171 M2-2

171 M2-2 - Economics 171: Decisions Under Uncertainty...

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Economics 171: Decisions Under Uncertainty Solutions to Midterm 2: Winter 2010 1. (24 pts) Lottery A = ($30, 1), lottery B = ($0, 0.4; $30, 0.4; $50, 0.2) and lottery C = ($0, 0.6; $50, 0.4). a. Graph lotteries A , B and C in our standard triangle diagram with p 1 on the horizontal axis and p 3 on the vertical axis. (It may be helpful to make your graph to scale.) b. Nicola’s preferences are consistent with expected utility maximization. She prefers A to B and she prefers B to C . Illustrate these preferences by drawing appropriate indifference curves in your graph to (a). A good answer will illustrate these preferences with two or three parallel, linear indifference curves. c. If Nicola’s u ($0) = 0 and u ($50) = 1, what’s the most we can say about her u ($30)? This problem can be worked in two different ways: 1. Using the geometry from the graph. () $30 0 0.2 0 1 $30 0.2 0 $30 1 $30 $30 0.5 IC BC mm u u uu u > > −− >− > 1 1 0 p 1 = p ( x 1 ) p 3 = p ( x 3 ) C B A
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2. Purely algebraically. () ( ) () ( ) () () () () 0.4 0 0.4 $30 0.2 1 0.6 0 0.4 1 0.4 $30 0.2 $30 0.5 EU B EU C u u u > ++ > + > > 2. (26 pts) Gerald maximizes expected utility. He assigns a utility of 0 to $0 and he
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This note was uploaded on 06/08/2010 for the course ECON 171 taught by Professor Newhouse during the Spring '07 term at UCSD.

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171 M2-2 - Economics 171: Decisions Under Uncertainty...

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