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ECON60022

ECON 60022: DEVELOPMENT MICROECONOMICS

There are two sections (Section A and Section B). Answer 1 question from each Section. For this exam, you have to answer 2 questions in total.

Section A and B: The word count for each question (including any subparts to the question) is a maximum of 600 words (excluding any diagrams, references and equations). Anything more will not be read. A word count must be provided at the end of each answer.

Note: You have to submit typed responses. Your exam will not be accepted if it is not typed. You can include images of algebra or graphs if you wish.

Candidates are advised that the examiners attach considerable importance to the clarity with which answers are expressed

Answer one question from each Section.

World limit on each question (including sub-parts) is 600 words (Equations are not part of the word count). You must provide the word count after each answer.

Section A (answer any one question out of 2)

[1] Consider a model of intra-household allocation, based on the Cournot-Nash solution of Chen and Woolley (Economic Journal, 2001), where a household consisting of a male (m) and a female (f) member with the following utility function

y is the public good, ai, is the minimum amount of public good needed by individual i and is the private consumption of i. Households pool resources.

(a) If the minimum amount of public good needed by the female member is higher than that of the male member , discuss the equilibrium allocation of resources within the household.

[15 marks]

(b) Explain what happens to the overall equilibrium if the private consumption of male members are subjected to an ad-valorem tax. Would this be a policy governments should follow to increase within household expenditure on public goods? [Assume that . ]

[15 marks]

(c) Suppose and . If the household decides to maximise the total welfare of the household using a welfare function , discuss the equilibrium allocation of resources and compare it with the case where they act non-cooperatively.

[20 marks]

[2] Consider the Basu and Van (American Economic Review, 1998) which explains the existence of child labour

(a) A household consists of one adult and two children. Each child consumes the same as an adult. Using a Stone-Geary type utility function (as used by Basu and Van (1998)), find the conditions under which the household will send (i) both children to work, and (ii) just one child to work.

[15 marks]

(b) Suppose for each child employed, firms have to pay a fine f with probability p. Derive the equilibrium conditions for a profit maximising firm, and explain how the equilibrium is different from the case where there are no fines.

[15 marks]

(c) Do you think a ban on child labour will be useful if the government can only implement it partially?

[20 marks]

Section B (answer any one question out of 2)

[3] Using diagrams where possible, explain the main ideas and the implications of Bardhan and Udry’s (1999) adverse selection model of credit markets with focus on four cases:

(a) competitive equilibrium with complete information

[10 marks]

(b) competitive equilibrium with incomplete information

[10 marks]

(c) equilibrium with a fully informed monopolist

[15 marks]

(d) competition between an informed local money lender and uninformed outside lenders.

[15 marks]

[4] In the principal-agent model with moral hazard from Laffont and Martimort (2001),

(a) outline the conditions under which the principal always wants to induce high effort from the agent.

[10 marks]

(b) Show that the principal’s optimal transfers to the agent are in fact a first-best single payment in the complete information contract.

[10 marks]

(c) What are the principal’s optimal transfers to the agent in the presence of moral hazard when the agent is risk-neutral? How do these transfers change when the agent is protected by limited liability such that transfers must always be non-negative?

[15 marks]

(d) Show that the sharecropping contract is a weaker contract than the standard contract with limited liability in the presence of moral hazard due to the linear sharing rule.

[15 marks]

END OF EXAM