suppose that the market for housing is perfectly competitive,
i.e. there are many
consumers, and that housing is a normal good. Next year half the
consumers will be
getting an income shock that is either negative or positive. Every
consumer who will
potentially receive the shock knows they will be getting a shock.
First suppose that
shocks are independent and identically distributed across
individuals.
Note: in the following questions I ask you to compare the level of
risk. The kind of
the comparison I expect you to make is as follows: a distribution
that pays out a with
probability p and b with probability (1 ?p), it is riskier than a
distribution that
pays out c with probability p and d with probability (1 ?p) where a
?c ?d ?b.
1)
Assume that half the consumers who will experience the shock
have the same
high WTP while the other half have the same low WTP. Who
experiences more
risk in their CS from housing (i.e. dispersion), consumers who know
about the
shock and have high WTP, or consumers who know about the shock and
have low
WTP?
2)
Could consumers who do not expect a shock experience more risk
than those who
do? Give an example or provide reasoning.
3)
Suppose that shocks are now perfectly correlated across
individuals (i.e. all
shocked individuals either receive the positive shock or all
receive the negative
shock), could consumers who do not expect a shock experience more
risk than
those who do? Give an example or provide reasoning.