An agent has the following preferences over coffee mugs (c) and money (m):

U(c,m|rc,rm) = 2c+3m+(crc)+(mrm)

where:

- c 0 is the quantity of coffee mugs owned by the agent;

- m 0 is the quantity of money owned by the agent;

- rc 0 is the reference level of c;

- rm 0 is the reference level of m;

- 0 is an individual-specific parameter;

- (c rc) = { (c rc) 2 if c rc is the gain-loss utility for coffee mugs;

(c rc) 2 c < rc

- (mrm)={(mrm)3 if mrm isthegain-lossutilityformoney. (m rm) 3 m < rm

(a) For what value or values of are the agent's preferences reference-independent? Explain. [2 marks]

(b) For what values of is the agent loss averse? Explain. [2 marks]

Assume = 0 and that the agent is endowed with just 200, that is rc = 0 and rm = 200. Under these assumptions, answer the following four questions, carefully explaining how you derived your answers.

(c) What is the agent's marginal utility of coffee mugs? What is their marginal utility of a unit of money? [2 marks]

(d) Define the concept of willingness-to-pay (WTP) for a unit of a consumption good. What would be the agent's WTP to acquire a coffee mug? [4 marks]

(e) Suppose the agent was endowed with a coffee mug and 200 (i.e., rc = 1 and rm = 200). Define the concept of willingness-to-accept (WTA) and compute the agent's WTA for a coffee mug. [4 marks]

(f) Would the agent display the anomaly known as WTA-WTP disparity? Explain. [1 marks]

Now assume = 1 and = 2 and answer the following three questions, carefully explaining

how you derived your answers.

(g) Suppose the agent were endowed with just 200 (i.e., rc = 0 and rm = 200). What

would be their WTP for a coffee mug? [3 marks]

(h) Suppose the agent were endowed with a coffee mug and 200 (i.e., rc = 1 and rm =

200). What would be their WTA for a mug? [3 marks]

(i) Would the agent display the anomaly known as WTA-WTP disparity? Explain. [1

marks]

(j) Using graphs if you consider them to be appropriate, describe the differences between standard consumer theory, the model of reference-dependent preferences proposed by Tversky and Kahneman (TK, 1991) and the subsequent version developed by Koszegi and Rabin (KR, 2006). Explain how WTA and WTP are defined under each of these models. Discuss the nature of the reference point in the TK and KR models and outline how KR's model can explain experimental and field evidence that cannot be explained by TK's. [11 marks]