Economics 849 Midterm Answer Key

Prof. Bryan Caplan

Fall, 2003

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 six propositions is true or false. In 2-3 sentences (and clearly-labeled diagrams, when helpful), explain why.

 

1. "Suppose that getting to Boston and back is worth $300 to you. It costs the airline $200 to provide that transportation. But because of some extraordinary degree of monopoly power, the airline charges $1000 for the ticket." Landsburg, The Armchair Economist

 

T, F, and Explain: Landsburg concludes that price discrimination of this sort is inefficient.

 

FALSE. Landsburg concludes that this price discrimination will be efficient if individuals maximize Kaldor-Hicks efficiency. In that case, the traveler will buy the ticket, and transfer $800 to the airline by giving up $700 in surplus for themselves. If they follow their own self-interest, however, the outcome of the airline's pricing policy will have a deadweight cost of $100.

 

2. Suppose that there are 25,000,000 voters other than yourself. There is a 99% chance that the electorate is not evenly divided. In that case, p=.51. But there is a 1% chance that the electorate is evenly divided (p=.5).

 

T, F, and Explain: The overall probability of casting the decisive vote is, as usual, less than one-in-a-million.

 

FALSE. The probability of casting a decisive vote is given by:

 

 

This simplifies to:

 

 

 

3. Suppose the government currently taxes two goods, labor and movies. The supply of movies is much more elastic than the supply for labor.

 

T, F, and Explain: Under the Ramsey Rule for optimal taxation, if both elasticities fall (i.e., become more inelastic), then the taxes on both goods will rise.

 

FALSE. The Ramsey Rule tells us the optimal way to raise a GIVEN quantity of revenue; it prescribes relative tax rates, not absolute tax rates. If both elasticities fall by the same percent, then, tax rates will not change at all.

 

I gave partial credit for answers that pointed out that the Ramsey rule is about demand elasticities, not supply elasticities. That is not true in more complex versions of the rule, but I did create that impression in the notes.

 

4. Suppose there are three voters (#1, #2, and #3) and four spending options (a, b, c, and d). a is the highest spending level, b the second highest, c the third highest, and d the lowest. Voters' preference rankings are as follows:

 

Voter #1:

Voter #2:

Voter #3:

 

T, F, and Explain: A election will NOT reveal social intransitivity in this electorate, and spending level c will win.

 

TRUE. Graphing the preferences shows that these preferences are single-peaked: Voter #1's peak at a, #2's at d, and #3's at c. We can therefore apply the Median Voter Theorem, which reveals that c is the median.

 

 

5. Delli Carpini and Keeter's measure of education ranges from 1 (no high school) to 6 (graduate school). Their measure of income ranges from 1 (<$10,000/year) to 5 ($50,000+).

 

T, F, and Explain: Their regression results (Table 4.1) for knowledge of political Substance show that the male-female knowledge gap is comparable to more than 2 steps of education, but less than 5 steps of income.

 

FALSE. From Table 4.1, we can see that the gender gap is -1.76, the one-step education gap is .72, and the one-step income gap is .20. The gender gap is greater than 2 steps of education (1.44), but it is also greater than 5 steps of income (1.00).

 

A couple of students used the standardized regression coefficients rather than the unstandardized. (Standardized coefficients are unstandardized coefficients divided by the standard deviation of the independent variable in question). This is incorrect, but since I did not explain this point, I still gave credit for answers based on these numbers.

 

6. In Cooter's model of bicameralism, assume that $L<$U, but $L0>$U0.

 

T, F, and Explain: Given these assumptions, the Pareto set and the bargain set are actually the same.

 

TRUE. The Pareto set is the set of policies such that making one party better off makes the other worse off. That remains the set of points from $L to $U. The bargain set, however, is the subset of all points in the Pareto set that both parties prefer to $0. Since both $L<$U<$U0<$L0, it is clear that both houses prefer $U to $0, and therefore prefer any point in the range $L-$U to $0. Intuitively, parties would never bargain for more than $U, because they both prefer $U to any amount greater than $U.

 

 

Part 2: Short Essays

(20 points each)

In 6-8 sentences, answer all of the following questions.

 

1. We discussed four different views of "tax equity": the standard cardinal utility view, Rawls, Landsburg, and Rothbard. Analyze the equity effects of federalism from any TWO of these perspectives. Which view is less sympathetic toward federalism, and why?

 

As a general rule, the more redistribution a thinker favors, the less favorably he will view federalism, because federalism means tax competition. This tax competition allows citizens to escape redistribution by relocating.

 

Rawls favors more redistribution than cardinal utility recommends, so he is likely to be most hostile toward federalism.

 

Since cardinal utility argues for redistribution from rich to poor, however, it too is fairly hostile to federalism (at least on tax equity grounds), though not as hostile as Rawls.

 

Rothbard sees taxation as theft, so he is likely to be most positive toward federalism.

 

There are two strands in Landsburg: If he really wants the "Perfect Tax," he would naturally oppose federalism for thwarting redistribution. But based on his "principled objection" to redistribution, he would see federalism's ability to limit redistribution as equity-enhancing.

 

2. Suppose that before the recent Iraq war that voters but not the President - were rationally ignorant about the existence in Iraq of weapons of mass destruction. Explain two different ways that voters could have compensated for their inability to verify the President's claims.

 

One method would be the probability multiplier if Bush is later found to be lying. He could be punished by denying him reelection, impeachment, or worse.

 

Another method would be blanket skepticism: Assume no WMD until Bush proves otherwise. This would give Bush an incentive to provide information as soon as it became available.

 

One student made the novel suggestion of a Hansonian betting market.

 

 

3. "If the assumptions underlying the Miracle of Aggregation are correct, then all else equal we should expect citizen welfare to be greater in more populous states." Is this correct? Why or why not?

 

Yes, it is correct. The Miracle of Aggregation is based on the Law of Large Numbers. It says that ignorant voters tend to cancel each other out as N goes to infinity! Therefore as the number of voters N gets bigger, the Miracle is increasingly likely to hold. On the other hand, if there were only 3 voters and 2 voted randomly, the worse candidate would still win 25% of the time.