Problem Set 4

1. Explain the concept of moral hazard in 3-4 sentences. It is a situation in which one party gets involved in a risky event knowing that it is protected against the risk and the other party will incur the cost. These situations are caused due to information asymmetry ( When both parties have incomplete information about each oth er ), and are ubiquitous. They a re caused due to hidden actions. For example : Taking big bets in a marketplace with your firm's capital because you have limited exposure to the downside but lots of exposure to the upside .

2. Explain the concept of adverse selection in 3-4 sentences. Adverse selection refers to a situation where sellers have information that buyers do not, or vice versa, about some aspect of product quality. In the case of insurance, adverse selection is the tendency of those in dangerous jobs or high-risk lifestyles to get  life insurance . To fight adverse selection,  insurance  companies try to reduce exposure to large claims by limiting coverage or raising premiums. To overcome adverse selection, the following could be done :
Signaling - adopting ways to ascertain the quality of the product such as issuing warranti es, third party verification.
Screening -make efforts to learn more abou t the product or service .
3. What are the pros and cons of using GDP as a measure of a nation's well-being?
Pros:
GDP provides a better analysis or measure of economy activity through its growth rate and changes in an economy than any other existing measure. It summarizes a whole range of economic information in and determines the comparative strengths and weaknesses of various sectors. 
GDP serve as accurate barometer of the business climate, where it provides the government and business useful information to adjust in different kinds of contingency problems like recession and depression.
GDP serve as a simple proxy for social and economic welfare.

Cons:
G DP does not include non-market activities. These activities are based on production and consumption that occur outside the market economy that does not have a price attached like unpaid house workers, volunteer work, barter and the illegal drug trade.
It does not include domestic household products or black market.
It does not consider how the wealth of a nation is distributed equally. For example , GDP provides an estimate of each person share of the market economy but, in reality some people share of the economy is greater than others. This level of unequal distribution of incomes and consumption and the incidence of poverty cannot be determined by tracking the GDP.
Some GDP measured expenditures do not contribute to Economic Welfare. It does not account for any welfare loss or any negative events that results from an event such as a natural disaster environmental cleanup or reconstruction effort contributes to welfare and the GDP.
It does not accurately reflect the wellbeing and the living standards of people. The performance of few top companies can skew the GDP figure (It is a mean). E.g. : While India is the 5 th largest economy in terms of GDP, a significant number of people still earn less than $2 a day and lead a difficult life.


4. Please listen to the following Planet Money podcast (titled "How Recalculating GDP Can Help App Designers In Nigeria", broadcast on 5/31/2013): 
 http://wlrn.org/post/how-recalculating-gdp-can-help-app-designers-nigeria 
 and answer the following questions:
a. What are the arguments for restating Nigeria's GDP? The current Nigeria's GDP was calculated based on data collected in 1990. T here were significant developments o ver the last 2 decades . Many new industries such as telecommunications have sprung up. T he current GDP model did not capture the contributions from such fast-growing industries . So, they decided to upgrade by rebasing to a new year. This move would greatly help the country to borrow money at a low cost and invest in those sectors that further boost the economy. Further, this would also make Nigeria a target destination for investments.

b. What are the arguments against restating Nigeria's GDP? 
 If the GDP of Nigeria is restated, hence updated based on a new base year, Nigeria would become the largest