Essay Questions for Test 1

1. Draw the Circular Flow of Money model and label all parts.
SEE ATTACHED NOTEBOOK PAPER (HANDWRITTEN.)

3. Define Macroeconomics and Microeconomics.

- Macroeconomics: examines either the economy as a whole or its basic subdivisions or
aggregates (collection of specific economic units treated as if they were one unit), such as
the government, household and business sectors. It seeks to obtain an overview of the
structure of the economy and the relationships of its major aggregates.

- Microeconomics: studies how specific economic units such as individuals, households,

and firms make decisions to allocate limited resources, typically in markets where goods or
services are being bought and sold. It examines how these decisions and behaviors affect
the supply and demand for goods and services, which determines prices, and how prices, in
turn, determine the supply and demand of goods and services.

4. List the nine (9) characteristics of the Market System.

A. Private Property (land, capital)
B. Freedom of enterprise and choice (in what to buy/where to buy from – not forced to buy
from state.)
C. Self interest
D. Competition (large # of sellers – relatively easy entry/exit)
E. Market prices (help communicate tastes of consumers)
F. Active but limited government (promotes law and order and creates standards)
G. Reliance on technology and goods (more/better machines promote greater supply)
H. Specialization (and therefore, efficiency)
I. Use of money as a medium of exchange (emerged from the barter system)

5. What are the 3 major legal forms of business organization, and give 2 advantages and 2
disadvantages of each form?

A. Sole proprietorship: a business organization headed by one person (most prevalent)

Advantages:
1. easy to set up
2. Proprietor is his/her own boss
3. profit is proprietor’s income so there is an incentive to operate the business efficiently
Disadvantages:
1. financial resources are limited (may be insufficient)
2. proprietor has no help in decision making
3. proprietor is subject to unlimited liability (personal assets are up for grabs)
B. Partnership: 2 or more individuals own and operate a company
Advantages:
1. easy to organize
2. greater specialization than sole proprietorship
3. better access to financial resources than proprietorships
Disadvantages:
1. problems if one of the partners leaves (or dies)
2. possible difficulties in reaching consensus among partners (management)
3. still unlimited liabilities
C. Corporation: legal entity distinct from individual owners (most profits)
Advantages:
1. defining and comparing stocks and bonds
2. limited liabilities
3. permanence that is conducive to long-run planning and expansion of size and scope
Disadvantages:
1. red tape and expense in obtaining a corporate charter
2. double taxation of corporate income
3. principal-agent problem between owners (stockholders) and management.