Name:_______________________

Economics 370 Final

Prof. Bryan Caplan

Fall, 1997

Instructions:

• You have 2 hours, 45 minutes to complete this exam.
• You may use any books, notes, or other materials that you wish, but avoid spending too much time on any one question.
• Partial credit may be awarded on all questions.
• The maximum possible number of points is 300.
• You should have 10 pages, counting this one.

Part 1: True, False, and Explain

(10 points each - 3 for the right answer, and 7 for the explanation)

State whether each of the following propositions is true or false. Using 2-3 sentences, explain your answer.

1. Suppose that Econ 370 is taught at 3 different times during the week. In order to teach Econ 370, a professor must write his own lecture outlines; once the lecture outlines have been written, actually teaching each class takes 3 hours of time per week.

T, F, and Explain: If the professor values his time at \$20/hour, then the average cost curve of teaching Econ 370 is flat.

2. T, F, and Explain: If all firms have the same cost curves, then price will equal average cost unless both economic competition (e.g. cutting prices) and political competition (e.g. hiring lobbyists) are illegal.

3. In the shoe market, the most efficient firm earns positive profits.

T, F, and Explain: The monopoly profit earned by the most efficient firm has the same efficiency consequences - both positive and negative - as a patent.

4. T, F, and Explain: Predation is more difficult when the AC curve is flat or downward-sloping at the pre-predation market price.

5. T, F, and Explain: One of the few benefits of antitrust enforcement is that it makes it easier to privately solve path-dependence problems.

1. In a small town, there are ten stores, each selling a different good. None of the stores produce at the MES.
2. T, F, and Explain: If the number of people who shop in the town increases, both the number of stores and the prices charged at the original ten stores will increase.

3. Some mutual funds are "actively managed": the fund employs a team of expert investors to figure out "how to beat the market." Other mutual funds are "index funds" that just buy and hold a fixed portfolio of stocks.

Mutual funds charge a fee for their services; by definition the net return=(gross return minus management fee).

T, F, and Explain: Search theory predicts that the net return of the actively managed funds will exceed that of index funds.

8. T, F, and Explain: All-you-can-eat salad bars may suffer from an adverse selection problem.

9. T, F, and Explain: If bad workers found school easier and more enjoyable than good workers do, government subsidies to education would be less wasteful.

1. Suppose that the most efficient firm in an industry has a MC of \$10; the other, inefficient firms have MC=\$12. One regulatory solution to this problem is to subsidize inefficient firms by \$1.90/unit.
2. T, F, and Explain: One problem with this solution is that the government must raise the revenue for the subsidy by taxation - which is itself distortionary.

3. "[L]arge numbers of the electorate are politically uninformed and inarticulate. Some years ago, public opinion analysts reported what is now a typical finding about the low level of political information among adult Americans. Only about one-half the public knew the elementary fact that each state has two U.S. senators; fewer still knew the length of the terms of members of Congress or the number of Supreme Court justices. Apart from their ability to identify the president, most people can identify only one visible public figure, usually the governor of their state." (Dye and Zeigler, The Irony of Democracy)

T, F, and Explain: It is difficult for economic theory to explain why people know so little about issues of vital importance to their well-being.

12. T, F, and Explain: While government often prices goods inefficiently low (below MC), it at least has no reason set the prices of goods inefficiently high (above MC).

13. T, F, and Explain: An ideal government would be just as productively efficient as private enterprise.

1. Both the reading from Conquest ("The Death Roll") and the documentary seen in class (Harvest of Despair) discussed the consequences of agricultural collectivation in the USSR.
2. T, F, and Explain: The mass starvation accompanying collectivization was primarily the result of a severe knowledge problem, since the central planners generally did not know about local resources or weather conditions.

3. In Stalin's slave labor camps, writes Conquest (The Great Terror):

In the Kolyma camps, for men doing twelve to sixteen hours' heavy physical labor a day, eight months of it in very low temperatures, the daily ration, of very poor bread, is given by a former prisoner writing in the West:

 for more than 100% of the norm up to 930 grams for 100% 815 grams for 70-99% 715 grams for 50-69% 500 grams disciplinary ration 300 grams

T, F, and Explain: As this quotation indicates, a primary reason that socialist systems are productively inefficient is that they refuse to use material incentives.

16. T, F, and Explain: The main advantage of sub-contracting government services is the greater allocative efficiency of private supply.

17. In a system of private criminal law, the victim receives restitution from the criminal if he successfully prosecutes.

T, F, and Explain: While this would encourage victims to come forward, it would also be sure to spark far more false accusations than the current legal system does.

18. T, F, and Explain: Private police would not want to defend clearly guilty clients for the same reason that insurance companies won't insure against pre-existing conditions.

(20 points each)

In 4-6 sentences, answer all of the following questions.

1. If you wanted to help find a cure for AIDS, what would the efficiency advantages be of contributing to a cash prize payable to the discoverer of the cure? Would there be any disadvantages to this?

2. What does the "chicken" game suggest about the equilibrium level of fraud in free markets? How could regulation increase or decrease the efficiency of this equilibrium level?

3. At the end of the lecture of Week 10, I presented a proposal for reforming university education. What is the relationship between the economic theory of signaling and my proposal?

1. David Friedman ("Public Choice: The Economics of Politics") points out that "Real-world tariffs tend to go, not to infant industries, but to senile ones." He says that public choice theory explains this fact. Briefly summarize Friedman's argument. Is he right that public choice theory is the best explanation? Or would the "demand for idiocy" or some other explanation fit the facts better?
2. Rothbard ("The Public Sector") writes "[T]he government bureau acquires its income from mulcting the long-suffering taxpayer. Its operations therefore become inefficient, and costs zoom, since government bureaus need not worry about losses or bankruptcy..." Puzzle: Why don't high-ranking bureaucrats get compensation tied closely to their performance, as the CEO of a corporation would? Is there any efficiency rationale, or is this just an instance of the "demand for idiocy"?

6. The most common objection to private police provision is that police agencies would fight wars with each other. State two arguments to the contrary, and briefly critique them.