Econ 277A Winter 2011
Problem Set 1
Due no later than 1/27
Problem 1
Suppose Kory is going to live for two periods. His lifetime utility is the sum of his period 1
and 2 utility,
ln(1 +
c
1

r
1
) + ln(1 +
c
2

r
2
)
.
His budget constraint is
c
1
+
c
2
≤
1. He is born with a ﬁxed
r
1
∈
[0
,
1],
r
2
is determined by
r
2
=
γc
1
+ (1

γ
)
r
1
, where
γ
∈
[0
,
1] is a parameter.
a Brieﬂy interpret these preferences. How do each period’s preferences compare to the
referencedependent preferences we’ve been studying? Comment on one or two unre
alistic aspects of these preferences.
b Solve for Kory’s optimal consumption proﬁle (
c
*
1
,c
*
2
), as a function of
r
1
and
γ
.
c Interpret. This includes commenting on the predicted values when
γ
= 0 and
γ
= 1,
and the comparative statics. When is
c
1
*
> c
*
2
?
Problem 2
Suppose people are told about the contents of two urns:
Urn 1 contains 100 balls, some of which are red and some of which are black.
Urn 2 contains 100 balls, of which 50 are red and 50 are black.
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 Fall '09
 GROSSMAN
 Utility, Malia, following gambles

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