Question 4. Arrow-Debreu Economy (7 marks) Consider a world in which there are only two dates: 0 and 1. At date 1 there are three possible states of nature: a good weather state (C), a fair weather state (F), and a bad weather state (B). Denote 31 as the set of these states, i.e., 81 E 31 = {0, F, B}. The state at date zero is known. Denote probabilities of the three states as it = (0.4, (13,03). There is one non-storable consumption good, apple. There are three consumers in this economy. Their preferences over apples are exactly the same and are given by the following expected utility function a+ Z 31u(6:,), 31631 where subscript k = 1, 2, 3 denotes each consumer. In period 0, the three consumers have a linear utility and, in period 1, the three consumers have the same instantaneous utility function: 1'7 um=c , 1 - 7 where 7 = 0.2 (the coelcient of relative risk aversion). The consumers' time discount factor, ,8, is 0.98. The consumers diifer in their endowments, which are given in the table below: Endowments t = 0 t = 1 39 G F B Consumer 1 0-4 3.2 1.8 0.9 Consumer 2 1.2 1.6 1.2 0.4 Consumer 3 2.0 1.2 0.6 0.2 Assume that atomic (Arrow-Debreu) securities are traded in this economy. One unit of 'G security' sells at time 0 at a price (19 and pays one unit of consumption at time 1 if state 'G' occurs and nothing otherwise. One unit of 'F security' sells at time 0 at a price (yr and pays one unit of consumption at time 1 if state 'F' occurs and nothing otherwise. One unit of 'B security' sells at time 0 at a price (13 and pays one unit of consumption in state '3' only. 1. Write down the consumer's budget constraint for all times and states, and dene a Market Equilibrium in this economy. Is there any trade of atomic (Arrow-Debreu) securities possible in this economy? (1 mark) 2. Write down the Lagrangian for the consumer's optimisation problem, nd the rst order necessary conditions, and characterise the equilibrium (i.e., compute the op- timal allocations and prices dened in the equilibrium). (2 marks) 3. At the equilibrium, calculate the forward price and risk premium for each atomic security. What do your results suggest about the consumers' preference? (1 mark)