Name:_______________________

Economics 812 Final

Prof. Bryan Caplan

Spring, 2005

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.  True, False, and Explain:  "Buy one, get one free" deals are normally Kaldor-Hicks inefficient.

2. Suppose that two players play this PD game, followed by this Coordination game.

 Defect Don't L R Defect 3,3 4,0 L 5,5 0,0 Don't 0,4 2,2 R 0,0 5,5

True, False, and Explain: If ß=.9, the only SGPNE are (Defect, Defect), (L,L) and (Defect, Defect), (R, R).

3.  Suppose firms in an industry have the same cost function, including a sunk cost.  Product demand rises, leading to a doubling of potential monopoly profits.  Two firms play mixed strategies to decide whether to enter.

True, False, and Explain:  The probability that both firms enter and lose money quadruples.

4.  An agent faces two choices: (1) A utility of 10 for sure; (2) A utility of 1 with 50% probability and a utility of 20 with 50% probability.

True, False, and Explain: If the agent prefers (1) to (2), then in terms of Expected Utility Theory, he is risk-averse.

Questions 5 and 6 refer to the following information:

There are two kinds of workers, good and bad.  Both types are equally numerous.  Good workers are worth \$100k to me; bad workers are worth \$25k to me.  It costs good workers \$25k to complete school, but \$50k for bad workers to do so.  I can tell if a worker finished school, but cannot observe their quality directly.  Workers earn 75% of their value to me if they choose to be self-employed.

5.  True, False, and Explain: I will not hire any workers, so asymmetric information entails no deadweight cost.

6.  Suppose I can find out a worker's true type by paying \$15k.

True, False, and Explain:  I will never pay this fee, because my expected gross profit per worker is only 50%*(\$100k-\$75k)=12.5k.

7.  Some economists argue that the perceived unfairness of nominal wage cuts would decline in a less inflationary environment.

True, False, and Explain:  According to Rabin ("Psychology and Economics"), there is no experimental evidence that perceptions of fairness respond to changes in market conditions.

8.  More educated workers usually get more benefits.

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

9.  True, False, and Explain:  Caplan ("Rational Irrationality and the Microfoundations of Political Failure") admits that "knife-edge stupidity" does not exist.

(20 points each)

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

1.  Consider the following sequential two-player games:

Game 1: Ultimatum game, Coordination game, Ultimatum game

Game 2: Coordination game, Ultimatum game, Coordination game

If both players are standard economic agents, will Game 1 "unravel"?  Game 2?  Explain your reasoning.

2.  Caplan's "Systematically Biased Beliefs About Economics" finds that economists worry less about high taxes than the general public.  Do you think this undermines the view that economists have rational expectations and the public does not?  Explain your answer, then present a good counter-argument to your view.

3.  It is widely believed that standard neoclassical economics supports free-market conclusions, while behavioral economics supports government intervention.  Give two counter-examples.  Explain your reasoning.