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midterm1-peis150.4

# midterm1-peis150.4 - P 1 P 2 ANSWER As we derived in class...

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UNIVERSITY OF CALIFORNIA, BERKELEY SPRING 2008 PROF. K. MAGIN PEIS 150.4 MIDTERM I ANSWERS PROBLEM #1 : True or False? In an exchange economy every trade is Pareto improvement. No credit will be given without detailed explanation. ANSWER: It is true. As we assumed in class all agents are utility-maximizers. So, no agent agrees to a trade, where he or she is worse o/. PROBLEM #2 : True or False? For every utility-maximizing individual i MU ik MU il = P l P k No credit will be given without detailed explanation. ANSWER: It is false. The correct relationship for a utility-maximizing agent i is MU ik MU il = P k P l ; i.e., if agent i gets twice as much utility by consuming a little more of com- modity k than commodity l; than one unit of commodity k has to be twice more expensive. PROBLEM #3 : Consider an economy with two agents and two commodities. Agent #1 has utility function U 1 = x 1 = 2 11 x 1 = 2 12 and endowment e 1 = (1 ; 2) : Agent #2 has utility function U 2 = x 1 = 3 21 x 2 = 3 22 and endowment e 2 = (3 ; 4) : Calculate

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Unformatted text preview: P 1 P 2 : ANSWER: As we derived in class P 2 P 1 = (1 & a ) e 11 +(1 & b ) e 21 ae 12 + be 22 : Here we have a = 1 = 2 and b = 1 = 3 : So, substituting these parameters and endowments into above equation we obtain P 2 P 1 = 1 = 2 ± 1+2 = 3 ± 3 1 = 2 ± 2+1 = 3 ± 4 = 15 = 14 1 PROBLEM #4 : You know now that monetary policy is neutral. Federal Reserve knows it too. However, it is trying now to use monetary policy to stimulate the econ-omy. How would you reconcile this apparent contradic-tion? Do you think that FED is going to be successful in stimulating the economy? ANSWER: Indeed, FED is not going to be successful in stimulating the economy since monetary policy is neutral. However, there is a strong public pressure on Federal Reserve simply to do something to prevent a recession. That is why Federal Reserve acts as it does. 2...
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