Economics 321 Midterm Answer Key

Prof. Bryan Caplan

Fall, 2002


Part 1: True, False, and Explain

(10 points each - 2 for the right answer, and 8 for the explanation)

State whether each of the following six propositions is true or false.  In 2-3 sentences, explain why.  Use diagrams if helpful.


1.  T, F, and Explain:  If average worker productivity in the economy rises, average real wages will rise unless Aggregate Labor Supply bends backwards.


FALSE.  Average wages will rises EVEN IF ALS does bend backwards.  In fact, real wages rise even more than if ALS were vertical or forward-sloping.  ALD rises when worker productivity rises; as the following diagram shows, this clearly increases the real wage.








2.  T, F, and Explain:  Even though their job is very unpleasant, garbage men are still paid their marginal productivity.


TRUE.  The unpleasantness of the job reduces the supply of garbage men, raising the marginal value product - and wage - of a garbage man.  But labor demand, which is determined by workers' marginal productivity, does not shift. 







3.  In his discussion of immigration, Landsburg remarks that "[W]e ostentatiously ignore the most obvious beneficiaries of open borders and can still conclude that open borders are a good thing."


T, F, and Explain:  According to Landsburg, the "most obvious beneficiaries" are highly skilled American workers.


FALSE.  The "most obvious beneficiaries," according to Landsburg, are the immigrants themselves, who earn much higher wages in the U.S. than they would in their home countries. (Fair Play, pp.20-22)

4.  Consider the effect of government safety regulations for both free workers and slaves.


T, F, and Explain:  These regulations make slaves better off but make free workers worse off.


TRUE.  Safety regulations essentially force free workers to buy (in the form of lower wages) safety that is worth less than it costs.  Slaves, in contrast, continue to receive the same subsistence pay, but face a lower risk of injury or death.  The cost of the safety regulation is borne by the slave owner in the form of reduced slave prices.






5.  In their senior year, George Mason students interview with various employers.  As entry-level workers, the students can expect to acquire a lot of general and firm-specific skills during their first few years on the job. 


T, F, and Explain:  If students know all about firms' reputations for pay raises, starting salaries will be lower than they would otherwise be, but raises will be higher.


TRUE.  Firms with a reputation for failing to give workers raises commensurate with their skills - even their firm-specific skills - will have trouble attracting workers.  Since it costs employers to teach skills, though, they have to implicitly charge workers for their training by paying them less at first.






6.  T, F, and Explain:  Controlling for intelligence does not weaken the case for credit market imperfections.


FALSE.  Controlling for intelligence greatly weakens the case for credit market imperfections.  The main evidence for credit market imperfections is the apparently high rate of return of education.  But controlling for IQ greatly reduces this estimated return to education, casting doubt on the idea that the return to education is anything out of the ordinary.




Part 2: Short Answer

(20 points each)

In 4-6 sentences, answer both of the following questions.  Use diagrams if helpful.



1.      According to Bastiat:


[I]f the secret wishes of each producer were realized, the world would speedily retrogress toward barbarism.  The sail would take the place of steam, the oar would replace the sail, and it in turn would have to yield to the wagon... (Economic Sophisms)


Why does Bastiat claim that this is the "secret wish" of producers?  What assumption about product demand elasticity does Bastiat need to make his assertion correct?  Explain using supply and demand diagrams.


Bastiat claims that this is producers' "secret wish" because producers want their product prices to be as high as possible.  On reflection, though, his claim is too strong.  Bastiat is only right if product demand is relatively inelastic.  In that case, reducing worker productivity raises labor demand and wages - product price rises much more in percent terms than quantity falls.  If product demand were actually highly elastic, Bastiat would be wrong - technological retrogression would make not only consumers of a product worse off, but its producers as well.








2.  Discuss the relevance of (a) externalities, (b) credit market imperfections, OR (c) intelligence research for your personal decisions about your education.  Does what you have learned about this topic make you more, less, or equally likely to pursue a graduate degree?  Why?


I choose (c) - intelligence research.  I have already finished my graduate degree, but let's suppose I were answering this question back in 1993 when I was applying to graduate schools.  If I had been familiar with intelligence research, I would have seen that the marginal benefit of more years of school was lower; much of the apparent effect of education is actually due to cognitive ability.  Thus, if was smart enough to get into Princeton's Ph.D. program, I was smart enough to get a significantly better-than-average job right out of college.  Perhaps I would have gotten into the computer field, for example.  I would probably have gone to graduate school anyway, but if I had been familiar with intelligence research my choice would have been much closer.