Name:_______________________

Economics 812 Final

Prof. Bryan Caplan

Spring, 2010

Instructions:

·        You have 2 hours 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 120.

·        You should have five 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:  In the real world, lump-sum taxes are always the first-best efficient way for governments to raise a given amount of revenue.

2. Suppose you have two potential producers in a contestable industry with SUNK costs.  TC=10+Q.  If only one firm enters, it sets a monopoly price given the demand curve Q=10-2P.  If two firms enter, they compete price down to MC.

True, False, and Explain: In the MSNE, each firm’s probability of entry is .2.

3.  True, False, and Explain:  Kreps uses the Ellsberg Paradox to illustrate the effects of asymmetric information on consumer choice.

4.  Suppose everyone is risk-preferring.

True, False, and Explain:  Insurance markets can still exist.

5.  “Consider two professors.  John earns \$55,000 paid in monthly installments.  Joan earns a base salary of \$45,000 paid over twelve months, and a guaranteed extra \$10,000 paid during the summer months.” (Thaler, The Winner’s Curse)

True, False, and Explain:  Thaler explains that the “mental accounting” prediction is that Joan will outspend John during the summer, but John will outspend Joan throughout the rest of the year.

6.  True, False, and Explain: Caplan (“Rational Irrationality and the Microfoundations of Political Failure”) argues that irrationality leads (a) voters to give bureaucrats weak financial incentives for hard work, AND (b) bureaucrats to work hard despite their weak financial incentives to do so.

(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.  Suppose you want to test for RE about inflation.  You can either get data on (a) actual inflation and people’s inflation forecasts, or (b) experts’ inflation forecasts and laymen’s inflation forecasts.  State whether you would prefer to have (a) or (b), and carefully explain how your test would work.  When exactly would your test accept/reject the RE hypothesis?

3.  “Availability bias leads people to get less education.  Representativeness bias leads people to get more education.”  Explain why this sentence is plausible.  Give specific examples.