Total Points: 50

Q1. 13 points

(a). “Carl Menger argued that a medium of exchange could evolve spontaneously, i.e., through the voluntary actions of individuals, in a barter economy.” Explain. (5)

(b). Consider the valuations of potential buyers and sellers listed in the table below. Assume that the good being traded is a consumer good. Assume, moreover, that these individuals populate a world where only consumer goods are traded. Given these assumptions, answer the questions that follow:

i. Explain how these individuals evaluate the marginal utility and therefore the subjective value of units of money in their possession. How does money’s role as a medium of exchange influence this process of evaluation? (2+2)

ii. “The marginal utility of money depends on the prices of goods and the prices of goods depend on the marginal utility of money. Hence, any attempt to integrate money into the theory of marginal utility and subjective value is futile since it must involve arguing in a circle.” Explain how Mises refutes this objection to integrating money into the theory of marginal utility and shows that this does not entail arguing in a circle. (4)

Q2. 13 points

Consider Robinson Crusoe, shipwrecked and isolated on an island. Assume that he possesses no capital goods and that none of the nature-given material producer goods that he utilizes are scarce. Thus, labor is the only scarce producer good that he seeks to allocate. Given these assumptions, answer the following questions:

(a). Robinson possesses some technical knowledge, i.e., he has some knowledge of different production processes towards which he can devote his labor time. Each of these processes will ultimately yield him a consumer good. Assume now that this set of techniques that he knows is characterized by a trade-off between time and physical productivity. Provide an explanation of what such a “time-physical productivity trade-off” entails. (4)

(b). Assume now that Robinson knows two ways to catch fish. One process involves wading into the ocean and catching fish with his bare hands. This process will yield him one fish per hour worked in the nearer future, or present. A second process involves first building a raft and a net and then using these capital goods to fish. This process will yield him ten fish per hour worked in the more distant future. Assume that Robinson is contemplating how to allocate an hour of his time between the two processes. Assume, moreover, that the marginal utility of the ten fish in the future exceeds that of the one fish in the present. Given this, is it self-evident that Robinson will undertake the longer process? If not, what could make him opt to devote an hour to the shorter process? Provide a detailed explanation. (4)

(c). Consider now two Crusoes, one with a low rate of time preference and another with a high rate of time preference. Assume that each has lived, isolated, on an island for a considerable length of time. What, if any, would be the significant differences in how each of them allocates his labor time over the course of a day? Connect these differences to their respective standards of living and their respective bundles of capital goods. (5)

Q3 (a). 14 points

“Savings are needed to not just increase the stock of capital goods in an economy but are also essential for maintaining and replacing the capital goods that exist.” Do you agree with this statement? Please include an explanation with your answer. (4)

(b). Making use of the Hayekian Triangle, analyze all the effects of a decline in the rate of time preference of consumer-savers in an economy. (Feel free to make use of other graphs as well while answering this question). (5)

(c). Use the Hayekian Triangle to provide an explanation of the Austrian Theory of the Business Cycle. (Feel free to make use of other graphs as well while answering this question). (5)

Q4. 10 points

(a). “A mixed economy is an economic system that combines the best aspects of socialism and capitalism.” Critically analyze this statement. (4)

(b). A gallon of milk in Ruritania currently sells for $5. Concerned with the fact that many poor households are unable to afford adequate amounts of milk, the President of Ruritania has decided to limit the price of a gallon of milk to $3. What will be the consequences of such a policy in the Ruritanian economy? Based on your analysis of these consequences, do you believe that the price control will achieve its stated objectives? (6)