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Unformatted text preview: BUAD 351 - Economic Analysis for Business Decisions Homework 2 due: Wed 02/13/2008 PART (i): multiple choice question 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 answer d b a,d b b a b d b b c a b b c PART (ii) short questions 1. Explain brie&y what is meant by the compensating variation Compensating variation measures the amount of monetary compensation that a consumer needs to receive (or would be willing to pay) following a change in market conditions, such as a change in prices to leave him or her as well o as she was with her original bundle (before the change in market conditions). 2. Dene consumer surplus. Knowing the equilibrium market price and the demand curve, how would you measure consumer surplus? Consumer surplus measures the total benet a consumer derives from consuming a particular prod- uct minus the price paid. Consumer surplus is measured by the area below the (inverse) demand curve and above the price paid. That is, the dierence between marginal benet and price for each unit of consumption. 3. Suppose that Frank is considering giving Mike eight paper back books in exchange for 2 CDs. Explain the conditions under which this trade would be mutually benecial. Also explain the con- ditions under which Frank and Mike wont make the trade. The eective trade "price" is 4 books per CD. This trade would then be benecial as long as Franks marginal rate of substitution MRS CD;book is greater than 4 books per CD and Mikes marginal rate of substitution of paperback books for CD is less than 4 paperbacks per CD. If Franks MRS of paperbacks for CDs is less than 4, he wont agree to the trade. If Mikes MRS of paperbacks for CDs is greater that 4, he wont agree to the trade. Of course, the trade could still take place under other terms 1 Part (iii) slightly longer questions 4. Assume Tom&s benet function for water is U ( W ) = p W: There are two potential outcomes, drought and rainy season. In the case of drought, his water bundle is W d = 100 and in the case of rainy season, his water bundle is W r = 400 : The probability of drought is 3 = 4 : (a) Calculate the expected consumption of water 3 4 100 + 1 4 400 = 75 + 100 = 175 (b) What is Tom&s expected utility?...
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- Spring '07