Suppose you have 400,000 saved up and purchase a medium-sized ...

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Suppose you have 400,000 saved up and purchase a medium-sized house for 200,000. Consider the following 2 scenarios:
 
  i. The very next day, the prices of all houses, including the one you have just bought, double.
  ii. The very next day, the prices of all houses, including the one you bought, fall by half.
  Show that both scenarios increase your utility.

Question 2

If Ann's utility function is U = W0.5, and she invests in a business which can yield 6,400 with probability 1/5, and 3600 with probability 4/5, then her risk premium to avoid bearing this risk is
 
  A) 36.
  B) 41.6.
  C) 64.
  D) 100.

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Answer to Question 1

In both scenarios, you are still able to consume your original bundle  the selected house plus 200,000 of other goods. If the price of housing drops, the substitution effect allows you to reoptimize by selecting a larger house and spending less on other goods. If the price of housing increases, you can select a smaller house and spend more on other goods. In both cases, the re-optimization leads you to a higher utility level.

Answer to Question 2

A