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.**

__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. 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.