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MICRO POLITICAL ECONOMY SECTION (2.5 hours total)
This section has two parts A and B; you must answer both parts and there is some
choice in each part. Pay careful attention to the time limits!
Part A - Essay Questions – Answer one (1) of the following. (1 hour and 15
minutes)
a. In 1981, Douglass North wrote “competition in the face of ubiquitous scarcity
dictates that the more efficient institutions will survive and the inefficient ones
will perish.” Evaluate this proposition, making explicit reference to the concepts,
models, and evidence seen in the course.
b. Although neo-classical economists would argue that power cannot exist in
voluntary exchange, we have seen a number of examples of how power may
affect such exchange, both within and outside of markets. Offer a clear definition
of power and explain how it may affect outcomes in voluntary exchange, using
two examples. Be analytically clear—about how your examples meet the
definition and about the mechanism through which power affects outcomes.
Part B - Problems. Answer one (1) of the following. (1 hour and 15 minutes)
1. Consider a capitalist firm with contingent renewal.
Q is total output, e is effort per hour for each worker, and h is total hours of all workers.
Q = Q(he), with Q’>0 and Q”<0.
Employer seeks to maximize ∏=pQ-W, where W is the sum of wage payments to
workers. Identical workers maximize U = w – e2, given their fallback position Z.
Workers face a possibility, 0<t<1 of dismissal if caught shirking. t = t(e), t’>0.
a. Write an expression for the present value of the worker’s utility V and explain it.
b. Now assume that workers’ utility functions (differently than above) were such as
to define a BRF: (1-e) = β/w, for w > w, where w is the wage rate for which
V(w,e)=Z.
Let w =1.5 and β=1.
Find e, the level of effort provided at the market-clearing wage. Using the Solow
conditions, find e* and w*. Explain how the Solow conditions ensure a profitmazimixing result for the capitalist. Draw the function e=e(w).
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c. e* and w* are associated with a number of hours of labor hired, h*. Does this
choice by the employer result in an efficient outcome? Explain.
d. Contrast the BRF above to one representing the situation in a worker cooperative
or participatory firm. What might happen to the BRF? Explain why and add to
your graph above.
e. Carefully contrast the efficiency of this outcome with the efficiency of the
outcome described in c.
f. Drawing on empirical evidence, provide some support for these theoreticallydescribed differences in firm behavior.
2. Credit Markets
Borrowers have an expected return on borrowing of:
Y = (f, δ) = µf(1-f) – δ(1-f)
And lenders expect: П = δ (1-f)
a. Explain the exchange problem depicted in this model.
b. Lenders may use a contingent renewal approach to address this problem. Write down
the borrower’s utility function in such a situation, noting that fallback (z) =0 and also
assume i=0. Write down the borrower’s BRF.
c. Find f* and δ* chosen by the lender. Explain how these levels relate to the exchange
problem.
d. Now allow borrowers to have some collateral, k, so that:
Y (f, δ) = μ f (1-f) – δ(1-f)(1-k) – (1+ρ) k, where ρ=opportunity cost of k.
(No contingent renewal now, lenders use collateral instead to solve the exchange
problem.) Find the new δ*. How has the exchange problem changed compared to the
contingent renewal situation? How does this explain the change in δ* compared to c.
above? Explain.
e. Does this solution to the exchange problem result in an efficient outcome? Explain
carefully, discussing how the use of k affects which projects get funded. Explain the
implication for the Second Theorem of Welfare Economics.
f. Marx complained that “The economist assumes…what he is supposed to deduce
(explain).” Drawing on this model, carefully explain how classes are formed and
persist in a capitalist economy, according to Bowles.
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