BPP Field Exam 2010

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Question B1: Work in Teams

There are N employees at Yahoo. Employees can either work, [math]e = 1[/math], or shirk, [math]e=0[/math]. It costs a worker 1 dollar to work and zero dollars to shirk. Working or not cannot be monitored by the firm. For each unit of work, the firm earns z dollars where 1 < z < N. All workers have an outside option of working at Wendy's across the street and earning zero. Work/shirk decisions are made simultaneously.

1. Suppose that Yahoo is run as a commune. In that case, each worker i is awarded a share [math]s_i \gt 0[/math] of the profits where [math]∑ \Sigma s_i = 1[/math]. How much work will get done at Yahoo under the optimal communal scheme?

2. Carol Bartz, CEO of Yahoo, decides that the commune strategy isn't working. She (credibly) threatens to burn some of Yahoo's profits if performance targets are not met. Derive an optimal scheme. (Assume everyone is risk- neutral and pick your favorite equilibrium.) Is this really any better than the commune arrangement?

3. The Board of Directors does not approve of Carol's wasteful money burning scheme. Fortunately, Carol knows that her employees all have CARA preferences with an identical risk-aversion parameter, [math]\rho[/math]. She proposes a clever new scheme to get all the Yahoos to work. What is it?

Question B2: Relationship Specific Investments

Consider a buyer-seller transaction in which the buyer makes a relationship specific investment x in period 1. This investment costs the buyer [math]x^2[/math], and it only pays off if the buyer is supplied with a “widget” by the seller in period 2. The return from investment (assuming the widget is supplied) is x + v, where v is a random variable uniformly distributed on [math][– h,h][/math]. Assume that [math]h\in[0.25,0.5][/math]. Neither x nor v is observed by the seller, and the buyer only learns v in period 2 so that investment x is made prior to learning v. The seller's cost of producing the widget is zero.

Assume that no long-term contracts are possible and that the seller makes a take-it-or- leave-it offer to the buyer in period 2 (after the buyer has learned v). This offer is based on the seller's conjecture about the buyer's choice of x which will be correct in equilibrium (rational expectations).

(a) Compute the socially optimal investment decisions.

(b) Compute the buyer's equilibrium choice of investment. (Hint: observe that since the seller does not observe the buyer’s investment when making an offer, you can treat the buyer’s choice of investment and the seller’s choice of an offer as a simultaneous-move game.)

(c) Compare your solution in (b) to the first-best level obtained in part (a). How does the buyer’s investment vary with the amount of noise, h?

Question C1: Agenda Control and Status Quo

In many political and business settings, control over the agenda of policy changes is a potentially important institutional power, playing a significant role in determining policy outcomes. One type of agenda control (explored extensively by Cox and McCubbins in legislative settings) is negative agenda control, or gatekeeping: the ability to keep things off the agenda, and thus ensuring that the status quo is maintained. This question asks you to explore the relationship between negative agenda control and partisan politics within a legislative setting

Part A. According to the Cox and McCubbins, in the US House of Representatives (and in many legislatures around the world), the majority party has negative agenda control, but the minority party does not. Moreover, it has been posited that when the majority party fails to use its agenda control powers, congressional policy making is not partisan but instead is majoritarian.

(i) Formulate a model that captures the central features of Cox and McCubbins’ thesis as described above, being specific about all of the elements of the model.

(ii) Posit an empirically testable set of predictions from the model and prove why they hold. (Hint: consider absolute and relative rates at which laws pass the Congress when a particular party prefers the status quo).

Part B. Now consider an alternative institutional arrangement under consideration: that the Executive (president) can decree a policy that will be implemented at some cost to the executive. This is a common feature in many presidential systems (e.g. in a number of Latin American democracies).

(iii) Explain how you would modify your model in Part A to account for executive decree authority.

(iv) How would your predictions in part A(ii) above change. Prove your results.

Question C2: Retrospective Voting

1. Suppose a setting like that in Barro (1973), where an infinite pool of identical politicians is available. A voter appoints a politician in period 1, and must decide whether to reelect her in each period or appoint a new one. The politician has discretion over a $1 budget each period and must decide an amount x to steal, leaving 1-x to the voter. The voter commits to a retrospective voting rule {X1,X2,X3,...} such that if in period t the politician steals at most Xt then she is to be reappointed. Voter and politicians have the same discount rate δ and their utility for money is the identity function.

a. Characterize the optimal retrospective voting rule. Is it important that the voter can commit to a voting rule?

2. Suppose the same setting, but now a piece of legislation has mandated a term limit whereby the politician can be reelected only once.

a. Does this help the voter?

b. Is the voter better off, worse off, or the same if we assume he cannot commit to a voting rule?

3. (for bonus points) Would it help to extend term limits so that the politician can be reelected twice rather than just once? How does this answer depend on the voter being able to commit?