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Unformatted text preview: Homework 1 Answer, Spring 08 (Total 20 points) 1 (1 × 2): (i) You have an income of \$80 to spend on two commodities. Commodity 1 costs \$2 per unit and commodity 2 costs \$5 per unit. (i) Write down your budget equation. (ii) What is the opportunity cost of an extra 1 unit of good 1? Answer : (i) 2 x 1 + 5 x 2 = 80. (ii) 2 / 5 = 0 . 4 units of good 2. 2 (1.5 × 4): There are two states of the world, sunny (state 1) and rainy (state 2). The probability of state 1 is 0.7. Bob and Nancy are facing a problem to choose among contingent consumptions, in which a bundle ( x 1 ,x 2 ) denotes receiving x 1 units when state 1 occurs and receiving x 2 units when state 2 occurs. Bob cares only about the expected value of contingent consumption. Nancy is ex- tremely cautious and she cares only about the worst case, i.e, the case where the realized consumption is smaller. (i) Draw indifference curves that describe their preferences, respectively....
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