b) The first secret of happiness is consuming on the Budget line, that is the condition That is

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1 Problem 1 a). At bundle (80, 20),. This means at consumption bundle (80, 20) Monica is willing to trade 1 banana for 4 kiwis. Geometrically it means the slope of the indifference cure is -1/4 at the bundle (80,20). b) The first secret of happiness is consuming on the Budget line, that is the condition That is The Second secret of happiness is That is If the first secret is violated, Monica will have money left to buy more goods, so it is not optimal. If the second secret is violated, Monica can reallocate her consumption and increase her utility. c) Graph Problem 2 a) Any monotonic transformation will do the job, for example, b) Graph

2 c) Flowers are not Giffen goods because as we see if price of calla lilies increase to 3 its demand drop to 0. d) To find the optimal consumption bundle, you want to shift your indifference curve to north-east as far as possible but within the feasible choice. Problem 3 a) Graph b) An allocation is Pareto efficient it has to satisfy the following condition,, that is

3 c) To find the competitive equilibrium we need to solve the following problem Since we are only interested in relative price we can just set, then The first secret of happiness for Jeremy and Bill is, The second secret of happiness for them is We also know Solving the above equations we get

4 d) It is Pareto efficient because they consumed all the recourses and no one can improve without making another worse off, Problem 4 a) b) i.von Neuman- Morgenstern utility function: ii. Since c) iii. Expected value of the lottery is 3 so CE is bigger. P6 d) Because of the free entry we must have ATC MES = Price = 2 Therefore aggregate demand is D(p) = 7 2 =5. Given y MES = 1, the total number of firms in the market is 5. It is oligopolistic competitive, because we have only 5 firms. e) Plum will not be traded in this market because EBV = $4 while seller will not sell any plum for any price lower than $5. This outcome is not Pareto efficient because if we have perfect information we can gain to trade plums.

5 Problem 5 a) The total gains to trade are: b) MR = 100 2y, MC = 0 Therefore optimal level of production is y* = 50. Now plug this output in inverse demand function we have p = =50. c) With first degree of price discrimination the monopolist can gain the entire surplus from trade namely, the total gains to trade, since the cost of production is 0. Monopolist s profit is Comparing this to a) we see there is no DWL. d) Firm 1 facing the following problem, Given, to solve the above equation we differentiate with respect to and set it equals to 0. Now we have the best response function for firm 1, to get the best response function for firm 2 we just need to interchange the subscript of y 1 and y 2. (This works because they are identical firms) To find the individual production in equilibrium we just need to find the intersection of the two best response curves, So market price,

6 Clearly first degree price discrimination is Pareto efficient because we do not have DWL Problem 6 a) b) The Pareto efficient level of h is higher because when the bee keeper maximized her profit she did not take into account the positive externality of bees on trees.