James's preferences over cake, c, and money, m, can be represented by the utility function u (c, m) = c + m + µ (c − rc) + µ (m − rm) where rc is his cake reference point, rm is his money reference point, and the function µ (·) is defined as µ (z) = z , z ≥ 0 and λz, z < 0 where λ > 0. 1. If his reference point is the status quo (that is, his initial endowment), what is the maximum price Sam would be willing to pay to buy a cake? 2. If his reference point is the status quo, what is the minimum price Sam would be willing to accept to sell a cake he already owned?
James's preferences over cake, c, and money, m, can be represented by the utility function u (c, m) = c + m + µ (c − rc) + µ (m − rm) where rc is his cake reference point, rm is his money reference point, and the function µ (·) is defined as µ (z) = z , z ≥ 0 and λz, z < 0 where λ > 0. 1. If his reference point is the status quo (that is, his initial endowment), what is the maximum price Sam would be willing to pay to buy a cake? 2. If his reference point is the status quo, what is the minimum price Sam would be willing to accept to sell a cake he already owned?
Chapter1: Making Economics Decisions
Section: Chapter Questions
Problem 1QTC
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Question
James's preferences over cake, c, and money, m, can be represented by the utility function
u (c, m) = c + m + µ (c − rc) + µ (m − rm)
where rc is his cake reference point, rm is his money reference point, and the function µ (·) is
defined as µ (z) = z , z ≥ 0 and λz, z < 0 where λ > 0.
1. If his reference point is the status quo (that is, his initial endowment), what is the
maximum price Sam would be willing to pay to buy a cake?
2. If his reference point is the status quo, what is the minimum price Sam would be willing
to accept to sell a cake he already owned?
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