Economics 370 Final

Prof. Bryan Caplan

Spring, 2002




·        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 200.

·        You should have 7 pages, counting this one.


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 propositions is true or false.  Using 2-3 sentences, explain your answer.


1.  Two equally efficient airlines, American and United, fly between New York and Los Angeles.  At first, they charge a price of $400 per ticket.  After a sudden drop in demand, the price remains $400 a ticket.  A Senator goes on TV and says "Under competition, price falls when demand goes down.  Obviously, then, these airlines are NOT competing."


T, F, and Explain:  If there are constant MC and no fixed costs, the Senator is incorrect. 








2.  A government-sponsored tea monopoly charges $10 per pound of tea.  In response to public criticism, the government decides to impose a tea tax of $5/pound to "take the profit out of monopoly."  The government uses all of the tax money to give rebates to people who buy tea: Your rebate is proportional to the amount of tea you buy.


T, F, and Explain:  If there are no costs of administering the tax, it has no effect on consumer welfare or the equilibrium quantity of tea.








3.  Landsburg asks "Why is popcorn so expensive at the movie theater?"  By itself, he explain, monopoly is not an adequate explanation.


T, F, and Explain: Monopoly combined with customers with different popcorn demand curves would be an adequate explanation.






4.  Suppose that drug-users like to use the most popular or "hippest" drug.  For example, if other people are using cocaine, they want to use cocaine too.


T, F, and Explain:  Drug use might suffer from a "path dependence" problem.













5. A store gives a free prize - "no purchase necessary" - to every customer who walks in the door.


T, F, and Explain:  This promotion could create an adverse selection problem.










6.  "One cost of acquiring goods is the cost of acquiring information about what to buy... Even if a better deal is available from an unknown producer, the cost of determining that it is a better deal may be greater than the savings." (David Friedman, Hidden Order) 


T, F, and Explain:  One implication that Friedman draws from this is that imperfect information tends to reduce industry concentration.









7.  Suppose that firms do not know what their competitors' AC curves look like.


T, F, and Explain:  Predatory pricing would be one way for a firm to signal that it has low costs.












8.  T, F, and Explain:  Subsidizing inefficient firms is always an inefficient policy.













9.  Caplan argues that the "rational irrationality" of voters is one of the main problems with democracy.


T, F, and Explain:  This problem would be solved if voters had to memorize the voting records of their representatives.












10.  Suppose there is a fixed cost of $100 M to build a road that lasts forever without maintenance.  Every day at rush hour there are severe traffic jams.


T, F, and Explain: Charging tolls on this road to reduce congestion would be inefficient because MC is zero. 












11.  T, F, and Explain: Friedman's school voucher plan would probably have a bigger effect on productive efficiency than allocative efficiency.














12.  T, F, and Explain: One serious problem for a free market in punishment would be if the cost of keeping criminals in prison exceeded the typical inmate's maximum earnings.








Part 2: Short Answer

(20 points each)

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



1.  "An unintended consequence of this emphasis is that the cartels most likely to be discovered and prosecuted are those in which the price and output effects are small." (Posner, The Economic Analysis of Law)


Explain Posner's argument.  How could antitrust law and/or enforcement be changed to eliminate this problem?
















2.  During the "Internet boom," online retailers seemed to sell a lot of products for less than MC.  Using all of the tools you have learned in IO, try to explain what was going on in these markets.  Why were firms trying to accomplish?  Was imperfect information an important factor? 

3.  Carefully explain why is it inefficient to give medical care away for less than its MC.  Use a simple supply and demand diagram to illustrate your answer.  Carefully label the areas of the transfer and the deadweight loss.


















4.  Real-world policies often seem more efficient than you would expect given public opinion.  For example, trade policy seems much less protectionist than most Americans want.  Is it possible that voters' rational ignorance actually reduces the negative impact of voters' rational irrationality?  How exactly would this work?