XAT 2014 Question 14

Instructions

Analyze the following passage and provide appropriate answers for the questions that follow.
The assumption of rationality puts an economist in a position to “explain” some features of market behavior, such as the dispersion of prices of psychophysically identical goods such as beer according to the amount spent on advertising them (no doubt, the fact that most beer is bought by individuals rather than as raw material by firms, which could be expected to be more rational than individuals, is part of the explanation.) Clearly something is wrong somewhere with the usual model of a competitive market with perfect information, for the virtually content less advertising cannot be considered as increasing the utility of beer in an obvious way. But if one can keep the assumption of rational actors, one need not get into the intellectual swamp of sentiment nor of preferences that depend on price. If one agrees, for example, that consumers use advertising as an index of the effort a producer will put into protecting its reputation and so as a predictor of quality control efforts, one can combine it with the standard mechanism and derive testable consequences from it.

But why, logically speaking, does it not matter that any of us, with a few years’ training, could disprove the assumptions? It is for the same reason that the statistical mechanics of gases is not undermined when Rutherford teaches a lot of only moderately bright physicists to use X-ray diffraction to disprove the assumption that molecules are little hard elastic balls. The point is, departures that Rutherford teaches us to find from the mechanism built into statistical mechanics are small and hardly ever systematic at level of gases. Ignorance and error about the quality of beer is also, unlikely to be systematic at the level of the consumers’ beer market, though it would become systematic if buyers imposed quality control procedures on sellers in contracts of sale (as corporations very often do in their contracts with suppliers). So when we find beers that advertising can make the ignorance and error systematic at the level of markets, just as lasers with wavelengths resonant with the internal structures and sizes of molecules can make molecular motions in gases systematic. The interesting one is that virtually content-less advertising is nevertheless information to a rational actor.

Question 14

Which of the following statements would be the closest to the arguments in the passage?



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