Solutions - UNIVERSITY OF CALIFORNIA HAAS SCHOOL OF...

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UNIVERSITY OF CALIFORNIA HAAS SCHOOL OF BUSINESS EWMBA 201A—Economic Analysis for Business Decisions Fall 2009 Felix Várdy MIDTERM EXAM – SOLUTIONS Note: These solutions are just a template. Clever answers that deviate from these are fine. Instructions: The numbers in brackets indicate the points for each question. Total: 100 points + 10 bonus points. You only have 90 minutes to do the exam, and I do not expect everybody to be able to finish all the questions. So be strategic about which questions you choose to answer and how much time you spend on each of them! Please Write Legibly. Briefly explain your answers (that is, don’t just write “yes” or “no” and don’t just write down a numerical answer without showing how you derived it). Correctly annotate graphs and figures. 1. [25 Points] Martha has a vineyard which she can use for two purposes that year: tourism and wine production (the tourists steal the grapes so she cannot do both). If she produces wine and the weather turns out to be good, she generates a profit of $25,000. If she produces wine and the weather is bad, she generates a profit of $5,000. If she dedicates her vineyard to tourism and the weather is good, she generates a profit of $15,000. If she dedicates her vineyard to tourism and the weather is bad, she generates a profit of $10,000. The probability that the weather is good is only ¼. a) Draw Martha’s decision tree, assuming that she can only make her choice about what to use the land for before she knows what the weather will be. (4) b) If Martha were risk neutral, how would she use her vineyard? (4) c) You observe Martha producing wine. What can you conclude about her preferences? (4) d) If Martha were risk neutral, what would be her maximum willingness to pay for a perfectly accurate weather forecast that would allow her to make a contingent decision what to do with the land? (4) e) Martha now has a third option (but no perfectly accurate weather forecast): to rent her land for the year at $11,000 profit. The rent does not depend on what the weather will be that year, which is unknown at the time the lease is signed. What would Martha do if she were risk-neutral? Risk-averse? Risk-loving? That is, which land-use choices are consistent with each of these risk-attitudes? (9)
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b) If Martha were risk-neutral, she would choose tourism. c) Martha must be risk-loving, since she is choosing the option with the lower EV but the potentially higher payout. d) If Martha were risk-neutral and knew whether the weather would be good or bad, she would choose tourism if the weather would be bad and wine if the weather would be good. This would give her 13,750 in expectation (0.75*10,000 + 0.25*25,000). Since without the weather report she would expect profits of 11,250 by choosing tourism, she would be willing to pay up to 2,500 for the weather report. e) If Martha were risk-neutral, she would definitely choose tourism, as it has a higher
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This note was uploaded on 09/15/2009 for the course EWMBA 201A taught by Professor Wolfram during the Fall '07 term at University of California, Berkeley.

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Solutions - UNIVERSITY OF CALIFORNIA HAAS SCHOOL OF...

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