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BUS702 : Economics For Managers

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1. The article discusses how a “disproportionate preference for safety” could lead to another financial crisis similar to the GFC-2008.
a) Draw a demand-supply diagram of an asset, which is initially perceived as risky. Suppose the asset in question is now perceived as risk-free. How will your demand-supply diagram change? Show the change in the same diagram. Briefly explain.
b) What happens when the asset in “part a”, is suddenly revealed to be risky?
c) Suppose the banking sector raises money by selling such financial assets to investors. For the banking sector as well as for investors in general, discuss the macro-economic implications of incorrectly perceiving risky financial assets as risk-free. What happens when the truth about such assets is suddenly revealed?
2. The article discusses the impact of China-Australia free trade agreement on Australian agribusiness. In particular, the article discusses how Australian beef imports into China would benefit from a complete removal of tariffs.
a) In this course, we studied the impact of tariffs on imports. Consider the market for beef in China, and, analyse what happens in this market, when China eliminates tariffs on beef imports from Australia (Hint: Do a welfare analysis. That is, calculate the total surplus before and after tariff removal).
b) By citing evidence from the article, make a case that the argument in part “a” above is not entirely correct? Explain.

3. The article talks about the concept of “shared-responsibility mortgage” and argues that this new type of mortgage is superior to the standard mortgage.
a) The authors write that ‘..research shows that debt contracts have large negative externalities on the economy that are not properly priced among private parties’. Using the concept of externalities studied in this course, explain the authors’ statement.
b) Explain how the ‘shared-responsibility mortgage’ contract mitigates the negative externality of the debt contract.
c) The authors claim that the government tilts the field in favour of typical or standard debt contracts by making the standard debt contracts securitizable, whereas, ‘shared responsibility mortgages’ are not securitizable. Securitization involves carving-out risk-free assets from a pool of risky mortgages, and selling them separately to investors. In Q1, you read an article that discusses “disproportionate preference for safety” among investors. Integrate the concept of “disproportionate preference for safety” with the notion of “securitization” to explain how the government tilts the field.
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