Monetary Economics 2nd Edition Jagdish Handa - Solutions

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Health care Broadly speaking, in Europe, health care is provided by the government and paid for by taxes. That is, individuals are taxed by the government, which then uses the tax money to provide healthcare services for the citizens. In the US, again broadly speaking, health care is largely
Value functions Suppose that you are loss averse, and that your value function is v(x) = x for gains and v(x) = 3x for losses. (a) Represent the value function graphically, in the manner of Figure 3.11. (b) Represent your indifference curves graphically, in the manner of Figure 3.13(b), assuming
Salary comparisons, cont. At one university library, there is a single book that is so popular that it is chained to the checkout counter. You would hope that it is some important medical reference work. But it is the book that lists the salaries of all university employees. Presumably, no one
Salary comparisons Insofar as you use other people’s salaries as a reference point, what does the theory seem to say about maximizing value in your life?
Exam scores Assume that Alysha and Billy have the following value function over exam scores: v(x) = x/2 for gains and v(x) = 2x for losses. Both of them use the expected exam score as their reference point. (a) Alysha expects to score 75 out of 100 on her upcoming midterm exam. She does better than
Bonuses Draw a graph that illustrates how a person who gets a five percent raise can be elated if she did not expect a raise at all, but feel cheated if she expected a ten percent raise.
Latte discounts Many coffee shops give customers a small discount if they bring their own reusable mug. The coffee shops could equivalently lower all prices and add a small penalty to the bill of customers who do not bring their own mugs. Yet, few coffee shops go for the latter solution. Why? In
The tax cut Suppose Alex and Bob are loss averse, so that their value function is v(x) = x/2 for gains and v(x) = 2x for losses. Because of an upcoming election, politician R promises a tax cut which would give each citizen an additional $2 in his or her pocket every day. Politician D opposes the
Thievery A thief steals $100 from a victim. Let us suppose that the thief and victim have the same value function over money: v(x) = x/2 for gains and v(x) = 2x for losses. (a) How much, in value terms, does the thief gain as a result of his robbery? (b) How much, in value terms, does the victim
The stock market Alicia, Benice, and Charlie own stock in the same company. When they bought the stock, it was worth $10. It later rose to $17, but then dropped to $12 before they sold it. The three are loss averse and have the same value function: v(x) = x/2 for gains and v(x) = 2x for losses. (a)
The bond market An ill-fated investment of yours in the junk bond market just decreased from $1 to $0. Your value function is v(x) = x/2 for gains and v(x) = 2x for losses. (a) Suppose, first, that your reference point is $0. In value terms, how large is the loss you just experienced?(b) Suppose,
Having and losing In fact, it is possible to be worse off in value terms even if you are better off in dollar terms. Working with the same value function, compute the net effect in value terms of gaining $6 and subsequently losing $4. Assume that you incorporate the $6 into your endowment
Toy Yoda, cont. Suppose that the same value function captures the waitress’s value function over cars in Example 3.34. What is the total change in value she experiences after she gains a car and then loses it? Assume that she incorporates it into her endowment and therefore adjusts her reference
Losses and gains Use the value function above to answer the following two questions: (a) What is the increase in value you would experience if you found $10? (b) What is the decrease in value you would experience if you lost $10? (c) In absolute terms, which is the greater number? Here are the
WTA vs. WTP In the presence of loss aversion, your willingness-to-accept (WTA) does not in general equal your willingnessto-pay (WTP). When eliciting your WTA, you are asked to imagine that you have some good and to state what dollar amount you would be willing to accept in order to give the good
Third-party candidates, cont. Suppose that politician A in Exercise 3.29 above wanted to win elections instead by harnessing the power of the compromise effect. What sort of platform must the third-party politician endorse to have this effect? How do we best explain the decoy effect and other cases
Speed vs. safety, cont. Suppose that you want to harness the power of the compromise effect to sell more Bugattis (see Exercise 3.26). What sort of vehicle would you need to introduce to do so?
Wingmen and wingwomen To improve your chances on the dating scene, you have decided to recruit a wingman or wingwoman. (a) How, in general terms, should you choose your wingman or wingwoman? (b) Imagine that your attractiveness and intelligence are both rated 9 on a 10-point scale. You have two
Third-party candidate Politician A has decided to run for political office on a platform promising lower taxes and cuts in public services. His opponent B promises higher taxes and more funding for public services. All things equal, the voters prefer low taxes and generous public services. Now,
Real-estate sales Suppose that you are a real-estate agent showing two properties to potential customers. The one is in good shape but far from the clients’ office; the other is only in decent shape but close to the office. (a) If you want the customers to choose the former, what third property
Decoy effect For this question, refer to Figure 3.8.(a) If you are in charge of marketing the target product, in what area would you want to put the decoy? (b) Assuming the decoy works as anticipated, does the figure show the indifference curves the way they look before or after the introduction of
Speed vs. safety Imagine that you are in charge of selling a car that is very fast but not very safe. Let us call it a “Bugatti.” (When people complained about the poorly designed brakes of his cars, Mr Bugatti himself is alleged to have said: “My cars are for driving, not for braking.”)
Expansion condition If x is chosen from the menu {x, y}, assuming that you are not indif erent between x and y, you must not choose y from the menu {x, y, z}.
Revenge When wronged, many people feel a strong urge to take revenge. Assuming revenge is costly, would not a revenge simply be a matter of honoring the sunk cost of whatever injury they have already sustained? Or are there conditions under which taking revenge can be rational?
The F-35 The F-35 is the US military’s next-generation fighter jet. Plagued with technical difficulties, the project was $160 billion over budget already by early 2014. Critics argue that the project needs to be cancelled. But the US Department of Defense (DOD) still wants its planes. “I
Course selection Students at an expensive liberal arts college may take courses at a nearby public university at no additional charge. One of their professors tells them that it would make no sense to do so, since they would be losing the money they paid for tuition at the pricier college. Given
The fridge When cleaning out your fridge, you find some food obviously rotting in the back. You have no trouble throwing away the cheap mass-produced cheese somebody gave you, but you just cannot bring yourself to toss the amazing cheese you brought back from Paris. So you put it back in the back
Reading habits According to a survey administered by Goodreads. com, 38.1 percent of readers say they will finish a book they started reading no matter what – even if they hate it. This behavior can be understood as an effort to honor the sunk cost involved in buying and starting to read the book.
Sunk costs Draw decision trees for people who (a) hold on to failed investments and (b) stay in bad relationships, in such a way that it becomes clear that the people in question are committing the sunkcost fallacy.
The basketball game Imagine that you paid $80 for a ticket for a college basketball game to be played about an hour’s drive away. The ticket cannot be sold. On the day of the game, there is a freak snowstorm that makes driving hazardous. Would you go to the game? Now, imagine that the ticket
The opportunity cost of an economics education What is (or would be) the opportunity cost, for you, of taking a course in behavioral economics? Upon reflection, is it (or would it be) worth it?
War or terror Imagine that a new terrorist group is threatening the lives of innocent civilians, and that all things equal, it would be a good thing if the group vanished. Does this necessarily make it a good idea to launch military action to destroy it? Why do people ignore opportunity costs? The
Advertising campaigns Your latest efforts to boost revenue led to an advertising campaign that turned out to be hugely successful: an investment of $1000 led to a $5000 boost in revenue. Does this mean that the investment in the advertising campaign was rational?
One day at a time The field study mentioned in Section 1.3 found that New York City cab drivers who set their own hours ignore opportunity costs in a big way. The study found that cab drivers operate with a daily income target, meaning that they will work until they have earned that amount and
Whatever it takes Politicians sometimes promise to do “whatever it takes” to eliminate poverty, defeat terrorism, etc. Use the concept of opportunity cost to explain why that is not the best idea. There are systematic data on how much money is lost by people who ignore opportunity costs. Here
Room service Suppose that you are staying at an expensive hotel that offers in-room dining for $60. Ordinarily you would not pay that kind of money for a meal, but you say to yourself: “I already paid $220 for this room, so what’s $60 more?” Explain in what way your decision to pay $60 for
shows. A person who ignores the opportunity cost of a bad relationship, for example, could miss out on a lot. If you were surprised by the opportunity costs of watching the “Gangnam Style” video, chances are you underestimated them. Here is another example. Example 3.8 Ignoring opportunity
Opportunity costs, cont. Using the language of opportunity cost, explain why highly paid people are less likely than poor people to mow their own lawns, clean their own houses, maintain their own cars, and so on. In practice, however, people frequently overlook or underestimate opportunity costs.
Opportunity costs What is the opportunity cost of (a) staying in an unfulfilling relationship, (b) pursuing a course of study that does not excite you, and (c) sleeping until noon? The concept of opportunity cost has considerable explanatory power.
ai is a rational choice ⇔ u(ai ) ≥ c(ai )Example 3.5 Gangnam Style By mid-2014, the goofy music video “Gangnam Style” became the most watched YouTube clip of all time. According to a review by The Economist, in the amount of time people spent watching the clip, they could instead have built
Opportunity costs This exercise refers to Figure 3.3. Suppose that a fifth act (call it a5 ) becomes available. Assume that a5 has a utility of 9. (a) What would the tree look like now? (b) What would happen to the opportunity costs of the different alternatives?
Opportunity cost c (ai) = max {u (a1), u (a2), …, u (ai−1), u (ai+1), …, u (an)}
Investment problem (a) Draw a decision tree illustrating this decision problem. (b) What is the opportunity cost of buying real estate? (c) What is the opportunity cost of buying bonds?
Consumer-choice theory and indifference curves For each of the sets of indifference curves in Figure 2.9, what assumption rules it out?
Consumer-choice theory Do the following quotations agree or disagree with the assumptions of consumer-choice theory (see box on page 28)? (a) “Variety is the spice of life” – William Cowper. (b) “(I Can’t Get No) Satisfaction” – The Rolling Stones. (c) “People will always choose
Irrationality Explain (in words) why each of the characters below is irrational according to the theory you have learned in this chapter. (a) In the drama Sophie’s Choice, the title character finds herself in a Nazi concentration camp and must choose which one of her children is to be put to
As part of your answer to the following questions, make sure to specify what the universe is. (a) Give an example of a relation that is complete but not transitive. (b) Give an example of a relation that is transitive but not complete.
More properties of the preference relation Here are two relations: “is married to” and “is not married to.” Supposing the universe is the set of all living human beings, which of these is... (a) reflexive (b) irreflexive (c) symmetric (d) asymmetric (e) antisymmetric
For each of the relations and properties in Table 2.1, use a check mark to identify whether or not the relation has the property. Table 2.1 Properties of weak preference, indifference, and strong preference
Misguided criticism Many criticisms of standard economics are quite mistaken. Explain where the following critics go wrong. (a) An otherwise illuminating article about behavioral economics in Harvard Magazine asserts that “the standard model of the human actor — Economic Man — that classical
Prove Proposition 2.34(ii). It is easy to confirm that the proposition is true of the utility function from Figure 2.7. One important point to note is that utility functions are not unique. The sequence of numbers 〈1, 2, 3〉 in Figure 2.7 could have been chosen very differently. The sequence
Properties of u(·) Given a utility function u(·) representing the preference relation the following conditions hold: (i) x ≻ y ⇔u(x) > u(y) (ii) x ~ y ⇔ u(x) = u(y)
Representation theorem If the set of alternatives is finite then ≽ is a rational preference relation just in case there exists a utility function representing ≽.
Definition of u(·) A function u(·) from the set of alternatives into the set of real numbers is a uti/ity function representing the preference relation ≽ just in case x ≽ y ⇔ u(x) ≥ u(y) (for all x and y).
Budget sets Suppose that your budget is $12. Use a graph to answer the following questions: (a) What is the budget set when apples cost $3 and bananas cost $4? (b) What is the budget set when apples cost $6 and bananas cost $2? (c) What is the budget set when apples always cost $2, the first banana
The menu, cont. If you can also choose to eat an appetizer only, or an entrée only, or nothing at all, what would the new menu be? There is no assumption that a menu is small, or even finite, though we frequently assume that it is. In economics, the menu is often referred to as the budget set.
Example 2.29 The menu If a restaurant offers two appetizers (soup and salad) and two entrées (chicken and beef) and you must choose one appetizer and one entrée, what is your set of alternatives? Since there are four possible combinations, your set of alternatives is {soup-and-chicken,
Indifference curves Represent the following sets of indifference curves graphically: (a) Suppose that an apple for you is always as good as two bananas. (b) Suppose that one apple is always as good, as far as you are concerned, as a banana. (c) Suppose that you do not care for tea without milk or
Cycling preferences, cont. By contrast, it is possible for the weak preference relation to cycle. This is to say that there may well be an x, y, and z such that x ≽ y & y ≽ z & z ≽ x. If this is so, what do we know about the agent’s preferences over x, y, and z? Prove it. In cases of
Cycling preferences Using the definitions and propositions discussed so far, show that it is impossible for a rational strict preference relation to cycle. To do so, suppose (for the sake of the argument) that x ≻ y & y ≻ z & z ≻ x and show that this leads to a contradiction.
Teacups Imagine that there are 1000 cups of tea lined up in front of you. The cups are identical except for one difference: the cup to the far left (c1 ) contains one grain of sugar, the second from the left (c2 ) contains two grains of sugar, the third from the left (c3 ) contains three grains of
Vacations Suppose that you are offered two vacation packages, one to California and one to Florida, and that you are perfectly indifferent between the two. Let us call the Florida package f and the California packagec. So f ~c. Now, somebody improves the Florida package by adding an apple to it.
Negative transitivity Prove the following two principles. You might already have been tempted to invoke these two in your proofs. But remember that you may not do so before you have established them. (a) If ¬ x ≽ y and ¬ y ≽ z, then ¬ x ≽ z (b) If ¬ x > y and ¬ y ≻ z, then ¬ x ≻ z
Prove that if ¬ x ~ y and y ~ z, then ¬ x ≻ z.
Establish the following important and intuitive principles. (For the record, some of them are logically equivalent.) (a) If x ≻ y then x ≽ y (b) If x ≻ y then ¬ y ≽ x (c) If x ≽ y then ¬ y ≻ x (d) If x ≻ y then ¬ x ~ y (e) If x ~ y then ¬ x ≻ y (f) If ¬ x ≽ y then y ≽ x (g)
Prove the following principle: x ≻ y & y ≽ z → x ≻ z (for all x, y, z). Notice that this proof has two parts. First, prove that x ≽ z second, prove that ¬ z ≽ x.
Prove Proposition 2.16(iii). Prove it by contradiction, by first assuming that there is an x such that x ≻ x.
on page 15. In future exercises, you will see just how useful proofs by contradiction can be.
The enemy of your enemy, cont. Use a proof by contradiction to establish that “is the enemy of” is not transitive, as in
Using the definitions and propositions discussed so far, complete the first part of the proof of Proposition 2.16(i). Notice that the proofs of Proposition 2.16(i) and (ii) involve constructing proofs by contradiction. Such proofs are also called indirect proofs. This mode of reasoning might look
Iterated transitivity In this exercise you will prove the following principle in two different ways: x ~ y & y ~ z & z ~ p → x ~ p. (a) First prove it by applying the transitivity of indifference (Proposition 2.12(iii)). (b) Then prove it without assuming the transitivity of indifference. (You
Prove the following principle: x ≽ y & y ~ z → x ≽ z. In your various proofs, it is always acceptable to rely on propositions you have already established. The following exercise shows how useful this can be.
Preferences and the universe Use your understanding of transitivity and completeness to answer the following questions: (a) If the universe is {apple, banana, starvation}, what does the transitivity of the preference relation entail? (b) If the universe is {apple, banana}, what does the
Assuming the universe is the set of all natural numbers, meaning that U = {1, 2, 3, 4, …}, are the following relations transitive? Are they complete? (a) “is at least as great as” (≥) (b) “is equal to” (=) (c) “is strictly greater than” (≥) (d) “is divisible by” ( | )
The enemy of your enemy Suppose it is true, as people say, that the enemy of your enemy is your friend. What does this mean for the transitivity of “is the enemy of”? (Assume there are no true frenemies: people who are simultaneously friends and enemies.)
Assuming the universe is the set of all people – past, present, and future – are the following relations transitive? Are they complete? (a) “is the mother of” (b) “is an ancestor of” (c) “is the sister of” (d) “detests” (e) “weighs more than” (f) “has the same first name
Preferences Suppose d denotes “enjoying a cool drink on a hot day” and r denotes “getting roasted over an open fire.” (a) How would you state your preference over these two options? (b) How would you express a masochist’s preference over these two options?The following exercise serves to
The universe Suppose we are talking about all countries that are members of the United Nations. How would that be written? A universe may have infinitely many members, in which case simple enumeration is inconvenient. This is true, for instance, when you consider the time at which you entered the
Relations Assume that f denotes France and n denotes Norway, and that B means “is bigger than.” (a) How would you write that France is bigger than Norway? (b) How would you write that Norway is bigger than France? (c) How would you write that Norway is bigger than Norway? In order to speak
Numeracy In a 2010 study on financial decision-making, people’s answers to three quick mathematics questions were strong predictors of their wealth: households where both spouses answered all three questions correctly were more than eight times as wealthy as households where neither spouse
Descriptive vs. normative Which of the following claims are descriptive and which are normative? (Answers to this and other exercises can be found in the Appendix.) (a) On average, people save less than 10 percent of their income for retirement. (b) People do not save as much for retirement as they
“Banking inefficiency and the excessive regulation of the banking sector and interest rates in some of the LDCs have proved to be highly detrimental to their growth rates.” Can this be explained by monetary growth theories? Cite the relevant literature on this subject and relate it to the
LDCs have at times resorted to high money growth rates to finance their development efforts in an attempt to push up their growth rates. What is the theoretical analysis to support this policy? Was it misguided in retrospect and, if so, why?
“Central bank policies that produce low inflation increase long-run economic growth.”Present the relevant theories and empirical evidence on this proposition.
How would you test for the contribution of (a) the quantity of money, (b) the financial sector, to growth for a selected group of countries? Specify your variables, estimating equations and the frequency of data you would use. Perform this test and interpret your results.
What is the empirical evidence on the contribution of (a) the quantity of money, (b) the financial sector, to growth? Cite at least one study on each of these. Compare their findings and explain the reasons for any findings that may be different.
Should a distinction be drawn between the growth rate of fiat money provided by the central bank and that of inside money provided by private commercial banks for the proper analysis of money in growth theory? Explain your answer.
“It is vital for understanding the contribution of money to growth that we distinguish between the quantity of money and the size and efficiency of the financial sector.”Discuss.
“Given that saving is positively related to the rate of interest and that an increase in the rate of inflation will increase the rate of interest, both saving and the growth rate of the economy will be positively related to the inflation rate and the money growth rate.”Discuss in the context of
“Rapid increases in the money stock cause inflation and inflation raises interest rates, so that investment is reduced by the rapid increases in the money stock. Consequently, high rates of money growth reduce the growth rate of the economy.” Discuss this statement in the context of monetary
Is there room for considering changes in the structure and efficiency of the financial sector in the traditional neoclassical growth theories with money? If so, how would you modify the standard model to accommodate such changes? What implications would they have for the steady-state and the
In the context of the endogenous growth theories with money, is the money growth rate neutral for the steady state and the pre-steady states of the economy? Explain your answer.
In the context of the traditional neoclassical growth theories with money, is the money growth rate neutral for the steady state and the pre-steady states of the economy? Explain your answer.
Set up an OLG model with two lifestages, an indirect MIUF approach with a Cobb–Douglas transactions technology and an indirect MIPF with a unit elasticity of substitution between labor, capital and real balances. Make any other assumptions that you require. For this model, derive the
Set up an OLG model with two lifestages, a Cobb–Douglas production function with capital and labor but without money, and a Cobb–Douglas transactions technology that uses both capital and labor for making payments to complete purchases of inputs and sales of output. Make any other assumptions
Set up an OLG model with two lifestages, a utility function without money in it and a Cobb–Douglas transactions technology for making payments to complete purchases of commodities. Make any other assumptions that you require. For this model, derive the representative worker’s supply function
Discuss the different parts of the following statement: “For the modern economy, the theory of the speculative demand for money has come to the conclusion that there is no longer an asset demand for M1 and that any demand for it is only for facilitating current transactions. However, the OLG
If currency (a fiat money) is intrinsically useless for firms and households, are demand/checking deposits also intrinsically useless for them? Why, then, do they hold these when there are other highly liquid assets such as savings deposits and money market mutual funds(MMMF)that offer higher
Why does the W–M–M theorem hold in the analysis of Chapter 22 but not in the analysis presented in this chapter? What is the critical difference in the assumptions that changed this finding and what is your own assessment of their plausibility?Does the W–M–M theorem hold or not hold in
What is the meaning of utility in microeconomic theory? In answering this question, consider the following. Why are goods that seem to harm the individual’s physical or mental wellbeing placed in the utility function? Why do goods with upward-sloping demand functions (i.e. with ∂xd i/∂pi >0)

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Monetary Economics 2nd Edition Jagdish Handa - Solutions

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