Part 1: De?nitions

For each pair of terms/concepts, de?ne each term/concept and explain the relationship between them. The ideal answer is three sentences. One for each de?nition and one for the relationship.

1. Discount Factor and Present Value

2. Expenditure function and Hicksian demands

3. Potential Pareto Improvement and Total Surplus

4. Ordinary Income Effect and Endowment Income Effect

5. Marginal Rate of Substitution and Indifference Curves

Part 2: Short Answer

1. M.D. Einstein is considering what she should do for the rest of her life. She is considering becoming a brain surgeon. She estimates that this would involve tuition of $50,000. However, she reckons that her lifetime earnings would be $1,000,000. Her next best alternative is to go into business with her brother Albert as a partner in his time travel ?rm. She estimates that this would net her lifetime earnings of $1,600,000. If she decides to become a doctor, what value must she put on the prestige and superior working conditions of being a doctor? What is this called? Suppose tuition rises to $100,000, would her choice of career necessarily change? Why or Why not?

2. Explain why having rednecks is not the only reason why trying to sell electric powered cars in Alberta is unlikely to be as pro?table as selling them in Ontario and Quebec when the price of gasoline is high or rises.

3. Explain why prices can be used to infer value.

Part 3: Problems

1. Two tribes inhabit an island where pineapples fall from trees. The population of each tribe has been normalized to 1. A member of the "Got to Have it Now" tribe or GHN has the following utility function: UGHN(c1; c2) = c1 + ln(c2). The marginal utility for ?rst period consumption for a GHN is constant and equal to 1: for second period consumption it is 1=c2. A member of the "I'm Cool, I Can Wait" tribe or ICIW has the following utility function: UICIW(c1; c2) = ln(c1) + c2. The marginal utility for ?rst period consumption for a ICIW is 1=c1: for second period consumption it is constant and equal to one. There are two time periods. The endowment of a GHN tribe member is (mGHN 1 ;mGHN

2 ). The endowment of a ICIW tribe member is (mICIW 1 ;mICIW 2 ). Despite their limited diet, the natives are quite sophisticated. There is a central clearing house where each can post offers of how many period 2 pineapples they will give up for a period 1 pineapple.

(a) How are the posted offers related to the interest rate? What is the budget constraint of a member of the ICIW tribe? The GHN tribe?

(b) Explain the origin of the name for each tribe.

(c) What is the gross demand for consumption by a ICIW tribe member for pineapples in period 1? In period 2? For a GHN tribe member in
period 1? In period 2?

(d) What are the net demands for consumption in period 1 for a member of the GHN tribe? The ICIW tribe?

(e) Suppose that mGHN = 8;mGHN 2 = 10;mICIW 1 = 9; and mICIW 2 = 9. What is the equilibrium interest rate, or the price of period 1 pineapples, in terms of period 2 pineapples? What tribemembers are "lenders"?

How much do they lend? What is the per period consumption of the "borrowers"? The "lenders"?