Prof. Bryan Caplan

Econ 812


HW #6


1.  Consider the following gambles:


Gamble 1: 50% chance of $100, 50% chance of $0.

Gamble 2: 10% chance of $50,000, 40% chance of $10,000, 50% chance of $1.

Gamble 3: Equal chances of $100, $1000, $10,000, $100,000, and $1,000,000.


Fill in the certainty equivalents:


Gamble 1

Gamble 2

Gamble 3














2.  An EU maximizer gets $100 with probability p and $0 with probability (1-p).  Graph EU as a function of p.


3.  Consider a risk-neutral farmer with the cost function TC=q2.  The market price is 10 with p=.5, and 1 with p=.5.  If the farmer has RE, what is his profit-maximizing output level?  If the farmer beliefs do not satisfy RE (he thinks p=a), solve for lost profit as a function of a.


4.  Suppose your probability of finding a job is given by p=f.5, where f is the fraction of your time that you devote to job search.  Your gross EU of getting a job is 10; your gross EU without a job is 0.  Your net EU=EU(job outcome) - bf2.  Solve for your optimal f.


5.  Suppose your EU=w.5, and insurance is sold at twice the actuarially fair rate.  Your uninsured income is $40,000 with p=.9, and $10,000 with p=.1.  Solve for your optimal quantity of insurance.


6.  Do your beliefs about your overall academic performance satisfy RE? (1 paragraph)


7.  Use search theory to explain optimal test-taking strategy. (1 paragraph)


8.  After reading Caplan's Economic Journal piece, pick the belief typical of economists that you agree with the least.  Where are your fellow economists going wrong?  Is this systematic or random error? (half a page)