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Amit S.
IIT Roorkee, Bank of America, CFA, Economics
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Economics
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Question:

How would a Universal Basic Income (UBI) affect the Labor force participation rate in an economy?

Amit S.
Answer:

Universal Basic Income (UBI) entails giving out a particular income to all the individuals in the economy irrespective of their income and consumption levels. This is a poverty alleviation tool that intends to correct the flaws of traditional poverty alleviation tools like in-kind allocations, price subsidy, targeted transfers. Impact of UBI on labor force participation rate: Since UBI will involve giving out a subsistence level of income to all individuals, there are fears of a reduction in labor force participation rate due to UBI. In a Labor-Leisure trade-off diagram, UBI will come as an income effect. And since, leisure is a "normal good", income effect would tend to increase demand for leisure. Thus there should be a tendency to reduce labor supply. Let us consider an economy with two types of individuals for the impact of the income effect. One section is a high-income group and other is a low-income group. For High-income group UBI as a share of total income is very low and thus income effect is negligible. For Low-income group, the marginal utility of income is significantly higher than the marginal utility of Leisure. Thus, income effect is low. Also, for low-income levels, there is sharply falling marginal utility of money. They exhibit Petersberg's Paradox. Thus, individuals are highly risk-averse. Thus they tend not to invest and prefer regular wage employment. But with UBI, there is no risk of falling below Subsistence wage and this floor protection allows them to take risky investments and it increases employment opportunities for themselves and for other low-income sections.

Microeconomics
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Question:

Which among Cournot, Bertrand and Stackelberg oligopoly models is closet to perfect competition with respect to social welfare?

Amit S.
Answer:

In a Cournot model, the competitors compete on market share. Both firms in a classic Cournot case make simultaneous decisions about output assuming other firm does not change output in a particular period. In this case, equilibrium is attained at a level where Price is always greater than marginal cost. In a Bertrand model, firms compete on price. This is a more aggressive form of competition. In this case when there is homogeneous good produced by both firms, then each firm will undercut the other in price in each subsequent period. This will end in market equilibrium where Price equals marginal cost if both firms have same marginal costs, else price will be just below the marginal cost of the firm with higher marginal cost. So if both firms have same marginal costs, then equilibrium is similar to that achieved in perfect competition. This is called Bertrand Paradox. Hence, this form of competition leads to highest welfare among three forms of oligopolies. In a Stackelberg model, one firm is a smarter firm and it also plays first. And firms in this competition in market share. So this is a modified version of Cournot. One firm that is also a smart firm plays first and then the second firm plays. In this case, the first mover makes a credible commitment to output. In this case, the first mover produces higher than that produced by Cournot and the second mover produces lower than that produced by Cournot player. However, even in this case, the price is greater than marginal cost. Thus Bertrand model has highest social welfare among Cournot, Bertrand, and Stackelberg.

Macroeconomics
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Question:

Liquidity preference is neither necessary nor sufficient, except in two limited cases, to explain unemployment equilibrium in Keynesian model.

Amit S.
Answer:

Keynes gave a new theory of demand of money which was different from classical view on money. Keynes contended that money is demanded transactional, precautionary and speculative purposes. Hence, money demand was a function of income as well as that of interest rates. The equilibrium between money and bonds in the portfolios of individuals was decided by interest rate and liquidity preference. This helped identify interest rate in the market. Keynes said this interest rate played out in money market would decide the level of investment and hence the level of aggregate demand. However, Modigliani contended that except in two limited cases of "liquidity trap" and "interest inelastic investment demand" there will be an equilibrium at full employment. driven by fall in wages. And even in these two limiting cases where the Keynes effect is not played out due to barriers, the wealth effect also know as Pigou effect will bring about full employment by shifting IS curve rightwards.

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