Tutorial 6

Exercise 1. The consequences of pure impatience

1. Draw the indifference curves of a person who is always more impatient than Julia in Figure
11.3b from CORE (Unit 11, 2016 version), for any level of consumption now and
consumption later.

2. Draw a set of indifference curves for Julia if she does not experience diminishing marginal
returns to consumption. Would she then desire to smooth her consumption?
If she does not experiment diminishing marginal returns to consumption, she will not consider that
one additional unit of “good” A (here consumption later) get less and less valuable the more it is
consumed. As the utility will always remain the same, she wouldn’t need to smooth her consumption.
3. Draw a set of indifference curves for Julia if she does not experience diminishing marginal
returns to consumption and has no pure impatience.

4. Based on your answers to the above parts, what must be true of a consumer’s indifference
curves for her to want to smooth consumption?

If a consumer wants to smooth consumption, his/her indifference curves must be convex.

Exercise 2. A household’s balance sheet (*)

Consider a family of two parents and two children who have a mortgage on their home. They have
paid off half the mortgage. The family also owns a car and a portfolio of shares in companies. They
spend their income on food, clothing, and private school fees, and have retirement savings held in a
pension fund.

1. Which of these items would be on a balance sheet for the household?

The car, shares in companies, income spent (on food, clothing, private school fees and retirement
savings), as well as half of the mortgage would figure on the balance sheet. However, the other half
of the mortgage -the one they haven’t paid yet- would be on the liabilities.
 2. Think of some typical values for these items in your country for a family of this type. Using
the example of the bank’s balance sheet in Figure 11.15 from CORE (Unit 11, 2016 version)
as a guide, construct a balance sheet for your hypothetical household.

ASSETS (owned by the family Price LIABILITIES (what the Price

or owed to it) family owes other
individuals, and banks)

350 000€ 350 000€

Half the value of their home Half the mortgage left to
(part of the mortgage that is pay
already paid)

15 000€
Car

Portfolio of shares in companies 10 000€

Income spent (food, clothing, 6000€/month

private school fees)

Retirement savings (pension 350€/month

fund)

Exercise 3. Beveridge curves and the German labour market

Note: Although according to the Beveridge curves, the German labour market does a better job at
matching workers with job openings, average unemployment in Germany over the period in Figure
15.7 from CORE (Unit 15, 2016 version) was higher than in the US.

Consider the possible role of aggregate demand (Section 13.10, Unit 13, 2016 version, on Okun’s law,
and Section 12.3, Unit 12, 2016 version) on aggregate demand and unemployment from CORE and
factors that shift the wage curve and profit curve (Unit 9, 2016 version). How can you explain this
fact, and what kind of data could be used to find support for your hypothesis?

As the aggregate demand is lower in Germany, the vacancy rate is reduced and it is pretty good at
matching workers with job openings. As the US unemployment is lower, the wage curve would be
higher.

Exercise 4. Unemployment rates and labour market institutions (*)

Some people have argued that high unemployment in some European countries relative to
the US during the 1990s and 2000s was due to the existence of rigid labour market institutions
(defined as including powerful unions, generous unemployment benefits, and strong employment
protection legislation).
1. Using Figure 15.1 from CORE (Unit 15, 2016 version), check if the unemployment rate
has always been higher in most European countries compared to the US.
Comparing with the other countries in the chart, the US stands pretty average, always around 5 to 10
percent unemployment over 50 years. While some countries have been facing higher rates for long
(Spain from 1975-79, Canada and Ireland from 1960 for instance), some European countries also had
way better performances (Norway), or better performances at some given time (Netherlands, from
2000 and before 1980, Italy before 1980, Germany since 2009). Therefore, the statement in the
instructions is not true.
2. From what you have learned in Unit 15 from CORE, and by looking at Figures 15.1, 15.15,
and 15.17 from CORE (Unit 15, 2016 version), evaluate the claim that high unemployment
in Europe was due to the existence of rigid labour market institutions.
This claim, after studying the Core, doesn’t seem fully accurate. Sometimes country do take
advantage of trade unions (which are considered as a mark of rigid institution), such as in
Nordic countries which have a lower unemployment rate than the USA. (15.15 : Higher
unionization rate, but lower unemployment than the US). Nonetheless, it is not always true
(Spain has a high rate of unionization, but a high unemployment as well). The same goes for
unemployment benefit, if we take a look at figure 15.17 : even though if the employment
model showed us that normally, unemployment benefit should raise the wage curve and thus
discourage firms to hire, countries that have those advantages are not overthrown by
unemployment. Effectively, if we compare the US with a small unemployment benefit, and
Sweden or even France, we can see that those European countries only have 1 or 2 points
more of percentage of unemployment rate. This is not a huge difference. Besides, European
countries with low unemployment benefit do not have a lower unemployment rate : if we take
a look at the case of Poland, we can see that the average unemployment rate is 15%, which is
way higher than European countries with large unemployment benefit. As for the difference
between the unemployment rates of countries with large unemployment benefits, according to
the CORE, we can state that it is based on how well are designed the institutions.

Exercise 5. The labour market model (*)

1. Explain how to use the labour market model (wage-setting curve and price-setting curve)
to show the changes in labour market performance of the UK and the Netherlands over
the last 40 years as discussed in section 15.8 from CORE (Unit 15, 2016 version). Draw
separate diagrams for each country.
For the UK, the government policies reduced the power of trade unions, which therefore resulted in a
shift to the right of the wage-setting curve. Therefore, the price of a hour of work is reduced since
there’s more competition in the job market (the insiders don’t have power over the outsiders), and,
thus, the price-setting curve goes lower.
For the Netherlands, the reforms of the government lead to a decrease of wages (shift of the wage
curve to the right), but the counterpart was therefore less hours of work, and less output per worker. In
order to remain productive enough, the companies need to hire more.

2. What other factors may have contributed to the performance of these countries?
When studying both countries situation, we can also recall that both countries are part of the
EU, which open a free market to them and their production. Since they are both efficient,
they can sell even in other countries. The quality of their institutions also account in that,
since they foster more entrepreneurship, and therefore, less unemployment.

Exercise 6. Limits on lending (discussion)

Many countries have policies to limit how much interest a moneylender can charge on a loan.
1. Do you think these limits are a good idea?
I do think so, because this way it prevents the banks to benefit from their dominant position over the
entrepreneurs who need a loan in order to make their business thrive. Moreover, this way, in case of a
crisis, or depending of the confidence into the borrower for instance, even with high interest rates,
some incentives to borrow to invest still remains, and therefore keeps the economy from stagnating.
2. Who benefits from the laws and who loses?
The winners to me are the entrepreneurs or those who have a specific project and do not have a
perfect financial situation, because they are not hindered from borrowing. Therefore, it is beneficial to
the economy in some ways, because the banks can still raise their rate to a certain extent, which
selects the most fully developed projects.
The losers are the banks which cannot make profits as high as they would like to, and have hard times
reimbursing their debts. Because less money enters, the banks savings are lower, and the loans have to
be sure projects.
3. What are likely to be the long-term effects of such laws?
On the long run, we can imagine that, since the banks would be unable to tax highly the really risky
projects, it would probably implement a harsher selection, since each loan has to be profitable and the
bank cannot afford taking any risk which could endanger its growth. We can even imagine it would
tend to charge more, to ensure the solidity of the project. We can also imagine that, if the maximum
rate is limited in only one country of a free-trade zone, it would attract investors with a risky project,
because they know that even if they are financed with the maximum interest rate it will still be lower
than what they would have to pay in their own country. The thing is, this way, the banks in the other
countries might lower their rates for those with a ready project. There's therefore a phenomenon of
adverse selection: those with a bad project go in the country with a limited maximum, while the ones
with a good one go abroad where the banks are eager to get more customers, and therefore offer a
lower rate than the domestic banks.

4. Contrast this approach to helping the poor gain access to loans with the Grameen Bank
in Exercise 11.8 from CORE (Unit 11, 2016 version).
Unfortunately for poor people, a limited maximum rate might not be enough to give them access to
credit. It is not because the maximum rate is lower that the bank will accept to borrow to a poorer
person, even though he/she has a good project: it is a bet for the bank which won't make up for the
risk it takes. Since the poor people's problems are usually the lack of confidence from the banks, the
Grameen Bank's initiative is wise enough, because it enables them to acquire this confidence, showing
the capability to reimburse on time, and limiting the loss of banks if one of the individuals cannot pay
on time.