Homework_1_solutions

# Homework_1_solutions - plus one penny Show that a clever...

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Homework 1 solutions 1. For each of the following utility functions graph the indifference curves through the  bundles (2,3) and (2,4). Find one other bundle on each indifference curve. For each of  them find the formula for the Marginal Rate of Substitution (if possible) and find the value  of the MRS at (2,3) and at (2,4). Which ones have strictly decreasing marginal rates of  substitution?

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2. The Money Pump . Suppose that Pam’s preferences do not satisfy transitivity. In particular suppose that she prefers chocolate bars to peanuts, peanuts to licorice and licorice to chocolate. Suppose in addition that she is always willing to give up one penny in order to get her more preferred good. For example if she has a bag of peanuts and is offered a chocolate bar she would gladly give up the bag of peanuts

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Unformatted text preview: plus one penny. Show that a clever trader could extract all of Pam’s money (one penny at a time) by offering her a sequence of trades. Answer: This exercise gives an example where violation of transitivity can lead to implausible results. Suppose b=chocolate bars, p=peanuts and l=licorice. Her preferences are: This means that you can give her first peanuts. Then take a penny from her and exchange the peanuts with a chocolate since she likes it more. Then take a penny and trade chocolate with licorice. Then take another penny and trade the licorice with peanuts. Repeat until you get all her money. If transitivity is violated this could actually happen. Therefore this is an example of things that could go wrong when transitivity is not satisfied....
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## This note was uploaded on 02/10/2010 for the course IEOR 3600 taught by Professor Chudnovsky during the Winter '09 term at Columbia.

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Homework_1_solutions - plus one penny Show that a clever...

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