Microeconomics of Financial Markets - Assignment Example

Last First number Macro & Micro economics PROBLEM SET 2B Income effect is the change in the consumption pattern observed with the utility level constant, which is the result of change in the prices of the goods and services. For a utility maximizing consumer, the effect of the change in price (that is a decrease or increase in price) is quite likely to affect the utility function of the consumer, which is depicted in figure-1 below (Arnold 261-265). Figure-1 The graph shows the income effect of fall in price of good X on the consumer’s utility curve. Observable in the above figure, U1 and U2 are the two utility curves. A shift in the budget line along the bundle A is shown in the figure. The shift in budget line is parallel that indicates the fact that with a decrease in price of good X, the consumers’ real income increases. Furthermore, this implies that the consumer can now afford more goods and services as compared to the previous condition. Therefore, the parallel shift of the budget line and income effect shifts the consumer to a higher utility level. The movement from A to point B that depicts the effect of fall in price of good X. In case of normal goods, the consumption increases with the rise in income. On the other hand, in case of inferior goods, consumption falls with the rise in income (Arnold 261-265). 2) The change in price represents change in consumption pattern. A consumer is in a better position when consumption is located on a higher indifference curve, which indicates to a consumer’s response to the change in price of goods with respect to its nature. To be noted in this context, price effect is positive in case of normal goods. As positive income change causing shift in the budget line refers to its movement to a higher utility curve, the upward movement indicates that the consumer can purchase larger quantity of goods with same amount (Arnold 261-265). The change in consumption pattern is depicted as a shift in the budget line to a higher position as shown the figure-2 below. Figure-2 3) Income effect is primarily considered as the result of the change in income earned by an individual. The effect can be positive as well as negative with respect to the type of goods. In case of normal goods, the income effect is positive but for inferior goods, it is negative. With the increase in income earned, preference for inferior goods decreases among consumers and so, the consumers become more likely to purchase substitutes. It is in this context that the shift in consumer preferences gives more satisfaction to the consumers as can be observed with reference to figure 2 (Arnold 261-265). Figure-2 PROBLEM SET 3A 1) In Bayes Theorem, a and b denote two events, independent of each other; while r and w represent qualitative variables (Chib and Griffiths 70-150). 2) According to Bayes Theorem, the quality of information is determined by the probability values of the two variables, r and w. Increase in value of r and w implies that the quality of information is improving and thereby, imposes effects on the value of conditional probability (Chib and Griffiths 100-250). 3) Assuming that the value of information goes up for a given value of b, in such case the probability value also increases. Consider a function, say f= (P∩B).b, where (P∩B) denotes the value of information. Let (P∩B) = ∏ and the value of b is 2. For this case, if the value of information increases to ∏=3, the value of function is f= (3×2) that is 6. On the other hand, if the value of b goes up where b=4 then f= (3×4) that is 12. So, the value of function increases with the change in value of b (Chib and Griffiths 100-120). 4) Pa= P (a, b, r, w)/ Pa Case1: (b, r, w) = (.3, .8, .2) Pa= P (a, .3, .8, .2)/ Pa = Pa×.3×.8×.2/ Pa =0.048 Case 2: (b, r, w) = (.3, .9, .1) Pa= P (a, .3, .9, .1)/ Pa = Pa×.3×.9×.1/ Pa =0.027 Case 3: (b, r, w) = (.4, .9, .1) Pa= P (a, .4, .9, .1)/ Pa = Pa×.4×.9×.1/ Pa =0.036 Case 4: (b, r, w) = (.6, .9, .1) Pa= P (a, .6, .9, .1)/ Pa = Pa×.6×.9×.1/ Pa =0.054 PROBLEM SET 3B 1) Considering the O.J. Simpson trial case the Bayes Theorem can be expressed as, P(A|B) = [P(B|A)* P(A)]/ P(B)] Here, A and B denote two individual events. ‘A’ denotes the event that the individual jurors in the criminal case are likely to vote not guilty. On the other hand, event B states that the individual jurors in the civil trial are likely to vote in favour of guilty. According to the theorem, both the events are independent of each other. P(A|B) denotes conditional probability that is the probability of event A, considering event B to be true. Correspondingly, P(B|A) denotes the probability of event B considering that event A is true. 2) The presence of jury is essential so that the trial is fair and justified. It is worth mentioning that the verdict of a case is also influenced by the perceptions and the beliefs possessed by the jury members. This difference in beliefs that exists between the jury(s) and the defendant(s), often leads to diverse judgements even in similar cases. The personal characteristics of jurors and criminals may indirectly influence the judgement. The prosecutor is therefore responsible to gather the proofs to present it before the jury. These proofs and the investigations performed by the police also impose a strong influence on the decision of the jury. Therefore, in such case, a jury may believe that the defendant is probably guilty. PROBLEM SET 3C 4) According to the Bayes Theorem, two events can be identified from the given case scenario, where each individual jury member can vote in favour of not guilty. On the other hand, the other event states that every jury member unanimously cannot vote not guilty. Therefore, probability is low that all the criminal jury will have the same decision together if taken unanimously. 5) Considering the O.J. criminal case, two events become apparently identifiable, i.e. all the jury members may give the verdict unanimously and in such case, the total time involved in the verdict is reduced. On the other hand, the next event states that the jury members can give their decision on case individually that may take a few hours more but the decision to be accurate. However, for this case, the probability that the criminal jury will give similar judgement is low. PROBLEM SET 4A 1) A. Consider a linear demand curve QD= a-bP, where ‘a’ denotes the quantity demanded if the price is zero and the condition where change in ‘b’ affects the slope of the demand curve. The quantity demanded and price is denoted by QD and P respectively. On the other hand, supply function is denoted by QS= c-dP, where c is the quantity that is supplied when the price is zero and change in quantity ‘d’ affects the slope of supply curve. QD1= 144-133 P1 QS1= 142-163 P1 QD2= 146-121 P2 QS2= 140-154 P2 QD3= 147-142 P3 QS3= 134-147 P3 QD4= 154-108 P4 QS4= 126-167 P4 QD5= 167-97 P5 QS5= 121-172 P5 QD6= 161-105 P6 QS6= 116-177 P6 1) B. In equilibrium, the quantity demanded is assumed to be equal to quantity supplied. Therefore, for this reason, QD= Qs. This further implies, a-bP=c+DP Or, a-c= d P + b P Or, (a-c)=P(d+b) 2) A shift in market demand curve with the supply remaining constant is shown in the figure-3 below. In the figure, D and S represent the demand and supply curve for a product X. With the upward shift in demand curve from D to D/ and supply remaining constant, results increase in price and quantity. The upward increases in price is also shown as a movement from P to P/ and increase in quantity is depicted as Q/ (SSCC 1-5). Figure-3(SSCC 1-5) PROBLEM SET 5 Consider a two-stage auction, where in the first stage, the bidders set a minimum chase price to win the auction; and in the second stage, in order to win the bid, the chasing players bid higher compared to the former. Illustratively, assuming that in a two stage auction of a product, three players value the product as 10, 11 and 12 respectively. The value of the product in the first stage of bidding is fixed according to the actual price of the product. On the other hand, the players in auction, bid 20, 21 and 22 respectively, to ensure that the bids made by them were higher in the first stage. In this case even if the player wins the bid, he/she may suffer a loss in future. In order to win the bid, the player should therefore bid for a higher price as compared to the first stage, without taking into consideration the actual price of the product. Therefore, this may cost more to the winner after the individual wins the auction and to avoid the problem of over paying, the bidders should the stage for one instead of two that may result into loss with greater risks. Works Cited Chib, Siddhartha and William Griffiths. Bayesian Econometrics.UK: Emerald Group Publishing, 2008. Print. Roger A. Arnold. Microeconomics. USA: Cengage Learning, 2015. Print. “Supply and Demand.” SSCC. n.d. Web. 18 Feb. 2015. Read More