Economics 812 Final

Prof. Bryan Caplan

Spring, 2003




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


1. According to Caplan (SEJ 1999), "[I]f there is a small probability that one is delusional, the perception of a zero-probability event would rationally provoke one to doubt one's own perception rather than believe that the impossible has occurred."


True, False, and Explain: Caplan's conclusion can be logically deduced from Bayes' Rule if delusional people have a strictly positive probability of thinking they observe 0-probability events, non-delusional people have a 0 probability of thinking they observe 0-probability events, and P(you're sane)>P(you're insane)>0.











2. Suppose that two players play this PD game 100 times in a row:


Player 2


Player 1











Afterwards, they simultaneously play an Ultimatum game where Player 1 splits a total payoff of 1 between himself and Player 2.


True, False, and Explain: Cooperation in this game will "unravel" due to backwards induction.








Questions 3 and 4 refer to the following information.

There is an industry with a fixed cost and constant MC. 2 firms simultaneously decide whether to enter the industry. Firms set prices, not quantities.


3. True, False, and Explain: If the fixed costs are NOT sunk, there are two PSNE. If the fixed costs ARE sunk, there is a MSNE but no PSNE.










4. True, False, and Explain: The outcome of the game is more efficient if costs are sunk.








5. Suppose your EU=w.9, and insurance is sold at 1% more than the actuarially fair rate. Without insurance, your wealth is $10,000 with p=.5 and $0 with p=.5.


True, False, and Explain: You will fully insure.









6. Suppose that everyone overestimates their personal probability of death by 50%.


True, False, and Explain: There will be propitious selection in the market for life insurance.





7. "Most things in life don't turn out as well as you thought they would. While psychologists, poets, and philosophers have often remarked on this phenomenon, few have recognized that it is a necessary consequence of informed, rational decision making." (Landsburg, The Armchair Economist)


True, False, and Explain: If by "rational," Landsburg means "rational expectations," his last statement is incorrect.












8. True, False, and Explain: Caplan (Stigler-Becker vs. Myers-Briggs) claims that empirical personality research strongly contradicts the standard economic assumption of stable preferences.











9. A critic of behavioral economics runs the following experiment. Half of the subjects guess the populations of twenty countries. The remaining subjects try to list as many people as they can from each of the twenty countries. The true populations of these countries are known to the experimenter.


True, False, and Explain: This data can be used to test for availability bias.










10. More educated workers tend to enjoy their work more.


True, False, and Explain: This tends to bias standard estimates of the return to education downwards.












11. True, False, and Explain: A standard neoclassical agent with diminishing marginal utility of wealth and access to perfect capital markets will always have a constant level of consumption.













12. True, False, and Explain: Caplan ("Rational Irrationality and the Microfoundations of Political Failure") argues that asymmetric information leads rational voters to vote for policies that encourage rent-seeking.
Part 2:
Short Answer

(20 points each)

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


1. For an infinitely-repeated 3-firm oligopoly game, determine the critical value of b for Bertrand collusion enforced by punishments of just ONE turn of Nash reversion.



















2. Suppose you are a fully rational individual living in a closed society like North Korea where all news is tightly monitored by the government. Explain in detail how you would go about forming rational beliefs under these conditions. What are the main conclusions you would draw?
















3. What would prevent Beckerian optimal punishment from driving efficiency wages down to the market-clearing level? Discuss at least TWO mechanisms.




















4. How does the endowment effect influence democratic politics? Discuss in general terms, and give the most plausible example you can. How might a paternalistic economist take advantage of the electorate's endowment effect? A self-interested demagogue?