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1. Insurance and Crowd Out

a)[5 points] Suppose an individual was earning $1000 a week and then becomes unemployed. The individual then has no labor market earnings but can borrow from family and friends. Suppose that the UI system provides $600 a week in benefits. The table below summarizes the individual’s situation. X and Y are unknown variables.

(information in pdf.)

What are X and Y if UI benefits don’t affect borrowing from family and friends (no crowd out)? What are X and Y if individuals reduce borrowing from family and friends by a dollar for every dollar of social insurance benefits (full crowd out)? What are X and Y if individuals reduce their borrowing from family and friends by 50 cents for every dollar of social insurance benefits (partial crowd out)?

b)[10 points] Suppose the government of India is thinking about introducing a formal unemployment insurance program. You collect data from the area in which they are thinking about introducing the program and determine that consumption is completely smooth when individuals experience unemployment shocks. One of your advisors says that this shows that there will be no welfare gain from introducing formal social insurance. Another counters that “economists have shown” that there will definitely be gains from introducing formal social insurance, even if observed consumption is smooth. What do you think? Explain (4-6 sentences)

2. Informal InsuranceThe following questions are based on the Chetty-Looney paper from the readings. It’s a short paper and you should read it fully.

Chetty, R. and Looney, A. (August 2006) “Income Risk and the Benefits of Social Insurance: Evidence from Indonesia and the United States”

a)[5 points] One of the main findings of the paper is that in both Indonesia and the US, food consumption falls by about 10 per cent (at the median) when individuals become unemployed. Why is similarity in the percentage drop surprising?

b)[5 points] What are the estimation strategy and the underlying identification assumption of this paper?

c)[5 points] Why do the authors argue that any violation of the identification assumption would overstate the true consumption drop?

d)[10 points] Describe how the results in table 3 are supposed to convince readers that the identifying assumption is valid. What is your assessment?

e)[5 points] How do households in the US and Indonesia smooth food consumption (2-3 points for each country are sufficient)?

f) [5 points] Explain why the results on school attendance and educational expenditures in table 5 suggest that households use costly mechanisms to smooth consumption. What is a concern with this interpretation?


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