Ph.D. Qualification Examination in Microeconomics
Examiners: Borcherding, Denzau and Filson
May 27, 2009/100 points/Five Hours
You have one hour to read and outline your thoughts on this examination, and another
four hours to answer the questions on official qual exam paper. Carefully follow all
directions. Please write legibly and use your time economically. Good luck.
Section A. M.A.-Level Section on Microeconomics & New Institutional Economics
(40 points)
A 1: Basic Microeconomics (20 points)
Answer question A1-1) or A1-2) and any two from this section (which includes one from
the pair A1-1 and A1-2 not chosen).
A1-1) Textbook Durability
The late Jack Hirshleifer (along with co-authors David Hirshleifer and Amihai Glazier)
now have a paperback edition of their iconic intermediate micro theory text. Paperbacks
have been standard editions in developing, poor countries, but they are now beginning to
become standard in the rich OECD countries. Does this suggest anything about the
frequency of new editions, especially given the cheapness of electronic printing, or is it
just a reflection of rising cost of hard-cover books? Predict the future, but recall that
consumers have choices, no matter what a professor’s syllabus says. Be sure to consider
transactions costs and property rights along with technology in your answer.
A1-2) Insurance Contracts
Health, fire and burglary insurance contracts typically are complex in construction
compared to life insurance. In the former, some items are not insured, or subject to
“deductibles.” Others are subject to fractional compensation. Assume a dental insurance
contract formed in a competitive environment:
a. What parts are likely insured and what are not?
b. Sometimes check ups and cleanings are covered and sometimes not, but often
required at least yearly. Why?
c. Why are life insurance contracts, beyond ascertainment of health status,
typically not so complex?
A1-3) Freakonomics Deconstructed
In their Freakonomics volume the two Steves – Levitt and Dubner – claim that real estate
brokers chisel their clients. Professor Levitt and one of his students found that real estate
brokers spent roughly ten days to two weeks longer selling their own houses and
properties than when they worked for a client. Adam Smith over two centuries before
claimed share-cropping was also inefficient. If an agent gets less than 100% of the value
of her increment of effort – according to Levitt, Dubner, and Smith – they will offer less
than all optimal effort. (Levitt teaches at Chicago, by the way and Dubner is a journalist
for the New York Times. Smith died in 1798.) Critique the theory and implication of
inefficiency in share-contracting
A1-4) International Trade and Specific Factors
It is generally accepted that because certain goods and services are not shippable at
reasonable costs, their prices can diverge between national markets by sizeable amounts.
“Haircuts” are the classic example. But haircuts would surely become more subject to
the Law of One Price, if various factors of production were more globalized. Offer a
theory of international price dispersion where the variance is subject to different
globalizing and observable factors. Give examples and predict future trends.
A1-5) Aluminum and Economic History of Stocks and Flows
Decades ago, ALCOA, a U.S.-based international corporation, was sued for using its
monopoly power. Today, ALCOA is still a giant but nobody in the U.S. Department of
Justice or the E.U.’s Competition Bureau would dream of worrying about the behavior of
ALCOA. The world is awash in aluminum. The stock of existing aluminum is huge
compared to bauxite, the mineral from which aluminum is smelted, the flow of new
aluminum.
d. Offer a stock-flow theory of pricing for aluminum with respect to mark-up
over marginal cost.
e. If ALCOA really had monopoly power back in the Forties, why did it sell its
stuff outright, rather than just leasing ingots for long-periods, requiring their
return as scrap sometime in the future? According to students of ALCOA,
that company never thought this would work, antitrust issues aside.
A1-6) Is This Intelligent Design?
It is well known that the cost of training a student for a first degree in the humanities is at
least 30 to 50% lower than in the hard sciences. Economists come pretty cheap too, as do
lawyers. At professional school levels, schools specializing in medicine, engineering,
business, and law charge from two to three times the tuition of schools of education,
music, social work, and theology. Note, however, the undergraduate liberal arts colleges
– such as our sister institutions of CMC, Pitzer, Pomona, and Scripps – do not charge
different tuitions to different majors reflecting cost and market value-added dimensions.
Should these famous liberal arts colleges change their one-price tuition policies to insure
large revenues per graduate?
A 2: Neo-institutional Economics (20 points)
Answer question A2-1 or A2-2 and one from A2-3 and A2-4. Cite any literature you
think salient.
A2-1) Coercive Paternalism and Anchoring Theory
Chicago behavioral economist Richard Thaler claims people are not very thoughtful
about their futures. If they take a job where they have to affirmatively check a box to
“opt into” even a generously subsidized company savings plan, they tend in over half the
cases to pass up that opportunity. On the other hand, if they have to check a box to “opt
out,” well less than half will do this. Thaler argues that the law should require companies
who offer pensions to require their forms to be “opt out.” Critique Thaler’s work, taking
as a policy given that personal savings is a social good, but so too is free individual
choice.
A2-2) Applied Welfare Economics and the Political Economy of Tax Reform
According to leading public finance gurus, the personal income tax has a huge
deadweight effect in the U.S. because it taxes effort and risk at progressive rates; treats
capital gains as earned income; and taxes savings as well as the income from capital. The
conventional wisdom has it that the U.S. personal income tax dissipates perhaps 50 cents
for every dollar it raises on the margin. A flat tax of 17% on earned incomes, with
savings deductible from income, capital gains exempt, and with no taxed on incomes
under $40,000 would, the tax gurus claim, replace the revenues of the current U.S. tax
and raise growth rates by half of one percent. Query, if this is such a good idea, how
come it seems to be rejected politically?
A2-3) We are in the midst of the greatest financial panic since 1929. Economists
disagree over policy choices. Write an essay explaining why, with all the advances in
economic analysis since the Great Depression in macroeconomics, transactions costs
economics, public choice and behavioral economics, the variance in policy
pronouncements is so great amongst the best minds in the profession.
A2-4) James M. Buchanan, Nobel Prize in Economics, 1986, claims that economic
policy analysis is systemically flawed by offering good economics, but poor political
analysis. He notes that practical politics, on the other hand, is flawed by the practice of
good politics, but the employment of bad economics.
a. Whatever does he mean?
b. How would concentrating on the “rules” of politics lead to a better solution of
this paradox?
c. Why has the paradox been more easily overcome in the rich world than in
developing societies?
Section B: Questions Based on Economics 316 (30 points)
Answer either B1 or B2, but not both.
B1)
Chicken Economics
In the small town of Tyson, there is only one large employer that almost everyone works
for: the Tyson chicken firm. Suppose that the supply of labor to Tyson is given by
L = -120 + 10w.
The firm uses a production function involving labor (L) and capital services (K):
q = L0.5 K0.5.
The price of capital services is 1, and the output is sold on a competitive national market
at a price of 10.
a.
What is the firm’s optimal choice of L, K and q?
b.
What is the wage paid by Tyson?
c.
Suppose that Tyson is now required to pay a minimum wage of 20. How
does this affect its optimal choice of L, K and q?
B2)
A Modern Hicksion Utility Problem
Suppose a consumer's direct utility function is
U = x10.5 x20.5.
a.
Derive the expenditure function, and the indirect utility function.
Let p2 = 1, and income $100. Suppose that p1 rises from $1 to $4.
b.
What is the initial utility level? The final utility level after the price
change?
c.
How must more income would enable the consumer to get back to the
original utility level?
d.
At the old prices, how must less income would enable the consumer
require to get to the final utility level?
Suppose the consumer had a utility function,
U = X1 X2.
e.
How would this affect your answers to parts c and d above?
Section C: Questions Based on Economics 317 (30 points)
Answer only one of the following two questions:
C1)
A Principal and Agent Problem
Consider a two-effort-level principal-agent model. Suppose that effort has distinct effects
on revenues R and costs C, where π = R − C . Let f R ( R | e) and f C (C | e) denote the
density functions of R and C conditional on e, and assume that, conditional on e, R and C
are independently distributed. Assume that R ∈ [ Rl , Ru ] and C ∈ [Cl , Cu ] , and that for all
e, f R ( R | e) > 0 for all R ∈ [ Rl , Ru ] and f C (C | e) > 0 for all C ∈ [Cl , Cu ] .
The two effort choices are {eR , eC } where eR devotes more time to revenue
improvements and eC devotes more time to cost reduction. In particular, assume that
FR ( R | eR ) < FR ( R | eC ) for all R ∈ [ Rl , Ru ] and that FC (C | eC ) > FC (C | eR ) for all
C ∈ [Cl , Cu ] . Moreover, assume that the monotone likelihood ratio property holds for
each of these variables in the following form: [ f R ( R | eR ) / f R ( R | eC )] is increasing in R,
and [ f C (C | e R ) / fC (C | eC )] is increasing in C. Finally, the manager prefers revenue
enhancement to cost reduction, so his cost of effort function g(.) is such that
g (eC ) > g (eR ) .
a. Suppose that the principal wants to implement effort choice eC and that both R and C
are observable. Set up the principal’s optimization problem and describe the constraints.
b. Derive the first-order conditional for the optimal compensation scheme w(R,C). How
does it depend on R and C? Provide an intuitive explanation for your results.
c. How would the answer to b. change if the agent could always unobservably reduce the
revenues of the firm (in a way that is of no direct benefit to him?)
d. What if, in addition, costs are now unobservable by a court, so that compensation can
be made contingent only on revenues? Can the principal still implement eC ?
C2)
A Problem in Entry Barrier Strategy
Consider an incumbent firm I facing a potential entrant E. I wishes to keep E out of the
market. Suppose that I is one of two possible types; one has high ability θ h and the other
has low ability θl , where θ h > θl . Initially, E believes that I is the high type with
probability λ .
Suppose that I can make a visible investment x before E decides whether to enter or not.
E observes x, updates its beliefs about I’s type, and then decides whether to enter or not.
If E stays out, I gets the payoff π 1 − c( x | θ ) and E gets 0. If E enters, I gets the payoff
π 2 − c( x | θ ) , and E gets π he if I is the high ability type and π le if I is the low ability type.
a. Describe the general requirements that must be satisfied in a separating weak perfect
Bayesian equilibrium (WPBE).
b. Suppose that π he > 0 and π le > 0 . Does a separating WPBE exist in this game? Either
characterize one or show that one cannot exist.
c. Suppose that π he < 0 and π le > 0 . Suppose that c( x | θ ) = 0 for all x. Does a separating
WPBE exist? Either characterize one or show that one cannot exist.
x
d. Suppose that π he < 0 , π le > 0 , and that c( x | θ ) = . Suppose that π 1 = π 2 . Does a
θ
separating WPBE exist? Either characterize one or show that one cannot exist.
x
e. Suppose that π he < 0 , π le > 0 , c( x | θ ) = , and that π 1 > π 2 . Does a separating WPBE
θ
exist? Either characterize one or show that one cannot exist.