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 200.
• You should have ? pages, counting this one.

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

1. Two industries start with the same number of firms. In industry #1, the AC of the firms is flat. In industry #2, the firms have U-shaped AC curves. Initially, P=AC and firms produce at the lowest possible AC.

T, F, and Explain: Cartels are more likely to be successful in industry #2 than in industry #1.

2. Two identical firms lobby for a monopoly privilege that the government gives away. Cash bribes are too risky to use.

T, F, and Explain: If the firms (on average) face a "break-even" constraint, the existence of the monopoly privilege makes them (on average) better off.

3. T, F, and Explain: The Robinson-Patnam Act is one of the least economically inefficient features of the antitrust laws.

4. T, F, and Explain: When population increases, the total level of innovation typically increases, but innovation as a fraction of total output decreases.

5. When a trial results in a "hung jury," the prosecution is allowed to re-try the case, but they rarely do.

T, F, and Explain: Either prosecutors don't understand search theory, or the likelihood of winning a second trial is less than the probability of winning the first.

6. Voters are often "rationally ignorant" about the quality of government programs. Government officials usually know a lot about their programs' quality.

T, F, and Explain: There is an inefficiently large number of government programs because politics suffers from an asymmetric information problem (similar to the one that appears in e.g. insurance markets).

7. In theory, allocative inefficiencies arising from firms' different degree of efficiency can be eliminated by offering to subsidize the less efficient firms.

T, F, and Explain: Even if the government had perfect knowledge of firms' costs, this subsidy still has a serious ability problem: Taxes would be necessary for the subsidy, and taxes themselves create allocative inefficiencies.

8. The government imposes rent control, effectively monitors quality, and makes the penalties for bribery so severe that it isn't worth taking them.

T, F, and Explain: The full surplus "rectangle" (P_market-P_control)*Q_control is transferred to tenants.

9. "[T]he grant of garden plots, a few animals, and other bits of 'private' property... invited kolkhozniks [Soviet collective farmers] to skip the collective work in favor of their personal plots, which in some years accounted for almost 40 percent of their real income. This remarkable diversion of energy to private activities resulted in the fact, reported for 1959, that almost 40 percent of all meat and milk in the Soviet Union came from garden plots..." (Friedrich and Brzezinski, Totalitarian Dictatorship and Autocracy)

T, F, and Explain: The existence of personal plots reduced the government's share of agricultural output, and probably the government farm's total agricultural output as well.

10. T, F, and Explain: "In both the private and public sectors, there is an adequate measure of the overall performance of the organization - profits in private firms and popularity in the government." (Breton and Wintrobe, The Logic of Bureaucratic Conduct)

11. Bakunin argued that because the labor supply curve was approximately vertical, workers would tend to earn their bare subsistence.

T, F, and Explain: Bakunin would be wrong even for a fully socialist economy.

12. There is free entry into the schooling market, and there is "room" for many firms (producing at the minimum efficient scale) in the market. Without a voucher program, schools charge $1000/year. The government then implements a $1000/year voucher program.

T, F, and Explain: Schools will raise their price to $2000/year, and poorer parents will still be unable to afford private schooling.

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

1. Explain why a lawsuit - even one sure to lose in the end - is probably a more effective way for large firms to "predate" against small firms than just charging low prices.

2. If the signaling theory of education is largely correct for higher education, what would the economic impact of eliminating all subsidies to colleges and universities be? Focus on the labor market.

3. [Posner question]

4. David Friedman's article ("Private Creation and Enforcement of Law: An Historical Case") on private defense services in medieval Iceland states:

One obvious objection to a system of private enforcement is that the poor (or weak) would be defenseless. The Icelandic system dealt with this problem by giving the victim a property right--the right to be reimbursed by the criminal--and making that right transferable. The victim could turn over his case to someone else, either gratis or in return for a consideration. A man who did not have sufficient resources to prosecute a case or enforce a verdict could sell it to another who did and who expected to make a profit in both money and reputation by winning the case and collecting the fine. This meant that an attack on even the poorest victim could lead to eventual punishment.

Is this particular argument convincing in a modern context? Why or why not?