BUSINESS ECONOMICS I; Problem Set III

1. Many commentators and political analysts have ar!ed

that one "ay to improve the o!tcomes o# the democratic
process is to implement a system o# comp!lsory votin in
"hich people "ho do not cast a vote in eneral elections can
be s!b$ect to %nes or #orced to per#orm comm!nity service.
Some co!ntries &s!ch as 'rentina and Sinapore( have
already implemented s!ch systems. )ra"in on the material
presented in the lect!re* disc!ss this proposal. +hat
problems related to votin in eneral "o!ld this help solve,
+hat are the advantaes o# implementin this proposal, -he
disadvantaes,
One of the problems of direct democracy is that not everybody votes and,
depending on what the election is for, the rates of non-participation are
quite elevated, and therefore we dont get an accurate representation of the
populations opinion. There are other problems, though, such as
asymmetrical information and bounded rationality.
As for asymmetrical information, it is well known that not everybody
has information about every single campaign, because there are a lot of
them and it is quite impossible to know about them all. On the other hand,
we have to take into consideration that our choices are inuenced by the
information that we dispose of. !f, as ! said before, we only have a small
portion of information, our voting will be inuenced by this.
!f we think about this, it is clear that implementing the compulsory
voting will help prevent non-participation, and this is the principal
advantage that this proposal has. "evertheless, it doesnt matter if
everybody has to vote, the amount of information will be the same, and
thus people will vote depending on this information. #o, in conclusion, even
though non-participation is prevented, the problems with asymmetrical
information and bounded rationality is still there.
.. /-he traedy o# the commons0 problem in economics arises
"hen individ!als over1cons!me a shared reso!rce. One
e2ample is h!ntin. +hen h!nters 3ill as many animals as
they "ish* the stoc3 o# animals is depleted* and in some cases
destroyed completely. 4enerally* a!thorities re!late h!ntin
by decreein a limited h!ntin season #or each type o# prey.
)ra"in on the analytical #rame"or3 presented in class* ho"
can this re!latory #rame"or3 be e2plained, +hy is a h!ntin
season decreed instead o# each a!thori5ed h!nter bein
allocated a h!ntin 6!ota, &7!ndamentally the a!thorities
sho!ld care abo!t the amo!nt o# h!ntin* not "hen it ta3es
place(. Can yo! thin3 o# other &non1political( "ays o# dealin
"ith the traedy o# the commons problem in this case,
E2plain.
$unting is a practice that threatens dangerously the live of lots of species.
%entral planned economies need resource allocation in order to control their
economies. !f hunting becomes an e&tended practice, resources are likely to
be easily e&hausted. !n this case, governments have to take measures so
that hunting does not become a problem. !ts because of this that hunting
seasons are established.
'ven though this measure may not be the most e(cient one, is the
easiest to adopt by the government, because it would be much more
di(cult to take a list of all the authori)ed hunters and establish a hunting
quota. *urthermore, this regulation would not avoid the problem of
unauthori)ed hunters.
Thinking of a non-political way of dealing with this problem is quite
di(cult, because all the regulations that could be installed need to be
established by politicians. 'conomic-related measures could be the increase
of ta&es for hunters.
)escription o# the United States mortae mar3et prior to
.889
1. Identi#y potential problems o# pre1contract!al and post1
contract!al asymmetric in#ormation in the relationships
bet"een:
&a( Ban3s and borro"ers
+re-contractual, borrowers may not give away their level of risk, so banks
have no idea whether they are high or level risk, and dont know if the
borrower will be able to pay the debt.
+ost-contractual, if the borrower has a high risk level, he will not be able to
pay the debt or the interest, so bankers wont be able to collect the money
they lent, because borrowers may act opportunistic.
&b( Ban3s and investors
+re-contractual, investors do not know which level of risk the debt they are
acquiring has, because banks dont deliver that information, even though
they have it.
+ost-contractual, investors may end up not getting the money they spent on
the debt, because, whilst banks wash their hands by getting the money
back from the investors, these have to carry the debt.
&c( Investors and credit ratin aencies
+re-contractual, credit rating agencies dont let investors know the level of
risk of the debt they are acquiring, therefore investors cant know for sure if
they are taking a high or a low level risk.
+ost-contractual, because credit rating agencies have rated inversions in a
bad way, investors may end up with a high risk level inversion without
knowing it, and therefore with a very low chance of getting their money
back.
.. -hro!ho!t the .888;s ban3s became increasinly "illin
to loan money to borro"ers. 't one point* some ban3s bean
loanin money to people "ith no $ob* no income* and no
"ealth. 't the same time* credit ratin aencies ranted
/'''0 ratins to the mortaes that investors "ere b!yin.
-his essentially meant that credit ratin aencies "ere tellin
investors that borro"ers "o!ld al"ays pay bac3 their loans.
's a res!lt* trillions o# dollars "ere invested in mortaes.
<o"ever* in .889* many hih ris3 borro"ers in the US bean
de#a!ltin on their mortaes* and the val!e o# investors;
mortae investments pl!mmeted* helpin to inite a lobal
%nancial crisis. In liht o# yo!r ans"ers above* "hy do yo!
thin3 this happened, )oes it ma3e sense to say that it "as
somebody;s /#a!lt0, <o" "o!ld yo! s!est improvin the
#!nctionin o# the US mortae mar3et,
! think that the problem was a combination of the facts that the banks lent
money to people who could not pay them back, and that rating agencies
encouraged banks by saying that mortgages would always be paid. That
combination has resulted in the big -nancial crisis we are living right now. !f
we need to attribute the fault to someone, it would be both the banks and
the credit rating agencies. "evertheless, it is mainly because of the lack of
information that this happens.
The .# mortgage market should be more controlled, in the sense that
there should be more information, so that credit rating agencies are not
allowed to /lie0 on their quali-cations, and banks are more careful with
whom they give mortgages to, because that way the market will not be
regulated by speculation.