· 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 - 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. Two identical firms have constant AC curves for producing ballpoint pens.
T, F, and Explain: So long as both firms compete, price discrimination in the ballpoint pen market will not be possible.
2. In the early stages of the New Deal farm programs, the federal government purchased hogs from farmers and destroyed them. The diagram below shows the hog market before and after.
T, F, and Explain: The total Deadweight Loss of this policy is given by (area I + area II).
3. Suppose that the MC of an ice cream cone is $1.00. Dairy Queen, the only vendor of ice cream in a town, decides to cut its price from $1.10 to $.80 due to rumors that a Baskin Robbins may enter the ice cream market.
T, F, and Explain: Dairy Queen's predation may actually increase the deadweight losses due to allocative inefficiency.
4. In intro micro, students learn that if demand increases, both price and quantity increase.
T, F, and Explain: This is actually an oversimplification; in fact, an increase in demand ALWAYS raises price, but has an ambiguous effect on quantity (which depends on the shape of the industry's cost curves).
5. T, F, and Explain: Price regulation invariably reduces quality.
6. Suppose a company sells insurance against a $1000 accident. The accident happens 20% of the time to uninsured parties.
T, F, and Explain: Due to the moral hazard problem, the actuarially fair premium is actually less than $200.
7. T, F, and Explain: If regulations raise firms' fixed costs, the concentration index has to increase.
8. "The invisible hand of the market has its counterpart in the aloof disinterest of the judge. The method by which judges are compensated and the rules of judicial ethics are designed to assure that the judge will have no financial or other interest in the outcome of a case before him..." (Posner, Economic Analysis of Law)
T, F, and Explain: If Posner is right on this point, then there is no serious incentive problem for government judges.
9. Think of charity as a good like any other (people buy more if the price is less).
T, F, and Explain: For the same reason that democracy fails to give people incentives to gather information, it also encourages them to vote for what they see as "public-interested" policies.
10. Suppose the government subsidizes 50% of the costs of its rail commuter system (tickets cover the remaining 50%).
T, F, and Explain: If the productive efficiency of this system is typical of government operations, full privatization would not bankrupt the rail system.
11. "'In a planned economy, a man with a new and more efficient machine is dangerous to everyone. I'll tell you why. The Plan demands 100 percent production, 12 months a year, 24 - maybe 30 - days a month. Everything is all calculated out: productivity of machines in the factory, size of the work force, amount of steel and other materials needed. Planners know just about what can be produced. If you introduce new machinery, you have to shut down the plant, or part of it. That means the Plan will not be fulfilled. That will be bad for the factory director and the workers. They will not get the bonuses that sometimes comprise 20-30 percent of their pay.'" (a Soviet journalist, quoted in Hedrick Smith, The Russians)
T, F, and Explain: This passage illustrates one of the key knowledge problems with government ownership: there is no way for planners to know what MC is without market prices.
12. T, F, and Explain: An efficiency advantage of Friedman's voucher program over full privatization is that all children would be assured 13 years of quality education.
Part 2: Short Answer
(20 points each)
In 4-6 sentences, answer all of the following questions.
1. There is a possibility that Microsoft will be "broken up" into a number of smaller firms. The efficiency impact of such a break-up depends partly on the shape of Microsoft's cost curves. Under what assumptions would a break-up be least economically harmful? What are Microsoft's cost curves actually likely to look like? Remember that Microsoft produces multiple products.
2. Suppose that the education industry mostly consists in wasteful signaling. Would this make privatization more or less desirable than if education taught useful skills?
3. "Jurors are not the only laymen used to adjudicate legal disputes. Most commercial arbitrators are nonlawyers... The difference between arbitrators and jurors is that the former are chosen for their expertise in the area in dispute, and the latter for their lack of expertise! The difference can be explained, though. There is a tradeoff between expertise and impartiality. The more a person knows about some area of life, the less the arguments and evidence of two disputants will influence his resolution of the dispute..." (Posner, Economic Analysis of Law)
Does Posner's argument here make any sense? Or do the facts that he describes simply reflect the inefficiency of the public court system? Explain your position.
4. "Caplan's paper 'The Logic of Collective Belief' shows that privatizing the defense services industry would actually be a very bad idea. Privatization might work if people were rational, but government provision makes more sense if, as Caplan says, people are often irrational." Argue for or against this claim.