· 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: A lump-sum tax is theoretically the most efficient way to raise a given amount of government revenue, but it is impractical in the real world.
2. Consider a two-period world. Agents have U=. In period one, everyone has a chance to buy or sell insurance for consumption in period 2. In period 2, each person receives an endowment of 0 with p=.5 and 4 with p=.5 (each person makes an independent draw from the probability distribution). There are no transactions costs.
True, False, and Explain: In general equilibrium, the price of insurance is actuarially fair.
3. Consider a risk-neutral farmer with the cost function TC=q2. The market price is 10 with p=.7, and 1 with p=.3.
True, False, and Explain: If the farmer has RE, his profit-maximizing level of output is 4.
4. True, False, and Explain: Efficiency wages cease to encourage work effort if all employers pay efficiency wages.
5. Suppose the Russian government suddenly decides to privatize its oil fields.
True, False, and Explain: If Russian voters suffer from debt aversion, we should expect their government’s spending to increase.
6. “If politicians create an agency, give it the incentives that it has, and retain
the power to abolish it or change its incentives at any time, in what sense are politicians not to blame for everything the agency does?” (Caplan, “Rational Irrationality and the Microfoundations of Political Failure”)
True, False, and Explain: Caplan is arguing that politicians are being irrational when create independent agencies.
Part 2: Short Answer
(20 points each)
In 4-6 sentences AND/OR equations, answer each of the following three questions.
1. “Behavioral economics actually makes me more optimistic about the efficiency of the economy.” Name the two strongest empirical findings the optimist could cite. Then make his case for him.
2. Build on Kahneman’s chapter on “Answering an Easier Question” (Thinking, Fast and Slow) to explain a large belief gap between economists and the public on two questions from the Survey of Americans and Economists on the Economy.
3. All things considered, what is your best estimate of the true private return to education for the marginal 18-year-old American? The true social return? Use empirics from class to ground your answer.