Name:_______________________

Economics 812 Final

Prof. Bryan Caplan

Spring, 2013

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. Two players are deciding whether to contribute to a public good.  The public good is discrete: it is produced at the optimal level so long as one person contributes.  If the public good is produced, everyone gets a benefit of 3 if they didn't contribute, and 2 if they did.  If no one contributes, everyone gets 0.

True, False, and Explain:  This is a Prisoners’ Dilemma, not a Hawk-Dove game.

2. Suppose the demand curve for a contestable monopoly crosses the AC curve at three points.

True, False, and Explain:  There is a unique equilibrium.

3.  Suppose insurance companies are perfectly competitive and know true accident probabilities.  All of their potential customers are risk-neutral, but have a subjective P(getting in an accident) equal to the square root of the objective P(getting in an accident).

True, False, and Explain: All potential customers will definitely buy insurance.

4.  “Economic theory predicts that you are not enjoying this book as much as you thought you would.” (Landsburg, The Armchair Economist)

True, False, and Explain:  As Landsburg shows, neoclassical economics is not only consistent with, but implies, violation of the rational expectations assumption.

5.  Suppose the entire return to education stems from signaling.  The signal, however, is noisy; some good workers don’t have degrees, and some bad workers do.

True, False, and Explain:  The measured return to education will fall to zero if you fully control for ALL of the traits that education signals.

6. Voter’s rational ignorance creates a moral hazard problem for politicians.

True, False, and Explain: As usual, there is a simple way to mitigate this moral hazard problem.

(20 points each)

In 4-6 sentences AND/OR equations, answer each of the following three questions.

1.  In the modern U.S., what is the most efficient way for the federal government to spend an extra billion dollars?  What is the maximally utilitarian way for the federal government to spend this sum?  (In both cases, assume that tax cuts are not an option).  Use everything you’ve learned to craft a thoughtful answer, and be specific.

2. Some people argue that nominal wage rigidity is individually rational because many people (especially home-owners) have large nominally-denominated debt.  Is this a sound argument?  Why or why not?

3.  Paul Krugman recently accused anti-Keynesians of being “knaves and fools.”  What would Kahneman say about this accusation?  Use Thinking, Fast and Slow  to craft a thoughtful reply.