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Chapter 8 / Exercise 3
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Behavioural Economics Problem Set 4: Problems on Time Inconsistency Pei Cheng Yu The deadline for this problem set is week 10. Each question is worth 20 points. 1. Non-Preference Based Time Inconsistency Time inconsistency is actually more common than what our lectures suggest. In the lectures, we considered preference-based time inconsistency. There is also non- preference based time inconsistency. In fact, governments and firms can also be time-inconsistent. Much of modern macroeconomics is based on time-inconsistent policy making. For example, a benevolent government would like to provide bene- fits to the unemployed. To avoid moral hazard, it is optimal to limit the duration of these benefits. However, if the unemployed have not found a job by the end of this duration, the government has the incentive to extend its benefits. This problem is based on Paluszynski and Yu (2018). It is concerned with time-inconsistent firms. Consider an environment where consumers have private valuations v distributed uniformly on [ 0, 1 ] . A monopoly firm is selling a good at price p . The firm does not have commitment on this price. The consumers need to invest a fixed transaction cost of μ before purchasing the good. The consumers’ outside option of not pur- chasing is 0. a. Suppose μ = 0. What is the firm’s optimal selling price and its profits? b. Suppose μ > 0 and the firm sets a price of p 0. What is the minimal valuation of consumers who would invest μ to purchase the good? c. Given your answer in Part b., would the firm like to revise its price? What would the new price be? d. Suppose the consumers are rational and can anticipate the firm’s behavior. What is the firm’s profits? e. This is referred to as the hold-up problem. The consumers made a relationship specific investment of μ , and after it is sunk, the firm can take advantage of them. However, consumers forsee this and would avoid investing μ and the
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Blueprint Reading for Welders
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Chapter 8 / Exercise 3
Blueprint Reading for Welders
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