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Micro II Problem Set 3_2010

# Micro II Problem Set 3_2010 - NAME Problem Set#3 Micro II...

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NAME: Problem Set #3 Micro II – Spring Term 2010 Instructor: Gul Andaman DUE DATE: Wednesday, March 24, In the first slot 1. Suppose that Natasha’s utility function is given by   u ( I ) = 10 I , where I represents  annual income in thousands of dollars. a. Is Natasha risk loving, risk neutral, or risk averse?  Explain. b. Suppose that Natasha is currently earning an income of \$40,000 ( I  = 40) and can  earn that income next year with certainty.  She is offered a chance to take a new job  that offers a .6 probability of earning \$44,000, and a .4 probability of earning  \$33,000.  Should she take the new job? c. In (b), would Natasha be willing to buy insurance to protect against the variable  income associated with the new job?  If so, how much would she be willing to pay  for that insurance?  (Hint: What is the risk premium?) 2. As the owner of a family farm whose wealth is \$250,000, you must choose between  sitting this season out and investing last year’s earnings (\$200,000) in a safe money market  fund paying 5.0% or planting summer corn.  Planting costs \$200,000, with a six-month  time to harvest.  If there is rain, planting summer corn will yield \$500,000 in revenues at  harvest.  If there is a drought, planting will yield \$50,000 in revenues at harvest.  As a third  choice, you can purchase AgriCorp drought-resistant summer corn at a cost of \$250,000  that will yield \$500,000 in revenues at harvest if there is rain, and \$350,000 in revenues at

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Micro II Problem Set 3_2010 - NAME Problem Set#3 Micro II...

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