6 | Page Question Four - Consumer Behaviour (15 Marks) (a) Copy the set of axis below into your answer book and show a utility maximizing consumer with well-behaved preferences consuming a combination of good X and good Y. (2 marks) Good Y Good X (b) Show the effect on your diagram of a decrease in the price of good Y, when good Y is an inferior (but not a Giffen) good. Be sure to explain the income and substitution effects. (8 marks) Assume you are tutoring a friend of yours who has not done enough study for her ECON 207 term test. She is struggling to calculate the decomposition bundle. (c) Explain to your friend what a decomposition bundle is. (1 mark) Your friend has managed to work out that a consumer with the utility function U(X, Y)=XY consumes a best affordable bundle of (8,5). There is then a price change for one of the goods, after which the consumer's MRS is Y=3X. (d) Show your friend how to calculate the decomposition bundle. (4 marks)Question Five - Probability, Risk and Uncertainty (10 Marks) The diagram below shows a risk averse sports-person who has a guaranteed income of $60.000 for the upcoming tournament. However if the sports-person is injured, their income will drop to $10,000. There is a 50% chance they will suffer an injury during the tournament. The sports person has decided to take out insurance that guarantees their $60,000 income from the tournament even if they are injured. Utility U1- U2- 10 20 35 60 Income ($000's) (a) What is the number $35,000? How is it calculated? (2 marks) (b) What is Ul? (1 mark) (c) What is U2? (1 mark) option (d) What is the number $20,000? How is it calculated? (3 marks) contract (e) If the sports-person was charged a fair premium for insurance for the tournament, how much would the premium be? (1 mark) (f) Buying an option to purchase a good at a fixed price is a way to reduce risk through flexibility. Under what circumstances would an option not be exercised? (1 mark) (g) When would an option be preferred over diversification? (1 mark) END OF EXAMINATION PLEASE TURN OVER