Exercise 1. In this question, we study how the endowment effect model could accommodate the willing to sell and willingness to pay gap for a given object. Let M denote mug and C denote cash, so that bundles (M,C) represents different combination of mugs and cash. Given a reference point (rm, rc), suppose that preferences of John over different bundles of mugs and cash can be represented by the following utility function: U(rмrc) (M,C) = M + C + v(MTM) + v(C - rc) (1) where the function v(t) = { if t> 0 2t if t≤0 (2) captures loss aversion as shown in lecture. Please answer the following questions considering that John takes his endowment as a reference. 1. (15 points) Suppose John was given an endowment of (rm,rc) = (1,0). What is the minimum amount of cash that John is willing to accept to sell the mug? WTS 2. (15 points) Suppose John was given an endowment of (rm,rc) = (0,5). What is the maximum amount of cash that John is willing to pay for the mug? WTP 3. (5 points) Is there and if so what is a gap in the WTP and WTS? 4. (15 points) Suppose John was given an endowment of (rm,rc) = (0,0). Which of the following bundle would he prefer (1,0) or (0,1)
Exercise 1. In this question, we study how the endowment effect model could accommodate the willing to sell and willingness to pay gap for a given object. Let M denote mug and C denote cash, so that bundles (M,C) represents different combination of mugs and cash. Given a reference point (rm, rc), suppose that preferences of John over different bundles of mugs and cash can be represented by the following utility function: U(rмrc) (M,C) = M + C + v(MTM) + v(C - rc) (1) where the function v(t) = { if t> 0 2t if t≤0 (2) captures loss aversion as shown in lecture. Please answer the following questions considering that John takes his endowment as a reference. 1. (15 points) Suppose John was given an endowment of (rm,rc) = (1,0). What is the minimum amount of cash that John is willing to accept to sell the mug? WTS 2. (15 points) Suppose John was given an endowment of (rm,rc) = (0,5). What is the maximum amount of cash that John is willing to pay for the mug? WTP 3. (5 points) Is there and if so what is a gap in the WTP and WTS? 4. (15 points) Suppose John was given an endowment of (rm,rc) = (0,0). Which of the following bundle would he prefer (1,0) or (0,1)
Chapter4: Utility Maximization And Choice
Section: Chapter Questions
Problem 4.14P
Question
100%

Transcribed Image Text:Exercise 1.
In this question, we study how the endowment effect model could accommodate the willing to sell
and willingness to pay gap for a given object. Let M denote mug and C denote cash, so that bundles
(M,C) represents different combination of mugs and cash. Given a reference point (rm, rc), suppose
that preferences of John over different bundles of mugs and cash can be represented by the following
utility function:
U(rмrc) (M,C) = M + C + v(MTM) + v(C - rc)
(1)
where the function
v(t) =
{
if t> 0
2t
if t≤0
(2)
captures loss aversion as shown in lecture. Please answer the following questions considering that
John takes his endowment as a reference.
1. (15 points) Suppose John was given an endowment of (rm,rc) = (1,0). What is the minimum
amount of cash that John is willing to accept to sell the mug? WTS
2. (15 points) Suppose John was given an endowment of (rm,rc) = (0,5). What is the maximum
amount of cash that John is willing to pay for the mug? WTP
3. (5 points) Is there and if so what is a gap in the WTP and WTS?
4. (15 points) Suppose John was given an endowment of (rm,rc) = (0,0). Which of the following
bundle would he prefer (1,0) or (0,1)
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