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Please show enough work to demonstrate how you arrived at the calculation.
Florian has preferences over cash (c), pens (p) and mugs (m) as represented by the following utility function: u(c,p,m,rc,rp,rm) = c + 2p + 3m + v(c − rc) + 2v(p − rp) + 3v(m − rm), where v(x) = x if x ≥ 0 and v(x) = 3x if x ≤ 0. Assume that Florian’s reference point is his current endowment of c, p and m.
a) How much would Florian pay for a pen?
b) How much would he pay for a mug? Now assume that that Florian has at least 1 mug and 1 pen.
c) For how much money would Florian be willing to sell a pen? How about a mug?
d) Calculate Florian’s choosing price for a pen (mug). In other words, what amount of money would make Florian indifferent between that amount of money and a pen (mug)? Why is Florian’s choosing price different from his buying price?
e) Would Florian trade a mug for a pen? What about one of his pens for a mug? Explain why this behavior is either consistent or inconsistent with standard economic theory.
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