QUESTION 1 The Global Financial Crisis created a case for regulating the salaries of banking…

QUESTION 1 The Global Financial Crisis created a case for regulating the salaries of banking…

  1. QUESTION 1

    The Global Financial Crisis created a case for regulating the salaries of banking sector executives. In 2009, US President Barack Obama and the US Congress introduced a $500,000 bonus payment cap on designated executives of companies seeking a bailout. In response, Reed Hastings (CEO of Netflix) wrote an opinion piece inThe New York Times(see attachment 1). Unless otherwise specified, assume that labour markets in the US are perfectly competitive, and initially in autarky equilibria.

    1. (a) Explain the impact of the bonus payment cap on the labour market of US banking sector executives. Substantiate your answers with a diagram depicting the demand/supply in the labour market. [2 marks]

    2. (b) Instead of the bonus payment cap, consider instead Reed Hasting’s proposal of an income tax hike. Explain the impact of an income tax hike on the labour market of US banking sector executives. Substantiate your answers with a diagram depicting the demand/supply in the labour market. [2 marks]

    3. (c) According to the article, “Some will tell you [that an income tax hike] would reduce the incentive to earn but I don’t see that as likely. Besides, […] most of our motivation is the sheer challenge of the job anyway.” What do these statements imply in terms of who might bear most of the (proposed) tax burden? Substantiate your answers with a diagram depicting the demand/supply in the labour market. In light of public concerns regarding overpaid banking sector executives, do your answers make the tax hike proposal more or less appealing? [2 marks]

    4. (d) Suppose we were to compare the two policy options – a bonus payment cap and an income tax hike – where in both cases the same equilibrium labour quantity of banking sector executives is achieved. In which case is the society better off? Substantiate your answers with a diagram depicting the demand/supply in the labour market. [3 marks]

    5. (e) Suppose that labour markets in the US are open to international trade and there is perfect labour mobility across national boundaries. Given that there are many foreign banking

sector executives who are unemployed after the Global Financial Crisis, how might your answers to part (a) change? Substantiate your answers with appropriate diagrams. [3 marks]

QUESTION 2

Most countries use a combination of markets and government intervention to solve the economic problem of how much to produce and consume. For a country of your choice, explain with an example, where, why, and how markets and government interventions work well or poorly in making decisions to maximise society’s net benefit.

Suggested answer format:

  1. (a) Explain how competitive markets solve the economic problem that you have identified. [2 marks]

  2. (b) Set out the key assumptions required for the market solution to maximise society’s net benefits. In this context, explain why government intervention in this market is likely to cause an efficiency loss. [2 marks]

  3. (c) Consider a possible market failure in your example, and then describe the reasons for, and the magnitude of, the market failure. [2 marks]

  4. (d) For the market failure that you have identified, discuss government policy options to correct the market failure and how they might improve society’s net benefit. [2 marks]

ATTACHMENT 1

“Please Raise My Taxes”, by Reed Hastings,The New York Times, February 5, 2009

I’m the chief executive of a publicly traded company and, like my peers, I’m very highly paid. The difference between salaries like mine and those of average Americans creates a lot of tension, and I’d like to offer a suggestion. President Obama should celebrate our success, rather than trying to shame us or cap our pay. But he should also take half of our huge earnings in taxes, instead of the current one-third.

Then, the next time a chief executive earns an eye-popping amount of money, we can cheer that half of it is going to pay for our soldiers, schools and security. Higher taxes on huge pay days can finance opportunity for the next generation of Americans.

[…] Of course, it’s galling when a chief executive fails and is still handsomely rewarded. But with the concept of “tax, not shame,” a shocking $20 million severance package would generate $10 million for the government. That’s a far better solution than what we have today, not least because it works with the market rather than against it.

Another advantage is that it would also cover the sometimes huge earnings of hedge fund managers, star athletes, stunning movie stars, venture capitalists and the chief executives of private companies. Surely there is no reason to focus only on executives at publicly traded companies.

This week, President Obama proposed imposing a $500,000 compensation cap on companies seeking a bailout. It’s a terrible idea. We all want the taxpayers’ money returned, and capping compensation at bailout recipients will just make it that much harder for those boards to hire and hold on to the executives who can lead their companies to compete and thrive.

Perhaps a starting place for “tax, not shame” would be creating a top federal marginal tax rate of 50 percent on all income above $1 million per year. Some will tell you that would reduce the incentive to earn but I don’t see that as likely. Besides, half of a giant compensation package is still pretty huge, and most of our motivation is the sheer challenge of the job anyway.

Instead of trying to shame companies and executives, the president should take advantage of our success by using our outsized earnings to pay for the needs of our nation.

QUESTION 1 The Global Financial Crisis created a case for regulating the salaries of banking…

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