Suppose the price of milk (M) is $5, the price of a donut (D) is $2, and Li's budget is $100 for milk and donut.

Li is buying the bundle, M=10 and D=25, the marginal utility (MU) of milk is 25 and MU of donuts is 20 for Li.

Draw the budget line. Identify the bundle M=10 and D=25.

Is Li maximizing satisfaction--should Li buy 10 bottles of milk and 25 donuts?

Suppose the price of milk decreases from $5 to $4; the price of donut increases from $2 to $3; and income goes to $115. Would this result in an increase in Li's utility?

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May has a car that has a value of $10,000. She calculates that there is a 1% chance that an accident occurs. If an accident occurs, she will lose the car entirely. The premium to get his car insured is $200. Suppose May chooses to buy car insurance.

1. What is the definition of risk neutral? Can May be risk neutral? Explain.
2. What is the definition of risk loving? Can May be risk loving? Explain.
3. What is the definition of risk averse? Can May be risk averse? Explain.
4. Represent a plausible IC

There are only two gasoline stations in a small isolated town. If they each set a high price, they each earn $50. If they both set a low price, they each earn $25. If one firm sets a low price and the other sets a high price, the low-price firm earns $70 and the high-price firm earns $10.

1. Make a payoff matrix for the firms.
2. What a dominant strategy equilibrium?
3. Is there a dominant strategy equilibrium in the chocolate market? If so, what is it? Explain. If not, why not? Explain.
4. What is a Nash equilibrium?
5. What outcome, if any, is Nash equilibrium in the chocolate market? Explain.