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Economics 101A
Problem Set Number 8
DUE: Tuesday December 2
Note: Some of these problems take a little longer time.
Plan ahead and don’t leave the problem set to the last minute!
1.
Suppose that the following contracts are available:
contract G pays $1 if the SF Giants win the World Series, and 0 otherwise
contract O pays $1 if Oakland A’s win the World Series, and 0 otherwise
contract X pays $1 if any other team (except SF or Oakland) wins, and 0 otherwise
You can buy any number of each of these contracts for prices p
G
, p
O
, and p
X
, respectively.
For example, if you buy 10
G contracts and the Giants win, you get $10 next fall.
(a) Suppose p
G
=0.3 and p
O
=0.3.
What must be true about p
X
?
Why?
(b) Suppose that in the East Bay only
O contracts are available. Suppose that a Berkeley student has $y, which she can
either invest in cash or O contracts.
Let
B
O
represent the probability that she places on the event of the A’s winning.
If she buys x contracts, she has:
y + x  xp
O
in the fall if the A’s win
y  xp
O
in the fall if the A’s lose.
Find the first order condition for the optimal choice of x.
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This note was uploaded on 04/01/2009 for the course ECON 101a taught by Professor Staff during the Fall '08 term at University of California, Berkeley.
 Fall '08
 Staff
 Economics

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