Assignment
BEE2028/BEE3043 Money and Banking 1
October 25, 2013
• This assignment consists of short questions. Answer ALL the questions.
• The expected total length of your paper is 1000-1500 words. Numbers, mathematical symbols and equations also count as one word. For example, if you say “Let x be the price of an apple so x=100,” it counts as 10 words.
The maximum limit is 2499 words and the part that goes beyond this limit is subject to truncation by the markers.
• Your answers should be typed in Microsoft Word or other editors. (No hand-writing) It should be submitted both in the paper form and in the electric form.
• Your assignment is marked anonymously. Do not include your name.
• When you provide examples, ‘uniqueness’ is highly valued. You may refer to books, papers, websites, etc., but high marks will be given to examples that other students did not provide. (So try to avoid using examples that were taught in other modules or textbooks.) The examples should not be just a numerical example but should have a story.
• For question 1 and 3, the following are the marking criteria. (The percentages in the brackets are the estimated fraction of students who will get that mark.) 0-5 points (10 %) The concept misunderstood, or very common example.
10 points (60 %) The example is good and more or less unique.
15 points (20 %) The example is very interesting and unique.
20 points (10 %)
For question 2 and 4, the following are the marking criteria.
0-10 points (10 %) The concept misunderstood, or very common example.
15-20 points (70 %) The example is good and more or less unique.
25 points (10 %) The example is very interesting and unique.
30 points (10 %)
• The answer examples are provided at the end.

1

Questions
1. (20 points) ‘Multiplier effect’ is an economic term that refers to a situation in which an initial impact on some fundamentals has a second effect, a third effect, a fourth effect, and so on. Probably the most well-known example in macroeconomics is the effect of fiscal policy on equilibrium GDP. This is because the rise in GDP increases people’s income and the rise in people’s income increases GDP as well. In week 4’s lecture, we saw a multiplier effect in debt rollover (re-financing). That is, the rise in the borrower’s credit risk leads to a drop in the price of bonds that the borrower issues, and the latter further raises the former if that person is carrying out re-financing.
Provide your own example of a multiplier effect. The example can be economic or non-economic.
2. (30 points) In week 5, we examined the “James meets a girl” example to study how one updates his belief after observing a signal (new information) and how it affects his decision when he is an expected utility maximiser.
Also, we studied how a myopic optimiser and a dynamic optimiser can choose a different action from each other even if they have the same period utility structure. In a tutorial session, we also examined the “James finds a cafe” example, which has a very similar structure.
Create your own exercise questions and their solutions which involve (i) belief update, (ii) expected utility maximisation, and (iii) the difference between the myopic and dynamic optimisers. It is important that your question has a unique story. For solutions, draw diagrams of probability trees.
(For computing, MS Excel would be much more convenient than a calculator.) NOTE: For BEE3043 students, the numbers (probabilities, utilities, etc.) should be significantly different from those in the lecture slides, tutorial exercises, and the example answer of this assignment. BEE2028 students can use identical number settings.
3. (20 points) Examples of agents’ hidden types include ability, diligence, healthiness, faithfulness, honesty, etc. Sometimes, the principal wants to benefit only a particular type of people, but he cannot do so simply because he cannot distinguish that type from other types. In week 5, we saw