2.1 Adam Smith is often called the father of economics. His famous book, The Wea
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Question
2.1 Adam Smith is often called the father of economics. His famous book, The Wealth of Nations, talks about an “invisible hand” which automatically allocates goods to the persons most able to put them to good use. The invisible hand operates through the price mechanism for goods and services, so that individuals who trade on the market, while seeking only their own good, are actually efficiently allocating society’s resources.
His ideas, if applied to modern capital markets, imply that these markets would efficiently allocate investment capital to the firms that would use the capital most efficiently in producing goods and services for society. But this would happen only if markets were left to operate without state intervention.
Do you think modern governments should leave capital markets unregulated? Why or why not?
2.2 Consider a business firm, organized as a proprietorship, which has $100,000 invested in assets—a bank loan of $80,000 and $20,000 personal capital invested by the proprietor. If the firm becomes insolvent, who is at risk? Why?
2.3 In each of the following situations, moral hazard or adverse selection may be present. Indicate which you think is present, if any, and explain your choice.
a. An insurance company is thinking about issuing health insurance to a firm’s employees.
b. An insurance company has issued health insurance to a firm’s employees on the basis of their medical histories.
c. An investor is asking for a bank loan to support a new business she wants to operate. She is unwilling to submit to a credit check.
d. An investor has purchased shares in a new software company. He is just a shareholder, and is not going to be involved in the daily operations of the firm.
e. A grandfather has just given his grandson $100 as a birthday present.
2.4 In each of the situations considered in question 2.3, what could be done to overcome the problem?
Explanation / Answer
2.1 Without a whole host of government rules, capitalism could not exist. Even regulations and social programs help sustain a market economy by fixing many of its serious social and economic problem. Markets, like governments, are very much social constructs. The market is a set of behaviors that is structured by rules, and many of the most important rules have been developed and enforced by government. Without these rules, our prized free-market economy would be a stunted and feeble version of what we see today. To see how this is the case, lets looks at these essential rules. the vast infrastructure of laws and policies that make a modern capitalist economy possible.
2.2 The proprietor responsible for all, because he is the only owner for all. also the whole business unable to pay all debits.
2.3 c. An investor is asking for a bank loan to support a new business she wants to operate. She is unwilling to submit to a credit check. because without creadit check bank take a high risk. the bank is uncertien as to the indiviual and it may not be a smarter invesment.
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