Exam -2 Chapter 6- Consumers And Firms Flashcards
Utility
Is the happiness gained from a good.
cardinal utility
It cannot be directly measured
ordinal utility
it can be expressed as rankings of goods
It is not possible to meaningfully compare the utility or happiness of one person to the utility or the happiness of another person
True
Pareto optimality
The only way to know that a choice has made society ( or any group of people)better off is if no one is made worse off and at least one person is made better off
Total utility
The total utility is the sum of the utility obtained by a person’s entire consumption of a good.
Marginal utility
The marginal utility is the additional utility obtained by The consumption of one or more good
The law of diminishing marginal utility
States that as we can consume more of any one good, eventually the additional utility obtained from consuming more will decline.
What is the way for a consumer to maximize their utility?
It is to equate the marginal utility to the price for every good they buy.
When is a decision considered to be rational?
If we expect a result of that decision to make us better off
The substitution effect
When the price of a good changes The quantity of that good purchased changes because we can substitute towards or away from other goods whose price relative to the good has changed
Purchasing power
Is the real income of the consumer
Why does the quantity of all goods changes in the substitution effect
Because the new price of the good changes the real income or purchasing power of the consumers income. They will be able to afford more or fewer of all the goods. ( the income effect)
What does the price elasticity of demand measure?
It measures the responsiveness of the quantity demand it of a good to changes in its price
When does a good have an elastic demand
A good has an elastic demand if the percentage change in quantity demanded is larger than the percentage change in price.
Inelastic demand
Inelastic demand means that a larger percentage change in price is required to create a certain percentage change in quantity demanded.
Businesses facing elastic demand will be
Price sensitive, and have incentive to keep prices low
Businesses under inelastic demand will prefer and try
To maintain higher prices.
When does the elasticity of any good becomes more elastic?
The elasticity of any good becomes more elastic as time is considered.
Sole proprietorship
Most businesses are sole proprietorships,meaning that they are owned by one person who is entirely liable for their operations.
Partnership
A partnership exist when two or more people own a business and are entirely liable for its operations
Corporation
A corporation is a legally created entity that operates a business, and in doing so shields the owner of the business [its stockholders] from liability for its operations.
The corporation is subject to a
Separation of ownership and control of the company
A multinational corporation
Has assets and employees in more than one country. It operates through the ownership of subsidiary companies in other countries that it owns, at least in part.
Profit of a business
Profit off of business is equal to its revenue minus it’s opportunity cost.
Opportunity cost
Opportunity cost includes the explicit (money )cost and implicit (non-money )costs
Normal profits
Normal profit is enough profit to continue operations of the business and should be considered a cost of doing business.
Economic profit
Economic profit is the excess profit over normal profit
Utility
Utility is the economists word foe happiness or satisfaction
It is assumed that consumers
Attempt to maximize their utility and minimize their disutility. ( unhappiness)
Consumers do that which gives them the
The most pleasure, and avoid that which causes them pain
What do economists use to measure utility
Util is used as the basic measure of utility
Cardinal measurements
When we can exactly measure the value of something.
But cardinal measurement is not possible
Ordinal measurement
It occurs when we can put a group of things in order ( rank them) from highest to lowest.
Utility measurement is
Ordinal because consumers cannot measure their utility, but they can put goods in order of preference.
Not being able to measure utility creates
Problems
Interpersonal utility comparisons
Difficulty in making utility comparisons between people
It is impossible to make Interpersonal utility comparisons
True
Pareto optimality rule was created by whom
Vilfredo Pareto
Pareto optimality rule
Says that that the only way to guarantee society is better off because of an economic change is if at least one person is made better off, and no one is worse off.
What do we know about utility?
- We cannot measure it , except in ranking
- We cannot compare one persons happiness to another persons except in the most general of terms.
- If we want to make a group better off, we can only guarantee that will happen if we make no one in the group worse off, while making at least one person better off.
Total utility
Is the sum of all the utility a consumer has received from the consumption of a good.
What is not useful in making decisions about how to maximize our utility?
Total utility
Marginal utility
Is the additional utility obtained by consuming one more of a good
What does marginal utility do
- Controls behavior
- Define what has value
- State what the consumer will consume next
- State when the consumer will cease to consume more of a particular good.
——————— is everything when consumer decision making is considered
Marginal utility
What is the fundamental concept of economics
Scarcity
Since we want more than what we have, we are
Willing to pay for it.
If the marginal utility of a good is zero ( more air has no value) then the price of a good and its market value will be
Zero
If the marginal utility of a good is positive ( we want more music) then
It may have a price and a market value above zero.
Law of diminishing marginal utility
States that as I consume more of any good, the additional utility that I get from consuming more of it will eventually decline.
Law of diminishing marginal utility describes
People’s behavior
The concept of diminishing marginal utility is also related to the idea of
Downward sloping demand curves.
So the demand curve can be thought of as a representation of
Marginal utility or marginal benefits.
In part the law do demand is a reflection of the
Law of diminishing marginal utility
When does the problem of scarcity show up
It shows up in the limited income of consumers and the need for goods to have prices.
Consumers maximize their utility subject to
The constraints of their limited income
What determines the Best Buy of a product
Best buy can be determined by looking at the utility per dollar.
Optimal solution =
Optimal solution =marginal utility divided by price (MU/ price)
What do we expect from consumers
That they will always be changing their behaviors to buy more of goods with large marginal utility per dollar value, and less of goods that have smaller marginal utility per dollar. The result is that they are always moving towards the optimal, though they will never reach it.
Rationality
Decisions are economically rational if the person chooses that thing which they believe will bring them the greatest happiness.
Economists argue that
People maximize their expected utility, not their actual.
Price changes and consumers behavior
When the price of a good rises, it does not affect just the purchases of that good by consumers. Instead, all other goods are affected directly or indirectly
When the price of a good rises
The consumer substitute away from the newly higher price good to a lower price good
Substitution effect
When the price of a good rises The quantity of that good demanded will fall, and the demand for other, less expensive, goods will increase. This is the substitution effect.
When the price of a good rises
It is no different than if the income of the consumer falls . The consumer will tend to buy fewer goods in total
Income effect
When the price of a good rises, consumers buy fewer of all goods.
What does price elasticity of demand measure?
It measures the responsiveness of quantity demanded to changes in the price of the good
Elastic demand
A change in price causes a larger percentage change in quantity demanded
Inelastic demand
A change in price causes a smaller percentage change in quantity demanded
In elastic demand, the quantity demanded is
Sensitive to price changes
In inelastic demand, the quantity demanded is
Insensitive to pricing changes
Examples of elastic goods
Buyers are sensitive to the price
Furniture, automobiles, airline tickets
Examples of inelastic goods
Buyers are not sensitive to the price
Basic food products such as salt, wheat, corn, gasoline, housing
Revenue and elastic demand
As the price decreases, business revenue increases. Consumers response strongly to the price decrease, and by a lot more of the product.
Revenue and inelastic demand
As the price increases, business revenue increases. Consumers buy regardless of price, so the price increase does not cause them to buy much less of a good.
Business behavior with elastic demand
Consumers are price sensitive. businesses will push low prices [frequent sales] and try to emphasize value in their marketing
Business behavior with inelastic demand
Consumers are not price sensitive. Firms rarely have sales. Where possible, the firm will raise the price to increase their revenue
Elasticity and time
The increase in price will eventually cause a substitution effect
What happens to elasticity with time
The consumer is insensitive in the short-term, but given enough time, become sensitive to price and changes the quantity demanded
Elasticity
Sensitivity to prices
Elasticity increases as we
Consider a longer period of time
Understanding elasticity helps the economists explain
Some important behaviors and to accurately predict that effect of price changes in certain circumstances.
Economists believe that consumers are rational because
They would never enter knowingly into a transaction that made them worse off than they were before.
Consumer surplus
Is the difference between the highest amount that a consumer would have paid for something and the amount that they actually paid.
For example consumer is willing to pay five dollars for sandwich. Cost of sandwich is $4.50. Consumer surplus equals five dollars -$4.50 equals $.50
Business firms up classified in the following ways
Sole proprietorship, partnership, And corporation
proprietorship
It is the one person business
Most Countries require businesses to
Obtain a license from the state, county, and or city
proprietorship ends when
The owner ceases us to do business ( often by bankruptcy, retirement, or death)
Most proprietorship last
Five years or less
Why does proprietorship rarely grow to be a large business without changing its business form?
The reason is liability. The owner of the business and the business are inseparable.
Why does the proprietorship have difficulty raising large sums of money to expand or enhance their business?
Because banks are typically the only source of business loans and they are often reluctant to loan to small businesses, given the risk associated with them
Examples of proprietorship
Small construction firms, restaurants that don’t belong to chains, small grocery stores/many markets, hair salons, gardeners, insurance agents, family farms, secretary who sells quilts at the swap meet
Partnership
Is a business owned by two or more individuals, which suffers from the same liability issues as proprietorships, except that the partners are jointly liable that is you are responsible for what your partner does that same way as if you had done it.
Corporation
A corporation is a legally created entity that has many of the same rights and privileges of human beings. A corporation has the right of free speech, a fourth amendment right to protection from illegal searches, a right to due process and so on
The corporation is essentially a legally created person
That represents the business
You can identify corporations by the letters
Stuck after their names: Inc, Ltd, PlC, LLC etc
To start a Corporation
One or more people must apply to the government in which the corporation will be housed, so even though a corporation may sell in 200 different countries, it always has a hole in one.
What are the advantages of corporations
The owners of the corporations are the owners of the shares of stock issued by the company.
They have a right to elect the Board of Directors who actually run the company.
They have a legal shield of liability that encourages people to invest in corporations
Suppose a corporation is sued by a customer
The customer sues the corporation as an entity, not the owners [stockholders]
If the company is worth $2 million, but loses a 2 billion Dollar lawsuit, the corporation maybe bankrupted, but the owners cannot lose more than the amount they paid for the stock. This is because the consumer cannot sue the stockholder or the people in the corporation, just the corporation itself
Stock
A share of stock confers on the owner partial ownership of the assets of the company issuing the share.
Each share of stock also carries with it
One vote in the election of board of directors of the company, who are responsible for the operation of the company.
The profits of the company belong to the
Stockholders
Since the stockholders do not usually run the company
They are rarely paid the entire amount of the profits.
Typically, the company keeps some of the profits, called
Retained earnings, and pays the rest to the stockholders
The payments to stockholders are called what
Dividends
Since stockholders are paid from profits, companies that do not earn a profit
Normally will not pay a dividend.
note there are forms of stock that relinquish their voting rights in exchange for a guaranteed dividend
What are the stockholders interested in
In dividends ( which requires profits) or increase in the value of the stock [which requires profits and/ or growth in revenue of the Firm]
Proxy fight
An attempt by a person or a group to gain control of a firm by getting its stockholders to grant that person or group the authority to vote its shares to replace the current management. An attempt to overthrow management and take over the business.
Why are corporate dividends are among the most heavily taxed income.
The dividends of the corporation are Taxed twice in the United States, when the corporation earns a profit , it must pay a tax on that profit to the IRS. The dividends are then paid out of the after-tax profits. When a person receives their dividend check, the dividend counts as a personal income. Thus corporate dividends are among the most heavily taxed income.
What are the advantages of financing the corporations through stock
- There is no requirement of paying dividends. The corporation can raise money without having to pay a cent to the buyers of the stock. If they do pay dividends, The amount is adjustable based on the operations of the company.
- There are large number of entities that buy stock, from individual people, mutual funds, to institutional investors such as pension funds. Many of these investors are in for the long-term, meaning that growth is more important to them than dividends, allowing the company to minimize the dividends it bees.
What are the disadvantages of financing the corporation through stock?
- The issuance of new stock dilutes the ownership of the existing stockholders. Existing stockholders will not be happy that their shares have been devalued.
- Once the original owner holds less than 50% of the stock, they can be voted out of control of the company by the stockholders.
Bonds
A bond is essentially a loan made by a person to the company.
It is a promise to repay money given to the firm at a future date with an additional sum of money called interest.
The interest is sometimes paid quarterly or annually , or it can be held and paid as a lump sum when the bond becomes due ( matures)
What are the advantages of the corporation selling bonds?
- That they are attractive to investors who want a set, regular, return on their investment
- They do not confer ownership in the company. Once a bond is repaid, The bond holder and the firm are no longer attached. A stock holder and the company or together forever.
- If something happens and the company declares bankruptcy, the bond holder is a creditor and is entitled to a payment.
When a stock holder owns a bankrupt company
They will receive payments out of assets only after all the creditors are paid. Since the company declared bankruptcy, it was unable to pay its creditors, which means that the stockholders expect, and usually get nothing from a bankrupt company
Nonprofit corporations
They are a special class of corporation that is founded for a public purpose, rather then to earn profits.
Examples of non-profit companies
Charities and churches, some hospitals, credit unions, private schools, and homeowners association’s
What is a nonprofit corporation supposed to do
It is supposed to do good deeds, and not earn a profit doing that. It is generally tax exempt, except where its operations are out side of its public purpose
All corporations are owned by their
Stockholders
When the stock of the company is sold to the public
The corporation is publicly held. For example in the New York Stock Exchange or on NASDAQ
Some corporations are owned
By one person, a few people, or by a family. For example Facebook and Microsoft when they started had a small number of private owners.
The stock of these companies is not traded.
These are called closely held or private corporations.
Private corporation
In a private corporation, the family or small group that owns the stock trades the value of the total control of the company for giving up their ability to raise money through the sale of stock.
The activities of a public corporation are regulated by
The SEC securities exchange commission
A closely held corporation
Is not subject to these requirements and often keeps its data secret from the general public
There is a limit as to how many investors a company can have and remain private.
True
Insider trading
The officers and top management of a corporation are limited in their ability To buy and sell the Corporations stock and must report the transactions that they make.
Making a trade on insider information is
Is illegal, and if you get caught, you can go to jail, and pay a fine
Equal to three times the profit you made.
Why have public corporations declined in number
Because many have transitioned into private concerns.
Also because of the dramatic increase in the use of state owned enterprises (SOE) around the world.
State owned enterprises
Is exactly what it’s name implies meaning a business that is owned by the government. It may be hundred percent owned or partially owned.
What are the advantages of a SOE’s State owned enterprises
- Having full support of the government ensures that government rules and regulations will support business,
- that foreign competition will have significant barriers to overcome, and
- that significant financial resources are available to help the business grow
What are the disadvantages of state owned enterprises
Consumers can find themselves with fewer choices
Corruption in the government can undermine the effectiveness of the business
Government leaders can enrich themselves by profiting from the business
Multinational corporation’s (MNC)
A multinational corporation is a distinctive type of business that has assets and employees in more than one country
Multinational corporation
Has factories in many countries.
Employees person’s across the globe
Sells goods everywhere that could be produced anywhere
Technically we identify a multinational corporation because
It has subsidiary corporations in countries other than its home nation.
Subsidiary corporation
Usually called just a subsidiary , is a corporation owned by another corporation
Multinational corporation’s are sometimes abbreviated as
MNC, MNE ( multinational enterprises), TNC ( trans national corporation)
What are the benefits of being a multinational corporation
Ability to adapt to culture can be an advantage to the multinational corporation
What are the disadvantages of being a multinational corporation
A multinational can fail because it uses a subsidiary it creates to avoid adapting to foreign culture.
Another issue is the conversion of currencies and the problems that it can create for a business
Revenue of a business
Is the amount of money it obtains from selling its goods and services
Profit
Profit is the difference between revenue and cost. Profit equals revenue minus cost
Definition of cost according to accountant
Cost is the money paid out by the business in exchange for the natural resources, labor and capital it employs
The accountant is really saying
Profit= revenue- explicit cost
The economists says
Profit= Revenue - opportunity cost
Or
Profit= Revenue- ( explicit + implicit cost)
Many business owners
Pay themselves as if they were employee in order to clear up the question of how much profit they really earned.
Economists Believe that
Some of what accountants call profit is really a cost
Normal profit
Is the economists term for sufficient profit to allow the entrepreneur to continue to operate the business
Economic profits
Profits over and above normal profits are called economic profits, and are more truly the profits of the business.
An economist would say that normal profits are a cost, so that the true fundamental question of accounting should be
Economic profit= revenue - cost ( including normal profit)
Short time horizon
Some businesses have a short time horizon. That is, they need to make money now, and are not too concerned with the future.
Long time horizon
Other businesses plan for a long time horizon, and may make decisions that lessens profits this year, in hopes of making more profits in the future
Profit stream
Essentially, the business wants to maximize the entirety of its profits over time [called its profits stream)
Future profits
Are not known or even uncertain. The less certain the future the more pressing the needs of the present, the more concerned the business will be with current profits.
