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Microeconomics 1, Master 1 APE
Exam
Michaelmas Term 20062007
1. Prove that a Giffen good is necessarily an inferior good.
3. State Hotelling’s lemma.
Exercise 1
Forecasters predict there is a 50% probability that the upcoming growing season will be a drought. As
sume Ted is an expected utility maximizer with a Bernoulli function
u
(
x
) =
ln
(
x
)
:
Ted’s initial wealth is
equal to zero.
Ted initially has the choice between two crops (Potatoes/Strawberry) yielding the following payoffs
(in euros):
Normal Rain
Drought
Potatoes
5000
40000
Strawberry
20000
12000
There are constant returns to scale in (the payoffs of) each production.
1. If Ted can only plant one crop, which crop should he plant?
2. Ted can choose any combination of Potatoes and Strawberry crops. Which crop mix should he
choose?
3. Assume Ted decides to plant half of his land with each crop. He is offered Strawberry insurance.
This insurance costs 5000 euros and pays 10000 euros in the case of a drought. Should Ted buy it?
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This note was uploaded on 02/01/2011 for the course ECONOMY 6 taught by Professor Fallahi during the Spring '10 term at Cambridge.
 Spring '10
 fallahi
 Microeconomics

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