· 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 35% of all agents in an economy have U=ln x + ln y, and the other 65% have U=.5 ln x + ln y. All agents start with one unit of x and three units of y.
True, False, and Explain: In general equilibrium, exactly 65% of the agents consume more y than x.
2. Suppose that two players play the following game.
For Type A players, x=6; for Type B players, x=1. Players know both their own type and their opponent's type.
True, False, and Explain: If Player 1 is Type A, there is no MSNE. If Player 1 is Type B, there is a MSNE, but since it is not focal, in practice we would not expect it to happen.
3. True, False, and Explain: Cournot competition with free entry, zero fixed costs, and constant marginal costs leads to a perfectly efficient outcome.
4. Suppose demanders of insurance are risk-averse, but suppliers of insurance are risk-neutral.
True, False, and Explain: As long as they have rational expectations, demanders will buy some insurance.
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 both kinds of workers $5k to finish school. I can tell if a worker finished school, but cannot observe their quality directly. Workers earn 40% of their value to me if they choose to be self-employed. Finally, assume that if a worker fails to go to school, I automatically conclude that he is bad.
5. True, False, and Explain: Everyone goes to school and earns the same wage.
6. Suppose workers earn 80% of their value to me if they are self-employed.
True, False, and Explain: Only bad workers will go to school, and will earn a net wage (wages minus schooling costs) of $20k.
7. "[L]oss aversion says that the value function abruptly changes slope at the reference level, so that people dislike even small-scale risk."
"While people are likely to be risk averse over gains, they are often risk-loving over losses." (both quotes from Rabin, "Psychology and Economics")
True, False, and Explain: These two statements are inconsistent.
8. Suppose that education causes a temporary increase in intelligence, but the effect "fades-out" after a year.
True, False, and Explain: Controlling for intelligence, the estimated effect of education is downwardly biased.
9. Caplan argues that irrationality has psychological benefits for many – if not most – people.
True, False, and Explain: Economic theory cannot say whether the private psychological benefits of irrationality exceed its social costs.
Part 2: Short Answer
(20 points each)
In 4-6 sentences AND/OR equations, answer each of the following three questions.
1. Suppose you have two potential producers in a contestable industry with SUNK costs. TC=1000+10Q. Demand is given by Q=100-P. In a MSNE, what is the probability that there are (a) 0 firms; (b) 1 firm; (c) 2 firms?
2. Caplan's "Systematically Biased Beliefs About Economics" controls for various measures of self-serving bias and ideological bias. Argue that he should not have controlled for these variables, and that as a result, his final estimates underestimate the magnitude of the public's biases. (Hint: What is the direction of causation?)
3. Clearly explain how a behavioral anomaly of your choice helps to mitigate a market failure of your choice. Be as original as possible.