Name:_______________________

Economics 812 Final

Prof. Bryan Caplan

Spring, 2014

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. Some economists worry that economies will become increasingly unequal if the real interest rate r exceeds the rate of economic growth g.

True, False, and Explain: In an intertemporal general equilibrium consumption model, the real interest rate r cannot exceed the rate of economic growth g.

2. True, False, and Explain: In a Coordination game – like a Prisoners’ Dilemma – agents do not need communication to reach a PSNE.

3. An agent faces two choices: (1) A utility of 10 for sure; (2) A utility of 0 with 50% probability and a utility of 20 with 50% probability.

True, False, and Explain: If the agent is indifferent between (1) and (2), then in terms of Expected Utility Theory, he must be risk-neutral.

4. “No one really has preferences for fair or vindictive behavior. When people act ‘fairly’ or ‘vindictively,’ they’re just signaling.”

True, False, and Explain: This claim is not theoretically consistent with the signaling model.

5. “The initial attempt to believe is an automatic operation of System 1, which involves the construction of the best possible interpretation of the situation.” (Kahneman, Thinking, Fast and Slow)

True, False, and Explain: This model of belief formation implies that lies are persuasive because people are usually telling the truth.

6. Senior #1 and Senior #2 are both undergraduates in their final year of college. Senior #1 knows he has a 90% chance of successfully graduating this year. Senior #2 knows he has a 90% chance of failing out. Both students satisfy the Permanent Income Hypothesis.

True, False, and Explain: Both students will increase their consumption if they successfully graduate, but Senior #1 will increase his post-graduation consumption by a smaller fraction than Senior #2.

Part 2: Short Answer

(20 points each)

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

1. In the real world, what would happen if a restaurant adopted Landsburg’s system for splitting checks? (The Armchair Economist)

2. Use the signaling model of education to explain the sheepskin effect. Precisely specify why, in the real world, discrete educational achievement is so much more informative to employers than continuous educational achievement.

3. The nominal wage rigidity model blames unemployment on nominal wages’ failure to swiftly fall to market-clearing levels. Can this model also explain the fact that high-ability workers are less likely to lose their jobs during recessions? If not, how can you modify the nominal rigidity rigidity model to explain why recessions hit low-ability workers harder?