Question 1

In what sense are profit and loss signals?

Accepted Answer

Profit and loss signals not only direct resources in a market economy, but also provide information about consumer demand by indicating which goods are profitable and which are not.

Question 2

Many years ago someone developed an item that was simply a small rock inside a box with holes. The person earned large profits from selling "pet rocks." Which of the following theories on the source of profits best describes the reason behind this success?

Accepted Answer

The success of the "pet rock" is best explained by the theory that profit is the return to the entrepreneur as innovator. The person who developed the idea was able to create a new product that was unique and appealed to a certain market, leading to large profits. This success was not based on uncertainty or arbitrage opportunities, nor was it solely due to chance.

Question 3

If the nominal interest rate is 8 percent and the real interest rate is 6 percent, then the expected rate of inflation is

Accepted Answer

The expected rate of inflation is equal to the nominal interest rate minus the real interest rate. In this case, 8% - 6% = 2%, so the expected rate of inflation is 2%.

Question 4

Risk

Accepted Answer

Risk exists when the probability of a given event can be estimated, distinguishing it from uncertainty, where such probabilities cannot be determined.

Question 5

Pure economic rent is

Accepted Answer

Pure economic rent refers to the payment made for the use of land or other resources that are perfectly inelastic in supply, meaning their supply does not increase as the price increases. This is because the amount of land, for example, is fixed regardless of the price it can command.

Question 6

Profits are income to

Accepted Answer

Profits are the rewards for the entrepreneurship that involves taking risks in production. These rewards are received by the entrepreneurs who have organized the factors of production (land, labor, capital) to create a profitable firm. Therefore, profits are income to the entrepreneurs who bear the risks of production.

Question 7

A person buys X in one market and combines it with Y purchased in another market. The combination of X and Y gives Z, which the person sells in a third market for a higher price than the sum of the prices of X and Y. Which theory of profit is most consistent with this example?

Accepted Answer

This example describes an arbitrage opportunity, where the person is able to make a profit by buying X and Y in different markets and selling the resulting combination, Z, for a higher price in a third market. According to the theory of profit as the return to being alert to an arbitrage opportunity, profit arises from exploiting price differences across markets due to imperfect information or transaction costs.

Question 8

George earns $500,000 playing baseball for team X. His next best alternative to playing baseball is to own a fast-food restaurant, for which he would earn $100,000 a year. His next best alternative to playing baseball for team X is playing baseball for team Y, for which he would earn $400,000 a year. This example best illustrates the economic principle that

Accepted Answer

This example illustrates the concept of economic rent, which is the difference between the income earned from a particular factor of production (in this case, playing baseball for team X) and the income that would be earned from the best alternative use of that factor (in this case, owning a fast-food restaurant or playing baseball for team Y). Economic rent differs depending upon the perspective from which the factor is viewed, as it is based on the opportunity cost of that factor. Therefore, choice D is the correct answer.

Question 9

If X is the actual amount of income or receipts and i is the interest rate (in decimals)that could be earned on alternative uses of money that face the same risk, the present value of X one year from now is computed by

Accepted Answer

The formula for finding present value is X/(1+i), not X/(1-i) or any other variation listed.

Question 10

Ceteris paribus , the nominal rate of interest will increase when the

Accepted Answer

According to the Fisher Effect, the nominal interest rate is equal to the real interest rate plus the rate of inflation. Therefore, if the expected rate of inflation increases, the nominal rate of interest will also increase.

Question 11

Which of the following is not a theory of the source of profit as discussed in the textbook?

Accepted Answer

The other three options (uncertainty, alertness to arbitrage opportunities, and innovation) are discussed in the textbook as potential sources of profit, but ownership of resources is not considered a theory of profit.

Question 12

If the nominal rate of interest is 5 percent and the expected rate of inflation is 6 percent, then the real rate of interest is

Accepted Answer

The real rate of interest is calculated by subtracting the inflation rate from the nominal interest rate. Real rate of interest = Nominal rate of interest - Inflation rate. In this case, the real rate of interest = 5% - 6% = -1%.

Question 13

The difference between artificial rents and real rents is that

Accepted Answer

Artificial rents are those created by government intervention, such as rent control policies, subsidies, or taxes. Real rents, on the other hand, are determined by the market forces of supply and demand, without any government interference. Therefore, option A is the correct answer. Option B is incorrect because the size of rents is not determined by whether they are real or artificial, but by the forces of supply and demand. Option C is incorrect because artificial rents can occur in any market where the government intervenes, regardless of the elasticity of supply. Option D is also incorrect because both artificial and real rents can be subject to rent-seeking behavior, which involves using political influence to gain economic benefits at the expense of others.

Question 14

In a very popular movie, the principal character wore aviator sunglasses that were given to the movie studio by the producer of the sunglasses. The sunglasses suddenly became very popular, and the sunglasses producer earned significant profits. Which of the following theories on the source of profits discussed in the textbook best describes the reason behind this success?

Accepted Answer

The answer of In a very popular movie, the principal...

Question 15

Which of the following statements is true?

Accepted Answer

The competition for real rents often leads to increased supply and lower prices. Option A is incorrect because competition for real rents can lead to increased efficiency and innovation, making it socially productive. Option C and D are incorrect because the size of a firm is not necessarily linked to whether it receives artificial or real rents.

Question 16

An increase in the anticipated (or expected)rate of inflation will cause the nominal interest rate to

Accepted Answer

The Fisher effect describes the relationship between inflation and both nominal and real interest rates. It states that the nominal interest rate is equal to the sum of the real interest rate and the expected inflation rate. Therefore, if the anticipated rate of inflation increases, the nominal interest rate will increase by the same amount to maintain the real interest rate.

Question 17

If a firm is incurring a loss, the loss is a signal that

Accepted Answer

When a firm is incurring a loss, it means that the price it is charging for its goods or services is less than the cost of producing them. This indicates that consumers are not willing to pay enough for the goods or services, and therefore, they would rather have some of the resources used by the loss-making firm be used to produce other goods or services that they value more highly. This is a signal that resources should be reallocated from the loss-making firm to other more profitable ventures.

Question 18

Jim Smith made his fortune by buying and selling real estate. Which of the following theories on the source of profits best describes the reason behind his success?

Accepted Answer

Jim Smith's success in buying and selling real estate can be attributed to his alertness to arbitrage opportunities. He was able to identify undervalued properties, purchase them, and then sell them at a higher value, earning a profit. This fits with the theory that profit is the reward for being entrepreneurial and alert to opportunities for arbitrage.

Question 19

Which of the following statements is false ?

Accepted Answer

Artificial rents, like subsidies or monopolistic market positions enforced by regulations, also attract competition from individuals and firms, contrary to the assertion in option C. Both real and artificial rents can motivate entities to compete, as both can offer above-normal returns.

Question 20

Uncertainty

Accepted Answer

Uncertainty refers to a situation where the probabilities of different outcomes are unknown or cannot be estimated with confidence. It is different from risk, which refers to a situation where the probabilities of different outcomes are known or can be estimated with some degree of confidence. Economic rent seeking is a concept related to the use of resources to gain economic benefits without creating any new wealth.

Quiz 16: Interest, Rent, and Profit