Download Quiz 2:

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).