Econ 30041
Tutorial 3.
1. Suppose in a country S, there are two occupations: entrepreneur or labourer. To become an entrepreneur one needs £20,000. The rate of interest is 10 percent per year. Each entrepreneur employs 10 workers at £w per year. Together they produce output worth £30,000 per year. At the end of the year, entrepreneur has to pay back the loan.
If the loan is not paid, the entrepreneur would be caught and 20 percent of the business profit would be seized, along with the collateral. However, in that case the entrepreneur gets to keep the loan and the interest payment.
(a) Find the formula that shows how much collateral the bank should ask for before it lends the money
(b) What happens to collateral if wage, (i) w= 1000, (ii) w=2000 and (iii) w=2500. Does the collateral go up or down? Explain your answer.
2. Consider a person in time t, with wealth w(t), who faces the choice between three occupations described in Topic 3. For subsistence the earning is fixed at z, and for employment in the labour market pays w(t) and entrepreneurship leads to net profit π>z. Whatever income is received is added to her wealth (plus a fixed interest rate r). A fixed fraction of the total is consumed.
(a) Find the equation that describes the starting wealth in period (t+1) for each of the three occupations.
(b) Under high inequality, what is the long run wealth (steady state) of an individual who earns subsistence wage year after year? And what is the long run wealth (steady state) of an individual who is an entrepreneur?
3. What is the difference between taste-based discrimination and statistical discrimination?
(b) In the presence of non-discriminatory employers, taste-based discrimination as in the Becker model, would be completely eliminated. Do you agree? Why?