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Question One: Indicates the correct phrase by () mark, and the incorrect phrase by (x): 5 points 1. The firm that maximizes, profit will demand labour up to the point at which the wages equal the marginal physical product of labour (MPPL)=W (x) 2. The demand curve for labour in a perfectly competitive model is given by the marginal revenue product curve. () 3. If all markets are perfectly competitive, then the equilibrium for the economy as a whole is pareto optimal [ economy is allocatively efficient] () 4. Lorenz curve plots the relationship between the cumulative percentage of total disposal income and the cumulative percentage o the population. () 5. Externalities always create a market failure. () Question Two: Suppose that money GDP at market prices or Kuwait in 2003 was equivalent to 500 million KD and it increased to 600 million KD in 2004. The inflation rate between 2003 & 2004 was 5% calculate the Following: 10 points 1. The price index for 2004 (GDP deflator) assuming 2003 as a base year. The answer is: GDP 2003 500 2004 600 The inflation rate= 5% Price index (GDP deflator) = 100+5=105 2. Kuwait's real GDP or GDP at constant market prices in 2004. The answer is: GDP real 2004= GDP nominal/GDP deflator*100= 600/105*100= 571.428 3. Kuwait's GDP growth rate in money (market prices) term. The answer is: Growth rate nominal= GDPn 2004-GDPn 2003/GDPn 2003*100= 600-500/500*100= 20 4. Kuwait's GDP growth rate in real (constant prices) term. The answer is: Growth rate real= GDPr2004-GDPr2003/GDPr2003*100= 571.428500/500*100= 14.285 5. Compare your findings in parts 3 & 4. The answer is: In part (4) result 14.285 is less than result in part (3) 20 because inflation rate in part (4) is not included while it is included in part (3). Question Three: 1) A monopolist has inverse demand function o p=100-q, and the total cost function of c=100+2q+3q^3, what are the profit maximizing price and output? The answer is: MC=MR MR=∆TR/∆Q MC=∆TC/∆C TR=P*Q = (100-g) g= 100g-g^2 MR=∆TR/∆Q=100-2g MC=∆TC/∆C=2+6g 98=8g 8=98/8=12.25 P=100-12.25=87.75 ∏= (P-AC) AC= TC/Q =100+2g+3g^2/g =100/g+2+3g =100/12.25+2+3(12.25) =8.163+2+36.75=46.913 π = (87.75-46.913)*12.25 π= 500.253 2) Distinguish between the variables that cause a movement along the demand curve, and that cause a shit o the demand curve? The answer is: The price o the x good Px is the variable that cause a movement along the demand curve. Any other variables other than the price of the good itself like: 1) Pr: price related goods (substitutes or commodities) 2) Y: the income o the consumer 3) T: the taste o the consumer 4) Pe: the expected price o the good. Those variables (Pr, Y, T, and Pe) cause a shift in the demand curve. Ex. Of shift in the demand curve: D → → Q Ex. Of movement along the demand curve: P ………….. C ……………….. B …………………….. A D Q Chapter 10 Market Failure in Health Finance & Delivery: The diversity of health care finance & delivery: The need for health care is very hard to predict. In rich countries, people gain access to health care mainly through insurance or taxation. Insurance allows people to pay a predetermined amount and receive treatment if they need it. In paying taxes, you pay a sum of money and receive treatment determined by clinical need, not by the amount you pay. Neither taxes nor insurance guarantee that you will receive all you need in practice. Market failure in health care delivery: (No Government Intervention) Under conditions of perfect competition the market should deliver an efficient allocation of all goods. This outcome can't be achieved in health care market. (Why?) As we have the necessarily conditions for competitive market are: 1) 2) 3) 4) Firms and consumers are price takers. Firms and consumers are well-informed. Goods and services are homogenous. Free entry and exist. And also we need to add the following condition: 5) no externalities [ since this would create a market failure as we saw in ch.8] - Health care provider has more information than the patient, the patients have no experience to determine what they exactly need [ basic health care, surgery, etc…] and also they don’t know the impact of health care on their own health. - Treatment is differing from one person (patient) to another. - In health care market, externalities or showing up providing health care for one patient doesn’t benefit the others. Example of that is vaccination against infection disease benefit both the person treated and many other people who contact with him/her. - Positive externalities for those three reasons, a free market in market in health-care delivery wouldn’t be allocatively efficient. Market failure in health-care finance and insurance: As we saw in previous discussion that the market can't deliver health care are efficiently, but what about the health care finance? Does the market can be efficiently in this matter? The answer of this question depends heavily on the conditions of efficient private insurance. These conditions are: 1. Enough people have to be insured to make the calculated probabilities reliable this condition can't be hold for those people with low income. For example, if a group of people including you 1% chance of being ill in any year, and the average cost to the insurance company is 2500$ per illness plus 5$ per person for making profit then the annual premium that the insurance company will change is: Premium is= Pz+A 1% * 2500$ + 5= 30$ 2. The probability that any individual needs compensation to be independent of the probability of the same problem for others. Infections diseases are obviously a problem here. (Insurance company has to pay for those who have the disease and those who might get the infection from them). 3. The probability of the insured disaster must be less than one. This condition does not hold on the care of widespread disaster such as poverty. For example being already sick or disable, the insurance company will cover the cost of the treatment. 4. People must not be able to influence the probability of the insured event. Moral hazard→ insurance company lacks good information on the actions of the insured person would create a market failure. 5. Insurance needs good information about the risks attached to each individual (some high risk people may represent themselves as low risks and so pay insufficient premiums) [adverse selection] So the private health-care insurance is problematic and unlikely to be insufficient of society wishes all its members to be insured to cover the cost of the health care. Some people will be excluded by a lack of income, given the market failure on private insurance. To avoid this market failure in private insurance, government use social insurance which is compulsory [based on income ability] and universal , and so this scheme of insurance generates insurance redistribution from rich to poor, and that average has a right to adequate health care. Is health care redistributive: If poverty and ill are associated, then we can weaken this link by improving the health services that the poor receive. A widely accepted view that health care should be provided on the basis of income ability. There are two aspects to redistribute the health care which are: -who pays for it, -and what get it. To analyze this consider figure 10.2 in p.295 shows the distribution of income and the health finance concentration curve (the distribution of the burden of payment for health care). If health finance concentration curve lies outside the Lorenz curve for pre-tax income, the health care finance is progressive (low income group pay smaller proportion of their income for health then higher income group). If health finance concentration curve lies inside the Lorenz for pre-tax income the heath care finance is regressive [low income group pay higher proportion of their income for health then high income group]. If health finance concentration and Lorenz curves coincide, then the proportion of income used to pay for heath or the same for both high and low income. Using the analyzer, we will find that countries that rely most on private insurance (e.g. USA) have regressive health care financing systems, that is, health care finance is more unequal than pre-tax income while the countries that rely most on social insurance (e.g. France) have progressive heath care financing system (that is heath care finance is more equal than pre-tax income). Chapter 11 The Circular Flow of Income, National Income and Money The Circular Flow of Income: Figure 11.1 (p.314) The equilibrium is taken place when injections (I) = leakages (S) And the total expenditure (income) is Y= C + I = C+ S What would happen is S I? Model extention: Adding: 1. Government expenditure (exclude transfer payment) pension payment of employment. 2. Net foreign expenditure (x – m) Export – Import Figure 11.2 (p.319) equilibrium again is taken place when Injection = Leakages I + G + x= S + T + m We can re-arrange this equation to get total expenditure (income) I+(x-m)=S+(T-G) Y= C+I+G+(x-m) Surplus spending and deficit spending sector: The difference between GDP and GNP relates to the net flow of income from abroad [R consider (S-I)+(T-G)+(x-m)-R=0 The signification of this equation is that overall there's no deficit and no surplus, and so at anytime at least one sector will be in deficit and at least one in surplus (unless al three sectors are in balance). What is money: Money is a means of payment, store of value and unit of account. S I ………..…. ……………............. I I=S I,S Measure of money: M0 M1 M2 M3 M4 Notes and coins in circulation + reserves held by banks. M0 + non interest bearing bank deposits [measure of many supply]. M1 + other bank retail deposits. M2 + repurchase agreements, money market fund shares and paper. M3 + holding by private sector, other than monetary financial institutions. Banks, loans and money creation: Consider a simple bank balance sheet Assets Liabilities Loans Deposits Reserves Usually banks create money by accepts deposits from ind (bank pay interest), and lending them to other, so the profit = P lending – P deposit Banks can expand its balance sheets (create more money) if there is no limits in lending policy (by using whole reserves and deposits) as a loans for demanders. But this would create high risks placed on bank if all people came in the same day and asking their deposits, and so the bank should keep some reserves to meet the possible differences between withdraws and deposits, and these differences fluctuate from day to day. Same thing would happen if government expands the amount of notes and coins in circulation. Determining money supply: Consider B=C+R → 1 R=B-C Where B= base money (M0) C= notes and coins held by public R= reserves held by banks If we assume that the bank has to hold (by law) some reserves to meet possible differences between withdraws and deposits as a proportion of deposits de-noted by r, then we can write R=rD→ 2 where D stands for deposits then from 1 and 2 we have D= B-C/r=R/r → 3 The stick of money M is held either in the front of notes and coins (C) or in the form of deposits (D) so M=C+D → 4 Let's call the proportion of money held as cash (c), then C=cM → 5 Now play 3 and 5 into 4 M=C + D M=cM + b - C/r M=cM + R/r M=cM + (b - C)/r → 6 money supply equation Which can be re-written as: M=cM + (B-cM)/r and so M-cM+cM/r = B/r M [1-c+c/r] =B/r → M= [r-cr+c] =B M=B/[r-cr+c] or M= B/ [1-(1-c) (1-r)] Chapter 12 Aggregate demand The determinants of aggregate demand in closed economy: 1. consumption demand: Consider C= C0+bY → 1 where C0= Autonomous consumption b= margined prosperity to consume [0<b< 1] the part that doesn’t consume must be saved, so savings (S) is S= Y-C → 2 From 1 and 2 we have S= Y- (C0+bY)= -C0+Y (1-b)→ 3 Where (1-b) is marginal prosperity to save 0< (b-1) < 1 Note: MPC+MPS=1 Consumption function can be illustrated graphically by the following chart (figure 12.1 in p. 342). One of the stronger arguments against Keynes consumption model (equation 1) is that, consumption depends only on current income and ignores future income. - France Modigliani (Nobel prizewinner) argued that C affected not only by current income but also by future (life cycle hypothesis) ind smooth his/her consumption along his life cycle (save/ des-save). - Milton Friedman (Nobel prizewinner) distinct between transitory and permanent income and argued that only permanent income should inter the consumption function. 2. investment demand: investment consists of : a. fixed investment (buying capital to use in production) b. inventory investment (finished output in storage or work in proyners) investment function can be written Mathematically as I=I (r) → 4 where r = interest rate I=f(r) S r ………..…. : : : I I=S I,S Income determination: AD= Y=C+I plus 1 and 2 AD=Y= C0+bY+I(r) Y-bY= C0+ I(r) Y(1-b)= C0+I(r) → Y= 1/(1-b) [C0+I(r)] Model extension: Adding: 1. government expenditure G = G 2. net foreign expenditure (open economy) [x-m (Y-T)] when m is the marginal prosperity to import in 1 and 2 we treated G and x as exogenous variables, while M is endogenous now the equilibrium is AD= Y= C+I+G+ (x-m) Y= C0+b(Y-T)+I+ +X-m(Y-T) Y-bY+my= C0+bT+I+G+X+ mT Y(1-b+m)=C0+I+G+X-(b-m)T Y= 1/ (1-b+m)[ C0+I+G+X-(b-m)T] Chapter 13 Unemployment and inflation the Phillips curve: The Phillips curve is a graph showing a trade-off between unemployment and inflation. r↓=I↑=AD↑ Inflation PC Unemployment demand-pull and cost-push inflation: We will distinguish between them using Phillips curve. 1. demand-pull inflation: occurs when government using expanding policy to lower unemployment and rise inflation using its monetary/ fiscal policy [e.g. decreasing r→ I↑→ AD(Y)↑] then the price level increases so w/p↓ →less unemployment (employers hires more workers) so, we are moving from point A to B. 2. cost-push inflation: occurs when an increase in certain good prices leads to an increase in the prize level in the whole economy [e.g. oil prices crisis 1973] Inflation - B -A PC Unemployment the expectation Augmented Phillips curve: As we mentioned earlier the government set expanding policy (using monetary or fiscal policy) to accept higher level of inflation with lower level of unemployment. We are moving from point A to B, shown in figure 13.4 in p. 380. Since the prize level (P) is rising while nominal wages are fiscal then w/p is falling, so employers are able to hire more workers to increase production to off set the increased in AD, then we come up with higher level of inflation and lower level of unemployment. This story is taken place if and only if workers are irrational or don’t taking into accounts their expectation of inflation last year, or if their expectations are mistaken. If we assume that the workers are rational and take the last year expectation of inflation rate into accounts then when inflation is rising they will not accept same level of nominal wage, they will higher level since they know that their w/p is falling or if the worker decide to leave work (not working) then we will have the same level of unemployment with higher level of inflation (PC shifts up-ward) then we move from point B to C. Same story would happen [moving from C to D and from D to E] to end up with vertical Phillips curve (phase A, C and E). Friedman called the rate of employment at point A, C and E the natural rate of unemployment which defined as the rate at which the labour market is clearly in a Long-run. Rational expectation: If we assume that we have rational expectation or the information is perfect (perfect competition economy) then when the government uses expansion policy (raise inflation and lower unemployment), this policy will not work perfectly. It will cause higher inflation and no change to the level of unemployment since people perceive this policy and react in such way that the level of unemployment doesn’t change (ask higher level of W or level work). Chapter 14 International trade and production Competitive advantage: Assuming two countries (home and foreign) and two goods (x and y), each country can produce both goods; consumers in each country want to consume both goods. If there is no trade the consumers must be supplied by local production. If there is a trade then the country that more productive in term of producing certain good (x or y) expand its output and exports the extra production. [Figure 14.4 in p. 401] Now suppose home has 100 workers and each worker can produce either 2y or one x, then Total production when producing y only is 200 Total production when producing x only is 100 Likewise, if foreign has 200 workers and each worker can produce either 1/2 of y or 1/2 of x, then Total production when producing y only is 100 Total production when producing x only is 100 For home country suppose the country at point AH (100 units of y and 50 unit of x) and the country wants to consume one more good of x then the opportunity cost of this preference is 2 units of y, since we need to allocate one worker from good y production to good x (so we are losing 2 units of good y to get one extra unit of good x) what about the opportunity cost of foreign country to get one extra unit of good x? Now let's say that the relative prices in the world market are 300$ for x and 200 $ for y so producing one unit of x costs 1.5 unit of y (1.5:1) - For home country the production of each unit of x has an opportunity cost of 2y, but importing x cost 1.5unit of y (then it is much better for home country to close good x production and specialized in production of good y point QH ). - For foreign country the production of each unit of x has an opportunity cost of one unit y, but importing x costs 1.5 unit of y (then it's much better for foreign country to close good y production and specialized in production of good x point QF). If all home's y production were exported, then it could offered to import 133 units of good x [200*200/300=133], while if all foreign x production were exported it could offered 150 units of good y [100*300/200=150]. If there's no trade (Auturky) home/foreign consumption has to lie somewhere along the line HF, that is without trade you can consume only what you produce, trade increases the size of each economy consumption set in the sense that each economy can offered to consume more than it could in the absence of trade (point C). Terms of trade: A country's terms of trade are the ratio of its export prices to its imports prices Terms of trade= index of exports prices/ index of imports prices*100 If Px=300, Py=200 Home Tt=200/300*100=66.67% Foreign Tt=300/200*100=150% If Px changes to 250 and Py=200 Home Tt=200/250*100=80% Better off Due to the changes of world prices. Foreign Tt=250/200*100=125% worse-off Trade policy: Definition: Tariffs: are taxes imposed on imports of goods or services Quotas: are quantitative limits placed on the volume of imports of specific goods or services over a specified period. The effect of trade policy: Consider the implications of putting a tariff on the good that imported and produced domestically now if there's no trade, then the price would Pa (S=D), now suppose that the price of the good on the world market is Pw, if there's free trade there is also the price inside the home economy, at this price the production is Qf and consumption is Cf and since Cf > Qf then the difference between them is met by MC > P. Now when government imposes a tariff (t) on imports price would jump up to Pw + t, so production increases to Qt while consumption reduced to Ct. (Figure 14.5 in p. 410). Gainers Losers - government gain a revenue of - consumers lose: (Ct- Qt)t [(area B)] 1. reduction in consumption - producers gain from higher 2. the effect of price increasing price (t Ct)= area E+A+B so, total (Qt- Qf)t [area A + E] consumer lose is E+A+B+C But lose area A (since they are producing at MC > Pw so producer net gain = A + E – A= E π=TR= (Qt- Qf)t So net gain from this trade policy is B- (E+A+B+C) + E=-(A+C) So tariff has therefore reduced welfare in the economy as a whole. Note: in our previous analysis we are assuming that the home demand is constant, so we end up with a lose, but in general imposing a tariff would reduce the demand of product, and reduce Pw and this is a term of trade improvement from the point of view importing country [Tt= export (price)/ import (price)]. How a tariff on imports can reduce the world price for a good? Once tariff is imposed the price increases (from Pw to Pw + t), then demand on imports decreases have the supply of imports exceeds demand at the old world price (not seen in previous picture). - Optimal tariff: The optimal tariff is the one that maximize the countries gains, to see how this works consider figure 14.6 in p. 412, as before free trade position is Pw^f with production Qf and consumption Cf, when imposing tariff the world price would fall Pw^t however the domestic price inclusive of the tariff rises to Pw^t + t. The net effect of the tariff is going to be a lot of (A+C) as before, and again of H which is equal to quantity imported (Ct-Qt)(Pw^f - Pw^t) and as H > A+C, then country\s is enhanced by imposing tariff. How can we influence our term of trade? A. from import side: As imports supply curve is horizontal then Pw is fixed and so the certainly can't improve its term of trade hence the optimal tariff = zero. As imports supply curve get steeper the optimal tariff gets longer. B. from exports side: A country can do so by pushing up the price of its exports by exporting less. Trade and market structure: Inter-industry: when a country imports a product, it does not also export products of the same industry. Intra-industry: trade which involves a country both exporting and importing products of the same industry. Gains from intra-industry trade: 1. Ease of monopolistic competition: the equilibrium is taken place at point A (MR=MC) with Qa and Pa and zero π, now suppose: 1) Two industrial economies, 2) No trade barriers. 2. This intra trade occurs, each market supplied by twice as many firms (home & foreign), and this would increase competition and so squeeze price-cost margins, till we reach new equilibrium point at T with Qt and Pt. the benefits from trade are: 1) More competition, 2) Producing at lower AC, 3) Variety effects. So, both countries gain from trade. Case of monopoly: When trade barriers are high and there's no trade, then each country has just single form which acts as a monopolist (figure 14.7 in p. 417) producing at Qa and Pa, and so π= πa. (Figure 14.8 in p.420) Now when trade is permitted, then we would have f letter AR and MR curves, since home firm competes with the foreign one (doubly) and as seen from (graph 2) the firms are making lose (AR lies below AC) this means that one firm should exits from industry and so the remaining firm is a monopolist at the world level, which set Pm and Qm and making πt (graph 3).