Ph.D. Qualification Examination in Microeconomics
Examiners: Borcherding, Denzau and Filson
January 28, 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.
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
Answer question A1-1) or A1-2) and any two others.
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 Steve’s – 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 sharecropping was also inefficient. If an agent gets less than 100% of the value of her increment of
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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?
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A 2: Neo-institutional Economics
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?
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Section B: Questions Based on Economics 316 (30 points)
Answer either B1 or B2, but not both.
B1)
The Value of Information
Suppose a firm faces an inverse demand function
p = x - 10q,
where x is a random variable taking the value 200 or 400 with equal probabilities. Average
cost is constant at 10. Assume further that the firm is risk-neutral.
a.
Suppose that the firm can arrange its production system so that it must choose
either price or quantity first, before knowing the true state of demand. Which would it
choose, and why?
b.
What would the firm pay an economist for knowledge of the value of x, if you
are certain she could tell you before you set price?
B2)
Variation and Duality
Suppose that a consumer's preferences can be represented by
U = a ln x1 + b ln x2 ,
a.
b.
c.
d.
e.
for x1).
a, b > 0.
Give the Marshallian demand for x1 and x2.
Show the indirect utility function.
What are the Hicksian demands?
Show that the Marshallian demand for x1 is downward sloped.
What is the cost to the consumer of a tax on x1 of size t (assume a competitive market
Does this cost depend on income?
Section C: Questions Based on Economics 317 (30 points)
Answer only one of the following two questions:
C1)
Warranty Choice
Consider a game played between a monopolist M and a single consumer C . M ’s product
“works” with probability  and is useless with probability 1 -  . Suppose that  is either l
or h , where l < h , and that the value of  is known to M but not to C (note that knowing
 is just knowing the probability that the product works - neither player knows whether the
product works until after it is purchased). C has prior beliefs Pr{  h }   and
Pr{  l }  1   . M announces a price p and a warranty w . After observing p and w , C
updates her beliefs and decides whether to buy the product or not. Once the product is
purchased, the uncertainty about whether it works is resolved. Payoffs are determined as
follows: if C buys the product and the product works, M gets a payoff of p and C gets 1-
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p ; if C buys the product and it does not work, M gets p – w and C gets w – p ; if C does
not buy the product then both players get 0. The objective in answering this question is to
determine whether there exists a separating perfect Bayesian equilibrium in which the type of
M with  = l (hereafter referred to as the low type) chooses w =0. Assume that no warranty
can ever exceed 1.
a. Draw the game tree.
b. Suppose w =0. Suppose that it is common knowledge that M is the low type. What is M ’s
optimal price? Argue that in any separating weak perfect Bayesian equilibrium in which the
low type chooses w =0, the low type must charge this price.
c. In order for a separating perfect Bayesian equilibrium to exist in this game, two incentivecompatibility conditions must be satisfied. What are they?
d. Check each player’s equilibrium strategy against off-the-path strategies.
e. Is there a separating weak perfect Bayesian equilibrium in which the low type chooses
w =0? If so describe it. If not explain why.
C2)
Contract Choice and Chiseling
Consider the following principal-agent game. P wants to hire A for a one-time project. If A
works for P, A can choose high effort, eH , or low effort, eL .
Profits are either high,  H , or low,  L , where  H >  L . If A chooses eH , then profits are  H
with probability  H and  L with probability 1 -  H . If A chooses eL , then profits are  H
with probability  L and  L with probability 1 -  L , where  H   L .
A maximizes expected utility using a utility function defined on certain outcomes:
U (w, e)  V (w)  e , where w is the wage, e is the effort choice, V '(w)  0 , and V ''  0 .
P designs a contract, A then accepts it or not, and if A accepts, A then chooses an effort level.
A has a reservation utility level of U 0 .
a. Suppose P maximizes expected profits from the project less the expected wages (P is risk
neutral). Explain how to implement eL and eH if effort is observable and verifiable.
b. Continue to assume that P is risk neutral. If e is not observable, and P wants to implement
eL , what is the optimal contract? Explain.
c. Now suppose that P is also risk averse. P evaluates certain money payoffs using the
function U p (  w)  (  w)1/ 2 . Further, assume that V ( w)  w1/ 2 . Show how to implement
eL and eH if effort is observable and verifiable (set up and solve the principal’s problem).
d. Maintain the assumptions in part c. If e is not observable, and P wants to implement eL ,
will the contract you derived in part c. work? Explain.
e. Maintain the assumptions in part c. If e is not observable, and P wants to implement eH ,
will the contract you derived in part c. work? Explain.
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A1 - A List of Short Questions to Supplement Section A1
You may answer any two of these in place of one of the elective questions in Section A1.
1)
In a world of clones, all with identical tastes, there would be no need for economic
exchange. TRUE or FALSE, and explain.
2)
A competitive firm always sells at its minimum average cost. True or false, and
explain.
3)
"It's true in theory, but not in practice." Discuss the meaning and relevance of this
statement for economics or political economy.
4)
Some economists claim that the competitive market model is a poor way to explain
the size of firms. Evaluate this claim.
5)
It is claimed appropriately by psychologists that heroin is addictive, and thus priceinelastic. It also claimed by some in law enforcement that the provision of heroin
is monopolized. Explain the economic dilemma involved in these two statements,
and try to resolve it.
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