Tuesday, December 2, 2014

Last Year's Final Exam

Final Exam fall 2013

The final this time around will be in the same format.  I haven't written it yet and probably won't till after class on Thursday.


  1. A student emailed me with the following. I will respond in subsequent comments.

    Could you give me some critique on economic efficiency? Also, I do not fully understand the government agencies procurement and the bidding process. Is there any material that I can look at for this part?

    1. On economic efficiency -

      This is considered in the first real Excel Homework (not the tutorial). You might want to review that. I will give a discussion here. There are two distinct concepts given.

      In the supply and demand (partial equilibrium) setting the concept is social surplus - the area under the demand curve and above the supply curve up to the given output. The efficient output maximizes the social surplus. It is the output at which the demand price equals the supply price. When output is less than the efficient output, perhaps because one side of the market has the power to influence the price in its favor, there is a deadweight loss. With this efficiency concept it is thought that the efficient output is independent of how the surplus is distributed. In English, efficiency means to make the pie as big as possible. Equity concerns who gets what share of the pie. In partial equilibrium, efficiency considerations and equity consideration can be handled separately.

      In the Edgeworth Box (general equilibrium) setting, the efficiency concept is Pareto Optimality. An allocation is Pareto Optimal if in order to make one consumer better off, some other consumer must be made worse off. If an allocation is not Pareto Optimal, then there are gains from trade. This means at least one consumer can do better with no harm going to anyone else. In the Edgeworth Box, the set of Pareto Optimal allocations is called the Contract Curve. In general, moving from one point to another along the Contract Curve, both the amount of Good X and the amount of Good Y vary. In this case, efficiency and equity have to be considered together. Each are pieces of the same issue.

      The last part of the Excel Homework consider the case of No Income Effects in the demand for one of the goods. If both consumers exhibit no income effects in their demand for the same good then, in the Edgeworth Box, the efficient division of that good across the two consumers doesn't vary with how the other good is divided. In this case, efficiency and equity can be separated, so the partial equilibrium and general equilibrium concepts coincide.

    2. I'm afraid that on procurement there is nothing for you to read. You'll have to rely on class discussion for that. Below, let me make a few points that we considered.

      First, private industry also does procurement when it purchases inputs, but then sometimes the issue is cast as whether to produce the input in house (vertically integrate) or to go to the market. Those who worry about how organizations operate (particularly Oliver Williamson) will note that there is governance of procurement, even in the private sector. But that governance may not be as formal as it is with government agencies, where there are rules and regulations that cover purchases.

      Those rules and regulations are there mainly so the government agency gets a good deal with the purchase. They are also there to reduce the chance of employee opportunism, where here the employee in question is the procurement officer or others involved in the purchase. Recall that we talked about "bribes" in the form of future employment with the firm and the problem of "the revolving door." If such bribes work, the employee effectively becomes the agent of the firm, rather than of the government agency.

      There is more art than science in what makes for a good deal. Price matters, but the case where only price matters is when the purchase is of a "commodity" - the product is homogeneous, the good is an inspection good not an experience good, and the market determines the price. For newer products and ones which are "big ticket items" (in class I gave the example of the purchase of the software that powered Illinois Compass) one wants to think of the purchase as the beginning of a relationship with the vendor, not simply as buying the item. So a good deal is one where the relationship looks promising at the outset.