Pre Midterm 1

Question 1

What is the Law of Diminishing Marginal Utility?

Answer 1

The greater amount consumed of a good/service, the less utility gained from an incremental increase in the consumption of that good/service.

Question 2

What is the Consumer’s Objective?

Answer 2

The consumer’s objective is to maximize his/her utility given his/her level of wealth.

Question 3

What is the Budget Constraint?

Answer 3

The Budget Constraint is similar to the possibilities frontier, in that it shows affordable solutions in buying two goods/services.

Question 4

When is the consumer considered to be in the best possible situation of utility?

Answer 4

Marginal utility (good A) / Price (good A) = Marginal utility (good B) / Price (good B)

Question 5

What does Marginal Utility (good A) / Price (good A) equal?

Answer 5

The amount of utility gained by one more additional dollar spent on good A.

Question 6

If Mu(A) / P(A) > Mu(B) / P(B), what will happen?

Answer 6

The consumer will buy more of good A, thus decreasing the Mu(A) and less of good B, thus increasing the Mu(B). This would happen until the Mu(A) = Mu(B).

Question 7

What is the Consumer Equilibrium?

Answer 7

The Consumer Equilibrium is defined as those levels of quantities such that the consumer’s utility is maxed. The consumer has no incentive to reallocate his/her budget.

Question 8

What two conditions must be met for a Consumer Equilibrium?

Answer 8

1. The consumer must spend all of their money.

2. Equimarginal Consumption

Question 9

What two things does a demand curve show us?

Answer 9

1. What quantity a consumer is willing to buy at a given price.
2. What price a consumer is willing to pay for a certain quantity.

Question 10

What is Consumer Surplus?

Answer 10

The amount the consumer is willing to pay, minus the amount they have to pay.

Question 11

What characteristics make up a Private Good?

Answer 11

1. Rival Consumption

2. Exclusion

Question 12

What characteristics make up a Public Good?

Answer 12

1. Non-rival Consumption
2. Non-exclusion
   ex. National Defence

Question 13

What are the Advantages / Disadvantages of a Sole Partnership?

Answer 13

Advantages:
Easy to form, easy to dissolve
Decision making power resides with the sole owner
Only taxed once, based on the individual’s income

Disadvantages:
Unlimited Liability for the debts of the firm

Question 14

What are the Advantages / Disadvantages of a Partnership?

Answer 14

Advantages:
Easy to form and dissolve
Permits specialization

Disadvantages:
Each of the partners has unlimited liability
Decision making becomes more costly

Question 15

What are the Advantages / Disadvantages of a Corporation?

Answer 15

Advantages:
Corporations are in good positions to raise large sums of money
Shareholders enjoy limited liability

Disadvantages:
Subject to double taxation
Corporations are subject to a principal agent problem

Question 16

What two main ways do corporations have of raising money?

Answer 16

Bonds and Stocks

Question 17

What are the characteristics of a Bond?

Answer 17

1. A bond is a legal claim against the company
2. It represents debt
3. The return on a bond is the interest rate, which must be paid wether the corporation makes money on it or not

Question 18

What three forms does debt financing typically take?

Answer 18

1. Loans
2. Bills and Notes
3. Bonds and Debentures

Question 19

What are the characteristics of a Stock?

Answer 19

1. Called a share. Represents ownership in a company
2. Holders of a Common Stock elect the company’s board of directors
3. Holders of a Preferential Stock do not have say in the company, but get preferential treatment in the payment of dividends