Problem set II (Reference Dependence) Instructions: i) When in doubt, round numeric responses to two decimal places ii) It is okay . Problems: For problems (1)-(2)-(3), assume that the utility of consuming c1 mugs and c2 money is m((c1, c2)) = c1 c2 1) Show that if the consumer expects to buy at price p with probability q ? [0, 1], i) the utility from buying is 1 ? p (1 ? q)?(1 ? ?p), and her utility if she does not buy is q?(p ? ?). ii) She is indifferent between buying and not buying if q = (1 ??)p ? (1 ?) ?(? ? 1)(p 1) 2) Under ? = 2, ? = 1, in the notes, we have derived pmax = 1 ?? 1 ? = 3 2 , pmin = 1 ? 1 ?? = 2 3 . Take any 2 3

Equilibrium 2: If vou start by not expecting to buy at price p, then it is your best response to not buy the mugs. What is the utility at each equilibrium outcome? Which outcome has higher utility? (your answer should depend on whether p = 1 or p =1orp 1 or P