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Midterm2answers F2006 - Economics 1 Fall 2006 University of...

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Economics 1 Midterm Exam #2 Fall 2006 November 20, 2006 University of California, Berkeley 12:10-12:55 PM Page 1 of 15 Midterm #2 Please do not open the exam until you are told to do so. At 12:55, pass your exams to the aisles, where the GSIs will pick them up. Do no leave the auditorium before the exams are passed in, even if you have finished your answers. Please remain seated until all of the exams are collected Points for each question are given in parentheses. Total points: 100 Your Name__________________________ Your SID____________________________ Your GSI’s Name_____________________

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Economics 1 Midterm Exam #2 Fall 2006 November 20, 2006 University of California, Berkeley 12:10-12:55 PM Page 3 of 15 1. (8 points) By the terms of your grandparents’ trust, you will receive \$121,000 two years from now, when your grandparents think you will be old enough to spend it wisely. Assuming a 10% interest rate, what is the present value of this gift? Show your work. 000 , 100 \$ 21 . 1 121 ) 1 . 1 ( 121 2 = = = K K PV 2. (5 points) Assume a von Neuman-Morgenstern utility function with the standard shape. Consider the following two lotteries: (A) a lottery that costs \$1 per ticket and gives you a 1 % chance to win \$1000, or (B) a lottery that costs \$1 per ticket and gives you a 5 % chance to win \$200. Which lottery provides the higher expected utility? Explain briefly, using graphs if it helps. Lottery B provides the higher expected utility. Typical VNM utility functions exhibit diminishing marginal utility of wealth, and therefore risk aversion. People with such utility functions prefer less risky bets for the same expected value, and would therefore prefer lottery B over lottery A.
Economics 1 Midterm Exam #2 Fall 2006 November 20, 2006 University of California, Berkeley 12:10-12:55 PM Page 5 of 15 3. (10 points) A pharmaceutical company has developed a vaccine for a common virus. The company holds a patent on the vaccine, such that it is the only seller. The vaccine provides external social benefits beyond the benefits of the vaccinated person because vaccinations prevent the spread of the virus and the social costs of treating ill people who are not insured and cannot pay for their own health care. The demand (D) and marginal social benefit (MSB) curves are given below, along with the marginal cost of providing the vaccination.

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Midterm2answers F2006 - Economics 1 Fall 2006 University of...

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