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ECO3592011 UniversityofToronto PracticeProblems DepartmentofEconomics ECO 359 Practice Problems 1 1. Consider the situation of Chuck Noland who is stranded on an island: Chuck has to decide on his consumption today, ? and next year, ? . Today (2 L I) he has income 5 L IH coconuts, # $ # next year (2 L J) is cyclically bad and he has only 5 $ L Mcoconuts. His utility function is %:? #? $ L ? ?#. O$ce every year he gets a visitor from the Wilson Bank Inc. who allows him to lend or borrow money at interest rate N. In addition to putting money to the bank or borrowing money from it, he can invest some of his income in his coconut plant which will give him a marginal rate of return + L M . +, where + is the amount he invests in the plant. (a) Which level of investment will he choose? (b) The NPV of investing I units into the project is given by I & L .+ - :N . +J + I - N Verify that maximizing the above NPV indeed yields your answer in (a). (c) You will now be asked to describe Chucks budget constraint. Do this in three steps:
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