Question

(3 points) Warm up. For each of the following terms, define and give an example.

Liquidity

Discount rate

Adverse Selection

Insurance

Occupational crowding

Complementary and substitute immigration

Answer 1

1. Liquidity refers to the ability of converting an investment (or capital) into cash. It is necessary because liquidity is needed for meeting financial obligations like bills, or immediate payrolls etc. The most common form of liquidity is cash, which is used by the individuals for day-to-day transactions. Examples of liquidity are: cash, marketable securities (like bonds, certificate of deposits etc.), cash equivalents (these include treasury bills, commercial papers) etc.

2. Discount rate is:

- In context of banking, it is the rate of interest at which the banker of banks (that is, the Federal Reserve or Central bank of the economy) provides loans to the commercial banks or other depository institutions.

- In context of Cash flow analysis, it is the rate of interest used to determine the present value of the future cash flows in a discounted cash flow analyis.

For example, currently, the federal discount rate of US is 2.25.

3. Adverse selection is a situation in which the two parties, buyers and sellers do not have symmetric information before a deal they will enter into. In this situation, one party has less or inaccurate information as compared to the other party. There lies a difference in the information endowed by both the parties.

For example, Party A and B apllied for health insurance. Party A suffers from a disease whereas, Party B is fit and healthy. While applying for insurance, Party A does not disclose about the disease with a fear of higher insurance premium and mentions 'Healthy' in its health status. Party B also mentions 'Healthy' in the health status. This is adverse selection because the insurance company is unaware of the disease of Party A and charges the same amount of premium to both the diseased and non-diseased party.

4. Insurance refers to a contract in which one party promises to provide reimbursement or financial protection to another party against losses occured by a specified contingency or uncertainity. It is a form of financial protection from losses. Examples of various kind os insurance available are: Health insurance, Life insurance, vehicle insurance, home insurance etc.

5. When crowding of certain group of workers (groups based on colour like black and white, gender like men and women, age, race etc.) into a certain or limited jobs occur, it is known as occupational crowding. This generally occurs in an economy where ther are particular job roles defined for certain groups, say, gender (men and women), age groups (young and old) etc. However, it is not a common scenario today as in today's time, people have full liberty to choose their careers and job roles. For example, offering 'pink-collar' jobs to women and 'blue-collar' jobs to men is occupational crowding.

6. Complementary and substitute immigration - When there is a positive relation between incomes and the productive factors (like domestic workers) due to immigration, it is termed as complementary immigration. When there is a negative relation between incomes and the productive factors (like domestic workers) due to immigration, it is termed as a substitute immigration. For example, in an economy, some domestic workers produce a final good. The immigration of skilled workers will be a complement to skilled domestic workers as the number of skilled labor in the economy will rise and hence, it will be beneficial for the economy as quality production will take place. It results in a rise in the worker's wages. Whereas, immigration of skilled workers will be a substitute to unskilled domestic workers and the overall worker's wages will fall.

In other words, a rise in immigration flow will result in high income for productive factors which are complementary with the immigrant labor. On the other hand, a rise in the immigration flow will result in low income for productive factors which do not complement the characteristics of the productive factor (and thus, prove to be a competition to the immigrant labor).