Pepperdine University

FINC 655

Chapter 2

Multiple Choice Solutions:

1)An individuals value for a good or service is the

1. 1. The amount of money he or she used to pay for a good. [Past payments do not necessarily indicate the current value of a good or service to an individual]
   2. The amount of money he or she is willing to pay for it. [to “value” a good means that you want it and can pay for it]
   3. The amount of money he or she has to spend on goods. [Total individual wealth does not reflect the value of a particular good or service]
   4. None of the above [To “value” a good means that you want it and can pay for it]

2. The biggest advantage of capitalism is
   1. Generates wealth with the help of government intervention [Not all government intervention generates wealth, often it does the opposite. Rather, governments play a critical role in facilitating wealth generating transactions, particularly by enforcing property rights and contracts.]
   2. That prices assists in moving assets from high valued to low value uses [Wealth is created when assets move from lower to higher valued uses]
   3. It forces involuntary exchanges [Voluntary transactions create wealth]
   4. Creates wealth by letting a person follow his or her own self-interest [a buyer willingly buys if the price is above her value, and a seller sells when the price is above her value, otherwise they would not transact]

3. Wealth creating transactions are more likely to occur
   1. With private property rights [private property rights facilitate voluntary transactions]
   2. With contract enforcement [contract enforcement helps facilitate voluntary transactions]
   3. With black markets [black markets are often created from a wealth-generating arbitrage opportunity]
   4. All of the above [By making sure that buyers and sellers can keep the gains of trade, legal mechanisms such as private property and contract rights that facilitate voluntary transactions will help generate wealth; black markets also create wealth from seizing arbitrage opportunities that exist from inefficiencies in the market]

4. Government regulation
   1. provides incentives to conduct business in an illegal black market [government regulation that impedes the movement of assets to higher valued uses destroys wealth. Black markets arise in part because of the arbitrage opportunities created in these situations]

1. 2. plays no role in generating wealth [governments play a critical role in the wealth creating process by enforcing property rights and contracts]

1. 3. is the best way to eliminate poverty [There are other opportunities beyond government regulation to address poverty, especially as often some regulations ultimately result in wealth destroying transactions]
   4. does not enforce property rights [One of governments most important roles is the enforcement of private property rights]

5. An example of price floor is
   1. Minimum wages [by outlawing wages below a certain price, minimum wages are an example of a price floor]
   2. Rent controls in New York [this is an example of a price ceiling, in which the price of rent cannot go above a specified value]
   3. Both a and b [Of the two options, one is indeed an example of a price floor, while the other is a price ceiling]
   4. None of the above [At least one of the answers above is an example of a price floor, which is defined as a regulation that outlaws trade at prices below the specified “floor” value]

6. A price ceiling:
   1. Is a government-set price above market equilibrium price. [A price ceiling is a regulation that outlaws trade above a specified price; it does not have to be above market equilibrium]
   2. Is the equivalent of an implicit tax on producers and an implicit subsidy to consumers. [Price ceilings prevent producers from selling at a higher price to consumers who would be willing to pay more, while consumers have the opportunity to purchase something they may not have been able to otherwise]
   3. Will create a surplus. [Likely, both the consumer (buyer) and producer (seller) will value the good at or above the specified ceiling. If the producer is forced to sell, any surplus for the consumer is a loss for the producer, so no net surplus is created from the transaction]
   4. Causes an increase in consumer and producer surplus. [Both the consumer (buyer) and producer [seller] likely value the item at or above the specified ceiling, resulting in a benefit for the consumer but a loss of potential wealth for the producers]

7. Taxes:
   1. Impede the movement of assets to higher valued uses. [This is the result of anything that deters a wealth creating transaction]
   2. Reduce incentives to work. [By not allowing people to capture the full value of their labor and production, taxes reduce the incentive to work]
   3. Decrease the number of wealth creating transactions. [If a tax is larger than the total surplus created by a transaction, the transaction will not take place]
   4. All the above [when taxes are larger than the surplus of a transaction, that transaction will not take place, thus deterring a wealth creating transaction. Likewise, by not allowing people to keep the gains from their own trade, taxes can diminish the incentive to work].

8. A consumer values a car at $30,000 and a producer values the same car at $20,000. If the transaction is completed at $24,000, the transaction will generate:
   1. No surplus [A surplus is created from this transaction]
   2. $4,000 worth of seller surplus and unknown amount of buyer surplus [Seller surplus is $4000, (Final price less seller value); Similarly, buyer surplus can be calculated by looking at the difference between the buyer value and the final price.