Name:_______________________

Economics 812 Final

Prof. Bryan Caplan

Spring, 2002

Instructions:

·        You have 2 hours and 30 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 nine propositions is true or false.  Using 2-3 sentences AND/OR equations, explain your answer.

1.  All agents in an economy have U=ln x + ln y.  25% have 1 unit of x and 0 units of y.  75% have 0 units of x and 1 unit of y.

True, False, and Explain:

2. True, False, and Explain: In a pure coordination game, repeated play strictly increases the number of NE.

3.  "The economically correct argument is the most politically incorrect argument imaginable." (Landsburg, The Armchair Economist)

True, False, and Explain:  Landsburg is explaining that laws restricting women's use of cosmetic surgery make women in general worse off.

4.  A group of N oligopolists producing identical products plays a finite number of turns.  Two of the players are then randomly selected to play a Hawk-Dove game ONCE.

True, False, and Explain: With rational, selfish players, some degree of collusion may be sustainable under Cournot competition, but NOT Bertrand competition.

5.  True, False, and Explain: One piece of empirical evidence against expected utility theory is that people gamble and play lotteries.

6.  In a "market for lemons," the true value of cars to sellers is uniformly distributed on the interval [0,100].  Buyers value cars at 25% more than sellers.  Now suppose that buyers in this market do NOT have rational expectations, but sellers do.  To be specific, buyers believe the quality of the average car available for sale is as high as the quality of the average car not available for sale.

True, False, and Explain:  This market with asymmetric information and irrational expectations is as efficient as a comparable market with symmetric information and rational expectations.

7.  After several decades, the government finally eliminates sugar subsidies in 2005.  The sugar industry is thrown into a severe crisis and many plantations go bankrupt.

True, False, and Explain:  This is strong evidence that sugar executives did not have rational expectations about government sugar policy.

8.  In experiments on the endowment effect, some people are given mugs and asked to sell them back, while others are merely given the opportunity to buy a mug.  The Coase Theorem predicts that mugs will sell for the same price in both treatments.

True, False, and Explain:  Thaler admits that transactions costs make it impossible to give a clear experimental prediction about mug prices.

9.  In a "psychologist/engineer" problem, the base rate is 70% engineers, 30% lawyers.  Fred's P(having a pocket protector| a person is an engineer)=.5, and P(a person is an engineer|having a pocket protector)=.8.  If the base rate is changed to 30% engineers, 70% lawyers, Fred's P(a person is an engineer|having a pocket protector) falls to .3.

True, False, and Explain:  Fred does NOT suffer from representativeness bias.

10.  More educated workers tend to enjoy their work more and are less likely to be unemployed.

True, False, and Explain:  BOTH of these factors bias standard estimates of the return to education downwards.

11.  True, False, and Explain:  The "liquidity constraints" and "debt aversion" explanations for observed departures from consumption smoothing are empirically indistinguishable.

12.  Wittman argues that "concentrated benefits, diffuse costs" problems could be overcome with an omnibus repeal bill.

True, False, and Explain:  According to Wittman, theorists such as Fiorina and Noll and Shepsle and Weingast rule out such an omnibus repeal by assuming that elections are not competitive.
Part 2:

(20 points each)

In 4-6 sentences AND/OR equations, answer all three of the following questions.

1.  Governments sometimes give away services, such as health care, without charge.  Assuming there is no rationing, use a supply-and-demand diagram to show the deadweight costs of this policy relative to the competitive equilibrium.  Explain your diagram, and discuss the implications for moral hazard in insurance.

2.  Suppose your EU=w.3, and insurance is sold at 10% more than the actuarially fair rate.  Your uninsured income is \$100,000 with p=.5, and \$50,000 with

p=.5.  Using this information, do the following: (a) Calculate your coefficient of absolute risk aversion.  (b) Solve for your optimal quantity of insurance, i.

3.  What is the one thing you learned in this class that has the highest PRIVATE value for you?  What is the one thing you learned in this class that would have the highest SOCIAL benefit if it were widely understood?  In other words, what is the most useful lesson you learned for your own behavior, and what is the most useful lesson society could learn for policy?  Explain your answers.

4.  Caplan argues that systematically biased beliefs about economics lead to inefficient policies.  Part of the motivation for his survey of intelligence research is his view that public opinion has systematically biased views on this topic as well.  In a democracy, what consequences of these biases might Caplan predict for education policy?  How would Wittman respond?  Who is right?