Economics 812 Final

Prof. Bryan Caplan

Spring, 2007




        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: Prices in betting markets are determined by agents' preferences and endowments, not objective probabilities. However, if some people have more accurate beliefs than others, then over time, prices become more and more likely to reflect objective probabilities.









2. Suppose that two players play the following game twice.












True, False, and Explain: What Kreps calls "cheap talk" cannot improve the efficiency of this game if both players engage in backwards induction.










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


True, False, and Explain: In symmetric Nash equilibrium, c1=c2<2/3.







4. Suppose your U=w.5. 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 $20,000 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 keep searching and decline to buy insurance.









5. Consider a risk-neutral farmer with the cost function TC=q.5.  The market price is 3 with p=.5, and 0 with p=.5. 


True, False, and Explain: If the farmer has RE, he sets q=1/3. If the farmer's beliefs do not satisfy RE (he thinks the price=3 with p=.2), his profits fall by 50%.









6. True, False, and Explain: Landsburg argues that cosmetic surgery is socially wasteful signaling.











7. Thaler (The Winner's Curse) presents evidence that people violate basic economic assumptions.


True, False, and Explain: Thaler nevertheless embraces basic economic assumptions as "normative"; he believes that people should act like standard economic agents.










8. Consider an efficiency wage model.

True, False, and Explain:  As the average worker becomes less selfish, the unemployment rate falls. As the average worker becomes more myopic, the unemployment rate rises.













9. True, False, and Explain: If the efficient markets hypothesis is correct, then the marginal private cost of irrational investing can easily be zero.







Part 2: Short Answer

(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=.8 ln x + .2 ln y; the Type B's have U=.2 ln x + .8 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. Caplan defends the signaling model of education, but his colleague Tyler Cowen responds: "If education is pure signaling, just give everyone a standardized test in seventh grade and then close up the schools." (Marginal Revolution) How does Caplan's lecture on intelligence research make him vulnerable to this objection? How could Caplan's views about personality ("Stigler-Becker vs. Myers-Briggs") allow him to answer Cowen's objection?














3. "If voter misinformation were an important reason for poor policy choices, then we should be able to observe more informed voters making better policy choices. For example, college-educated people probably have more informed opinions: perhaps their professors told them that there is too much pork barrel politics. Hence, college-educated persons would be the least likely to be in favor of more government spending (unless they are the recipients of such largess), and persons with only a grade school education should be the most likely. However, survey data do not support such a conclusion." (Wittman, "Why Democracies Produce Efficient Results")


To what extent does Caplan's "What Makes People Think Like Economists?" undermine Wittman's claim? Be careful to distinguish between Wittman's specific claims and Caplan's empirical findings.