You can view and download a copy of the exam from last year. The format this time around will be identical and the content will be similar.

Next Monday in class, part of the time will be devoted to a review of that exam. It would be very good, as preparation, that you write up you own answers to the questions ahead of time and that if you have any problems or issues in doing so that you come ready with these to the review session. It will be a much more productive activity that way.

This comment was posted elsewhere on the site. I am reposting it here so others can see it along with my response.

ReplyDeleteAdam SmithOctober 5, 2015 at 4:20 PM

Could you explain dynamic efficiency criticism and static efficiency criticism again?

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Static efficiency for this purpose refers to Social Surplus as the measure. Attaining static efficiency means we maximize the Social Surplus.

DeleteDynamic efficiency refers to growth in the level of economic activity over some time period. If growth has been greater over the entire time period, while the starting point is the same, then the faster growing alternative is more efficient. Typically growth happens via population increase, diverting consumption into investment, or innovation in new products or in processes. Innovation is the part we'll focus on here.

Some innovation might occur no matter what - figuring out that the earth revolves around the sun and not vice versa, for example. But innovation is typically greater when there are good incentives in place to encourage it. Those incentives typically are of the form of giving the inventor some monopoly over the new product or process that comes with the invention. The monopoly creates deadweight loss, given that the invention has already occurred, but the monopoly also creates a prize which encourages the invention to happen in the first place.

I should add that if you bring this discussion to the real world, it is getting quite a bit of attention in pharmaceuticals, where drugs for AIDS, as an example, are priced extremely high, and there is an ethical issue of charging so much to patients who will die without the medication. But on the flip side of this, much investment in innovative activity fails, so you need large prizes for when it does succeed to encourage the activity overall.

Nobody begrudges an author who has his first novel become a hit making money of the writing, but the copyright law on which the author and his publisher have the monopoly for the book, now says the copyright lasts for 70 years after the author has passed away. At the time the book enters the public domain and may be redistributed for free. Until that time, if you own a hard copy of the book, you can sell that one copy, but if you have an electronic copy of the book, you can resell that to anyone.

So dynamic efficiency requires some temporary monopoly after the invention but for how long (and in the case of patents what constitutes a violation of the patent) is open to lots of debate. There is not general agreement of what the dynamic efficiency solution looks like, but only this very general idea that invention does require incentives.

Could you explain Prisoner’s Dilemma, Pareto Optimum, Nash equilibrium? When I go over the excel problem, I am confused about: 1. In what situation, Prisoner's dilemma dominated strategy is also Pareto Optimum. 2. In what situation, nash equilibrium is also Pareto optimum?

ReplyDeletePrisoner's Dilemma is a particular bi-matrix game with the following characteristics. Each player has two strategies, cooperate or cheat. When a player considers only his own payoff, cheat is a dominant strategy. That means that regardless of whether the other player chooses to cooperate or cheat, the player gets a higher payoff from cheating than from cooperation. However, if both players were to choose cooperate, that gives a higher payoff for each than when both players choose cheat, which is the equilibrium of the game. So in the Prisoner's Dilemma, the equilibrium is NOT Pareto Optimal.

ReplyDeleteA Pareto Optimum is an allocation where to improve the payoff for one of the actors, it is necessary to lessen the payoff of another actor. In other words, all the gains from trade are exploited at a Pareto Optimum. In the Edgeworth box, a Pareto Optimal allocation where both consumers have positive amounts of each good, is characterized by the consumers having the same Marginal Rate of Substitution. In a bi-matrix game, if side payments are allowed then a Pareto Optimum maximizes the sum of the two payoffs. If side payments are not allowed, other possibilities can be Pareto Optimal as well, if they give one player a greater payoff than where the sum of payoffs is biggest.

A Nash equilibrium is a pair of strategies, one for each player with the following properties. Each strategy is the best response to the rival's strategy. So if each player expects the rival to play the Nash Equilibrium strategy, and if each player then plays his best response, then the expectations players have are confirmed by the play of the game. Nash Equilibrium, in effect, means self-fulfilling expectations.

There is no general statement that can be made about Nash Equilibrium and Pareto Optimality. In the Excel homework there was a "pure coordination game" which had two distinct Nash Equilibria that could be Pareto ranked, one was better for both players than the other.

A student asked:

ReplyDeleteHi Professor,

With regards to the subject, can you help me understand the intuition with flatter demand curve when the service quality is higher? I understand the case with supply-side, in which it gets steeper as it is more expensive to produce higher quality goods. It isn't so clear with the demand side.

Thanks,

The demand curve can be thought of as a willingness to pay schedule. It gives how much the buyer is willing to pay for the marginal unit of quantity as a function of the overall quantity purchased. The quality measure we are considering is a vertical measure, where we can talk about higher quality or lower quality. It makes sense that with higher quality, the buyer's willingness to pay goes up. Since the demand curve is downward sloping and since we are only looking at the case where quality affects the slope but not the intercept (and this we did to keep the math as easy as possible) then for the willingness to pay to increase, the demand curve must get flatter.

DeleteLikewise, the supply curve can be thought of as a marginal cost schedule. Marginal cost rises with quality.

DeleteA student asked:

ReplyDeleteHi Professor,

I have a question on excel hw "a strategic look at the efficiency principle 3" on how to get the value of p and c. Since I don't know how to upload the picture on the course website, I choose to email for convenience.

Thanks,

I took a screen shoot of the Prisoner's Dilemma game modified with the contract cost, c, and the punishment for breaking the contract, p. If you right click on the link, choose open in a new tab. I can't display it directly in the comment.

DeleteLet's first consider the equilibrium of the game with no contract. This is bottom, right and both players earn 2. The contract aims to modify the game so in the modified game the equilibrium is top, left. In this case the players earn 7-c in equilibrium. For this outcome to be better than not writing a contract at all, c must be less than 5.

Now imagine that the row player cheats and plays bottom. In this case the row player gets payoff 9-c-p. If the punishment is to deter cheating than 9-c-p < 7-c. This amounts to p > 2.

Hi Professor,

ReplyDeleteCan you help explain how we arrive to the following solution in here: http://postimg.org/image/52553nfkd/

If bottom left is considered one of the efficient outcome, why isn't top right be considered an efficient outcome too?

For the first question, on the second part with the students updated preferences. Would Alice's first choice now be Stanford because that is where she tentatively accepted her offer from?

ReplyDeleteI am having a hard time understanding how to arrive at the solution for part d and e on the transfer pricing section. I don't recall discussing/working a problem containing lump sum payments in addition to transfer pricing

ReplyDeleteCan anybody share the final matches of Part 1 - Matching from the practice exam. I didn't write it down when we went over it in class so I'm not sure if I did it right.

ReplyDeleteon the second round, it ends with alice-yale, barbara-stanford,charlie-hopkins... I think..

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