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Q1. Suppose an investment can yield three possible cash flows with their probabilities given in the parentheses: $600(p=0.5); $-100 (p=0.2) and $800 (p=0.3). 

a) Compute the expected value and the standard deviation of this investment. Is this investment risky? Why? 

b) The equation E(x)=359 + 0.5SD describes the indifference curve of this investor. Is this investor risk averse, risk neutral, or risk loving? Explain your answer and draw the curve. 

c) How much would this person pay for the investment opportunity (certainty equivalent of the current investment)? How much is risk premium for the current investment? 

Q2. Patrick consumes only two goods: Celtic Music concerts and Celtic Springs Water. Patrick earns $100 per month at his part-time job in the library. The price of Celtic concerts is $10. The price of Celtic Springs Water is $2. Patrick currently goes to 5 Celtic concerts and consumes 25 bottles of Celtic Spring Water in a month. 
(a) Draw Patrick''s budget constraint and optimal consumption bundle. Please put Celtic concerts on the x-axis. 
(b) In April Patrick receives a 5% pay increase. Meanwhile the inflation raises the price of concerts to $10.50 and the price of Celtic Springs Water to $2.10. Draw Patrick''s new budget constraint and optimal consumption bundle. Please put Celtic concerts on the x-axis. How many Celtic concerts does he attend in April? How many bottles of water does he drink in April?

Microeconomics, Economics

  • Category:- Microeconomics
  • Reference No.:- M9683732

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