Exercise 2 (15 points) Let us assume that an indiiidnal has a property initially valued at 500.0006. With a probability lt'lO. he can lose 90% of the initial value. He nds the situation not interesting and therefore he is going to sell the propeiw. Denote W3 his wealth in the had event and we his wealth if there is no damage. 1. In the plan (W3. W6) show the endomnent point. 2. The individual can buy insurance that pays y when there is a damage. paying premium 0.1 yE. He can choose y. Find analytically and show on the graph his budget constraint. 3. Suppose the individual's cash utility niction is u(m) = M. Write his Yon Neumann h'lorgenstern utility function and using a graph of DUI?) say if he is risk averse. risk neutral or risk loving. 4. What is his MRS at the endowment point (no insurance)? Show that the endowment point is not optimal. 5. What is the optimal insurance and wealth levels under the two events'.J Does he insure fully?J 6. Consider now the insurance premium is 0.2 By. Compare with the previous situation. Give the economic interpretation. What is the incidence of a Tax on prices? a. A Tax increases the buyer price and decreases the seller price b. A Tax decreases the buyer price and has no effect on the seller price 0. A Tax has no effect on the buyer price and decreases the seller price d. A Tax decreases the buyer price and increases the seller price Suppose that David's risk preferences are given by the cash utility function with I his annual income in thousands of dollars. What can you tell about David's behaviour? O a. David's risk preferences are changing depending on his income level O b. David is risk neutral O c. David is risk averse O d. David is risk loverConsider Marcel and Maurice, the only two companies competing in the market for handmade pies in Paris. For Christmas period, Marcel and Maurice can decide to either advertise around town or not to advertise. Advertising increases each companies' costs but will also increase revenues. Marcel and Maurice don't know each other's strategy. The payoff model for Marcel and Maurice deciding to advertise or not is given below: Marcel Don't advertise Advertise Don't advertise 15 ; 15 10 ; 20 Maurice Advertise 20 ; 10 12 ; 12 Which situation corresponds to a Nash Equilibrium for Marcel and Maurice? O a. Marcel advertise, Maurice don't O b. Maurice advertise, Marcel don't O c. Marcel and Maurice don't advertise O d. Marcel and Maurice advertise1. Considering a production function, the law of diminishing return in factor inputs implies that: The increase in output produced by raising one input by one unit (at the same time) falls as the used quantity of all inputs rises The increase in output produced by raising one input by one unit falls as the used quantity of that factor inputs rises The contribution of factor inputs to total output growth declines as factor inputs become scarcer because of overexploitation or demographic decline O Doubling the quantity of all inputs causes a less than double increase in output 2. Considering the production function shown below, wow would you represent an improvement in total factor productivity A movement to the right along the production function A movement to the left of the production function O An upward shift of the production function A downward shift of the production function 3. Starting from a simple Cobb-Douglas production function show how to compute total factor productivity growth (2 points) 4. An economy has the following characteristics: adult population = 100; employed adult population = 80; unemployed adult population = 10. Compute the [2 point] The unemployment rate The employment rate5. Why is the unemployment rate only an imperfect metric of the state of labour market? Statistical offices rely on samples to count unemployed people, which means that the unemployment rate suffers from statistical errors Many unemployed people work in the informal economy (i.e. they are not registered) The unemployment rate is too volatile The unemployment rate can go down if unemployed people stop looking for work, giving the impression that the labour market has improved (and viceversa) 6. What causes the so-called frictional unemployment? The ups and downs of the economy The time it takes to find a new job Too high wages High level of unionization or too much job protection 7. Starting from the national income accounting identity, show that total saving is the sum of private and public saving and that saving equals investment [2 points] 8. According to the quantity theory of money, monetary policy O is powerful tool to increase real GDP in the short and long term O is powerful tool to increase real GDP but only in the short term O has not effect on real GDP in the long term as it affects only nominal variables O is useful to fight recession but bot to increase slow down the economy 0 9. You deposit the EUR 100 in your bank account. The CB's reserve requirement is 20% of deposits [2 points] A) What is the maximum amount that the money supply could increase? B) What is the amount that the money supply could increase if the bank does not lend the money you have deposited?10. The quantity equation of money link the money in circulation (M), velocity of money (V), real GDP (Y) and the price level (P); assuming that in a given period P = 5, Y = 2000 and M = 2000 [2 points] a) find the velocity of money of this economy b) find the price inflation rate if the money in circulation increase by 10% in a next period 11. The European Central Bank (ECB) has increased money supply (Mi] to combat the crisis. The graph below shows the behaviour of Mland M3 since 2014 (M1 and M3 are indexed to 100 in Jan 2014). What can you infer from this graph? 150 145 140 135 130 M1 125 120 ME 115 110 105 100 45 01-09-2016 01-03-2016 01-06-2016 01-12-2015 01-06-2015 01-03-2017 01-06-2014 01-09-2015 01-03-2015 01-06-2017 01-09-2014 01-12-2016 01-03-2014 01-12-2014 01-09-2017 This is as expected as theory and empirical studies suggest that M3 grows always slower than M1 O The increase in M1 has been too low to have any effect of M3; the ECB should increase M1 even more O The banking system has not lent the money the ECB has created This is as expected as M1 and M3 move independently from each other, always12. What does the Fisher effect refer to? The increase in prices following an increase in money supply O The change in nominal variables following change in the quantity of money in circulation The one-to-one adjustment of the nominal interest rate and inflation rate The change in the real exchange rate following a change in the inflation rate 13. What are the most important limitations of the purchasing power parity theory? Economic agents are not rational and have imperfect information 0 There are many goods that are not traded internationally and agents have only imperfect information about them There are many goods and services that cannot be traded internationally and goods produced in different countries are not perfect substitute O Goods produced in different countries are not perfect substitute and people prefer to buy goods from their countries 14. In a fractional reserve banking system: [3 points] what is the reserve ratio (provide a simple definition - one line - and a simple numerical example) ? what is the money multiplier (use the simple numerical example that you have chosen above)? assuming deposits increase by EUR 100; compute the expected increase in money supply (write the formula at least) 15. Write down the expression the real exchange rate: [2 point]