FHCE 3150 Final Exam Study Guide
Adverse selection is the process by which
"undesirable" members of a particular market are more likely to participate in exchange
An individual who is considering consumption between two time periods (year 1 and year 2) has an endowment of $20,000 in year 1 and $15,000 in year 2. If the interest rate is 5%, what is the maximum appropriate amount that can be spent on consumption in year 1?
$34,285
The model of intertemporal choice illustrates 3 things:
(1) the budget constraints faced by consumers, (2) their preferences between current and future consumption, and (3) how these two conjointly determine households' decisions regarding optimal consumption and saving over an extended period of time.
A gamble in which you win D dollars if the coin comes up heads, but lose D dollars if the coin comes up tails has an expected value of
0
Say, Anna's utility function was given by UA = (MA)(MM), where MA is Anna's wealth and MM is Marie's wealth. Initially, Anna has 160 units of wealth and Marie has 40. When Anna maximizes her utility level is equal to
10,000
Seth could consume $120 next year if he saved all his current earnings. He expects to earn nothing next year. The intermporal budget constraint for Seth is given by the equation C2 = 120 - 1.2*C1, where C1 = possible consumption in year 1 and C2 = possible consumption in year 2. Assume that C1 is on the horizontal axis and C2 is on the vertical axis. What is the present value of the total consumption available?
100
In Figure 17-1, if the reference time period is one week, N equals _______ hours.
168
Suppose Microsoft stock will provide either a return of 10 or 20 percent over the next year and that the probability of the former outcome is 0.25 while the probability of the latter is 0.75. The expected return on Microsoft stock over the next year is thus __________
17.5
_________ will causes the budget line in figure 17-1 to rotate from NY2 to NY3.
A rise in the wage rate
The labor demand curve is downward sloping due to:
A substitution effect and a scale effect
An increase in the wage rate makes leisure more expensive
True
Measuring Unemployment Rate
UR = U/LF
Giving consumers more options to choose from makes consumers worse off.
Uncertain
In the income-leisure model, the worker is seeking to maximize ____________
Utility
If borrowing and lending is possible at a positive interest rate and if there is present and future income, then the intertemporal budget constraint
Will be a straight line with a slope steeper than -1
Suppose you receive Y1 of your income this period and Y2 of your income in the next period. If you can either borrow or lend at an interest rate r, what is the most you can consume in the future period?
Y1 (1 + r) + Y2
Fred is considering consumption between two periods and is earning an income of $1,000 in both periods. If the interest rate is 8%, Fred borrows $500, but if the interest rate rises to 18%, Fred saves $500. Is this behavior economically reasonable?
Yes, the higher interest rate will raise the cost of current consumption, including him to cut back current consumption. He could cut back so much that he becomes a saver.
Suppose there are two individuals, each with an income $10,000 this year and next year. Frank consumes $10,833 the first year and $9,000 the second, while Michelle consumes $9,167 the first year and $11,000 the second. Is this market for loanable funds?
Yes. Because the supply of loanable funds to the demand since the amount that one person wants to borrow is equal to the other amount a person wants to save.
For a signal between two adversaries to be credible, it must
be costly to fake or duplicate
Suppose leisure is shown on the horizontal axis and weekly income is shown on the vertical axis, an increase in the wage rate will cause the budget line to:
become steeper
An individual is considering consumption in two periods. He has decided to borrow $1,000 in period 1, given his endowment and the interest rate. Other things remaining the same, if the interest rate increases, he will:
borrow less than $1,000
If an impatient and a patient consumer face the same intertemporal budget constraint, have the same first-year income, and if their indifference curves are both normally shaped, then
both will have the same marginal rate of time preference at equilibrium unless one or the other is at a corner solution
For a risk-loving individual with return on the x-axis and total utility on the y-axis, the slope of the total utility curve:
increases at an increasing rate
Velma starts a business for $150,000 that gives her a 50% change of losing and a 50% change of gaining an expected annual return of $75,000. John is content with a job that pays him $75,000 per year with near certainty; there is only about a 1% chance of losing his job each year. Suppose risk is on the horizontal axis and return on the vertical axis. Velma's indifference curve for risk and return:
is flatter than John's
A risk-neutral consumer
is indifferent between accepting and refusing a fair gamble
The Kahneman-Tversky value function shows that a gain of $100
is valued less than two gains of $50
The "self-interest theory" considers an act to be rational if
it efficiently promotes the ongoing material interest of the person who performs it without the requirement that social justice be achieved
For an individual who is saving for a specific purpose, say a car, an increase in the interest rate is most likely to
lead to lesser saving in the current period have a stronger substitution effect than income effect
The income effect of a wage rate typically assumes that:
leisure is a normal good
What is a secondary labor market?
low wages and unstable employment relationships
Labor force:
non-institutionalized individuals aged 16 or above who are either working or actively seeking work
Rational individuals always prefer
to increase the quantity or quality of the goods and services they consume.
income =
total compensation + unearned income (or income = earnings + unearned income)
Say Anna's utility function was given by UA = (MA)(MM), where MA is Anna's wealth and MM is Marie's wealth. Initially, Anna has 160 units of wealth and Marie has 40. In order to maximize her utility Anna should:
transfer 60 units to Marie
earnings =
wage x hours
When a job applicant discloses information that could be seen as favorable by potential employers, other job candidates who do not disclose information:
will be seen as more unfavorable by potential employers
Labor market participants
workers, firms, the government
Industry demand for labor
• An industry's demand for labor consists of the total demand for a particular type of worker in a given industry. (An industry consists of all of the firms that produce a given type of output.) • An industry's labor demand curve is determined by adding together the labor demand curves for all of the firms in the industry.
Slope of labor demand curve
• Both the substitution and scale effects result in a reduction in the quantity of labor demanded when the wage rate rises. • A change in the wage changes the quantity of labor demanded, but does not affect labor demand. Labor demand changes only if the labor demand curve shifts in some manner (as discussed below).
Measurement Issues
• Labor Force measurement relies on subjectivity and likely understates the effects of a recession • The added worker effect refers to an increase in the labor supply of for example married women when their husbands become unemployed. • EPR is a better measure of fluctuations in economic activity than the UR
Market demand for labor
• The market for a given category of labor consists of all of the firms that might hire a given type of labor, regardless of the industry in which the firm operates. • The market demand for labor is determined by adding together all of the industry demand for labor curves.
The scale effect associated with a wage increase involves the following steps:
• higher wages result in higher average and marginal costs of production, • leading to an increase in the equilibrium price of the product, • leading to a reduction in the quantity of the product demanded, • leading to a reduction in the use of all inputs used to produce the product.
Labor demand may shift due to changes in:
• the demand for the product, and • the prices of other resources.
Standard rational choice theory accepts which of the following?
People are creatures of reason
Which statement is true?
An increase in the interest rate will always cause a reduction in current consumption
Behavioral economics studies behavior, but neoclassical economics does not.
False
Workers will always work fewer hours when the wage rate increases.
False
According to the rational choice model which of these two events should be valued more by rational consumers: A). gift mug valued at %10 B). finding the mug you thought was lost, which cost you $10 to purchase
Both events should have the same value
We had two boxes of candy on the counter. Both were identical, except one was a 10-pound box and the other was only a 1-pound box. Because it was Christmas, I rationalized that four pieces a day would be okay, but I always felt better when I took candy out of the large box instead of the small one. This tendency is an illustration of
Fear of losing options
Labor Market Participants: Firms
Demanders of labor (aggregate individual decisions to derive a downward-sloping labor demand curve) Goal: Strive to maximize profits subject to constraints Determine: • How many workers to employ • Which workers to hire • How much to pay each worker • Whether to hire additional workers • Whether to fire workers• How much capital to employ • Working conditions • Length of the work week
Measuring Employment Rate
Employment: Population Ratio (percent of population that is employed) EPR = E/P
For a risk-averse individual, with return on the x-axis and total utility on the y-axis, the slope of the total utility curve:
increases at a decreasing rate
Consider a two-year period where a consumer has an income of $10,000 in year 1 and $8,000 in year 2. The consumer can borrow or lend at an interest rate of 10 percent. If the consumer decides to save $1,000 in year 1, it means:
He will have a higher consumption in year 2 than in year 1
Suppose there are two individuals, each with an income $10,000 this year and next year. Frank consumes $10,833 the first year and $9,000 the second, while Michelle consumes $9,167 the first year and $11,000 the second. What is the interest rate? What does saving equal? Borrowing?
IR = 20% Savings = $833 To solve this --> $833(1 + r) = $1,000
Which of the following gambles should be considered more attractive?
If heads, you win $9; if tails, you lose $6
If the interest rate increases, the price of current consumption
Increase relative to the price of future consumption
Measuring the Labor Force Participation Rate
LFPR = LF/P P = civilian adult population 16 years or older not in institutions
Measuring the Labor Force
Labor Force = Employed + Unemployed Does not tell us about intensity of work
An increase in the interest rate
Makes borrowers worse off (shift away current consumption) The income effect will be negative for a net-borrower
An increase in the interest rate
Makes savers better off because they are able to reach a higher level of utility (the IR is making current consumption is more expensive, so cut current consumption and encourages saving even more). The sub effect and income effect work in opposite directions for a net-saver (income, positive and sub, negative).
A risk-averse individual who owns a $200,000 house and faces the prospect that the house will burn down with the probability 0.05 in any given year will be willing to pay how much of an annual premium to fully insure against such a loss?
More than $10,000
In Figure 17-1, assume the worker is initially in equilibrium at point A. Weekly earnings and work hours are __________ respectively.
OY1 and NL2
Labor Market Participants: The Government
Regulations determine ground rules in the labor market • Taxes on earnings • Training subsidies • Payroll taxes • Affirmative action laws • Minimum wages • Worker condition regulations • Immigration laws
If you were to behave according to the typical rational choice model when confronted with a loss of $100 on the same day in which you receive an unexpected gift of $125 you would
See the net gain of $25 and consider yourself better off
Labor Market Participants: Workers
Suppliers of labor (aggregate individual decisions to derive an upward-sloping labor supply curve) Goal: Strive to maximize well-being (utility) subject to constraints Determine: • Whether or not to work • How many hours to work • Which skills to acquire • Whether or not to quit a job • Which occupation to work in • Whether to join a union • How much effort to put forth at work
Point A represents my endowments for today and tomorrow, the real interest rate is r, and you observe that I consume at point M. From this information what do you know about me?
That I need to borrow in order to finance my higher consumption planned tomorrow.
Which of the following statement is correct for a typical worker?
The substitution effect of a higher wage encourages more work, and the income effect encourages less work
A fundamental axiom of rational choice theory is
choices should be independent of irrelevant alternatives
A reduction in an individual's future income will cause
consumption to fall in both time periods because consumption in both years are normal goods
According to Keynes' absolute income hypothesis,
current consumption depends only on current income.
The labor force participation rate rises
during an expansion and falls during a recession
total compensation =
earnings + fringe benefits
As a result of the substitution effect of a lower wage, hours of work will:
fall due to a lower opportunity cost of leisure time
primary sector (agricultural) employment
has declined as a share of the labor force
secondary sector (industrial) employment
has declined slightly as a share of the labor force, but only in the past few decades
tertiary sector (service sector) employment
has increased as a share of the labor force
What is a primary labor market?
high wages and stable employment relationships
As a result of the substitution effect of a wage increase, a worker will:
increase his work hours
wage =
payment per unit of time
fringe benefits =
payments-in-kind + deferred compensation
Discouraged workers or Hidden unemployed
persons who have left the labor force, giving up in their search for work
A risk-averse individual ___________
prefers a sure return to an uncertain prospect generating the same expected return
Other things remaining the same, in the intertemporal consumer choice model a change in the endowment point:
produces a parallel shift in the consumer's budget line
The Kahneman-Tversky value function is
risk-averse in gains, risk seeking in losses
If you were to behave according to the rational choice model when confronted with a loss of $25 on the same day in which you receive an unexpected gift of $25, you would:
see the two events as exactly offsetting and thereby no consequences in your overall welfare.
When the size of the potential loss is small, most people will
self-insure because they can afford it and the expected loss is less than the insurance premium
The Kahneman-Tversky value function is
steeper in losses than in gains
substitution effect
substitution of other resources for a resource that becomes relatively more expensive
Say one morning you are considering whether to take UBER or riding the train to work. Both mediums would cost you about $4, but you have already paid in advance for the train (since you pay a flat fee at the beginning of the month). If the UBER would take slightly less time than the train ride, and you are mostly concerned with the time it takes you to get to work, you should:
take the cab (take the UBER)
The income-leisure model of work is based on the assumption that:
the worker is able to choose how many hours to work
In the income-leisure model of work, leisure is the portion of time when:
the worker is not receiving compensation from an employer
Unemployed:
those who are not working but are "actively seeking work"
In a two-year period, if a higher interest rate causes consumption in year 1 to rise:
the income effect associated with the higher interest rate is greater than the substitution effect
An individual's labor supply curve will bend backward when
the income effect of a higher wage is greater than the substitution effect
Refer to figure 17-1. If the number of leisure hours is OL1 after a change in wage rate, it implies that:
the income effect of the wage change is less than the substitution effect
In the intertemporal consumer choice model, an increase in ________ will alter the slope of the budget line
the interest rate
The more the people consume in the current period (today or the current year) and the less they save,
the less they will be able to consume in the next period (tomorrow or next year).
Expected return/value is defined as __________
the summed value of each possible rater of return weighted by its probability
The expected utility from an investment is defined as ____________
the summed value of each possible utility weighted by its probability
An increase in the number of discouraged workers causes
the unemployment rate to fall