Economics 370 Final

Prof. Bryan Caplan

Spring, 2004




        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. In a given industry, firms have a fixed cost but zero MC.


T, F, and Explain: This industry is a natural monopoly.










2. "On August 19, just before midnight, Roosevelt signed the codes for oil, steel, and lumber. But there were still two major industries to go: automobiles and coal. The problem in Detroit was Henry Ford. Suspicious and independent as ever, Ford had always stayed out of the National Automobile Chamber of Commerce; and he showed no greater disposition to join the other companies in working out an NRA code. Fearing that Ford's refusal would give him competitive advantages, the rest of the industry stalled." (Schlesinger, The Coming of the New Deal)

T, F, and Explain: As this example indicates, one problem with collusion is "cheating."












3. T, F, and Explain: Imposing a government monopoly in an industry with negative externalities (like air pollution) makes an inefficient situation even worse.








4. Safety regulators often impose minimum safety requirements on products.


T, F, and Explain: The main reason economists consider this inefficient is that the market would typically exceed these minimum safety requirements without regulation.











5. "And yet there is an argument that organized crime is likely to employ violence less frequently than unorganized crime. Violence frightens the public and therefore incites greater efforts by police to prevent the activity that gives rise to it." (Posner, Economic Analysis of Law)


T, F, and Explain: Posner rejects this argument, because as far as criminals are concerned, controlling the public's fear of violence is a public good.












6. In the absence of insurance, a driver with a typical level of caution has a 5% chance of getting into car accident costing $10,000. There is some moral hazard: Giving a driver insurance makes him take more risks.


T, F, and Explain: If there is advantageous selection, the actuarially fair premium might be less than $500.








7. T, F, and Explain: Subsidizing inefficient firms to drive prices closer to MC suffers from an ability problem.













8. Socialists often argue that growing up in a capitalist society makes people selfish. Selfishness is a product of "nurture," not "nature."


T, F, and Explain: If this claim were correct, all of the main incentive problems of socialism discussed in class could be safely ignored.














9. Litigation always has some negative externalities, because the defendant does not like being threatened with punishment (or actually punished!).


T, F, and Explain: A free-market defense industry would therefore have more than the socially optimal level of enforcement.










Part 2: Short Answer

(20 points each)

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



1. In the early stages of the New Deal farm price support programs, the government actually bought farm products and destroyed them. Using supply-and-demand diagrams, show the deadweight losses and transfers attributable to this policy. Who received the transfers, and who ultimately paid for them?


















2. Assume that 80% of education is actually wasteful signaling. Taking into account problems of ability, knowledge, and incentives, what do you think is the most efficient "anti-signaling" policy?

















3. Using the tools from the lectures on "Making Fair Comparisons," critique the following passage from Rothbard:


"Finally, the worst that could possibly happen would be for the State to be reestablished. And since the state is what we have now, any experimentation with a stateless society would have nothing to lose and everything to gain." (Power and Market)