Perfect Capital Market

Question 1

Under what condition can an entrepreneur with no initial funds start a firm?

Answer 1

If they have a production technology that will give them a rate of return on the investment of funds that is greater than the market rate of return, they are able to borrow funds to start the firm

Question 2

How can the market value (MV) of a firm be expressed?

Answer 2

Say the current period is period 1, MV in period 1 would be the value of the firm in the next period (i.e. the cash flow it receives in period 2, k2, minus the amount it invested in the previous period, I1, the whole thing discounted, plus the same for all of the future periods

Question 3

So long as the _____ ______ are maximised in each period, the market value of the firm will be maximised.

Answer 3

Firm’s profit (Kt - It-1)

Question 4

The manager/owner of the proprietary firm (who is also a consumer) of the firm, maximises the return on capital (i.e. makes the optimal investment) at the point where…

Answer 4

The marginal return on investment (represented by the MRT) is equal to the market interest rate (r), i.e. at the point where the market opportunities line is tangential to the transformation curve

Question 5

Utility is increasing as a function of…

Answer 5

Wealth (Wt)