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Solutions_HW1

# Solutions_HW1 - Solutions to HW 1 Anukriti Sharma February...

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Solutions to HW 1 Anukriti Sharma February 3, 2009 Question 1 . 1. Two possible reasons are: Icelandic banking sector was huge relative to the economy, unlike the US case. As a result, US government could meet its obligations, while Iceland couldn’t. Icelandic banks took a lot of foreign deposits, denominated in forex. On the other hand, deposits in the US banks were dollar denominated and the government could just print money in order to repay. 2. (a) Icelandic government should keep the size of the banking sector small relative to the size of its economy. (b) Banks can be allowed to stop withdrawals (or allow only a few) legally in case of bank runs. Secondly, bank deposits could be denominated in Icelandic currency instead of forex, so that government has an option of printing more money. Question 2 . 1. g ( x, y ) = c ax + by = c y = c b - a b x . So, we can rewrite the maximization problem as Max x x [ c b - a b x ]. FOC: c b - 2 a b x = 0 x * = c 2 a Substituting x * in the constraint gives: y * = c 2 b 2. Assume c > 0.

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Solutions_HW1 - Solutions to HW 1 Anukriti Sharma February...

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