Question

Use your analysis of the extent of self-insurance and coinsurance in your home country.

a) Will consumption expenditure fluctuate when there is an economy-wide shock to households?

b) What is the implication for fluctuations in GDP

Answer 1

1. Household shocks

People use two strategies to deal with shocks that are specific to their household


? Self-insuranceself-insurance Saving by a household in order to be able to maintain its consumption when there is a temporary fall in income or need for greater expenditure.close: Households that encounter an unusually high income in some period will save, so that when their luck reverses, they can spend their savings. As we saw in Unit 10, they may also borrow in bad times if they can, depending on how credit-constrained they are. It is called self-insurance because other households are not involved.
? Co-insuranceco-insurance A means of pooling savings across households in order for a household to be able to maintain consumption when it experiences a temporary fall in income or the need for greater expenditure.close: Households that have been fortunate during a particular period can help a household hit by bad luck. Sometimes this is done among members of extended families or among friends and neighbours. Since the mid-twentieth century, particularly in richer countries, co-insurance has taken the form of citizens paying taxes, which are then used to support individuals who are temporarily out of work, called unemployment benefits.
Informal co-insurance among family and friends is based on both reciprocity and trust: you are willing to help those who have helped you in the past, and you trust the people who you helped to do the same in return. Altruismaltruism The willingness to bear a cost in order to benefit somebody else.close towards those in need is also usually involved, although co-insurance can work without it.


These strategies reflect two important aspects of household preferences:

• People prefer a smooth pattern of consumption: they dislike consumption that fluctuates as a result of bad or good shocks such as injury or good harvests. So they will self-insure.
Households are not solely selfish: They are willing to provide support to each other to help smooth the effect of good and bad luck. They often trust others to do the same, even when they do not have a way of enforcing this. Altruistic and reciprocal preferences remain important even when co-insurance takes the form of a tax-supported unemployment benefit, because these are among the motives for supporting the public policies in question.

B) implications of fluctuations in GDP

? Shocks to aggregate demand and supply cause fluctuations in GDP and employment in the short run.

? some of the GDP fluctuate components are:-

• Consumption

• Investment

• Government spending on goods & services

• Experts

• Imports

• Net trade