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EconFinalExamStudyGuide - Final Exam Review Sheet Chapter...

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Final Exam Review Sheet : Chapter 22 Risk and the Allais paradox -One can change from being risk averse to being a risk taker -Wealthy don’t play the lottery they get insurance -The poor look to get rich quick so they play the lottery Risk aversion and risk taking -Risk averse are not willing to be risky (Insurance) -Risk taking will play the lottery (give up the sure thing of the price of the ticket for a chance to win money! Negative v. positive time preferences -Negative- Not thinking about Now but more so Later -Positive is thinking about right Now -Overall more people have positive time preferences which creates a positive pure rate of interest Business Organization -Proprietorships-Easy to form and dissolve, simple decision making, profit is taxed only once. HOWEVER, there is UNLIMITED LIABILITY for all debts. -Partnerships- Relatively easy to form and dissolve, allows for more effective specialization, profit is taxed only once. HOWEVER, there is UNLIMITED LIABILITY. -Corporations-Persons own shares in the company, LIMITED LIABILITY, continues to exist after owner leaves Efficient market hypothesis and related discussion -Two Approaches -1. Random Walk Theory - (Efficient Market Hypothesis)- theory that there are no predictable trends in stock prices that can be used to “get rich quick” (past means nothing, only future matters) 2. Markets can be Exploited - Inside information that is not available to the general public (trading spaces movie clip)
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Asymmetric information -Asymmetric Information- Information possessed by one side of a transaction but not the other -Adverse Selection- In financial markets when those who are the worst risks are the ones most likely to be involved in the situation (Homer Simpson getting obese to be disabled) When one party knows the something the other doesn’t. Applying for credit when they get fired! -Moral Hazard- A problem that occurs because of a change in behavior after a transaction (or policy) is completed. (flood insurance) -Principal Agent Problem-The Conflict of Interest- occurs when managers/agents of firms pursue their own objectives to the detriment of the goals of the firm’s principals, or owners. Components of the interest rate -1. Risk Premium -2. Inflationary premium -3. Pure Interest (Pay someone for using their money) * Nominal interest rate- price we actually pay (Risk premium and inflationary premium) Other factors -. Length of the loan (longer the greater the charge) -Handling charges (The larger the loan, lower the interest rate) (Large loan equals irrelevant handling charges) Present value and discounting (2) -Present value- The value of a future amount expressed in today’s dollars The most someone would pay today to receive a certain sum at some point in the future -Discounting-Finding that present value! (Future Money/ (1+ interest rate)
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EconFinalExamStudyGuide - Final Exam Review Sheet Chapter...

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