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UCLA - ECON148 - Practice Final Solutions 2
UCLA - ECON148 - Practice Final Solutions 2
UCLA - ECON148 - Practice Final Solutions 2
(1) FALSE. Someone with CARA utility has constant risk aversion.
(2) FALSE. You will be more likely to buy a winter coat on days that are cold.
1
Problem 2. If Alice prefers P to Q, it means that
1 –
2 >q
4
2– > 4q
(1) This means that 2– > 4q implies 2— > 4q for all values of q. This is only true if 2— Ø 2–
or — Ø –.
(2) Risk aversion for Ben means — Æ 1. Thus, – Æ 1 so Alice is also risk averse.
(3) We know – Æ 1, but that says nothing about whether — is greater or less than 1. Thus,
we do not know.
2
Problem 3. Here are the rewards for Days 1 to 4
1 2 3 4
Day 1 Steve 4 3 2 5
Day 2 Steve 6 2 5
Day 3 Steve 4 5
(4) The sophisticated Steve will get drunk and study on Day 4.
3
Problem 4. We solve for the different parts.
c2 c3
c1 + + Æ 10
2 4
(2) Setting the constraint to an equality and plugging it back to the Year 1 utility, we get
c2 c3 c2 c3
U (c1 , c2 , c3 ) = 10 ≠ ≠ + +
2 4 3 3
1 1
Since 4
< 3
< 12 , Year 1 Emma will max out c3 and set c1 = 0. This means Year 2
Emma’s budget constraint is
c3
c2 + Æ 20
2
Setting it to an equality and plugging it back to the Year 2 utility, we get
c3 c3
U (c2 , c3 ) = 20 ≠ +
2 3
c3
c2 + Æ 2 (10 ≠ c1 )
2
(4) Setting the constraint to an equality and plugging it back to the Year 2 utility, we get
c3 c3
U (c2 , c3 ) = 2 (10 ≠ c1 ) ≠ +
2 3
So Year 2 Emma will set c3 = 0 and c2 = 2 (10 ≠ c1 ). Year 1 Emma now gets
2
U (c1 , c2 , c3 ) = c1 + (10 ≠ c1 )
3
(5) She understands that her Year 2 self will consume everything in Year 2 so she preempts
it by consuming everything in Year 1.
4
Problem 5. We solve the two parts:
(1) Let p be Sara’s belief that the drawn ball in Urn 2 is Black. Since she strictly prefers
1
B1 to B2, it means that 2
> p. Since she strictly prefers R1 to R2, it means that
1
2
> 1 ≠ p or p > 12 . This is a contradiction. Sara is ambiguity-averse because she
dislikes betting on unknown probabilities.
1
◊ 100 > 1min2 p ◊ 100
2 3
ÆpÆ 3
1 1
>
2 3
1
◊ 100 > 1min2 (1 ≠ p) ◊ 100
2 3
ÆpÆ 3
1 1
>
2 3