Martina and Phillip are investors who trade stocks of two companies specializing in the sale of agricultural products – Bysto & Co. (x1) and Polan & Co. (x2). There are no other investors (besides Martina and Phillip). Revenues from stocks are risky – they depend on whether there was much rain or not during the summer time. Both situations are equally likely. The dividend per single share of Bysto & Co. amounts to 1 zloty if the summer was rainy, or 0 otherwise. For Polan & Co. the contrary holds, i.e. the dividend per single share of that company is 0 if the summer was rainy, or 1 otherwise. Martina owns 100 shares of Bysto &Co. and does not have any shares of Polan & Co., while Phillip has 100 shares of Polan & Co. and does not have any shares of Bysto & Co. Both Martina and Phillip maximize their expected utility given by the following formula: Ui(x1,x2) = ½lnx1 + ½lnx2.

a) In the Edgeworth box indicate the initial endowment and specify whether it is an efficient allocation (provide a reasoning for your answer).

b) What is the equilibrium price of shares?

c) What can be said about the risk connected with Martina’s and Phillip’s shares in the initial situation and in equilibrium? Which of these two allocations is less risky?

Answer rating: 100% (QA)

A Initial Endowment and Efficient Allocation The initial endowment for Martina and Phillip is shown in the Edgeworth box below The endowment is not ef... View the full answer