MidtermOnthisexamMean:56StandardDeviation23Not90-100Aetc.VeryRoughProjectionA:80-100B:60-80C:40-60AnApplicationofEconomicstoExamsTheproblemAfteransweringthequestionsyouknowtheanswerto,tenminutesareleftSoyouwritesomethingontheonesyoudon’tknowtheanswertoThishasseveralcostsItwastesyourtimewritingitandminegradingitImightgivesomeonecreditforsomethinghereallydoesn’tknowbecauseheisgoodatfakingitImightfailtogivesomeonecreditforsomethinghedoesknow,becauseIthinkheisfakingitTheDelphicoraclesaidthatSocrateswasthewisestmaninAthensButSocratesknewhedidn’tknowanythingAftertalkingtoothersinAthens,heconcludethattheydidn’tknowanythingeitherButthoughttheydidMySolution:20%creditforknowingthatyoudon’tknowsomethingYougetitforleavingaquestionblankorwriting“Idon’tknow”ortheequivalentAppliesonlytoacompletequestion,notapart.Willapplyonthefinal.ConsidertheincentivesSomeGeneralIssuesonthisExamTalkingaboutthesubjectinsteadofansweringthequestion.WhenIcrossstuffoutitdoesn’tmeanitiswrongItmeansitisirrelevanttothequestionConfusingwhatisefficientwithwhatwillhappenorwhatisintheindividual’sinterestAnimportantmistake,sinceacentralproblemIshowtopreventsituationswherewhathappensisnotefficientForexampleproblemIBTheairlinedoesnotcontrolnoiseWhichisnottheefficientsolutionButisthesolutionthatresultsfromeachpartyactinginhisowninterestQuestionIA:Soundreduction,nosoundproofing.B.Airlinehastherighttomakesound,isnotliableIfnobargaining,airlinemakessound,homeownerssoundproof.Ifbargaining,homeownerscouldofferamillion+forsoundreductionButprobablywon’tbecauseoftheirpublicgoodproblemAnexampleofaninefficientoutcomefromrationalbehaviorC.Airlinereducessoundwithorwithoutbargaining.SomeseemedtothinkitcouldbargaintogetthehomeownerstopaypartofitButwhywouldthey?Ifitmakessound,theyarecompensated.D.Nowthepublicgoodproblemdisappears,sotheanswerchangesinB“Levelingtheplayingfield”isabadmetaphorItisaseriousmistaketothinkofeverythingasazerosumgameSometimeswhathelpsonepartyhurtstheotherButsometimesitbenefitsbothpartiesbyproducingamoreefficientoutcomeConsidercaseBWithmanyhomeowners,theairlinedoesn’treducenoiseWithonefirm,itispaidbetween$1,000,000and$1,200,000toreducenoiseWhichcostsitonly$1,000,000SobothsidesarebetteroffIfEverythingisZeroSumWhateverhelpsmemusthurtyouSoalldisagreementsareaboutWhichofusgetsthegoodiesExamplesofthemistakeIfChinagetsricher,wearelesscompetitive,whichisbadIftherichgetricherthepoormustgetpoorerAllpoliticaldisagreementsareaboutwhichsideyouareonrichorpoor,blackorwhite,AmericansorforeignersSoRepublicansandDemocratsareenemiesAndallisfairinloveandwarHusbandsandwivesareenemiestooConsiderimplicationsofthebeliefInsettlementnegotiationsIntradenegotiationsIninterpersonalrelationsAverydangerousmistakeQuestionIIRationality:IndividualstendtotaketheactionthatbestachievestheirobjectivesCouldaddthePosnerconjectureasoneapproachAndfiguringouttheconsequencesoflawasanotherButdon’thaveto“LegalIssuesthatithelpstounderstand”requiresThatitisalegalissue.“Whypeoplerobbanks”isnotalegalissueHowlawshouldpreventbankrobberiesisThateconomicstellssomethingwedidn’talreadyknowWealreadyknewwhypeoplerobbanksBecausethat’swherethemoneyisButwemightnotknowtheriskofgivinglifeimprisonmentforarmedrobberyOrtheargumentinfavorofpermittingconcealedcarryWhatmattersisnotifthevictimusuallydefeatsthemugger,butIfithappensoftenenoughtomakemuggingunprofitableQuestionIIIInthePrisoner’sDilemmaitdoesn’tmatterwhattheothercriminaldoesYouarebetteroffconfessingwhetherornothedoesAdominantstrategy,notjustaNashequilibriumApplicationsmightincludeRealizingthatpermittingpleabargainingmaynotreduceaveragesentencesOthercaseswhereindividualrationalitydoesnotproducegrouprationality,forsimilarreasonsMultiplelandholdersoveroneoilpoolOverfishingNobodydidbilateralmonopoly.Ifsomeonehad…TheproblemwithinjunctiveremediesthatcreatealargebargainingrangeTheargumentforlongtermcontractsWhichwewillgetintowhendiscussingmarriageQuestionIVThelackoftroutisanegativeexternalityAslongasanyonelikestofishthereforanyreasonThatisacost.Butwhatistheinefficiencythatresults?ThepriceofAluminumisbelowitsrealcostofproductionSosomepeopleusealuminumwhen,allcostsconsidered,itwouldbecheaperTousesteelorwoodorfiberglassor…AnetlossAlternatively,Idon’tcoolmyfactoryinsomeotherwayThatwouldhaveavoidedtheproblemAndwouldcostmelessthanitsavesthefishermenWarmwatercouldalsobeapositiveexternalityAsafewstudentspointedout,possiblyallswimmersInwhichcasethepriceofaluminumcouldbeinefficientlyaboveitsrealcostofproductionLoweringthepriceofaluminumisapecuniaryexternalityAnegativeexternalitytocompetitors,positivetotheircustomersThetwoeffectscancel,soitdoesnotproduceaninefficiencyWorkersworking,aluminumbeingconsumed,arecostsButtheyarenotexternalcosts,becauseYouhavetopayforbothSotakethemintoaccountinyourdecisionsQuestionVRiskaversionisnotaboutpresentvsfuturebutaboutyoubeingrichorpoorRiskpreferringdoesn’tmeanyoulikeriskThatyouwouldchoosetoflipacoin,headsyouloseathousanddollar,tailsyoudon’t.Onlythatyoulikeacoinflipwhereheadsyouloseathousand,tailsyouwinathousand.Whatdoriskaverse,riskneutral,andriskpreferringmeanInmoneyInlifeIngradesRiskaversioninmoneyisduetodecliningmarginalutilityofincomeAndthatdoesnotimplydecliningmarginalutilityofyearsorgradesExanteexpostquestion:DeathsvsDentsOnemajorproblemwithexpostishavingtoimposelargepunishmentsIftheonlyresultisdenting,thatisunnecessarySoapureexpostsystemmakesmuchmoresensethanifaccidentskillInterestingbutnotentirelycorrectanswerExpostdoesn’tworkifaccidentskill,becauseYoucan’tpunishadeadmanYoucouldstillpunishadriverforanaccidentthatkillssomeoneelseMoreinteresting,therearewaysofpunishingadeadmani.e.thingshappeningafterhediesthat,before,hedoesn’twanttohappenRefusingtoburyasuicideinconsecratedgroundisatraditionalsolutionConfiscatinghispropertysothathiswifeandchildrenstarveKillingorpunishingpeoplehecaresaboutmoregenerallyPunishmentfortreasoninImperialChinaRelativesareexecutedorenslavedAfterall,weknowyoucanrewardadeadmanOtherwisenobodywouldbuylifeinsuranceItonlypayswhenheisdeadAndbuyingitmeanshevaluesnowthathappeningthenQuestionVIEconomicsofinsuranceRiskAversion=DecliningMUIOneimplicationisthatthefactthatpeoplebuyinsuranceisevidenceThatredistributivetaxationcanincreaseutilityAlthoughevidenceshortofproof—asevidenceusuallyisAdverseSelectionShowsareasonnottolimitinsurancecompanies’abilitytochargedifferentratestodifferentcustomersSinceifyoucan’tchargebadriskratestobadrisks,insuranceisapoordealforgoodrisksAndeveryoneendsuppayingbadriskpricesornotgettinginsuredAlsoanargumentforforcingpeopletobuyinsurancesoastopreventadverseselectionThevalueoflifeThevalueofmylifetomeislarge,asshownbymychoicesSodamagesfortortiouslossoflifeshouldincludeitHedonicdamagesButitisfinite,asshownbymychoices,soregulationsshouldnotbeinfinitelycautiousEconomicefficiencyTortdamagessufficienttomakethevictimwhole:TheargumentforPigouviantaxationThechoicebetweenpropertyrulesandliabilityrulesBotharewaysofmovinggoodstotheirhighestvalueduse,whichistheefficientoutcomeAndsometimesone,sometimestheother,doesitatlowercostAndForSomethingDifferentCoase’sFinalBook:HowChinaWentCapitalistStrikingfacts20foldincreaseinGDPpercapitafromMao’sdeathto2010.ShiftfromacommunisttoamostlycapitalistsystemWiththeCommunistPartystillincontrolMaostillrevered,socialismstilltheofficialideologyMao’spartofthestoryInfavorofdecentralization,criticalofStalin,butDidn’tknowhowtodoitThesolutiontothecoordinationproblemispricesandtradeAndheknewthatmustbewrongsincethatwouldbecapitalismSohisversionwaslotsofcommunes,mostlyself-sufficientThesystemoscillatedbetweencentralplanninganddecentralizationSincebothfailed,thesolutionmustbeculture,morale,somethinglikethat.TheGreatLeapForward,whichresultedinafaminethatkilledabout30millionpeopleAndthentheCulturalRevolutionWhathappenedafterMaodied?ManyhighstatuspeoplewhohadbeenpurgedcamebackTheyknewtheGreatLeapForwardandtheCulturalRevolutionweremistakesIndeedsomeofthemhadbeenpurgedforrecognizingthatAndtryingtopersuadeMaoNowtheycouldgoabroad,seetherealityofcapitalismAdeputypremierofChinavisitedEnglandObservedthataLondontrashcollectorhadseveraltimeshisincomeEnglandwouldbetheperfectcommunistcountryifitonlyhadacommunistpartyrunningitConclusion:Wemustbedoingsomethingwrongbutdon’tknowwhatTrylotsofthings,believeinthefactsAndwewillwinoutbecausesocialismisbetterPolicyafterMao’sdeathAttemptstoreformstaterunsector,givemorepowertofirmsMadesomeimprovement,but…Unwillingtogoalltheway,becauseHeavyindustryetc.waswhatmattered,soithadtobesocialistMeanwhile,inthemarginsCovertprivatizationoflandFirmsnominallyrunbylocalgovernments,permittedbutdisapprovedofVerysmallscaleprivateemploymentinthecities,tosoakupunemployedToleratedbecausenotimportantand…learnfromfactsTheSpecialEconomicZonesweredeliberatepolicyIntendedtolearnfromcapitalismwhilepreventingcontagionInitiallydoneinunimportantplaces.WhichrapidlybecameimportantSotheexceptiongraduallybecametheruleDualtrackpricing–govtfirmssoldtheirquotaattheofficialprice,butProductionabovethequotacouldbesoldatwhateverpricebuyerswouldpayGavegovernmentofficialsexperiencewithmarketswithinpublicsectorProvidedaccesstoresources,atacost,totheprivatesectorButalsoproducedinefficienciesandcorruptionCouldnottellifasuccessfulgovernmentfirmwaswellrunorjustgotfavorabletermsfromthegovernmentTheResultPrivatepracticeonthemarginswasverysuccessfulSofirstnotpunishedThenpermitted(agriculture)inparticularlyunsuccessfulplacesThenpushedeverywhereStateownedfirmslargelylosingmoney,atprovincialandlocallevelSomostofthemwereeventuallyprivatizedChinaendedupwithsomestatemonopoliesButmostproductionprivateGovernmentrevenueof~20%ofnationalincome,lowerthanintheU.S.Andtheyredefinedsocialismtob