Economics 202 Principles of Economics (Honors) Fall , (6 pts) Explain why cartel agreements such as OPEC are notoriously unstable.

Transcription

1 Name Final Exam Economics 202 Principles of Economics (Honors) Fall 2013 Chapter 9: Games and Strategic Behavior 1. (4 pts) Define Nash equilibrium. 2, (6 pts) Explain why cartel agreements such as OPEC are notoriously unstable. 3. (10 pts) Suppose Toyota is negotiating to hire a small firm to manufacture its dashboards. If producing the dashboards requires a large investment in equipment that cannot be used for any other purpose, why might the small firm insist on a long-term contract? -1-

2 4. (30 pts) Suppose that the United States and China act as rational, selfinterested governments. The payoffs when setting their trade policies are: The United States Tariff Free trade China Tariff Free Trade -$300 for each -$500 for China $200 for the United States $200 for China -$500 for the United States $100 for each a. If the United States adopts a tariff, China chooses Tariff/Free trade (circle one) If the United States picks free trade, China chooses Tariff/Free trade (circle one) Does China have a dominant strategy? Yes/No (circle one) If yes, what? Tariff/Free trade (circle one) b. If China adopts a tariff, the United States chooses Tariff/Free trade (circle one) If China picks free trade, the United States chooses Tariff/Free trade (circle one) Does the United States have a dominant strategy? Yes/No (circle one) If so, what? Tariff/Free trade (circle one) c. What is the equilibrium outcome in this game? Is this game a prisoner s dilemma? Yes/No (circle one). Explain why or why not. d. Bilateral or multilateral trade agreements attempt to get two or more countries to adopt trade policies that are closer to free trade. Using the simple game above, explain why such agreements might benefit the countries involved. e. If an agreement to both adopt free trade did not include a way to enforce the agreement, what would be apt to happen? -2-

3 Chapter 10: Externalities and Property Rights 6. (4 pts) Define negative externality. 7. (4 pts) State the Coase Theorem 8. (4 pts) What is the tragedy of the commons? 9. (18 pts) Suppose dogs impose nuisance costs on others due to barking and pooping on neighbors lawns. Explain how an annual license fee for dogs might improve efficiency by shifting the equilibrium number of dogs closer to the socially optimal level. If correcting for negative externalities is the main purpose of the license fee, how should the fee be set? The city should raise the fee until... If some dogs are quiet and well-behaved (and their owners pick up after their messes), while other dogs run amuck, why is a uniform annual fee not an optimal policy? What other approach might better address the issue of problem dogs? -3-

4 10. (20 pts) Suppose the law says that Jones may emit smoke from his factory even though the smoke harms Smith, who lives downwind. a. If the relevant costs and benefits of filtering the smoke from Jones's production process are as shown in the following table, and if Jones and Smith can negotiate with one another at no cost, will Jones emit smoke? Yes/No (circle one). Explain. Jones emits smoke Jones does not emit smoke Surplus for Jones $200 $160 Surplus for Smith b. As in the previous question but now the surplus for Jones when he emits smoke is $220. If Jones and Smith can negotiate with one another at no cost, will Jones emit smoke? Yes/No (circle one). Explain. Jones emits smoke Jones does not emit smoke Surplus for Jones $220 $160 Surplus for Smith Bonus 11. (2 pts) Describe the most recent experiment gla (2 pts) What is the most important concept that you learned in this course and why is it so important? On my honor as an Aggie, I have neither given nor received unauthorized aid on this exam. Signature -4-

5 Final Exam Solutions Economics 202 Principles of Economics (Honors) Fall 2013 Chapter 9: Games and Strategic Behavior 1. (4 pts) Define Nash equilibrium. A Nash equilibrium is any combination of strategy choices in which each players choice is his or her best choice, given the other players choices. 2, (6 pts) Explain why cartel agreements such as OPEC are notoriously unstable. A cartel is any coalition of firms that conspires to restrict production for the purpose of increasing their profits. The problem facing a cartel is a classic example of a prisoner s dilemma. The cartel wants to set total industry production to the monopoly level, so that they can charge the monopoly price and split the monopoly profits. However, each firm would prefer to sell more at a lower price, with its rivals sticking to agreement to restrict output. Since the agreement is not legally enforceable, each firm will cheat and the agreement will unravel. Only through repeated play is there some limited ability for the cartel to discipline itself. 3. (10 pts) Suppose Toyota is negotiating to hire a small firm to manufacture its dashboards. If producing the dashboards requires a large investment in equipment that cannot be used for any other purpose, why might the small firm insist on a long-term contract? Toyota and the potential dashboard supplier face a commitment problem. Once the firm has made the large relationship-specific investment, Toyota could change the terms of the agreement and pay them much less for the dashboards than initially promised. A long-term agreement would protect the potential dashboard supplier from opportunistic behavior by Toyota and make sure that the investment in equipment pays off adequately. -1-

6 4. (30 pts) Suppose that the United States and China act as rational, selfinterested governments. The payoffs when setting their trade policies are: The United States Tariff Free trade China Tariff Free Trade -$300 for each -$500 for China $200 for the United States $200 for China -$500 for the United States $100 for each a. If the United States adopts a tariff, China chooses Tariff (-$300 > -$500) If the United States picks free trade, China chooses Tariff ($200 > $100) Does China have a dominant strategy? Yes If yes, what? Tariff b. If China adopts a tariff, the United States chooses Tariff (-$300 > -$500) If China picks free trade, the United States chooses Tariff ($200 > $100) Does the United States have a dominant strategy? Yes If so, what? Tariff c. What is the equilibrium outcome in this game? Both countries adopt a tariff and each loses $300. Is this game a prisoner s dilemma? Yes. Explain why or why not. A prisoner s dilemma is a game in which each player has a dominant strategy and the payoffs that result from each playing their dominant strategy are less than if each had picked another strategy. When each county follows its dominant strategy of imposing a tariff, the result is each earn -$300, when could have each earned $100 if both had chosen free trade. d. Bilateral or multilateral trade agreements attempt to get two or more countries to adopt trade policies that are closer to free trade. Using the simple game above, explain why such agreements might benefit the countries involved. A trade agreement could get the countries to the preferred outcome of both choosing free trade. The agreement would act as a commitment device, enabling them to do better than if each is permitted to adopt a tariff. e. If an agreement to both adopt free trade did not include a way to enforce the agreement, what would be apt to happen? Without enforcement, each country defects from the agreement and adopts a tariff. -2-

7 Chapter 10: Externalities and Property Rights 6. (4 pts) Define negative externality. A negative externality occurs when some of the cost of an activity falls on people other than those who pursue the activity. 7. (4 pts) State the Coase Theorem If, without any cost, people can negotiate the purchase and sale of the right to perform activities that cause externalities, then they can arrive at efficient solutions to the problems caused by externalities such as pollution. 8. (4 pts) What is the tragedy of the commons? A resource that has a zero price (due to lack of property rights) tends to be used until its marginal benefit falls to zero. 9. (18 pts) Suppose dogs impose nuisance costs on others due to barking and pooping on neighbors lawns. Explain how an annual license fee for dogs might improve efficiency by shifting the equilibrium number of dogs closer to the socially optimal level. Without any fee, the dogs impose a cost on others, leading to too many dogs. The fee would act like a tax and shift some of the social cost onto dog owners, leading to fewer dogs owned. If correcting for negative externalities is the main purpose of the license fee, how should the fee be set? The city should raise the fee until... Until the number of dogs owned matches the socially optimal number my making people paid a fee equal to the social cost imposed on others. If some dogs are quiet and well-behaved (and their owners pick up after their messes), while other dogs run amuck, why is a uniform annual fee not an optimal policy? What other approach might better address the issue of problem dogs? The fee might discourage someone from owning a dog that generates little externalities but might not do enough to discourage people from owning dogs that are a major nuisance. A better approach would be a system of fines for bad behavior. -3-

8 10. (20 pts) Suppose the law says that Jones may emit smoke from his factory even though the smoke harms Smith, who lives downwind. a. If the relevant costs and benefits of filtering the smoke from Jones's production process are as shown in the following table, and if Jones and Smith can negotiate with one another at no cost, will Jones emit smoke? No Explain. Jones emits smoke Jones does not emit smoke Surplus for Jones $200 $160 Surplus for Smith If Jones emits smoke, the total benefit is = $600. If he does not emit smoke the total benefit is = $610. Smith would gain = $50 if Jones did not emit smoke; Jones would lose = $40. So if Smith pays Jones $45 (anything 40-50) to not emit smoke, each will gain $5 compared to if Jones were to emit smoke. b. As in the previous question but now the surplus for Jones when he emits smoke is $220. If Jones and Smith can negotiate with one another at no cost, will Jones emit smoke? Yes. Explain. Jones emits smoke Jones does not emit smoke Surplus for Jones $220 $160 Surplus for Smith If Jones emits smoke, the total benefit is now = $620. If he does not emit smoke the total benefit is $610 as before. Smith would gain = $50 if Jones did not emit smoke; Jones would lose = $60. Smith can offer to pays Jones up to $50 to not emit smoke, but Jones requires $60 to agree so he would reject Jones offer and emit smoke. Bonus 11. (2 pts) Describe the most recent experiment gla3. Played a prisoner s dilemma game (each player had a dominent strategy that lead to an inferior outcome) and two coordination games. 12. (2 pts) What is the most important concept that you learned in this course and why is it so important? -4-