Name:_______________________

Economics 812 Final

Prof. Bryan Caplan

Spring, 2004

Instructions:

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

1.  Suppose you have a betting market for the 2004 presidential election.  The price of "Bush wins" shares sell for twice as much as "Bush does not win" shares.

True, False, and Explain:  As long as Arrow-Debreu assumptions and expected utility theory hold, this shows that the marginal trader believes that Bush will win with p=2/3.

2. Suppose that two players play the following three games in order: Ultimatum game, Coordination game, Prisoners' Dilemma.

True, False, and Explain: Standard game theory predicts that this game will completely "unravel."

3.  Suppose you have a 2-player version of the voluntary donation game from the notes, with one difference: Each agent cares somewhat about the other, so player one maximizes U1=c1D+.7*c2D, and player two maximizes U2=c2D+.7*c1D.

True, False, and Explain:  In symmetric Nash equilibrium, c1=c2>4/7.

4.  Economists often argue that the public overestimates the president's ability to influence the economy.

True, False, and Explain: Caplan ("Systematically Biased Beliefs About Economics") confirms the existence of this bias.

5.  Critics of the RE assumption often complain that it leads economists to under-estimate the chance of market failure.  It is not surprising, they maintain, that markets work well if everyone is "hyper-rational."

True, False, and Explain: The critics are correct given symmetric information, but the opposite might be true under asymmetric information.

6.  True, False, and Explain:  Thaler (The Winner's Curse) ignores Milton Friedman's contention that economic theories can have unrealistic assumptions as long as they make accurate predictions.

7.  Suppose your U=w.6.  You are searching for a job and face the following decision tree:

Step 1: You can either take a sure thing (w=\$50,000 with p=1) or keep searching (w=\$100,000 with p=.6; w=\$0 with p=.4).

Step 2: If you selected the second option, you are allowed to buy an "unemployment insurance" policy.  It costs \$10,000 and pays \$25,000 if you are unemployed.

Step 3:  You find out if you got a job.  If you did not, you collect the insurance payout.  Either way, you have to pay the premium.

True, False, and Explain:  You will take the sure thing.

8.  The U.S. stock market did not noticeably rise right after Saddam Hussein was captured.

True, False, and Explain:  The only explanation, according to the Efficient Markets Hypothesis, is that Saddam's capture had no important effect on the overall U.S. economy.

9.  Rationally ignorant voters could punish dishonest politicians by increasing the punishment for hard-to-detect offenses.

True, False, and Explain:  One reason that fully rational voters might fail to use this strategy is a coordination problem.

(20 points each)

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

1.  Suppose that on an island there are equal numbers of two types of agents.  The Type A's have U=.9 ln x + .1 ln y; the Type B's have U=.1 ln x + .9 ln y.  Both kinds of agents start out with 1 unit of x and 1 unit of y.  Compare and contrast the equilibrium outcomes in markets versus pair wise bargaining.  To be more precise, what happens if (a) Everyone participates in an island-wide general equilibrium market; (b) Each person of Type A bargains with one person of Type B?  You do NOT need to solve for the exact numbers; just qualitatively describe the differences between the two cases.  Is there any reason to expect the two outcomes to be the same?

2.  Based on all of the empirical evidence we have considered, did you overestimate your PRIVATE rate of return of getting a Ph.D. when you decided to go to grad school?  Did you overestimate the SOCIAL rate of return?  Defend your answer by explaining how the evidence has led you to modify your initial beliefs.

3.  Caplan's critics have argued that his own work shows important positive externalities of education.  Why would they say this?  How might Caplan respond?  Who is correct?