Economics 541 – Mid-Term Examination Winter 2014

Economics 541 – Mid-Term Examination Winter 2014

Question
	

Economics 541,


Mid-Term Examination


Winter 2014




There are a total of100
marksavailable.




Question 1. (30 marks
total)


In the unbundling
institutions paper we saw that the value of undertaking production to producerjwas:


Uj(ej) =F(P)a????1????mi????ej;whereejis the
idiosyncratic individual cost of undertaking the project,miwas the
cost of writing the financing contract (i=dfor debt
contract ori=efor equity contract),awas the return on the project and
F(P) was the probability that a project was not expropriated by the state.
There are a few noteworthy things about this equation. Firstly, the costs of
going to court,Cido not enter into this
expression.


A. Is it safe to conclude
that it is always beneficial to have a legal system with a cheaper cost of
writing contracts (i.e., lowm) even at the costs of higherC:? Explain
why or why not with reference toRthe
interest repayments required on loans anda. (10 marks)




B Is it safe to conclude
that it is always beneficial to have a political system where the probability
of being expropriated (1????F(P)) is
always low? Discuss with reference to both the feasibility offinancial markets
existing (the condition relatingRanda) and
with regards to the level of investment that will be undertaken given the feasibility
of lending. (5 marks)




C. Suppose that lending
were not competitive, so that lenders would be able to extract some rents from
theirfinancing operations. Would this afiect the feasibility condition for the
lending market (i.e., thecondition
relatingRand


a).
Explain whether it afiects it either qualitatively, quantitatively or both. (10
marks)


D. The main conclusion
from the empirical part of this paper was that


the quality of political
institutions seemed to have a large efiect on economic outcomes (GDP per
capita) whereas the quality of legal institutions determined only the form thatfinancial
contracts take (amongst other things perhaps), but did not afiect the overall
level of investment or economic outcomes. How does


this finding link to the
theoretical part of the paper? Discuss with relation to the choice of debt
versus equity financing. (5 marks)




Question 2 (20 marks
total)


The main insight of the
Greif model, considered in class, has to do with moral hazard in trading
situations. He considers a canonical principal agent problem in which the
principal (a merchant) has no extraneous means of enforcing contract and
punishing agents who cheat him, and must rely on the threat of terminating the
relationship with the agent to provide incentives for the agent to trade honestly.
The insight is that close knit groups of traders who share information, or at
least condition their actions on what happens to their colleagues and not just
on what happens to themselves can actually sustain a broader set of trading outcomes
than do traders who act in isolation.


Explain
intuitively why this is true in his set up. (5 marks)


B. In his paper, the
Genoese are the individualists, but the Maghribi are the collectivist. The
historical record suggests that it is the Genoese who came to dominate trade in
the Mediterranean, whereas Maghribi inuenced was limited and eventually waned.
Explain how he argues that this is consistent with the principal agent set up
he considers. (5 marks)


C. Now suppose thatfi= 0 that
is, trading relationships are never dissolved for exogenous reasons. Recall
also that nobody ever dies either. Explain intuitively why the relationship
between wages here is now difierent than whenfi >0, i.e.,
in the standard model. (10 marks)


path, if an agent were
to cheat, then a single job would become




Question 3 (15 marks
total)


Karlan and Zinman (2009)
designed afield experiment to seperately explore the inuence of Moral Hazard
and Adverse Selection in the credit market. They sent letters ofiering clients
of a South Africanfinancial institution an opportunity to borrow. The rate at
which they were invited to borrow was randomized


so that difierent groups
ended with difierent ofier rates. Suppose half received ratexand the
others ratex=2. Now, among those who agreed to borrow at an 3 initially high rate,x, they
randomly selected half of the clients and surprised them with the lower rate of
interestx=2.


A. Tell me { and explain
your reasoning { which two groups should be compared to isolate the pure efiect
of adverse selection on repayment rates. (5 marks)


B. Tell me { and explain
your reasoning { which two groups should be compared to isolate the efiect of
moral hazard on repayment rates. Explain why this is not, however, the pure efiect
of moral hazard, why there is also the possibility that something else could be
afiecting behavior. (10 marks)




Question 4 (15 marks
total)


Consider the /Theory of
Political Transitions" paper by Acemoglu and Robinson (2001). Commitment
problems and threats on both sides of the class divide are the key to why democratization
can occur there. The poor would like higher taxes and more redistribution, and
they are able to threaten revolutions that will (severely) destroy future value
of the Rich. The Rich, on the other hand, would like lower taxes and less
redistribution and they can threaten coups that will take power from the poor,
and also destroy value. The threat of revolutions enables the rich (if they are
in power) to commit to redistribution to the poor (in the future too). The
threat of coups allows the poor (if they are in power) to commit to not too
high a level of expropriation of the rich (in the future too).


A. Explain intuitively why
the state of the economy impinges on these commitments. In particular, what the
efiect of the economy being in a low state of productivity has on the
willingness of the group in power to accomodate the group out of power. (5
marks)




B. Explain intuitively why
an increase in the frequency of recessionary periods makes democratizationlesslikely.
(5 marks)


C. Explain intuitively why
more economically equal societies are less likely to democratize. (5 marks)




Question 5 (20 marks
total)


In the Nunn (2006) paper
on the efiects of slavery in Africa a key step was the use of instruments to
isolate a potentially causal efiect of slavery on present day outcomes. He used
distances from each African country to the locations where the slave labor was
eventually used as instruments.


Consider the following
factors { treaing each one seperately { and explain, briey, whether the factor
invalidates the use of these instruments:


A. Suppose that sugar
plantations were established in the West Indies because West Indies were close
to the Western Coast of Africa. 5 marks


B. Suppose that the
plantation economies in theWest Indies were established there because of the
high price of sugar and that there was massive demand for labor that
pre-existed the development of slavery in Africa. 5 marks


C. Suppose that distance
to the coastal ports is correlated with high rates of endemic disease like
Malaria { prevalent at the time of slavery and today. 5 marks


D. Suppose that the
countries in which many people were enslaved were also countries where there is
a high rate of HIV infection. 5 marks