Practice Final Econ 1

Lee Ohanian

Economics 2

Winter, 2011

Practice for Önal exam

1. Suppose that you are considering buying an apartment building that will

last for Öve years. There are Öve rental units. Suppose that the rent per unit is

$1,000 per month always. Suppose also that the units are never vacant. Show a

present value formula that you can use to value how much the building is worth.

Suppose the annual interest rate is r. Per month rent for the building is

always 5*1000=5,000, and the building is never vacant. Then, yearly rent is

12*5,000 = 60,000. The building pays o§ $60,000 per year for 5 years. Hence,

the present value formula to calculate the buildingís worth is

P DV =

60; 000

60; 000

60; 000

60; 000

60; 000

+

+

+

+

(1 + r) (1 + r)2

(1 + r)3

(1 + r)4

(1 + r)5

2. Suppose you are considering purchasing an oil well. There is a 70% chance

it produces 100 barrels of oil next year, and only that year, and there is a 30%

chance that it produces nothing. Suppose the price of a barrel of oil is $50 and

that the interest rate is 5%. Show a formula for the expected present discounted

value of the dollars paid out of that oil well.

EP DV =

0:7  (100  50) + 0:3  (0  50)

(1 + 0:05)

3. Show the expression for the rate of return on an asset.

Rate of return on an asset between periods t and t + 1 is

Pt+1 + Dividendst+1

1

Pt

where P shows the price of the asset

4. Recently, citizens were outraged over a U.S. Senator who tacked on to a

piece of environmental legislation $1,00,000 in federal funding that would fund

a community miniature golf course in his state. How does rational ignorance

help us understand how this type of event occurs?

Since the cost of this golf course is di§used over the whole population who

pays the taxes, by learning about this legislation, citizens individually do not

beneÖt a lot. However, as compared to the beneÖts, the cost of being informed

is high and accordingly people did not even know about this...