ante moral hazard it is because when the interest rate rises beyond some level, the borrower will prefer to make risky rather than safe investments.

3. R < y =  [c/(1-p)] What does the right side stand for?

It should be  R < y -  [c/(1-p)]. The right hand side is exactly the level of the interest repayment beyond which the borrower prefers to make the risky investment.

4. Can you please give me a precise definition of Ex Post Moral Hazard?

This occurs after the output from an investment has already been realized. It is a situation where the borrower has an incentive not to repay what was expected of him, even though he could. It is also sometimes referred to as the "enforcement problem".

October 22, 2010

I just have a quick question about the assignment. I saw in the announcements that there is typo for question B1, part b), where 1960 should actually be 2000. I was wondering if this typo also applies to part a) as well?

No. Only to part (b). The data plotter only allows you to divide countries into income classes based on per capita income for 2000.
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My friend and I would like to work on this assignment together. Do we submit a single draft with both of our names on it, or two separate assignments?

A single draft with both your names (and student #s) on it. Please put your names in alphabetical order.

October 21, 2010

Hi! I was a little confused by what you said in class, and just wanted to make sure I'm studying everything that is on the exam Monday! It is only up until (including) "ownership and tenancy", so the two Ray readings are the last things included on the exam? (Land rights and reform are not included?) Just wanted to double check!

That's correct.
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According to the New Institutional school, sharecropping is best viewed as the result of a trade-off between risk and incentives. To see this, suppose that the landlord is risk-neutral, but Tenant is risk-averse. In this case, according to the Chicago school view, we would expect to see a wage contract because the Landowner would then bear all the risk (which is costless to him). However, suppose that the Landlord cannot directly monitor the effort of the Tenant, and he cannot infer effort due to the risk in production. Under a wage contract, the Tenant would have little incentive work hard. The landlord could improve incentives by increasing the share of output received by the tenant (at the same time he could increase the fixed component of the rent so that he is no worse off). However, this means the Tenant would now bear some risk, which is costly. The incentive-constrained efficient value of the Tenant's output share is the one where the gains (due to better incentives) and the losses (due to risk) of increasing it any further are just equalized. Going all the way to a pure fixed rental contract would give the best incentives, but would be too costly because of the risk faced by the Tenant. So a sharecropping contract emerges as the best arrangement. Note that this results in lower effort and lower output than implied by the Chicago school. However, given the inherent incentive problem, it is the best they can do.

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I was wondering if you clarify the concept of conditional convergence and how it relates to the Solow model for me?

Suppose we have two economies with similar savings rates (s), population growth rates (n), education (h) and rates of technological change (g), but one economy has a higher initial output per worker than the other. The Solow model predicts that, in the long run, the economy with the lower initial output per worker should grow faster and catch up with the economy with the higher output per worker. This is conditional convergence.

In contrast, the concept of unconditional convergence implies that poorer countries should grow faster and catch up with richer ones, independent of their levels of s, n, h and g. This is NOT a prediction of the Solow model and it is not true in the data.

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> What does asymmetric information and moral hazard have to do with the new institutional view on sharecropping? You talked about something that the effort of worker cannot be observed.

The fact that the effort of the worker cannot be observed (or it is too costly to do so) implies that there is asymmetric information involved in this transaction. Specifically, the actions of one party (the worker/tenant) are hidden from another (the Land owner) and the cannot be inferred from the output due to the uncertainty. This implies that there is an incentive problem: the worker could provide low effort, but claim that he actually provided high effort and the resulting low output was the result of bad luck. This possibility is an example of "moral hazard" (or post-contractual opportunism). To reduce the problem, the Land owner can make the Tenant's income depend on his output by using a sharecropping arrangement. However, this also exposes the Tenant to more risk (which is costly). So there is an inherent trade-off between risk and incentives.

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> I just wanted to clarify a question on Assignment 2 from ECON 239. The 
> TA was unsure of my question and suggested to contact you about what context you wanted 
> a response for in question B1. I'm just unsure of what the discussion 
> of the charts should include. Do you want the the relationship described to refer to geography, agriculture and land distribution?

Question B1 is about convergence and the Solow model. All you have to do is say whether the statistical relationships look positive or negative and also how strong you think the correlation is.
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> I was just wondering how much detail about the Harrod-Domar and Solow growth models we need to have memorized for the midterm exam (ie. should we know all the formulas, or just the general principles behind them, etc).

You don't have to know the derivations in detail, but you should know and understand the bottom line. If you understand the model, you won't need to memorize formula.
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The Marshallian argument is the Development planning view. Specifically, sharecropping acts like a tax on effort and reduces individual farmers' incentives to work hard. Consequently, they would argue that this market failure should be removed by banning sharecropping.
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Hey,

I am just wondering where the assignment is due this Friday, is there a box somewhere in Dunning Hall?

There is a box labelled 239 on the second floor of Dunning.

September 29, 2010

When you say institutional arrangements, is that the same thing as economic institution?

Yes. Although the term typically used by economists is "economic institution", I think that sounds too much like it might mean a bank or something and confuses people. So I tend to use the term "institutional arrangement".

Can you give an example how religious or social norm govern an economic transaction?

Yes. Suppose you lend money to someone. Why should they pay it back to you? In some social contexts, if they don't pay you back, you could go around telling everyone and they might feel guilty, or they might develop a bad reputation. Recognizing this possibility, the borrower has an incentive to repay you. In other social contexts, the borrow might not care what other people think and has no incentive to repay you. In this case you might decide not to lend at all, or if possible, you might require a formal lending contract that is back up by the legal system. Social norms (which impose feelings of guilt) tend to work better in situations where everyone knows each other and mobility is limited (e.g. a geographically isolated village). They become less effective when people are more anonymous and mobile (e.g. a large city). So in the first case (isolated village), social norms are the least costly and most effective institutional arrangement. However, in the second case (large city), formal legal contracts may be the institutional arrangement that minimizes transactions costs.

September 28, 2010

I just have a question about the first assignment for 239 regarding sourcing. The first question asks us whether or not developing countries have succeeded in satisfying the MDG's, and I was wondering if you want us to provide sources on information regarding their success, or just state what we find in the notes/on the internet. Thanks in advance.

You should cite a couple of sources. A lot of them basically say the same thing. For this question it is best to be as brief as possible on each goal. No need for diagrams or tables etc.
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> B1 d) When you said “direct calculation of the growth in real per capita GNP “ you mean the growth rate between year 2001 and year 2009?
> Ex: (39012.42152 - 35818.07484) /35818.07484

The question is about the average growth rate over this period of nine years. As discussed in Lloyd-Ellis ch. 1, this is calculated as
(39012/ 35818)^(1/9) - 1  where ^ means "to the power of"

September 27, 2010

Hey, I have some problems with the questions regarding the Solow Model -- are you going to talk about the model in class this week?

I am going to talk about it on Wednesday.

Also, there is no link to Lloyd-Ellis ch. 3.2 in the Course Outline.

Actually, I just put it up.

And when I am alredy writing you an e-mail, when are the office hours for the TA? Couldn't find it on the web page.

It is on the website: just follow the link to "Teaching Assistants and Office Hours"
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>  For B1 a) You said "Calculate real total GNP in millions of 2002 dollars for each year". Will the "in millions of 2002 dollars" impact on my calculation or is it just an unit? I am just not sure what it means.

It will not impact on your calculation (although see below). It means that GNP has been converted into real terms using a price index that has 2002 as a base year (i.e. where CPI=100 in 2002).

For real per capita GNP, I am things like ,"0.00003". The numbers make no sense.

I used formula: nominal GNP = Nominal GDP + Net factor payments from abroad
Real GNP = Nominal GNP/Consumer Price Index

You should multiply this by 100 (see Lloyd-Ellis ch. 1)

Real GNP per capita = Real GNP/Population << for some reasons the number for it is really small!

Real GNP is in millions of dollars, so multiply by 1 million to get the $ income per person.
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For the Assignment B1, why didn't you give us the GDP deflator? Is it possible to use Consumer Price Index to express the Real GNP?

You are right that the GDP deflator is correct to compute real GDP. However, the CPI is more appropriate when computing the real purchasing power of GNP. In practice the GDP deflator and the CPI are almost identical.

September 23, 2010

I am writing assignment number 1 and are wondering which table you are refering to in question B2? The tables in the lecture notes are not named so I just want to be sure that I am using the right one .

I meant Table 4 in Lloyd-Ellis chapter 1, which is on the reading list

September 21, 2010

The question does not ask what the Gini coefficient for each case is. It just asks which is bigger. You should be able to answer this graphically.

September 19, 2010