- Credit markets
Discuss how Kiva seems to be coping with the problems of moral hazard and adverse selection in credit markets. You should devote one or two paragraphs to each concept.
- Savings and Discounting
When people choose to save, they are making a choice between consuming something today, and consuming something tomorrow. If it is the case that an individual’s “utility” is given by the function ln(c), then this intertemporal choice involves maximizing expected utility: ) subject to the fact that you can either get a return on income or take out a loan, so your “lifetime” income is equal to.
In this problem ρ is called the “discount rate”, which you should think of as the individual’s internal interest rate.
Because a person can either borrow or save, this intertemporal choice means that if they save today, they get to consume more tomorrow, since that savings earns an interest rate, so. Begin by taking as given that this individual earns $50 during the first period of their life, $60 during the second period, and that the interest rate r is equal to 0.20. Now answer the following questions:
- What is the present value of their lifetime earnings (i.e., x = )? Calculate the end points of the budget constraint. That is to say, if they save all their earnings (ctoday = 0), what will they have available to them in period 2? Conversely, if they borrow against all their future income, how much money will be available to them in period 1? Draw this budget constraint on a graph, with period 1 on the x-axis and period 2 on the y-axis.
- Suppose that their internal discount rate (ρ) is equal to .50, so their expected utility is: ). Which intertemporal consumption choice gives them higher utility, 60 today and 48 tomorrow, or 45 today and 66 tomorrow? Now suppose that their internal discount rate is equal to 0.10. Which of these two choices gives them higher utility? Indicate both of these points on your graph. Label the distances on the x-axis that indicates savings or borrowing in each of the two scenarios.
- Given this analysis and the Banerjee and Duflo reading, give two reasons why we might observe the poor saving less than the rich.
Let’s break down this economics homework assignment on credit markets and savings.
Step 1: Understand the Assignment
This task requires an analysis of Kiva’s handling of moral hazard and adverse selection, along with a comprehensive understanding of savings and discounting. To perform well, you’ll need to grasp these economic concepts, and apply them in practical scenarios.
Step 2: Research
Start with some initial research on Kiva’s strategies for dealing with moral hazard and adverse selection in their credit markets. You’ll need this information to discuss their approaches in detail.
Step 3: Formulate Your Arguments
Based on your research, prepare two distinct paragraphs – one for discussing how Kiva manages moral hazard and another for how they handle adverse selection.
Step 4: Perform Calculations
For the second part of the assignment, which revolves around savings and discounting, you will need to apply the formulas given to calculate the present value of lifetime earnings and to understand budget constraints.
- Calculate the present value of the individual’s lifetime earnings based on the provided income and interest rate. Determine what they would have available in period 2 if they save all their earnings in period 1, and how much they could have in period 1 if they borrow against all their future income.
- Draw the budget constraint on a graph, marking period 1 on the x-axis and period 2 on the y-axis.
- Compute the individual’s expected utility for different intertemporal consumption choices under two distinct discount rates.
Step 5: Write Your Responses
Begin writing your response, starting with an explanation of Kiva’s strategies for moral hazard and adverse selection, followed by your calculations and interpretations for the savings and discounting part. Don’t forget to indicate savings or borrowing scenarios on your graph.
Step 6: Reflect
Reflect on why the poor might save less than the rich, considering your analysis and the reading by Banerjee and Duflo.
Step 7: Review and Refine Your Work
Once your initial draft is complete, review your work, ensuring it’s coherent, maintains clear focus, and is written in a natural and human-like manner. Make sure your grammar and punctuation are correct.
Step 8: Proofread
Finally, proofread your assignment for any spelling or grammatical errors before submitting it.
These steps should help you produce a quality response to your assignment. Good luck!