Economics 370 Final

Prof. Bryan Caplan

Spring, 2003




        You have 2 hours to complete this exam.

        Write directly on the 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 150.

        You should have 6 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. Suppose that initially there are two steel firms, both charging $100/ton. After a third firm enters the market, the price of steel drops to $80/ton, and ONE of the incumbent firms goes bankrupt.


T, F, and Explain: Before the third firm entered, the other two firms were colluding on price.










2. Assume that the lowest-cost producer of computer chips is an American firm.


T, F, and Explain: A tariff on all non-American computer chips will reduce both productive and allocative efficiency.











3. Assume that to operate a firm that sells liquor, you have to pay a flat one-time fee of $100,000. It does not matter how much or how little liquor you sell.


T, F, and Explain: The equilibrium number of firms could go up or down.







4. T, F, and Explain: According to Scherer and Ross, patents are a less important incentive for innovation than the first-mover advantage.











5. Your time is worth $8/hour. Each hour you spend walking around New York City, you have a 50% chance of finding a $20 bill. Assume further that failure or success in one hour does NOT change your probability of success in the next hour; it is like flipping a coin.


T, F, and Explain: As long as these conditions stay the same, you should never quit looking for $20 bills.












6. T, F, and Explain: If adverse selection is a problem in the market for life insurance, one good way to signal to insurance companies that you are a low-risk person is to buy LESS insurance.












7. In private health insurance markets, people usually pay at most 20% of the actual cost of their medical bills.


T, F, and Explain: This system does NOT suffer from an incentive problem.











8. T, F, and Explain: The most quantitatively significant privatizations of the last thirty years happened in Western democracies like the United States and Great Britain.












9. In the current world, legal rules are supplied by politicians, who compete for the favor of the general public. In a privatized legal system, legal rules are supplied by judges, who compete for the business of private police firms, who in turn compete for the business of the general public.


T, F, and Explain: Caplan's model of "rational irrationality" suggests that irrationality would be equally problematic in both systems, because in both cases laws are ultimately chosen by the general public.









Part 2: Short Answer

(20 points each)

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



1. Robert Bork explains the conditions under which "predatory advertising" would be profitable. What are they? Does Bork think that predatory advertising is more or less likely to succeed than predatory pricing?

















2. In Socialism, Mises writes: "[I]nterventionist measures must needs result in conditions which from the point of view of their advocates are more unsatisfactory than the previous state of affairs they were designed to alter. These policies are therefore contrary to purpose." Would Caplan agree? Why or why not?















3. Using the notions of rational ignorance and rational irrationality, explain why it is surprising that deregulation and privatization happened. Then do your best to explain why these surprising changes nevertheless occured.