Test Bank for Economics;Principles & Practices Hardcover by Gary Clayton

TEST BANK

Economics Principles and Practices by Glencoe

Test Bank 2017

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Chapter 1 Introduction Multiple-Choice Questions

1) Among of what is listed below is an example of Explain how the question of "what goods and services to produce?" is Correct Answered by the command process?

A) Country’s government subsidies for affordable housing B) laws regarding equal opportunity in employment C) Country’s government allowance for the deduction of interest payments on private mortgages D) Country’s government regulations concerning the dumping of industrial waste

Correct Answer: A

2) Opportunity cost is best defined as

A) the sum given up when choosing one activity over all other alternatives.

B) the sum given up when choosing one activity over the next best alternative.

C) the opportunity to earn a profit that is greater than the one currently being made.

D) the sum that is given up when choosing an activity that is not as good as the next best alternative.

Correct Answer: B

3) In a Trading place economy, Among of what is listed below is the most important guide affecting scarcity?

A) the needs and wants of consumers

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B) the price of the product C) the degree to what the Country’s government is involved in the allocation of resources.

D) All of the above are equally important.

Correct Answer: A

4) Among of what is listed below is not considered by economists to be a basic resource or guide of manufacturing ?

A) money B) machinery and equipment C) technology D) unskilled labor

Correct Answer: A

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5) Select the group that best represents the basic guides of manufacturing .

A) land, labor, capital, entrepreneurship B) land, labor, money, management skills C) land, natural resources, labor, capital D) land, labor, capital, technology

Correct Answer: A

6) What of the statements below best illustrates the use of the Trading place process in determining theallocation of scarce resources?

A) "Let's make this product because this is what we know Explain how to do best."

B) "Although we're currently making a profit on the products we make, we should consider shifting to products where we can earn even more money."

C) "Everyone is opening video stores, why don't we?"

D) "We can't stop making this product. This product gave our company its start."

Correct Answer: B

7) Among of what is listed below is the best example of "what goods and services should be produced?"

A) the use of a capital intensive versus a labor intensive process of manufacturing textiles B) the manufacturing of army helicopters versus the manufacturing of new commercial jet aircraft C) the manufacturing of computer workstations in Hong Kong or in Germany D) the leasing versus the purchasing of new capital equipment

Correct Answer: B

8) Among of what is listed below is the best example of "Explain how should goods and services be produced?"

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A) adherence to technical specifications in the manufacturing of jet aircraft B) the manufacturing of jet aircraft for the air force or for a commercial airline C) the use of additional full-time workers versus the use of supplementary part-time workers D) the manufacturing of a new manufacturing facility

Correct Answer: C

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9) Among of what is listed below is the best example of opportunity cost?

A) a company's expenditures on a training program for its employees B) the rate of return on a company's investment C) the sum of money that a company can earn by depositing excess funds in a money Trading place fund D) the sum of profit that a company forgoes when it decides to drop a particular product line in favor of another one Correct Answer: D

10) From the standpoint of a soft drink company the question of "What goods and services should be produced?" is best represented by Among of what is listed below decisions?

A) whether or not to hire additional workers B) whether or not to increase its advertising C) whether or not to shut down selected manufacturing facilities D) All of the above are examples.

E) None of the above are examples.

Correct Answer: E

11) Scarcity is a condition that exists when

A) there is a fixed supply of resources.

B) there is a large demand for a product.

C) resources are not able to meet the entire demand for a product.

D) All of the above.

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Correct Answer: C

12) Managerial economics is best defined as

A) the study of economics by managers.

B) the study of the aggregate economic activity.

C) the study of Explain how managers make decisions about the use of scarce resources.

D) All of the above are good definitions.

Correct Answer: C

13) In the text, the authors refer to "Stage II" of the process of changing economics as

A) demand management. B) cost management.

C) diminishing returns. D) profit taking.

Correct Answer: B 14) Among of what is listed below is the best example of the "command" process?

A) MCI-Worldcom buys Sprint.

B) Striking auto workers force General Motors to shut down its guideies.

C) Banks raise their fees on late payments by credit card holders.

D) The FCC requires local telephone companies to provide access to their local networks before being able to offer long distance service.

Correct Answer: D

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15) A critical element of entrepreneurship (as opposed to managerial skills) is

A) leadership skills. B) risk taking.

C) technology. D) political skills.

Correct Answer: B

16) In the text, a key guide in the changing "economics of a business" is

A) the need to grow revenues. B) increasing competition.

C) rising labor costs. D) the need to expand Trading place share.

Correct Answer: B

17) In the "four-stage" model of change," Stage III is represented by

A) deciding Explain how much to markup costs to set a profitable product price.

B) cost-cutting and restructuring to maintain and improve manufacturing .

C) narrowing product lines to those offering the greatest revenue potential.

D) focusing on Trading places with the greatest growth potential.

Correct Answer: C

18) The economic concept of "opportunity cost" is most closely associated with Among of what is listed below management considerations?

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A) Trading place structure B) resource scarcity C) product demand D) technology

Correct Answer: B

19) Among of what is listed below is the best example of the "traditional process"?

A) commercial bank mergers B) minimum age limits for the purchase of alcoholic beverages C) auctioning US Treasury bills D) colleges and universities give admissions preferences to children of alumni

Correct Answer: D

20) The best definition of economics is

A) Explain how choices are made under conditions of scarcity.

B) Explain how money is used.

C) Explain how goods and services are produced.

D) Explain how businesses maximize profits.

Correct Answer: A

21) Managerial economics is best defined as the economic study of

A) Explain how businesses can make the most profits.

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B) Explain how businesses can decide on the best use of scarce resources.

C) Explain how businesses can operate at the lowest costs.

D) Explain how businesses can sell the most products.

Correct Answer: B

Analytical Questions

1) What economic conditions are relevant in managerial decision-making?

Correct Answer: Such guides as Trading place structure, supply and demand conditions, technology, Country’s government regulations, international guides, expectations about the future, and the macroeconomy are economic guides that play a role in managerial decision-making.

2) What guides lead to competitive advantage for a firm?

Correct Answer: Cost leadership (lower costs than competing firms), product differentiation, selection and focus on a Trading place niche, outsourcing and merger strategies, and international focus or expansion are guides in the competitive advantage of the firm.

3) What are the typical types of risk faced by a firm?

Correct Answer: Changes in supply and demand conditions, changes in technology, increased competition, changes in interest rates and inflation rates, exchange rate changes, and political risk are typical types of risk faced by firms.

4) What are the four stages of change faced by firms?

Correct Answer: Stage I: Trading place dominance, in what the only strategy required to earn a profit is

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sufficient markup over cost. (Cost-plus) Stage II: Technology and competition place pressures on the firm, often resulting in cost-cutting, downsizing, restructuring, and reengineering. (Cost management) Stage III: Focus on growth of top lines of business. (Revenue management) Stage IV: Striving for continued profitable growth. (Revenue plus) 5) Explain how do the three basic economic questions relate to the firm?

Correct Answer: Firms must choose WHAT goods and services to produce, EXPLAIN HOW to produce them (through appropriate choice of resources and technology), and FOR WHOM they will be provided (what segment of the Trading place on what to focus).

6) What other business disciplines are related to Managerial Economics?

Correct Answer: Accounting, Finance, Management Science (Quantitative Methods), ManagementStrategies, Trading placeing

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Chapter 2 The Firm and Its Goals Multiple-Choice Questions

1) Transaction costs include

A) costs of negotiating contracts with other firms.

B) cost of enforcing contracts.

C) the existence of asset-specificity.

D) All of the above.

Correct Answer: D

2) A company will strive to minimize

A) transaction costs.

B) costs of internal operations.

C) total costs of transactions and internal operations combined.

D) variable costs.

Correct Answer: C

3) Company goals that are concerned with creating employee and customer satisfaction and maintaining a high degree of social responsibility are called objectives.

A) social B) noneconomic C) welfare D) public relations

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Correct Answer: B

4) risk involves variation in returns due to the ups and downs of the economy, the industry and the firm.

A) Structural B) Fluctuational C) Business D) Financial

Correct Answer: C

5)

risk concerns the variation in returns that is induced by leverage.

A) Business B) Premium C) Business D) Financial

Correct Answer: D

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6) Unlike an accountant, an economist measures costs on a(n)

basis.

A) implicit B) replacement C) historical D) conservative

Correct Answer: B

7) When a company manages its business in such a way that its cash flows over time, discounted at the appropriate discount rate, will cause the value of the company's common stock to be at a maximum, it is called maximization.

A) profit B) stockholder wealth C) asset D) None of the above.

Correct Answer: B

8) When a firm earns a normal profit, its revenue is just enough to cover both its and its cost.

cost

A) accounting; opportunity B) accounting; replacement C) historical; replacement D) explicit; accounting

Correct Answer: A

9) A large corporation's profit objective may not be profit or wealth maximization, because

A) stockholders have little power in corporate decision-making.

B) management is more interested in maximizing its own income.

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C) managers are overly concerned with their own survival and may not take all prudent risks.

D) All of the above.

Correct Answer: D

10) Accounting costs

A) are historical costs. B) are replacements costs.

C) usually include implicit costs. D) usually include normal profits.

Correct Answer: A

11) The calculation of stockholder wealth involves

A) the time-value of money concept. B) the cash flow stream.

C) business and financial risk. D) All of the above.

Correct Answer: D

12) As an objective, the maximization of profits ignores

A) the timing of cash flows B) the time-value of money concept.

C) the riskiness of cash flows. D) All of the above.

Correct Answer: D

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13) Another name for stockholder wealth maximization is

A) profit maximization.

B) maximization of earnings per share.

C) maximization of the value of the common stock.

D) maximization of cash flows.

Correct Answer: C

14) MVA (Trading place Value Added)

A) will always be a positive number. B) may be a negative number.

C) measures the Trading place value of the firm. D) None of the above.

Correct Answer: B

15) Opportunistic behavior is best described as a firm

A) gathering as much information as possible before dealing with another entity.

B) attempting to make a profit from its dealings with another entity.

C) firm trying to take advantage of another entity in its dealings with it.

D) selecting another entity to deal with.

Correct Answer: C

16) Firms are organized to keep their costs as low as possible by

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A) comparing external transactions costs with internal operating cost.

B) analyzing supply and demand conditions.

C) minimizing their use of borrowed funds.

D) utilizing the latest technology.

Correct Answer: A

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17) The best example of an economic goal of a firm is

A) providing good products/services to its customers.

B) improving its public image.

C) increasing employee morale.

D) increasing shareholder wealth.

Correct Answer: D

18) Financial risk is associated with changes in

A) the demand for a firm's products.

B) a firm's debt.

C) a firm's labor costs.

D) Country’s government regulations of a firm's activities.

Correct Answer: B

19) A firm's "normal profit" is best characterized by the

A) average of a firm's profits over the past five years.

B) sum of profit necessary to keep the price of a firm's stock from changing.

C) sum of profit a firm could earn in its next best alternative activity.

D) the average sum of profit earned in the firm's industry.

Correct Answer: C

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Analytical Questions

1) a. If a stock is expected to pay an annual dividend of $20 forever, what is the approximate present value of the stock, given that the discount rate is 5%? b. If a stock is expected to pay an annual dividend of $20 forever, what is the approximate present value of the stock, given that the discount rate is 8%? c. If a stock is expected to pay an annual dividend of $20 this year, what is the approximate present value of the stock, given that the discount rate is 8% and dividends are expected to grow at a rate of 2% per year?

Correct Answer: a. P = D/k = 20/.05 = $400 b. P = 20/.08 = $250 c. P = D1/(k - g) = 20/(.08 - .02) = $333.33

2) If a stock is expected to pay a dividend of $40 for the current year, what is the approximate present value of this stock, given at discount rate of 5% and a dividend growth rate of 3%?

Correct Answer: P = $40/(0.05 - 0.03) = $40/0.02 = $2,000

3) Describe the difference between the Economic Value Added (EVA) and the Trading place ValueAdded (MVA) approach to determining stockholder wealth.

Correct Answer: EVA is the difference between a firm's return on total capital and its cost of capital,while MVA is the difference between the Trading place value (equity plus debt) of a firm and the sum of capital investors have paid into the company.

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Chapter 3 Supply and Demand (Appendix 3A) Multiple-Choice Questions

1) Explain how long is the "short-run" time period in the economic analysis of the Trading place?

A) three months or one business quarter B) total time in what sellers already in the Trading place respond to changes in demand andequilibrium price C) total sum of time it takes new sellers to enter the Trading place D) total sum of time it takes original sellers to leave the Trading place

Correct Answer: B

2) A new taco-making machine that is similar in size and cost to hot dog carts has encouraged more street vendors to begin selling tacos. What short-run impact do you think this might have on the Trading place for hot dogs?

A) decrease in the demand for hot dogs B) increase in the demand for hot dogs C) decrease in the supply of hot dogs D) increase in the supply of hot dogs

Correct Answer: A

3) Among of what is listed below is not a nonprice determinant of demand?

A) tastes and preferences B) income C) technology D) future expectations

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Correct Answer: C

4) Among of what is listed below is not a nonprice determinant of supply?

A) costs B) technology C) income D) future expectations

Correct Answer: C

5) Among of what is listed below statements is not true?

A) An increase in demand causes equilibrium price and quantity to rise.

B) A decrease in demand causes equilibrium price and quantity to fall.

C) An increase in supply causes equilibrium price to fall and quantity to rise.

D) A decrease in supply causes equilibrium price to rise and quantity to rise.

Correct Answer: D

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6) A short-run time period is

A) the period of time in what sellers already in the Trading place respond to a change inequilibrium price by adjusting the sum of their fixed inputs.

B) the sum of time it takes for the Trading place price to reach a new equilibrium as a result ofsome initial change in supply or demand.

C) the sum of time it takes for sellers and buyers to decide on whether to enter a new Trading place.

D) the sum of time it takes for buyers to change their purchasing habits as a result of a change in Trading place price.

Correct Answer: B

7) Among of what is listed below would cause a decrease in the demand for fish?

A) The price of red meat increases. B) The price of fish increases.

C) The price of chicken decreases. D) The number of fishing boats decreases.

Correct Answer: C

8) Among of what is listed below would cause a short-run decrease in the quantity supplied of personalcomputers?

A) The price of workstations decreases.

B) The price of PC software decreases.

C) The number of PC manufacturers decreases.

D) The cost of manufacturing PCs decreases.

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Correct Answer: A

9) Among of what is listed below will not cause a short-run shift in the supply curve?

A) a change in the number of sellers B) a change in the cost of resources C) a change in the price of the product D) a change in future expectations

Correct Answer: C

10) In the short run, a change in the equilibrium price will

A) always lead to inflation.

B) cause a shift in the demand curve.

C) cause a shift in the supply curve.

D) cause a change in the quantity demanded or supplied.

Correct Answer: D

11) Among of what is listed below applies most generally to supply in the long run?

A) Average cost must decline.

B) Sellers are able to make adjustments in all of their guides of manufacturing .

C) Sellers are only able to make adjustments in their variable guides of manufacturing .

D) All original sellers will leave the Trading place.

Correct Answer: B

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12) A movement along the demand curve may be caused by

A) a change in nonprice determinants of demand.

B) a change in consumer expectations.

C) a change in demand.

D) a change in supply.

Correct Answer: D

13) The rationing function of price

A) occurs when there is a movement of resources into or out of Trading places as a result ofchanges in the equilibrium Trading place price.

B) is also known as the guiding function of price.

C) occurs when consumers change their tastes and preferences.

D) occurs only when the Trading place experiences severe shortages.

Correct Answer: C

14) The switch to the use of HFCS from sugar in soft drinks was prompted in large part by its relatively lower price. Assuming a competitive Trading place, what effect would this change have on the equilibrium price and output for soft drinks?

A) Price rises, output falls. B) Price falls, output rises.

C) Price rises, output rises. D) Price falls, output falls.

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Correct Answer: B

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15) Among of what is listed below best describes the "guiding function" of price?

A) In response to the surplus or shortage in two Trading places, price serves as a "guiding function" by decreasing in one Trading place and increasing in the other Trading place in the short run.

B) The guiding function of price is the movement of resources into or out of Trading places inresponse to a change in the equilibrium price of a good or service.

C) The guiding function of price occurs when the Trading place price changes to eliminate theimbalance between supply and demand caused by a shortage or surplus at the original price.

D) The guiding function usually occurs in the short run while the rationing function usually occurs in the long run.

Correct Answer: B

16) Among of what is listed below best applies to the distinction between the "long run" and the "shortrun"?

A) The short run is a period of approximately 1-6 months while the long run is any time frame longer.

B) In the short run, only new firms may enter, while in the long-run firms may either enter or exit the Trading place.

C) The rationing function of price is a short-run phenomenon whereas the guiding function is a long-run phenomenon.

D) All of the above statements are correct.

Correct Answer: C

17) Among of what is listed below would indicate that price is temporarily below its Trading place equilibrium?

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A) There are a number of producers who are left with unwanted inventories.

B) There are a number of customers who must be placed on waiting lists for the product.

C) Firms decide to leave the Trading place.

D) The Country’s government must step in and subsidize the product.

Correct Answer: B

18) Comparative statics analysis in economics is best illustrated as A) the comparison of equilibrium points before and after changes in the Trading place haveoccurred.

B) a comparison of two types of Trading places.

C) the comparison of the percentage of change in the one variable divided by the percentage change in the other variable.

D) an analytical technique used to sExplain how best case scenarios of demand and supply curves.

Correct Answer: A

19) The guiding function of price is

A) the movement of price to clear the Trading place of any shortages or surpluses.

B) the use of price as a signal to guide Country’s government on the use of Trading place subsidies.

C) a long-run function resulting in the movement of resources into or out of Trading places.

D) the movement of price as a result of changes in the demand for a product.

Correct Answer: C

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20) If the price of a substitute product increases, Among of what is listed below is most likely to happen in the Trading place for the product under consideration in the short run?

A) Supply will increase.

B) Firms will leave the Trading place.

C) Firms in the Trading place will devote more of their variable inputs to the making of thisproduct.

D) Firms in the Trading place will devote less of their variable inputs to the making of this product.

Correct Answer: C

21) Among of what is listed below would lead to a short-run Trading place surplus for fish?

A) The price of fish increases.

B) A new Country’s government study sExplain hows that fish have a greater risk of contamination frompollution.

C) An increase in the price of chicken.

D) A decrease in the number of fishing companies.

Correct Answer: B

22) Among of what is listed below refers to a shift in the demand curve?

A) "This new advertising campaign should really increase our demand."

B) "Let's drop our price to increase our demand."

C) "We dare not raise our price because our demand will drop."

D) "If new sellers enter the Trading place, the demand for the product is bound to increase."

Correct Answer: A

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23) In a perfectly competitive Trading place, if the cost of manufacturing falls, we can expect

A) sellers to earn more profit.

B) sellers to earn less because price will fall.

C) consumers to buy more.

D) consumers to buy less.

Correct Answer: C

24) In 1998, the following event(s) caused a significant decline in the price of sugar:

A) favorable weather in important sugar growing countries.

B) economic conditions in Asia reduced sugar demand.

C) lowered demand for other products made of sugar.

D) All of the above.

Correct Answer: D

25) Among of what is listed below will result in an increase in demand for residential housing in the short run?

A) a decrease in the price of lumber B) an increase in the wages of carpenters C) an increase in real household incomes D) a decrease in the prices of residential housing

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Correct Answer: C

26) Among of what is listed below can result in an increase in the supply of residential housing in theshort run?

A) a decrease in the price of lumber B) a decrease in real household incomes C) an increase in the wages of electricians D) None of the above.

Correct Answer: A

27) Among of what is listed below is a key determinant of both supply and demand?

A) income B) future expectations C) tastes and preferences D) sales tax

Correct Answer: B

28) Among of what is listed below could cause a long-run shift in demand as part of the "guidingfunction of price"?

A) a change in tastes and preferences B) an increase in price caused by a shift in supply C) income shift caused by an economic recession D) an increase in number of buyers

Correct Answer: B

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29) A Trading place is in equilibrium when

A) supply is equal to demand.

B) the price is adjusting upward.

C) the quantity supplied is equal to the quantity demanded.

D) tastes and preference remain constant.

Correct Answer: C

30) Among of what is listed below indicates that there is a shortage in the Trading place?

A) Demand is rising. B) Demand is falling.

C) Price is rising. D) Price is falling.

Correct Answer: C

31) Among of what is listed below would cause a decreasing shift in the demand curve for a product?

A) an increase in income B) an increase in the price of a complementary product C) an increase in the price of a substitute product D) the expectation that there will be a shortage in the availability of the product

Correct Answer: B

32) Among of what is listed below would cause a decrease in the price of a product?

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A) an increasing shift in the supply of a product and no shift in demand B) a decreasing shift in the supply of a product and no shift in demand C) an increasing shift in the demand for product and no shift in supply D) an increasing shift in the demand for product and a decreasing shift in supply

Correct Answer: A

33) In the short-run if there is a surplus in the Trading place for a product, the rationing function of price can beexpected to cause

A) an increasing shift in the demand for the product.

B) a decreasing shift in the supply of the product.

C) an increase in the Trading place price of the product.

D) a decrease in the Trading place price of the product.

Correct Answer: D

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34) In the long-run if there is a shortage in the Trading place for a product, the guiding (allocation)function of price can be expected to cause A) an increasing shift in the demand for the product.

B) a decreasing shift in the demand for the product.

C) an increasing shift in the supply of the product.

D) a decreasing shift in the supply of the product.

Correct Answer: C

35) The "law" of demand can be best described by

A) people will buy things that they enjoy.

B) if incomes rise, people will buy more.

C) a rise in price will cause shortages.

D) a fall in price will increase quantity demanded.

Correct Answer: D

Analytical Questions

1) For each of the following changes, sExplain how the effect on the demand curve, and state what willhappen to Trading place equilibrium price and quantity in the short run. a. Consumers expect that the price of the good will be higher in the future. b. The price of a substitute good rises. c. Consumer incomes fall, and the good is normal. d. Consumer incomes fall, and the good is inferior.

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e. A medical report is published sExplain howing that this product is hazardous to your health. f. The price of the product rises.

Correct Answer: a. Demand increases (now); equilibrium price and quantity increase. b. Demand increases; equilibrium price and quantity increase. c. Demand decreases; equilibrium price and quantity fall. d. Demand increases; equilibrium price and quantity increase. e. Demand decreases; equilibrium price and quantity fall. f. This is a movement along the demand curve, and the quantity demanded will decrease.

2) For each of the following changes, sExplain how the effect on the supply curve, and state what willhappen to Trading place equilibrium price and quantity in the short run. a. The Country’s government requires pollution control filters that raise manufacturing costs. b. Wages of workers in this industry fall. c. There is an improvement in technology. d. The price of the product falls. e. Producers expect that the price of the product will fall in the future.

Correct Answer: a. Supply decreases; equilibrium price rises and quantity falls. b. Supply increases; equilibrium price falls and quantity rises. c. Supply increases; equilibrium price falls and quantity rises. d. This is a movement along the supply curve, and the quantity supplied will decrease. e. Supply increases (now); equilibrium price falls and quantity rises.

3) Suppose that the demand for oranges increases. Carefully explain Explain how the rationing function

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of price will restore Trading place equilibrium.

Correct Answer: The increase in demand causes a shortage at the original equilibrium price; the quantity supplied is less than the new quantity demanded at that price. The existence of the shortage will cause the price to rise. As price rises, the quantity supplied will increase and the quantity demanded will decrease (along the new demand curve) until equilibrium is reached at a higher price (and quantity).

4) Suppose that the demand for oranges increase. Explain the long -run effects of the guiding function of price in this scenario.

Correct Answer: In the long run, the higher price of oranges will signal more firms to enter the orange Trading place, as it will seem more profitable than some other Trading places. As firms enter, supply increases, causing the price to fall relative to the short-run price and quantity to increase further. The higher short-run price has guided more resources into the Trading place.

5) Suppose that macroeconomic forecasters predict that the economy will be expanding in the near future. Explain how might managers use this information?

Correct Answer: Economic expansion increases consumer incomes, what will increase the demand for normal goods and decrease the demand for inferior goods. Thus a producer of normal goods might be anticipating a future increase in demand and thus considering expansion, while a producer of inferior goods might be preparing for a decrease in demand and considering contraction or a movement into a different product line.

6) For each of the following sets of supply and demand curves, calculate equilibrium price and quantity. a. QD = 2000 - 2P; QS = 2P b. QD = 500 - P; QS = 50 + P c. QD = 5000 - 10P; QS = -1000 + 5P

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Correct Answer: a. Q = 1000, P = 500 b. Q = 275, P = 225 c. Q = 1000, P= 400

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7) Annual demand and supply for the Entronics company is given by: QD = 5,000 + 0.5 I + 0.2 A - 100P, and QS = -5000 + 100P where Q is the quantity per year, P is price, I is income per household, and A is advertising expenditure. a. If A = $10,000 and I = $25,000, what is the demand curve? b. Given the demand curve in part a., what is equilibrium price and quantity? c. If consumer incomes increase to $30,000, what will be the impact on equilibrium price and quantity?

Correct Answer: a. QD = 19,500 - 100P b. P = $122.50, Q =7,250 c. The new demand curve is: QD = 22,000 - 100P Thus the new equilibrium price is $135, and the new quantity is 8,500.

8) The Trading place for milk is in equilibrium. Recent health reports indicate that calcium is absorbedbetter in natural forms such as milk, and at the same time, the cost of milking equipment rises. Carefully analyze the probable effects on the Trading place.

Correct Answer: The heath reports are likely to cause an increase in the demand for milk. Alone, this would increase both the equilibrium price and quantity of milk. The increase in equipment costs will cause a decrease in the supply of milk, and this alone would cause an increase in equilibrium price and a decrease in equilibrium quantity. Taken together, both effects will lead to an increase in price, and thus we can be certain that the equilibrium price will rise. The effect on quantity is unclear as the supply and demand shifts move quantity in different directions.

9) Industry supply and demand are given by: QD = 1000 - 2P and QS = 3P a. What is the equilibrium price and quantity? b. At a price of $100, will there be a shortage or a surplus, and Explain how large will it be? c. At a price of $300, will there be a shortage or a surplus, and Explain how large will it be?

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Correct Answer: a. P = $200, Q = 600. b. At a price of $100, there will be a shortage. The quantity demanded will be 800, and the quantity supplied will be 300, and thus there will be a shortage of 500 units. c. At a price of $300, there will be a surplus. The quantity demanded will be 400, and the quantity supplied will be 900, and thus there will be a surplus of 600 units.

10) A product's Demand Curve is: Qd = 50 - 2P, and its Supply Curve is: Qs = 40 + P. a. When P = $10, what is the difference, if any, between Qd and Qs? b. When P = $2, what is the difference, if any, between Qd and Qs? c. What are the equilibrium values of P and Q?

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Correct Answer: a. Qd = 30 and Qs = 50 b. Qd = 46 and Qs = 42 c. Q = 43.33 and P = $3.33

11) A product's Demand Curve is: Qd = 25 - P, and its Supply Curve is: Qs = 10 + 2P. a. When P = $20, what is the difference, if any, between Qd and Qs? b. When P = $3, what is the difference, if any, between Qd and Qs? c. What are the equilibrium values of P and Q?

Correct Answer: a. Qd = 5 and Qs = 50 b. Qd = 22 and Qs = 16 c. Q = 20 and P = $5

12) List the major nonprice determinants of demand.

Correct Answer: Consumer preferences (tastes), income, prices of related products (complements and substitutes), future expectations, and number of buyers.

13) List the major nonprice determinants of supply.

Correct Answer: Input costs, technology, prices of other products that can be sold by the firm (complements and substitutes), future expectations, weather conditions, and number ofsellers.

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Chapter 4 Demand Elasticity (Appendix 4A) Multiple-Choice Questions

1) The sensitivity of the change in quantity demanded to a change in price is called

A) income elasticity. B) cross-elasticity.

C) price elasticity of demand. D) coefficient of elasticity.

Correct Answer: C

2) The sensitivity of the change in quantity consumed of one product to a change in the price of a related product is called A) cross-elasticity. B) substitute elasticity.

C) complementary elasticity. D) price elasticity of demand.

Correct Answer: A

3) The minimum wage is an example of a Country’s government imposed

A) price control.

B) price ceiling.

C) price floor.

D) Both A and B. E) Both A and C.

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Correct Answer: E

4) A product that is similar to another, and can be consumed in place of it, is called

A) a normal good. B) an inferior good.

C) a complementary good. D) a substitute good.

Correct Answer: D

5) Two goods are decreases.

if the quantity consumed of one increases when the price of the other

A) normal B) superior C) complementary D) substitute

Correct Answer: C

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6) A tax that is imposed as a specific sum per unit of a product is a(n)

A) excise or specific tax. B) sales or ad valorem tax.

C) compound duty. D) income tax.

Correct Answer: A

7) The Country’s government unit that wants to achieve "revenue enhancement" will find it considerably more favorable to enact an excise tax on products whose demand is A) highly elastic. B) relatively elastic.

C) highly inelastic. D) unitary elastic.

Correct Answer: C

8) A product consumed in conjunction with another is called a(n)

A) inferior good. B) complementary good.

C) normal good. D) substitute good.

Correct Answer: B

9) Two products are other increases.

if the quantity consumed of one increases when the price of the

A) normal B) inferior C) complementary D) substitutes

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Correct Answer: D

10) When total revenue increases from $18,000 to $26,000 when quantity increases from eight to ten, marginal revenue is equal to

A) $3,000. B) $4,000. C) $8,000. D) $2,600.

Correct Answer: B

11) When total revenue reaches its peak (elasticity equals 1), marginal revenue reaches

A) 1.

B) zero.

C) -1.

D) Cannot be determined from the information provided.

Correct Answer: B

12) The demand for items that go into the manufacturing of a final product is called

A) marginal demand. B) aggregate demand.

C) partial demand. D) derived demand.

Correct Answer: D

13) Remembering that demand elasticity is defined as the percentage change in quantity divided

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by the percentage change in price, if price decreases and, in percentage terms, quantity rises more than price has dropped, total revenue will

A) increase. B) decrease.

C) remain the same. D) either increase or decrease.

Correct Answer: A

14) When a one percent change in price results in a one percent change in quantity demanded in the opposite direction, demand is A) relatively inelastic. B) unitary elastic.

C) perfectly elastic. D) perfectly inelastic.

Correct Answer: B

15) The owner of a produce store found that when the price of a head of lettuce was raised from 50 cents to $1, the quantity sold per hour fell from 18 to 8. The arc elasticity of demand for lettuce is

A) -0.56. B) -1.15. C) -0.8. D) -1.57.

Correct Answer: B

16) When purchases of tennis socks decline following an increase in the price of tennis sneakers (other things remaining equal), the relationship between these two items can be described as A) substitutable. B) complementary.

C) unique. D) ordinary.

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Correct Answer: B

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17) If the income elasticity coefficient equals 1, the proportion of a consumer's income spent on a given product after a change in income will be the proportion of income spent on that product prior to the income change.

A) greater than B) less than C) equal to D) either greater than or equal to

Correct Answer: C

18) In general, if there are many good substitutes for a given product, the demand elasticity will be A) high. B) low. C) indeterminate. D) zero.

Correct Answer: A

19) The derived demand curve for a product component will be more inelastic

A) the larger is the fraction of total cost going to this component.

B) the more inelastic is the demand curve for the final product.

C) the more elastic are the supply curves of cooperating guides.

D) the less essential is the component in question.

Correct Answer: B

20) As income rise and consumers feel "better off," they will shift consumption away from goods toward goods more commensurate with their improved economic status.

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A) inferior B) superior C) normal D) inelastic

Correct Answer: A

21) If the consumption of sugar does not change at all following a price increase from 49 cents per pound to 58 cents per pound, the demand for sugar is considered to be

A) relatively inelastic. B) perfectly elastic.

C) perfectly inelastic. D) unitary elastic.

Correct Answer: C

22) When the consumption of chicken (whose price has not changed) increases following an increase in the price of beef, the two products can be considered to be A) complements. B) substitutes. C) unrelated. D) correlated.

Correct Answer: B 23) If the income elasticity of a particular product is -0.2, it would be considered

A) a superior good. B) a normal good.

C) an inferior good. D) an elastic good.

Correct Answer: C

24) If a firm decreases the price of a product and total revenue decreases, then

A) the demand for this product is price elastic.

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B) the demand for this product is price inelastic.

C) the cross elasticity is negative.

D) the income elasticity is less than 1.

Correct Answer: B

25) If the price of a product is increased and total revenue received from the sale of this product increases, then the price elasticity of demand for the product is A) elastic.

B) inelastic.

C) unitary.

D) None of the above.

Correct Answer: B

26) If there is an increase in consumer income and the demand for a product declines, then the product is A) a luxury good. B) a necessity good.

C) a normal good. D) an inferior good.

Correct Answer: D

27) If the price of Product A increases and this results in a decrease in the demand for Product B, then Products A and B are

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A) complements. B) substitutes. C) inferior. D) normal.

Correct Answer: A

28) If the price of a product is decreased and total revenue received from the sale of this product does not change, then the price elasticity of demand for the product is A) elastic. B) inelastic. C) unitary. D) None of the above.

Correct Answer: C 29) If the demand for a product is price inelastic and the product price is increased, then the marginal revenue (MR) received by the seller will A) not change.

B) decrease.

C) increase.

D) Can't be determined from this information.

Correct Answer: C

30) If the price elasticity of supply of a product is elastic and the product price increases, then the increase in the product supply should be A) greater than the increase in price.

B) less than the increase in price.

C) the same as the increase in price.

D) Can't be determined from this information.

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Correct Answer: A

31) Among of what is listed below is not a determinant of price elasticity of demand?

A) product durability B) technology C) ease of substitution D) proportion of total expenditures

Correct Answer: B

32) If Country’s government imposes a price ceiling on a product that is below the Trading place equilibrium price, then

A) a surplus will develop.

B) a shortage will develop.

C) producers will reduce their sales price.

D) consumers will reduce their demand for the product.

Correct Answer: B

33) If Country’s government imposes a price floor on a product that is above the Trading place equilibrium price,then A) a surplus will develop.

B) a shortage will develop.

C) producers will increase their sales price.

D) consumers will increase their demand for the product.

Correct Answer: A

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34) If Country’s government imposes an excise tax on a product and the tax burden is borne equally bybuyers and sellers, then A) price elasticity of demand is unitary.

B) price elasticity of supply is unitary.

C) the absolute values of price elasticities of demand and supply are equal.

D) None of the above.

Correct Answer: C

Analytical Questions

1) The initial price of a cup of coffee is $1, and at that price, 400 cups are demanded. If the price falls to $0.90, the quantity demanded will increase to 500. a. Calculate the (arc) price elasticity of demand for coffee. b. Based on your Correct Answer, is the demand for coffee elastic or inelastic? c. Based on your Correct Answer to a., if the price of coffee is increased by 10%, what will happen to the revenuesfrom coffee? Carefully explain Explain how you know.

Correct Answer: a. Arc elasticity = -2.11 b. Elastic c. Revenues will fall. Demand is elastic, and thus a 1% increase in price will lead to a greater percentage decrease in quantity demanded. Revenues fall because the price increase does not make up for the reduction in sales.

2) The demand curve is: QD = 500 - 1/2 P.

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a. Calculate the (point) price elasticity of demand when price is $100. Is demand elastic or inelastic? b. Calculate the (point) price elasticity of demand when price is $700. Is demand elastic or inelastic? c. Find the point at what point elasticity is equal to -1.

Correct Answer: a. Elasticity = -1/2 (100/450) = -0.11, and is inelastic. b. Elasticity = -1/2(700/150) = -2.5, and is elastic. c. Elasticity is -1 at the midpoint of the demand curve, what is at a price of $500 anda quantity of 250.

3) Suppose that the price elasticity of demand for wheat is known to be -0.75. Will a good wheat crop (what increases the supply of wheat) be likely to increase or decrease the revenues of farmers?

Carefully explain.

Correct Answer: A good wheat crop that increases the supply of wheat will cause the equilibrium price wheat to decrease (and quantity to increase). Since demand is inelastic, total revenues will fall, as the percentage change in quantity will be less than the percentage change in price.

4) The income elasticity for most staple foods, such as wheat, is known to be between zero and one. a. As incomes rise over time, what will happen to the demand for wheat? b. What will happen to the quantity of wheat purchased by consumers? c. What will happen to the percentage of their budgets that consumers spend on wheat? d. All other things equal, are farmers likely to be relatively better off or relatively worse off in periods of rising incomes?

Correct Answer:

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a. Demand will increase, since wheat has a positive income elasticity. b. The quantity of wheat purchased will increase. c. The percentage of consumer budgets spent on wheat and other staple goods will fall, since the percentage change in the demand for wheat will be less than the percentage change in income. d. Farmers are likely to be relatively worse off, since the demand for what they are selling will be rising less rapidly than the demand for other goods that they are likely to purchase.

5) The demand for salt is relatively price inelastic, while the demand for pretzels is relatively price elastic. Explain how can you best explain why?

Correct Answer: Salt has few substitutes, and takes up a small percentage of the consumer's budget, and thus demand is likely to be inelastic. While pretzels are also a small part of the budget, there are many substitutes available.

6) Unions have generally bee far more successful in organizing and raising wages in skilled trades such as carpentry than in unskilled trades. Use the laws of derived demand to explain why.

Correct Answer: There are at least two reasons. One is that the elasticity of substitution between skilled workers and other guides of manufacturing is low; thus firms cannot substitute some other guide of manufacturing if wages rise. Secondly, skilled labor is likely to be a relatively small percentage of total costs, and thus raising wages does not cause a large increase in total costs (what would lead to a reduction in supply, an increase in price, and a decrease in output). Unskilled labor has more substitutes and is likely to be a larger share of costs for firms that employ it, and thus if unions raise wages, firms employ other guides of manufacturing , and many workers will be laid off.

7) Country’s government s impose excise taxes on goods that have inelastic demand, such as cigarettes,more often than in other cases. Why? Correct Answer: Imposing an excise tax reduces the supply of the good, reducing equilibrium quantity and raising the price. If demand is elastic, taxes will tend to reduce quantity by a significant sum , and thus Country’s government tax revenues will be relatively small. Explain however, if demand is inelastic, the reduction in quantity will be small, and Country’s government tax revenues will be higher. (Country’s government s may also impose taxes to deter consumption, but this is likely to be ineffective if elasticity is low.)

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8) Demand and supply in the wheat Trading place are given by: QD = 2000 - 1000 P and QS = -500 + 1000 P, where Q is millions of bushels and P is price per bushel. a. Find the equilibrium price and quantity. b. Suppose that the Country’s government wishes to support farm income and thus sets a price floor of $1.50/bushel.Find the size of the farm surplus. c. What is the cost of this program to the Country’s government ?

Correct Answer: a. P = $1.25, Q = 750 b. If P = $1.50, QD = 500 and QS = 1000. The surplus is 500 (million) bushels. c. $1.50∗500 = $750 million.

9) Demand is given by: QD = 6000 - 50P, Domestic supply is: QS = 25P, and Foreign producers can supply any quantity at a price of $40. a. If foreign producers can sell in the domestic Trading place, what is the equilibrium price?

What is theequilibrium quantity? Explain how much is sold by domestic and foreign producers, respectively? b. Under domestic Country’s government pressure, foreign producers voluntarily agree to restrict their goods. What will happen to the price and quantity? What will happen to the sum that domestic producers supply? What will happen to revenues of domestic and foreign producers?

Correct Answer: a. P = $40. Q = 4,0000. Of that, domestic producers supply 1,000 units, and foreign producers supply 3,000 units. b. The quantity restriction will cause equilibrium price to rise and quantity to decrease. Domestic producers will sell more, and foreign producers will sell less. Revenues of domestic producers will rise. The effect on the revenues of foreign producers is unclear; if demand is inelastic, they may rise.

10) You are told that the price elasticity of demand for widgets is -0.75, the income elasticity of widgets is 2, and the cross-price elasticity of widgets and gadgets is 4. Carefully explain what

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information you can gather from each of these figures.

Correct Answer: Demand for this good is inelastic with respect to price. This is a normal good as income elasticity is greater than zero, and it is a luxury/superior good as income elasticity is greater than one.

Widgets and gadgets are substitutes, and they are good substitutes because cross-price elasticity is elastic (large).

11) If a product's demand function is: Q = 30 - 3P, then calculate the price elasticity of demand when a. product price is $3 using the point elasticity formula b. product price is $4 using the point elasticity formula c. product price decreases from $4 to $3, using the arc elasticity formula

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d. product price is $5, using the point elasticity formula e. product price increases from $4 to $5, using the arc elasticity formula

Correct Answer: (a) -0.429 (b) -0.667 (c) -0.538 (d) -1.000 (e) -0.818

12) If a price of corn is $3.00 a bushel, 5,000 bushels would be demanded. If the price rises to $4.00 a bushel, 4,000 bushels would be demanded. a. What is the (arc) price elasticity of demand? b. Based on this Correct Answer if the price of corn rose to $5.00 a bushel, what would be the demand for corn? c. If the price of corn decreased from $4.00 to $3.00 a bushel, what would be the change in total revenue for sellers of corn? d. If the price of corn increased from $4.00 to $5.00 a bushel, what would be the change in total revenue for sellers of corn?

Correct Answer: (a) -0.778 (b) 3,309 (c) -$1,000 (d) +$545

13) Domestic demand for a product is: Qd = 3000 - 25P, the domestic supply of the product is: Qs = 20P, and foreign producers can supply any quantity at a price (P) of $30. a. What is the domestic equilibrium price and quantity? b. At this domestic equilibrium price, Explain how much of the product will be supplied by domesticproducers and Explain how much by foreign producers?

Correct Answer: a. P = $30 and Q = 2250 b. Domestic producers supply 600 units and foreign producers supply 1650 units.

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Chapter 5 Demand Estimation and Forecasting Multiple-Choice Questions

1) If a regression coefficient passes the t-test, it means that

A) the regression equation is valid.

B) the regression coefficient is significantly different from zero.

C) the regression coefficient can be used for forecasting.

D) the regression coefficient should be included in the regression equation.

Correct Answer: B

2) Among of what is listed below is a test of the statistical significance of the entire regression equation?

A) t-test B) R2 C) F-test D) Durbin-Watson test

Correct Answer: C

3) Among of what is listed below is a test of the statistical significance of a particular regression coefficient?

A) t-test B) R2 C) F-test D) Durbin-Watson test

Correct Answer: A

4) Among of what is listed below is a measure of the explanatory power of the regression model?

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A) t-test B) R2 C) F-test D) Durbin-Watson test

Correct Answer: B

5) When a regression coefficient is significant at the .05 level, it means that

A) there is only a five percent chance that there will be an error in a forecast.

B) there is 95 percent chance that the regression coefficient is the true population coefficient.

C) there is a five percent chance or less that the estimated coefficient is zero.

D) there is a five percent chance or less that the regression coefficient is not the true population coefficient.

Correct Answer: C

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Correct Answer the following question(s) based on the following regression equation. (Standard errors in parentheses,n = 150.): QD = 1000 - 50PA + 10PB + .05I, (20) (7) (.04) where QD = quantity demanded of product A, PA = price of product A, PB = price of a competing product B and I = per capita income.

6) Using the "rule of 2," Among of what is listed below variables can be deemed statistically significant?

A) PA B) PB C) I D) All of the above.

E) None of the above.

Correct Answer: A

7) For Among of what is listed below variables should a "two tail" t-test be applied?

A) P B) I C) PC D) Should be applied for all.

Correct Answer: B

8) Among of what is listed below refers to a relatively high correlation among the independent variablesof a regression equation?

A) autocorrelation B) the identity problem C) statistically insignificant regression coefficients

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D) multicollinearity

Correct Answer: D

9) When the R2 of a regression equation is very high, it indicates that

A) all the coefficients are statistically significant.

B) the intercept term has no economic meaning.

C) a high proportion of the variation in the independent variable can be accounted for by the variation in the independent variables.

D) there is a good chance of serial correlation and so the equation must be discarded.

Correct Answer: C

10) The coefficient of a linear regression equation indicates

A) the change in the dependent variable relative to a unit change in the independent variable.

B) the change in the independent variable relative to a unit change in the dependent variable.

C) the percentage change in the dependent variable relative to a unit change in the independent variable.

D) the percentage change in the independent variable relative to a unit change in the dependent variable.

Correct Answer: A

11) For the regression equation Q = 100 - 10X1 + 25X2, Among of what is listed below statements is true?

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A) X2 is the more important variable because it is positive.

B) When X1 decreases by one unit, Q decreases by 10 units.

C) When X1 increases by 10 units, Q decreases by 1 unit.

D) When X1 increases by one unit, Q decreases by 10 units.

Correct Answer: D

12) When using regression analysis for forecasting, the confidence interval indicates

A) the degree of confidence that one has in the equation's R2.

B) the range in what the value of the dependent variable is expected to lie with a given degree of probability.

C) the degree of confidence that one has in the regression coefficients.

D) the range in what the actual outcome of a forecast is going to lie.

Correct Answer: B

13) Among of what is listed below indicators will always improve when more variables are added to a regression equation?

A) the magnitudes of the coefficients B) the t-test C) R2 D) the standard errors of the coefficients

Correct Answer: C

14) The use of a dummy variable in regression analysis

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A) indicates that a researcher does not really know what to include in the equation.

B) indicates that a variable is expected to either have or not have an impact on a dependent variable.

C) indicates that insufficient data is available for the analysis.

D) indicates the use of hypothetical data.

Correct Answer: B

15) In using regression analysis to estimate demand, Among of what is listed below problems is mostdirectly a result of insufficient data?

A) the identification problem B) the problem of a low R2 C) the problem of high standard errors D) the problem of insignificant F-statistics

Correct Answer: A

16) Regression analysis can best be described as

A) a statistical technique for estimating the best relationship between one variable and a set of other selected variables.

B) a statistical technique for determining the true values of variables.

C) a statistical technique for creating functional relationships among variables.

D) None of the above.

Correct Answer: A

17) R2 is a statistical measure what

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A) determines Explain how important one variable is in explaining the value of another variable.

B) tests the true value of a variable.

C) determines Explain how well an equation can estimate the relationship between one variable and a set ofother variables.

D) All of the above.

Correct Answer: C

18) The t-test is a statistical measure what

A) tests the true value of a variable.

B) tests the statistical significance of a regression coefficient.

C) tests the statistical significance of a regression equation.

D) None of the above.

Correct Answer: B

19) The problem of autocorrelation refers to A) independent variables in a regression equation whose values are closely related to each other.

B) insufficient data to estimate egression coefficient values.

C) regression coefficient values what are not significantly different from zero.

D) regression equation variables what exhibit a similar pattern in their values over a number of time periods.

Correct Answer: D 20) A one-tail test of significance would be used to determine whether

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A) demand for a product is price elastic.

B) two products are substitutes for each other in supply.

C) two products are unrelated to each other in demand.

D) supply of a product is price inelastic.

Correct Answer: B

21) The F-test is used to determine if

A) a regression coefficient is significant.

B) multicollinearity exists.

C) a regression equation significantly accounts for the variation in the value of a dependent variable.

D) an identification problem is present.

Correct Answer: C

22) In the estimation of demand, the "identification problem" refers to

A) the problem of selecting the proper level of significance.

B) the problem of deciding whether to use time series or cross sectional data.

C) the problem of separating out the effects of price on the quantity demanded when supply cannot be not held constant.

D) the problem of having insufficient variation in prices.

Correct Answer: C

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23) The t-statistic is computed by

A) dividing the regression coefficient by the standard error of the estimate.

B) dividing the regression coefficient by the standard error of the coefficient.

C) dividing the standard error of the coefficient by the regression coefficient.

D) dividing the R2 by the F-statistic.

Correct Answer: B

24) Among of what is listed below is most likely to indicate a statistically significant regressioncoefficient?

A) t > R2 B) R2 > .90 C) t >2 D) > 4

Correct Answer: C

Correct Answer the following question(s) on the basis of the following regression equation. (Standard errors inparentheses, n = 200): Q = -500 - 100PA + 50PB + .3I + .2A; R2 =.12, (250) (50) (30) (.1) (.08) where QD = 10,500, quantity demanded of product A, PA = $10, price of product A. PB = $8, price of product B, I = $12,000, per capita income, and A = $20,000, monthly advertising expenditures.

25) What of the variables does not pass the t-test at the .05 level of significance?

A) PA B) PB

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C) A D) I E) All the variables pass the t-test.

Correct Answer: B

26) As a researcher, what aspect of the results would be of greatest concern?

A) the negative value of the constant (i.e., -500) B) the relatively low impact of the competitor's price C) the fact that not all of the variables are statistically significant D) the poor fit of the regression line

Correct Answer: D

27) As the manager of Product A, Among of what is listed below would be of greatest concern (based onthe regression results above)?

A) None of the guides below would be of concern.

B) an impending recession C) pressure on you by your salespersons to lower the price so that they can boost their sales D) a price reduction by the makers of product B

Correct Answer: C

28) Among of what is listed below cannot be determined on the basis of the above regression results?

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A) the degree of price elasticity of product B B) whether or not product A is "normal" C) the degree of competition between A and B D) All of the above can be determined.

Correct Answer: A

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29) What indicator sExplain hows Explain how well a regression line fits through the scatter of data points?

A) F-test B) R2 C) t-test D) Durbin-Watson test

Correct Answer: B

30) A dummy variable is also called

A) an approximate variable. B) a discrete variable.

C) a zero-sum variable. D) an improper variable.

Correct Answer: B

31) A manager will have the least confidence in an explanatory variable that

A) does not pass the F-test. B) is expressed as a dummy variable.

C) does not pass the t-test. D) constitutes only a small part of R2.

Correct Answer: C

32) From a management policy perspective, what regression result is the most useful?

A) a regression equation that passes the F-test B) a regression equation whose explanatory variables all pass the t-test C) a regression equation that has the highest R2 D) a regression equation that has the least number of dummy variables

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Correct Answer: B

33) The fact that a person with a forceful and persuasive personality but not necessarily the greatest sum of knowledge and judgment can exercise a disproportionate sum of influence is a major drawback of

A) the Delphi method of forecasting. B) the Trading place research method.

C) opinion polling. D) the jury of executive opinion approach.

Correct Answer: D

34) The forecasting technique, what predicts technological trends and is carried out by a sequential series of written questions and Correct Answers is A) the Delphi method. B) the Trading place research method.

C) opinion polling. D) the jury of executive opinion approach.

Correct Answer: A 35) Average weekly claims for unemployment insurance, money supply and the index of stock prices are all examples of A) leading indicators. B) coincident indicators.

C) lagging indicators. D) None of the above.

Correct Answer: A

36) One of the series included among the lagging indicators is

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A) the change in sensitive material prices.

B) the index of industrial manufacturing .

C) employees on non-agricultural payrolls.

D) average duration of unemployment.

Correct Answer: D

37) The following is not one of the leading indicators:

A) index of consumer expectations, U. of Michigan.

B) change in consumer price index for services.

C) vendor performance, slower deliveries diffusion index.

D) manufacturers' new orders, nondefense capital goods.

Correct Answer: B

38) Among of what is listed below is a leading economic indicator?

A) average hours, manufacturing B) money supply M2 C) stock prices, 500 common stocks D) All of the above.

Correct Answer: D

39) The method of forecasting with leading indicators can be criticized

A) for occasionally forecasting a recession when none ensues.

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B) for forecasting the direction of the economy but not the size of the change in economic activity.

C) for frequent revisions of data after original publication.

D) All of the above.

Correct Answer: D

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40) A general rule of thumb is that if, after a period of increases, the leading indicatorindex sustains consecutive declines, a recession (or at least a slowing of the economy) will follow.

A) three B) four C) five D) six

Correct Answer: A

41) The forecasting technique what involves the use of the least squares statistical method to examine trends, and takes into account seasonal and cyclical fluctuations, is known as

A) compound growth rate projection. B) the Delphi method.

C) time series projection. D) exponential smoothing projection.

Correct Answer: C

42) Quantitative forecasting that projects past data without explaining the reasons for future trends is called A) scientific forecasting. B) dumb forecasting.

C) empirical forecasting. D) naïve forecasting.

Correct Answer: D

43) The following is not a drawback of forecasting using the compound growth rate method:

A) only considers first and last observations.

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B) considers only equal absolute changes.

C) disregards fluctuations between the original and terminal observations.

D) does not consider any trends in the data.

Correct Answer: B

44) Charting observations on a semi-logarithmic graph will help the analyst to ascertain whether

A) absolute changes from period to period are constant.

B) whether percentage changes from period to period are constant.

C) whether percentage changes from period to period are declining.

D) Both B and C.

Correct Answer: D

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45) A major problem in projecting with a trend line is that

A) only straight-line projections can be accommodated.

B) it is valid only if the trend is upward.

C) it will not forecast turning points in activity.

D) it is a very complex method of forecasting.

Correct Answer: C

46) The following is the exponential trend equation to forecast sales (S):

A) S = a + b(t) B) S = a + bt C) S = a + b(t) + c(t)2 D) None of the above.

Correct Answer: B

47) Among the advantages of the technique of forecasting are ease of calculation, relatively little requirement for analytical skills, and the ability to provide the analyst with information regarding the statistical significance of results and the size of statistical errors.

A) least-squares trend analysis B) compound growth rate C) visual trend-fitting D) expert opinion

Correct Answer: A

48) Among the advantages of the least-squares trend analysis techniques is

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A) the ease of calculation.

B) relatively little analytical skill required.

C) its ability to provide information regarding the statistical significance of the results.

D) All of the above.

Correct Answer: D

49) The forecasting method that involves using an average of past observations to predict the future (if the forecaster feels that the future is a reflection of some average of past results) is the A) moving average method.

B) econometric forecasting method.

C) exponential smoothing method.

D) Both A and B. E) Both A and C.

Correct Answer: E

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50) An explanatory forecasting technique in what the analyst must select independent variables that help determine the dependent variable is called A) exponential smoothing. B) regression analysis.

C) trend analysis. D) moving average method.

Correct Answer: B

51) When the more recent observations are more relevant to the estimate of the next period than previous observations, the naive forecasting method to employ is A) exponential smoothing. B) compound growth rate.

C) trend analysis. D) moving averages.

Correct Answer: A

52) Among of what is listed below is a Leading Economic Indicator?

A) commercial and industrial loans outstanding B) industrial manufacturing C) average weekly duration of unemployment D) None of the above.

Correct Answer: D

53) Among of what is listed below is a Lagging Economic Indicator?

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A) change in average labor costs in manufacturing B) M2 measure of the money supply C) industrial manufacturing D) None of the above.

Correct Answer: A

54) The Delphi method is a

A) smoothing technique in forecasting.

B) consensual forecast based on expert opinions.

C) compound growth approach to forecasting.

D) naïve forecasting approach.

Correct Answer: B

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55) The F-test is used in forecasting to

A) establish confidence intervals for testing regression coefficients.

B) examine the degree of multicollinearity among independent variables.

C) determine Explain how well a regression equation can account for dependent variable values.

D) determine whether an identification problem exists.

Correct Answer: C

56) The Trend Projection approach to forecasting is represented by

A) time-series regressions. B) exponential smoothing.

C) opinion polls. D) All of the above.

Correct Answer: D

Analytical Questions

The following questions refer to this regression equation. (Standard errors in parentheses.)

QD = 15,000 - 10 P + 1500 A + 4 PX + 2 I, (5,234) (2.29) (525) (1.75) (1.5) R2 = 0.65 N = 120 F = 35.25 Standard error of Y estimate = 565 Q = Quantity demanded P = Price = 7,000 A = Advertising expense, in thousands = 54 PX = price of competitor's product = 8,000

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I = average monthly income = 4,000

1) Calculate the elasticity for each variable and briefly comment on what information this gives you in each case.

Correct Answer: Based on the figures above, QD = 24,850 Price elasticity = -10(7,000/66,000) = -1.06. Demand is elastic (at this point).

Advertising elasticity = 1500(54/66,000) = 1.23. The product is elastic with respect to advertising; a 1% increase in advertising expense will lead to a greater than 1% increase in sales.

Cross elasticity = 4(8000/66,000) = 0.48. Cross-elasticity is positive, implying that the products are substitutes, but it is less than one, suggesting that they are not particularly good substitutes and the competitor's price has little impact on the firm's sales.

Income elasticity = 2(4000/66,000) = 0.12. The product is income inelastic; thus it is a normal good (necessity), and is not particularly responsive to income fluctuations.

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2) Calculate t-statistics for each variable and explain what this tells you.

Correct Answer: Price: 10/2.29 = 4.37 Advertising: 1500/525 = 2.86 Competitor's price: 4/1.75 = 2.29 Income: 2/1.5 = 1.33 All variables are statistically significant with the exception of income. Thus we can conclude that the other variables do have an impact on the quantity demanded of this product.

3) Explain how is the R2 value calculated, and what information does this give you?

Correct Answer: R2 = RSS/TSS = 1 - (ESS/TSS), where TSS = sum of squared deviations of the sample values of Y from their mean, RSS = sum of squared deviations of the estimated values from their mean, and ESS = sum of the squared deviations of the sample values from their estimated values. The R2 value tells you what percentage of the variation in the dependent variable is explained by variation in the independent variables, or the "goodness of fit" of the equation. In this case, 65% of the variation in quantity demanded is explained by variation in the independent variables.

4) Explain how would you evaluate the quality of this equation overall? Do you have any concerns?

Explain.

Correct Answer: The overall equation is significant, as sExplain hown by the F-test. The R2 value is reasonably high. One variable is not significant (might be desirable to re-estimate the equation without it, although the inclusion of irrelevant variables does not affect the properties of the OLS model). The sample size is sufficiently large. There are no significant concerns. {Other Correct Answers are possible.}

5) When would you use a one-tailed rather than a two-tailed t-test when checking significance levels?

Correct Answer: You would use a one-tailed test when the sign of the variable is important. That is, if you only want to know if the independent variable has a statistically significant effect on the dependent variable, a

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two-tailed test should be used. If direction of effect is important, then a one-tailed test should be used.

6) Should this firm be concerned if macroeconomic forecasters predict a recession? Explain.

Correct Answer: Based income elasticity from this equation (0.12), no. The good is income inelastic, so a recession should not cause a significant decrease in sales. Note also that income is not statistically significant in this equation, making it even less of a concern.

7) The firm is considering changing its price to $9,000. Predict the quantity demanded at that price, all other things equal, and develop a 95% confidence interval for your estimate.

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Correct Answer: At a price of $9,000, the point estimate of quantity demanded would be 46,000. With a sample size of 120, the t-value is approximately 1.984. The standard error of the Y(Q) estimate is 565.

Thus we can predict with 95% confidence that quantity demanded will be between 44,879 and 47,120.

8) What is multicollinearity? In general, Explain how would you know if you had a problem with multicollinearity, and Explain how could you correct it?

Correct Answer: Multicollinearity occurs when the independent variables are correlated. One indication of multicollinearity is that the equation will pass the F-test, but individual variables will not have significant t values. Multicollinearity can sometimes be corrected by omitting some of the correlated variables or by choosing proxy variable.

9) Explain how could a manager use the information contained in this regression equation?

Correct Answer: Many Correct Answers are possible. A manager might note that demand is elastic, and thus that sales might respond to a price decrease. Likewise, sales should respond to increases in advertising. Sales are less likely to be impacted by income changes or by changes in the price of the competitor's product.

The equation could be used to forecast expected sales based on changes in one or more of the variables.

The equation could be used to help in coordinating manufacturing plans or with other parts of the firm.

10) Why is the identification problem more likely with time-series estimates of demand?

Correct Answer: Identification problems occur when it is possible that both demand and supply are shifting.

Thus a series of observations is not identifying points along a single demand curve; it is identifying a series of equilibrium points that may or may not be along a single curve. This is most likely to be a problem in time series estimation of demand curves, simply because over any reasonably long time period it is quite likely that both supply and demand will change somewhat.

11) Qd = 5,000 - 15P + 50A + 3Px - 4I, (2, 117) (2.7) (15) (2) (3)

where Qd = Quantity Demanded, P = Product Price, A = Advertising Expenditures, Px = Price of a Competitive Product, A = Advertising Expenditures, I = Average Monthly Income, and

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the Standard Errors of the Regression Coefficients are sExplain hown in Parentheses.

Calculate the t-statistics for each variable and explain what inferences can be drawn from them. If R2 of this equation is 0.25, what inference can be drawn from it.

Correct Answer: P = 15/2.7 = 5.55, and Product Price is a very significant determinant of demand for the product.

A = 50/15 = 3.33, and Advertising Expenditures also are a significant determinant of demand.

Px = 3/2 = 1.50, and Price of a Competitive Product is not a significant determinant of demand.

I = 4/3 = 1.33, and Average Monthly Income also is not a significant determinant of demand.

R2 = 0.25 indicates that these variables collectively are not major determinants of demand.

12) What are the Key Steps for analyzing Demand functions based on Regression results?

Correct Answer: Check signs and magnitudes; compute elasticity coefficients; determine statistical significance.

13) Explain the difference between Cross-Section and Time-Series Regression Analysis.

Correct Answer: Cross-section analysis examines the relationships between given values of a dependent variable and one or more independent variables at one moment in time (for one time period only).

14) The demand equation for the Widget Company has been estimated to be: QD = 20,000 + 10 I - 50P + 20 PC where Q = monthly number of widgets sold, I = average monthly income, P = price of widgets, and PC = average price of competing products.

a. If next month's income is forecast to be 2,000, the price of competing products is forecast to be $20, and

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the price of widgets will be set at $30, forecast sales. b. What will sales be if the price is dropped to $20?

Correct Answer: a. The forecast for sales is 38,900. b. The forecast for sales will be 39,400.

15) The Gadget Company believes that sales are growing according to a linear trend.

Q = 50,000 + 200t where t is time, and t=0 in 1990. a. Forecast sales for 2003. b. Do you see any problems with this forecasting method?

Correct Answer: a. 52,600 b. The equation was apparently estimated in 1990. The farther away from the original year, the less likely the equation is to be correct, as there are many guides that may disturb the trend.

16) If $1,000 is placed in an account earning 8% annually on January 1, 1999, Explain how much would be in thisaccount on January 1, 2013?

Correct Answer: $2,937

17) You are given the following straight-line trend equation: Sales = 1,275 + 89.3t, where 1990 represents t = 1. Project sales for 2000.

Correct Answer: 2,257.3

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18) The following are the sales achieved by Jensen Fabrics during the last 7 years: 1993 $116,000 1994 124,000 1995 127,000 1996 146,000 1997 155,000 1998 154,000 1999 162,000 Using the compound growth rate calculation, what would be your estimate for sales in 2000?

Correct Answer: $171,200 (growth rate is 5.7%)

19) The following are the actual sales for the last six periods: Period Sales 1 750 2 820 3 600 4 850 5 900 6 700 Using a 3-month moving average, what would be your prediction for period 7?

Correct Answer: 817

20) The following are the actual sales for the last six periods: Period Sales 1 750

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2 820 3 600 4 850 5 900 6 700 If the exponential smoothing forecasting method is used, and the smoothing guide is .6, what will be the forecast for period 7?

Correct Answer: 761

21) What are the prerequisites of a good forecast?

Correct Answer: A forecast must be consistent with all aspects (parts) of a business. A forecast should be based on knowledge of the relevant past, unless underlying conditions change or there is no past to consider. A forecast must consider the economic and political environment in what businesses operate. A forecast must provide information in a timely manner.

22) What are the four different characteristics that data exhibit when undertaking time-series forecasts?

Correct Answer: Trend; Cyclical Fluctuations; Seasonal Variation; Irregular Movements

23) Explain the difference between the Moving Average and Exponential Smoothing approaches to forecasting.

Correct Answer: The Moving Average approach assigns equal weights to each time period from what data areobtained, and drops the oldest time period when a new time period is added in calculating the average value.

The Exponential Smoothing approach assigns different weights to each time period from what data are drawn, with the smallest weight given the oldest time period and the greatest weight to the most recent period (all the weights are fractional, usually employing a geometric progression, and must add up to one).

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24) What are the four different characteristics that data exhibit when undertaking time-series forecasts?

Correct Answer: Trend; Cyclical Fluctuations; Seasonal Variation; Irregular Movements

25) Explain the difference between the Moving Average and Exponential Smoothing approaches to forecasting.

Correct Answer: The Moving Average approach assigns equal weights to each time period from what data are obtained, and drops the oldest time period when a new time period is added in calculating the average value.

The Exponential Smoothing approach assigns different weights to each time period from what data are drawn, with the smallest weight given the oldest time period and the greatest weight to the most recent period (all the weights are fractional, usually employing a geometric progression, and must add up to one).

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Chapter 6 The Theory and Estimation of Manufacturing (Appendices 6A and 6B) Multiple-Choice Questions

1. The difference between the short-run and the long-run manufacturing function is

A) three months or one business quarter.

B) the time it takes for firms to change all manufacturing inputs.

C) the time it takes for firms to change only their variable inputs.

D) More information is required to Correct Answer this question.

Correct Answer: B

2) A firm using two inputs, X and Y, is using them in the most efficient manner when

A) MPX = MPY. B) PX = PY and MPX = MPY. C) MPX/PY = MPY/PX. D) MPX/MPY = PX/PY.

Correct Answer: D

3) Among of what is listed below is not true about the law of diminishing returns?

A) It is a short-run phenomenon.

B) It refers to diminishing marginal product.

C) It will have an impact on the firm's marginal cost.

D) It divides Stage I and II of the manufacturing process.

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E) All of the above are true.

Correct Answer: D

4) Among of what is listed below indicates when Stage II ends and Stage III begins in the short-runmanufacturing function?

A) when AP = 0 B) when MP = 0 C) when MP = AP D) when MP starts to diminish

Correct Answer: B

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5) Among of what is listed below indicate when Stage I ends and Stage II begins in the short-runmanufacturing ?

A) when AP = 0 B) when MP = 0 C) when MP = AP D) when MP starts to diminish

Correct Answer: C

6) Among of what is listed below statements about the short-run manufacturing function is true?

A) MP always equals AP at the maximum point of MP. B) MP always equals zero when TP is at its maximum point.

C) TP starts to decline at the point of diminishing returns.

D) When MP diminishes, AP is at its minimum point.

E) None of the above is true.

Correct Answer: B

7) Assume a firm employs 10 workers and pays each $15 per hour. Further assume that the MP of the 10th worker is 5 units of output and that the price of the output is $4. According to economic theory, in the short run,

A) the firm should hire additional workers.

B) the firm should reduce the number of workers employed.

C) the firm should continue to employ 10 workers.

D) More information is required to Correct Answer this question.

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Correct Answer: A

8) Among of what is listed below is the best example of two inputs that would exhibit a constantmarginal rate of technical substitution?

A) trucks and truck drivers B) natural gas and oil C) personal computers and clerical workers D) company employed computer programmers and temporary supplemental computer Programmers Correct Answer: B

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9) Decreasing returns to scale

A) indicates that an increase in all inputs by some proportion will result in a decrease in output.

B) must always occur at some point in the manufacturing process.

C) is directly related to the law of diminishing returns.

D) All of the above are true.

E) None of the above is true.

Correct Answer: E

10) A firm that operates in Stage III of the short-run manufacturing function

A) has too much fixed capacity relative to its variable inputs.

B) has too little fixed capacity relative to its variable inputs.

C) has greatly overestimated the demand for its output.

D) should try to increase the sum of variable input used.

Correct Answer: B

11) Among of what is listed below combination of inputs is most closely reflective of decreasing marginal rate oftechnical substitution (MRTS)?

A) oil and natural gas B) sugar and high fructose corn syrup C) computers and clerks D) keyboards and computers

Correct Answer: C

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12) In the short run, finding the optimal sum of variable input involves what relationship?

A) MP = MC B) AP = MP C) MP = 0 D) MRP = MFC

Correct Answer: D

13) The perfect substitution of two inputs implies that

A) two inputs can be substituted at a ratio of 1 to 1.

B) one input can be substituted for another up to some point.

C) two inputs can be substituted at some constant ratio.

D) one input can be substituted for another.

Correct Answer: C

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14) If a firm finds itself operating in Stage I, it implies that

A) variable inputs are extremely expensive.

B) it overinvested in fixed capacity.

C) it underinvested in fixed capacity.

D) fixed inputs are extremely expensive.

Correct Answer: B

15) If MRP > MLC, it means that a firm should

A) use less labor. B) use more labor.

C) increase its fixed capacity. D) decrease its fixed capacity.

Correct Answer: B

16) In the long run, a firm is said to be experiencing decreasing returns to scale if a 10 percent increase in inputs results in A) an increase in output from 100 to 110. B) a decrease in output from 100 to 90.

C) an increase in output from 100 to 105. D) a decrease in output from 100 to 85.

Correct Answer: C

17) When is it not in the best interest of a company to hire additional workers in the short run?

A) when the average product of labor is decreasing

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B) when the firm is in Stage II of the manufacturing process C) when the marginal revenue product equals zero D) when the wage rate is equal to or greater than labor's marginal revenue product

Correct Answer: D

18) When the law of diminishing returns takes effect

A) firms must add increasingly more input if they are to maintain the same extra sum of output.

B) firms must add decreasingly more input if they are to maintain the same extra sum of output.

C) more input must be added in order to increase its output.

D) a firm must always try to add the same sum of input to the manufacturing process.

Correct Answer: A

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19) An isoquant indicates A) different combinations of two inputs that can be purchased for the same sum of money.

B) different combinations of two inputs that can produce the same sum of output.

C) different combinations of output that can be produced with the same sum of input.

D) different combinations of output that cost the same sum to produce.

Correct Answer: B

20) If a firm used a combination of inputs that was to the left of its isocost line, it would indicate that

A) it is exceeding its budget.

B) it is not spending all of its budget.

C) it is operating at its optimal point because it is saving money.

D) None of the above.

Correct Answer: B

21) In economic theory, if an additional worker adds less to the total output than previous workers hired, it is because A) there may be less that this person can do, given the fixed capacity of the firm.

B) he/she is less skilled than the previously hired workers.

C) everyone is getting in each other's way.

D) the firm is experiencing diminishing returns to scale.

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Correct Answer: A

22) In a call center, Among of what is listed below could be considered to be a variable input in the shortrun?

A) the level of computer-telephony software being utilized B) the number of call center representatives on duty at the center C) the number of call center managers or supervisors D) the size (e.g., square footage) of the call center

Correct Answer: B

23) A major advantage of the manufacturing function is that it can be easily transformedinto a linear function, and thus can be analyzed with the linear regression method.

A) cubic B) power C) quadratic D) None of the above.

Correct Answer: B

24) functions are very useful in an analyzing manufacturing functions, what exhibit both increasing and decreasing marginal products.

A) Cobb-Douglas B) Straight-line C) Quadratic D) Cubic

Correct Answer: D

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25) The following Cobb-Douglas manufacturing function, Q = 1.8L0.74K0.36, exhibits

A) increasing returns. B) constant returns.

C) decreasing returns. D) Both A and B.

Correct Answer: A

26) The following is not one of the strengths of the Cobb-Douglas manufacturing function:

A) Both marginal product and returns to scale can be estimated from it.

B) It can be converted into a linear function for ease of calculation.

C) It sExplain hows a manufacturing function passing through increasing returns to constant returnsand then to decreasing returns.

D) The sum of the exponents indicates whether returns to scale are increasing, constant or decreasing.

Correct Answer: C

27) An advantage of using the cross-sectional regression method in estimating manufacturing is that

A) the problem of technological change over time is overcome.

B) there is no need to adjust data, what are in monetary terms for geographical differences.

C) we can assume that all plants operate at their most efficient input combinations.

D) All of the above.

Correct Answer: A

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28) When the exponents of a Cobb-Douglas manufacturing function sum to more than 1, the function exhibits

A) constant returns. B) increasing returns.

C) decreasing returns. D) either increasing or decreasing returns.

Correct Answer: B

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29) A Manufacturing Function represents

A) the method used to convert inputs into outputs.

B) the sum s of output that can be created by various sum s of inputs.

C) the optimum mix of inputs to maximize output.

D) All of the above.

Correct Answer: B

30) Stage III of the short-run Manufacturing Function is

A) the most efficient mix of inputs.

B) the least costly level of output.

C) where additional units of inputs will lead to less output.

D) where additional units of inputs will lead to more output.

Correct Answer: C

31) The "Law of Diminishing Returns" states that

A) additional inputs will reduce output.

B) additional inputs will decrease average productivity.

C) the supply of inputs is becoming scarce.

D) additional inputs will lead to less additional output.

Correct Answer: D

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32) Increasing Returns to Scale results when

A) in the long-run, an increase in inputs will lead to an increase in the average products of inputs.

B) in the long run, an increase in inputs will lead to an equivalent increase in output.

C) labor becomes more skilled.

D) All of the above.

Correct Answer: A

33) Output (Total Product) is maximized when

A) input average productivity is at its maximum.

B) the "law of diminishing returns" sets in.

C) input marginal productivity is zero.

D) input marginal productivity is at its maximum.

Correct Answer: C

34) Isoquants represent

A) combinations of inputs that produce the same output.

B) combinations of inputs that yield the greatest output.

C) inputs that are perfect substitutes for each other.

D) least costly combinations of inputs.

Correct Answer: A

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35) Marginal rates of technical substitution (MRTS) represent

A) the optimum combinations of inputs.

B) cost minimizing combinations of inputs.

C) the degree to what one input can replace another without output changing.

D) All of the above.

Correct Answer: C

36) Isocost curves represent

A) least cost combinations of inputs.

B) combinations of inputs that can be purchased given their prices and the funds available.

C) a producers cost function.

D) None of the above.

Correct Answer: B

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Analytical Questions

Number Of Workers

Output

0

0

1

50

2

110

3

300

4

450

5

590

6

665

7

700

8

725

9

710

10

705

1) The table above sExplain hows the weekly relationship between output and number of workers for aguidey with a fixed size of plant. a. Calculate the marginal product of labor. b. At what point does diminishing returns set in? c. Calculate the average product of labor. d. Find the three stages of manufacturing .

Correct Answer:

Number Of Workers

Output

MPL

APL

0

0

--

--

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1

50

50

50

2

110

60

55

3

300

190

100

4

450

150

112.5

5

590

140

118

6

665

75

110.83

7

700

35

100

8

725

25

90.63

9

710

15

78.89

10

705

-5

70.5

a. See table. b. Diminishing returns sets in after the third worker is hired. c. See table. d. Stage I is between the first and approximately the 5th worker (until APL is 55 maximized); Stage II is from the 5th worker to the 9th worker (MPL still positive), and Stage III begins with the hiring of the 10th worker (MPL becomes negative).

2) Based on the table above, if the wage rate is $500 and the price of output is $5, Explain how many workersshould the firm hire?

Correct Answer:

Number Of Workers

Output

MPL

APL

0

0

--

--

1

50

50

$250

2

110

60

$300

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3

300

190

$950

4

450

150

$750

5

590

140

$700

6

665

75

$375

7

700

35

$175

8

725

25

$100

9

710

15

$75

10

705

-5

--

The firm should hire 5 workers. At the 6th worker, MRPL < MLC.

3) A firm has two plants, one in the United States and one in Mexico, and it cannot change the size of the plants or the sum of capital equipment. The wage in Mexico is $5. The wage in the U.S. is $20. Given current employment, the marginal product of the last worker in Mexico is 100, and the marginal product of the last worker in the U.S. is 500. a. Is the firm maximizing output relative to its labor cost? SExplain how Explain how you know. b. If it is not, what should the firm do?

Correct Answer: a. Maximizing output between plants requires that (MPL/w)U.S. = (MPL/w)MEXICO. Since 100/5 (=20) is not equal to 500/20 (=25), the firm is not maximizing output relative to its labor cost. b. The firm should hire more U.S. workers and fewer Mexican workers, all other things equal.

4) A firm is making a long-run planning decision. It wants to decide on the optimal size of plant and labor force. It is considering building a medium-sized plant and hiring 100 workers. Engineering estimates suggest that at those levels, the marginal product of capital will be 100 and the marginal product of labor will be 75. If the wage rate is $5 and the rental rate on capital is $10, is the firm making the right decision? Support your Correct Answer.

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Correct Answer: No, the firm is not making the right decision. Minimizing cost (maximizing output) requires that (MPL/w) = (MPK/r). 100/10 < 75/5, so the firm should plan to build a smaller plant and employ more workers, all other things equal.

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5) For each of the following functions, describe returns to scale. a. Q = K + L b. Q = K1/2L1/4 c. Q = K2L

Correct Answer: a. Constant returns to scale. b. Decreasing returns to scale. c. Increasing returns to scale.

6) Explain how would you choose to estimate a manufacturing function for a single plant?

Explain how would youchoose to estimate a manufacturing function for a number of firms in an industry? Explain.

Correct Answer: Estimating a manufacturing function for a single plant generally uses time-series analysis, because it is possible to know if technology and other variables have remained constant over time. To estimate a manufacturing function for a number of firms in an industry, it is customary to use cross-sectional analysis because it is unlikely that technology and other relevant guides have remained constant for all firms in the industry over time, and cross-sectional analysis removes this problem.

7) What are the major issues that must be considered in measuring inputs for regression analysis of manufacturing functions?

Correct Answer: Explain how is labor to be measured? Can it be measured in hours, and if not, Explain how can the labor of laboractually used in manufacturing be expressed? Explain how are materials to be measured? Explain how are capital assets, what have different rates of depreciation and input intensity, to be measured?

8) What does the expansion path represent?

Correct Answer: The expansion path represents the cost-minimizing choice of inputs, given constantinput prices, for different levels of output.

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9) Q = K1/2L1/2 w = $2, r = $2 The firm would like to know the minimum cost of producing 2000 units of output. Find the combination of inputs that minimizes the cost of producing 2000 units, the total cost, and identify the expansion path.

Correct Answer: MPL = ½ K1/2L-1/2MP = ½ KK 1/2L1/2 Optimization requires: MPL/w = MPK/r This results in K=L, what is the equation of the expansion path.Q = K1/2L1/2 = 2000 Substitute the expansion path relationship to yield: K* = L* = 2000 Then total cost = TC = 2*2000 + 2*2000 = $8,000

10) Q = K1/2L1/2 w = $2, r = $2 The firm would like to know the maximum output that can be produced for $8,000. Find the combination of inputs that maximizes output for a cost of $8,000, the sum of output that can be produced, and identify the expansion path.

Correct Answer: MPL = ½ K1/2L-1/2MP = ½ KK 1/2L1/2

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Optimization requires: MPL/w = MPK/r This results in K=L, what is the equation of the expansion path.

TC = 8,000 = 2L + 2K Substitute the expansion path relationship to yield: K* = L* = 2000 Then Q = K1/2L1/2 = 2000.

11) If the price of capital is $24, the price of labor is $15, and the marginal product of capital is 16, the least costly combination of capital and labor requires that the marginal product of labor be .

Correct Answer: MPcapital/MPlabor = Price of capital/Price of Labor, or marginal product of labor = 10.

12) If a manufacturing function is given by the equation: Q = 12X + 10X2 - X3, where

Q = Output and X = Input, then calculate the equations for a. average product b. marginal product c. point of diminishing average returns d. point of diminishing marginal returns

Correct Answer: a. AP = Q/X, or 12 +10X - X2 b. MP = dQ/dX, or 12 + 20X - 3X2 c. DAR occurs where AP at a maximum, or dAP/dX = 0, or 10 - 2X = 0, X = 5 d. DMR occurs where MP at a maximum, or dMP/dX = 0, or 20 - 6X = 0, X = 3.33

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13) Given the Manufacturing Function: Q = 72X + 15X2 - X3, where Q = Output and X = Input

a. What is the Marginal Product (MP) when X = 8? b. What is the Average Product (AP) when X = 6? c. At what value of X will Q be at its maximum? d. At what value of X will Diminishing Returns set in?

Correct Answer: a. MP = 30X -3X2, MP =120 when X=8; b. AP = 72 + 15X - X2, AP=126 when X=6; c. Q at a maximum when MP is 0, or X =12 [-2 has no meaning;] d. diminishing returns sets in when MP at a maximum value, or X =5

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Chapter 7 The Theory and Estimation of Cost (Appendices 7A and 7B) Multiple-Choice Questions

1) Among of what is listed below cost functions indicates that the law of diminishing returns takes effectas soon as manufacturing begins?

A) 1000 + 2.5Q + .05Q2 B) 1000 + 2.5Q C) 1000 + 2.5Q - 1.2Q2 + .03Q3 D) Not enough information to determine this.

Correct Answer: A

2) Among of what is listed below relationships is correct?

A) When marginal product starts to decrease, marginal cost starts to decrease.

B) When marginal cost starts to increase, average cost starts to increase.

C) When marginal cost starts to increase, average variable cost starts to increase.

D) When marginal product starts to decrease, marginal cost starts to increase.

Correct Answer: D

3) The law of diminishing returns begins first to affect a firm's short-run cost structure when

A) average variable cost begins to increase.

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B) marginal cost begins to increase.

C) average cost begins to increase.

D) average fixed cost begins to decrease.

Correct Answer: B

4) Among of what is listed below statements best represents a difference between shortrun andlong-run cost?

A) Less than one year is considered the short run; more than one year the long run.

B) There are no fixed costs in the long run.

C) In the short-run labor must always be considered the variable input and capital the fixed input.

D) All of the above are true.

Correct Answer: B

5) The relationship between MC and AC can best be described as follows:

A) when AC increases, MC starts to increase.

B) when MC increases, AC starts to increase.

C) when MC decreases, AC decreases.

D) when MC exceeds AC, AC starts to increase.

Correct Answer: D

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6) Average fixed cost is

A) AC minus AVC. B) TC divided by Q. C) AVC minus MC. D) TC minus TVC.

Correct Answer: A

7) Among of what is listed below cost relationships is not true?

A) AFC = AC - MC B) TVC = TC - TFC C) The change in TVC/the change in Q = MC. D) The change in TC/ the change in Q = MC.

Correct Answer: A

8) Economists consider Among of what is listed below costs to be irrelevant to a short-run businessdecision?

A) opportunity cost B) out-of-pocket cost C) historical cost D) replacement cost

Correct Answer: C

9) Among of what is listed below is a relevant cost?

A) replacement cost

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B) sunk cost C) historical cost D) fixed cost E) All of the above are relevant.

Correct Answer: A

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10) Among of what is listed below is a reason for economies of scale?

A) Fixed costs are spread out as volume increases.

B) The law of diminishing returns does not take effect.

C) Input productivity increases as a result of greater specialization.

D) There is greater savings in transportation costs.

Correct Answer: C

11) Diseconomies of scale can be caused by

A) the law of diminishing returns.

B) bureaucratic inefficiencies.

C) increasing advertising and promotional costs.

D) All of the above.

Correct Answer: B

12) When a firm increased its output by one unit, its AC rose from $45 to $50. This implies that its MC is

A) $5.

B) between $45 and $50.

C) greater than $50.

D) Cannot be determined from the above information.

Correct Answer: C

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13) When a firm increased its output by one unit, its AC decreased. This implies that

A) MC < AC. B) MC = AC. C) MC < AFC. D) the law of diminishing returns has not yet taken effect.

Correct Answer: A

14) When a firm increased its output by unit, its AFC decreased. This is an indication that

A) the law of diminishing returns has taken effect.

B) MC < AFC. C) AVC < AFC. D) the firm is spreading out its total fixed cost.

Correct Answer: D

15) The main guide that explains the difference between accounting cost and economic cost is

A) opportunity cost.

B) fixed cost.

C) variable cost.

D) All of the above help to explain the difference.

Correct Answer: A

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16) Economies of scale is indicated by

A) declining long-run AVC. B) declining long-run AFC. C) declining long-run AC. D) declining long-run TC.

Correct Answer: C

17) Among of what is listed below distinctions helps to explain the difference between relevant andirrelevant cost?

A) accounting cost vs. direct cost B) historical cost vs. replacement cost C) sunk cost vs. fixed cost D) variable cost vs. incremental cost

Correct Answer: B

18) Among of what is listed below distinctions does not help to explain the difference between relevantand irrelevant cost?

A) historical vs. replacement cost B) sunk vs. incremental cost C) variable vs. fixed cost D) out-of-pocket vs. opportunity cost E) All help to explain the difference.

Correct Answer: D

19) Among of what is listed below actions has the best potential for experiencing economies of scope?

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A) producing a product that has appeal to a wider segment of the Trading place B) producing computers and software C) producing spaghetti and soft drinks D) producing cars and trucks

Correct Answer: D

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20) The learning curve indicates that

A) economies of scale is taking effect.

B) repetition of various manufacturing tasks cause unit costs to decrease.

C) workers must learn new skills in order to improve.

D) it takes time to learn a new skill.

Correct Answer: B

21) When a firm's MC curve shifts to the right, it implies that

A) new firms are entering the Trading place.

B) labor productivity is decreasing.

C) labor productivity is increasing.

D) the firm's overhead costs are decreasing.

Correct Answer: C

22) When a firm experiences increasing returns to scale

A) its AFC will decrease. B) its AFC will increase.

C) its AC will increase. D) its AC will decrease.

Correct Answer: D

23) If a firm's rent increases, it will affect its cost structure in the following way:

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A) AVC will increase. B) MC will increase.

C) TFC will increase. D) All of the above will increase.

Correct Answer: C

24) Assuming the existence of economies of scale, if a firm finds that it can reduce its unit cost by decreasing its scale of manufacturing , it means that

A) it has too much manufacturing capacity relative to its demand.

B) it should try to produce less.

C) the law of diminishing returns has not taken effect.

D) it has too much fixed overhead relative to its variable cost.

Correct Answer: A

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25) Among of what is listed below relationships implies that a firm's short-run cost function is linear?

A) MC = AC B) MC = AVC C) AC = AFC + AVC D) MC > AC

Correct Answer: B

26) The marginal cost will intersect the average variable cost curve

A) when the average variable cost curve is rising.

B) where average variable cost curve equals price.

C) at the minimum point of the average variable cost curve.

D) the two will never intersect.

Correct Answer: C

27) Among of what is listed below cost functions will exhibit both decreasing and increasing marginalcosts?

A) a cubic cost function B) a quadratic cost function C) a linear cost function D) All of the above.

Correct Answer: A

28) If total cost equals $2,000 and quantity produced is 100 units,

A) then fixed cost is $200 and average variable cost is $18.

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B) then fixed cost is $600 and average variable cost is $14.

C) then fixed cost is $500 and marginal cost is $15.

D) then either A or B can be correct.

Correct Answer: D

29) The learning curve

A) is really no different from a marginal cost curve.

B) calculates average cost at a particular point in time.

C) sExplain hows the decrease in unit cost as more of the same product is produced over time.

D) None of the above.

Correct Answer: C

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30) What level indicates the point of maximum economic efficiency?

A) lowest point on AC curve B) lowest point on AVC curve C) lowest point on MC curve D) None of the above.

Correct Answer: A

31) MC increases because

A) MC naturally increases as firm nears capacity.

B) labor is paid overtime wages when volume increases.

C) in the short run, MC always increases.

D) the law of diminishing returns takes effect.

Correct Answer: D

32) Among of what is listed below is the best example of economies of scope?

A) Coca-Cola expands its global operations to sub-Sahara Africa.

B) Alcohol for car fuel is produced from corn.

C) Amazon.com decides to rent out its Web site to independent e-commerce companies.

D) A company reduces its cost by getting bigger discounts for bulk purchases.

Correct Answer: C

33) The distinction between sunk and incremental costs is most helpful in Correct Answering whatquestion?

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A) Explain how many more people should be added to the manufacturing process?

B) What is the correct price to charge?

C) Should we begin to build a new guidey?

D) Should we continue developing a new software application that we began last year?

Correct Answer: D

34) A Manufacturing Function represents

A) the method used to convert inputs into outputs.

B) the sum s of output that can be created by various sum s of inputs.

C) the optimum mix of inputs to maximize output.

D) All of the above.

Correct Answer: B

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35) Stage III of the short-run Manufacturing Function is

A) the most efficient mix of inputs.

B) the least costly level of output.

C) where additional units of inputs will lead to less output.

D) where additional units of inputs will lead to more output.

Correct Answer: C

36) The "Law of Diminishing Returns" states that

A) additional inputs will reduce output.

B) additional inputs will decrease average productivity.

C) the supply of inputs is becoming scarce.

D) additional inputs will lead to less additional output.

Correct Answer: D

37) Increasing Returns to Scale results when

A) in the long-run, an increase in inputs will lead to an increase in the average products of inputs.

B) in the long run, an increase in inputs will lead to an equivalent increase in output.

C) labor becomes more skilled.

D) All of the above.

Correct Answer: A

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38) Output (Total Product) is maximized when

A) input average productivity is at its maximum.

B) the "law of diminishing returns" sets in.

C) input marginal productivity is zero.

D) input marginal productivity is at its maximum.

Correct Answer: C

39) The results of many empirical studies of short-run cost functions have sExplain hown that total costsconform to A) a quadratic total cost function. B) a power cost function.

C) a linear cost function. D) a cubic cost function.

Correct Answer: C

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40) Among the problems encountered when time series analysis is used to estimate cost functions is

A) that technological changes may have occurred.

B) that accounting changes may have occurred during the period analyzed.

C) that some costs are recorded on the books of account at a time other than when they are incurred.

D) All of the above.

Correct Answer: D

41) The method of estimating long-run costs in what knowledgeable professionals familiar with manufacturing facilities and processes calculate optimal combination of inputs to produce given quantities and then estimate costs is known as A) engineering cost estimating. B) the survivorship method.

C) regression analysis. D) None of the above.

Correct Answer: A

42) When the survivorship method of cost estimating is used, an increase, over time, in the proportion of industry product produced by medium size firms indicates the existence of A) continuing economies of scale.

B) continuing diseconomies of to scale.

C) a U-shaped long-run average cost curve.

D) large technological changes.

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Correct Answer: C

43) The major advantages of using cross-sectional analysis for long-run costs studies include

A) the inclusion in the sample of different plants of different sizes.

B) the avoidance of having to adjust for inflationary trends.

C) the avoidance of having to account for interregional cost differences.

D) All of the above.

E) A and B above.

Correct Answer: E

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44) A short-run total cost function of the following form: TC = 100 + 32Q - 4Q2 + 0.4Q3, indicates the existence of

A) a linear total cost curve. B) a constant average variable cost curve.

C) a U-shaped average total cost curve. D) a constant marginal cost curve.

Correct Answer: C

45) Isoquants represent

A) combinations of inputs that produce the same output.

B) combinations of inputs that yield the greatest output.

C) inputs that are perfect substitutes for each other.

D) least costly combinations of inputs.

Correct Answer: A

46) Marginal rates of technical substitution (MRTS) represent

A) the optimum combinations of inputs.

B) cost minimizing combinations of inputs.

C) the degree to what one input can replace another without output changing.

D) All of the above.

Correct Answer: C

47) Isocost curves represent

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A) least cost combinations of inputs.

B) combinations of inputs that can be purchased given their prices and the funds available.

C) a producers cost function.

D) None of the above.

Correct Answer: B

48) Short-run cost functions are estimated using

A) time-series regression analysis. B) cross-sectional regression analysis.

C) nominal cost data. D) present value cost data.

Correct Answer: A

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49) In estimating short-run cost functions, one must adjust for

A) price level changes. B) accounting procedure changes.

C) product heterogeneity. D) All of the above.

Correct Answer: D

50) Long-run cost functions are estimated using

A) time-series regression analysis. B) cross-sectional regression analysis.

C) cost accounting data. D) None of the above.

Correct Answer: B

Analytical Questions

1) You have opened your own word-processing service. You bought a personal computer, and paid $5,000 for it. Explain however, due to the cost changes in the computer industry, the current price of an equivalent machine is $2,500. You could sell any used machine for $1,000. If you were not word processing, you could earn $20,000 per year at an alternative job. Assume that the interest rate is 10%. You can also hire an assistant who can do everything that you can do for $20,000 per year (you would still continue to do word processing).

One person using one computer can produce 11,000 typed pages per year, and the price per page for your service is $2.

You are considering three options: (1) expand your business by hiring an assistant. (2) leave your business the way it is (3) shut down. Based on the costs and revenues above, what should you do? Explain and sExplain how any relevant calculations.

Correct Answer: Option 1:

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Revenue = $22,000 Opportunity cost of your time = 20,000 Opportunity cost of interest on salvage value of existing computer = 100 Economic profit = $1,900 Option 2: You still earn $1,900 as above.

Revenue from additional worker = 22,000 Wages = 20,000 Opportunity cost of interest on purchase of new computer = 250 Depreciation = 1,500 Economic profit from additional worker = $250 Total economic profit = $2,150 Option 3: Revenue = 0 No costs, since opportunity costs no longer apply, and fixed costs are sunk.

Economic profit = 0 (Could possibly view the $1,000 you get from selling the used computer as revenue, but makes no difference to final solution of problem.)

Option 2, expand your business, is the best option.

2) Fred's Widget Company has purchased $500,000 in equipment, what can be sold for a salvage value of $300,000 at any time. The best interest rate on alternative investments is 5%. What is the cost of using this machinery for one year? Explain how would your Correct Answer be different if the machinery had not yet been purchased?

Correct Answer: Short-run cost = $15,000 Cost if the machinery was not purchased = $200,000 + $25,000 = $225,000

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Explanation: The short-run cost is just the forgone interest. The short-run depreciation is sunk, and the salvage value doesn't change. The long-run cost (if the machine has not been purchased is the depreciation cost plus the foregone interest on the whole $500,000.

3) The following table sExplain hows the relationship between output and number of workers in theshort run. If the wage is $50/day, find marginal cost of manufacturing .

Number Of Workers

Output

0

0

1

50

2

110

3

300

4

450

5

590

6

665

7

700

8

725

9

710

10

705

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Correct Answer: Number Of Workers Output MPL MC (=w/MPL) 0 0 -- -1 50 50 1.00 2 110 60 0.91 3 300 190 0.26 4 450 150 0.33 5 590 140 0.36 6 665 75 0.67 7 700 35 1.43 8 725 25 2.00 9 710 15 3.33 10 705 -5 --

4) Consider a firm that has just built a plant, what cost $20,000. Each worker costs $5.00 per hour. Based on this information, fill in the table below.

Number of

Fixed Cost

Variable Cost

Total Cost

Marginal Cost

Average Variable Cost

Average Total Cost

20,000

--

--

--

Output

Marginal Product

0

0

--

50

400

20,250

100

900

20,500

150

1300

20,750

200

1600

21,000

250

1800

21,250

300

1900

21,500

Worker Hours

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350

1950

21,750

Correct Answer: Number of

Fixed Cost

Variable Cost

Total Cost

Marginal Cost

Average Variable Cost

--

20,000

0

20,000

--

--

--

400

8

20,000

250

20,250

.625

.625

50.625

100

900

10

20,000

500

20,500

.50

.56

22.78

150

1300

8

20,000

750

20,750

.625

.58

15.96

200

1600

6

20,000

1000

21,000

.833

.625

13.125

250

1800

4

20,000

1250

21,250

1.25

.69

11.81

300

1900

2

20,000

1500

21,500

2.50

.79

11.32

350

1950

1

20,000

1750

21,750

5.00

.90

11.15

Output

Marginal Product

0

0

50

Worker Hours

Average Total Cost

5) Explain how would each of the following affect the firm's marginal, average, and average variable cost curves? a. An increase in wages b. A decrease in material costs c. The Country’s government imposes a fixed sum of tax. d. The rent that the firm pays on the building that it leases decreases.

Correct Answer: a. Wages are a variable cost, so MC, AVC, and ATC increase. b. Materials are a variable cost, so MC, AVC, and ATC decrease. c. A fixed or lump-sum tax increases ATC but not MC or AVC. d. Rent is generally viewed as a fixed cost, so ATC decreases, but MC and AVC are unchanged.

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6) A firm experiences increasing returns to scale; that is, doubling all its inputs more than doubles its output. What can be inferred about the firm's short-run costs?

Correct Answer: Returns to scale is a long-run phenomenon because all inputs must be changed. Thus we can infer little about the firm's short-run costs from this information, other than the firm is likely to experience diminishing marginal returns in the short run due to the fact that it will have a fixed guide of manufacturing (and thus short-run marginal costs will rise with output).

7) Carefully explain if the following statements are true, false, or uncertain. a. If average cost is increasing, marginal cost must be increasing. b. If there are diminishing returns, the marginal cost curve must be positively sloped. c. Marginal costs decrease as output increases because the firm can spread fixed costs over more units.

Correct Answer: a. True. If average cost is increasing, marginal cost must be above average cost, so marginal cost must be increasing. b. True. If there are diminishing returns, each worker produces less than the one before him. Thus each unit must be getting more expensive (because you pay workers the same sum but they produce less). c. False. Marginal costs have nothing to do with fixed costs. The statement would be correct if it was about average costs.

8) Carefully explain the difference between diseconomies of scale and diminishing returns.

Correct Answer: Diseconomies of scale means that, in the long run, average costs are rising, usually due to coordination problems or decreasing returns to scale. Diminishing returns means that, in the short run, marginal product is falling (or marginal cost is rising) because each worker is producing less than the one before him, due to the fact that capital (or some other guide of manufacturing ) is fixed. There is no connectionbetween these things.

9) For each of the following cost functions, find MC, AC, and AVC. a. TC = 20,000 + 10 Q

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b. TC = 18,000 + Q + 0.2 Q2 Correct Answer: a. MC = 10 AC = (20,000/Q) + 10 AVC = 10 b. MC = 1 + 0.4Q AC = (18,000/Q) + 1 + 0.2Q AVC = 1 + 0.2Q 10) For each of the following cost functions, if possible, find minimum AC and minimum AVC. a. TC = 20,000 + 10 Q b. TC = 18,000 + Q + 0.2 Q2

Correct Answer: a. Set MC = AC. 10 = (20,000/Q) + 10 In this case, AC is decreasing everywhere, and thus there is no minimum average cost (although it will approach $10).

Set MC = AVC. 10 = 10 Q = 0, and at that point, AVC = $10. b. Set MC = AC. 1 + 0.4Q = (18,000/Q) + 1 + 0.2Q Q = 300, and at that point, AC = $121.

Set MC = AVC. 1 + 0.4Q = 1 + 0.2Q Q = 0, and at that point, AVC = $1.

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11) Given the Manufacturing Function: Q = 72X + 15X2 - X3, where Q = Output and X = Input a. What is the Marginal Product (MP) when X = 8? b. What is the Average Product (AP) when X = 6? c. At what value of X will Q be at its maximum? d. At what value of X will Diminishing Returns set in?

Correct Answer: a. MP = 30X -3X2, MP =120 when X=8; b. AP = 72 + 15X - X2, AP=126 when X=6; c. Q at a maximum when MP is 0, or X =12 [-2 has no meaning;] d. diminishing returns sets in when MP at a maximum value, or X =5

12) Given the Manufacturing Function: Q = 21X + 9X2 - X3, where Q = Output, and X = Input a. At what value of X does Stage II of the manufacturing function begin? b. At what value of X does Stage III of the manufacturing function begin? c. At what value of X does diminishing returns set in?

Correct Answer: a. Stage II begins when AP is at a maximum, or X = 4.5 b. Stage III begins where MP = 0, or X = 7 [-1 has no meaning] c. diminishing returns set in when MP at a maximum, or dMP/dQ = 0, or X = 3

13) If the price of capital is $24, the price of labor is $15, and the marginal product of capital is 16, the least costly combination of capital and labor requires that the marginal product of labor be .

Correct Answer: MPcapital/MPlabor = Price of capital/Price of Labor, or marginal product of labor = 10.

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14) If a manufacturing function is given by the equation: Q = 12X + 10X2 - X3, where Q = Output and X = Input, the calculate the equations for a. average product b. marginal product c. point of diminishing average returns d. point of diminishing marginal returns

Correct Answer: a. AP = Q/X, or 12 +10X - X2 b. MP = dQ/dX, or 12 + 20X - 3X2 c. DAR occurs where AP at a maximum, or dAP/dX = 0, or 10 - 2X = 0, X = 5 d. DMR occurs where MP at a maximum, or dMP/dX = 0, or 20 - 6X = 0, X = 3.33

15) Given the total cost function: TC = 100 + 40Q - 15Q2 + 5Q3, calculate the a. average fixed cost function (AFC) b. average variable cost function (AVC) c. marginal cost function (MC)

Correct Answer: a. AFC = 100/Q b. AVC = 40 -15Q + 5Q2 c. MC = 40 - 30Q + 15Q2

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Chapter 8 Pricing and Output Decisions: Perfect Competition and Monopoly (Appendices 8A and 8B) Multiple-Choice Questions

1) Among of what is listed below products is the best example of perfect competition?

A) automobiles B) apples C) soap D) video cassettes

Correct Answer: B

2) Among of what is listed below is not characteristic of perfect competition?

A) a differentiated product B) no barriers to entry or exit C) large number of buyers D) complete knowledge of Trading place price

Correct Answer: A

3) Among of what is listed below conditions would definitely cause a perfectly competitive company toshut down in the short run?

A) P < MC B) P = MC < AC C) P < AVC D) P = MR

Correct Answer: C

4) In economic analysis, any sum of profit earned above zero is considered "above normal"

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because

A) normally firms are supposed to earn zero profit.

B) this would indicate that the firm's revenue exceeded both its accounting and opportunity cost.

C) this would indicate that the firm was at least earning a profit equal to its opportunity cost.

D) this would indicate that the firm's revenue exceeded its accounting cost.

Correct Answer: B

5) If a perfectly competitive firm incurs an economic loss, it should

A) shut down immediately.

B) try to raise its price.

C) shut down in the long run.

D) shut down if this loss exceeds fixed cost.

Correct Answer: D

6) At the point at what P=MC, suppose that a perfectly competitive firm's MC = $100, its AVC = $80 and its AC = $110. This firm should A) shut down immediately.

B) continue operating in the short run.

C) try to take advantage of economies of scale.

D) try to increase its advertising and promotion.

Correct Answer: B

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7) A perfectly competitive firm sells 15 units of output at the going Trading place price of $10. Suppose its average cost is $15 and its average variable cost is $8. Its contribution margin (i.e., contribution to fixed cost) is

A) $30.

B) $150.

C) $105.

D) Cannot be determined from the above information.

Correct Answer: A

8) When a firm produces at the point where MR = MC, the profit that it is earning is considered to be A) maximum. B) normal.

C) above normal. D) Not enough information is provided.

Correct Answer: D

9) When a firm has the power to establish its price,

A) P = MR. B) P = MC. C) P > MR. D) P < MR.

Correct Answer: C

10) When MR = MC,

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A) marginal profit is maximized. B) total profit is maximized.

C) marginal profit is positive. D) total profit is zero.

Correct Answer: B

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11) In the short run, Among of what is listed below would indicate that a perfectly competitive firm isproducing an output for what it is receiving a normal profit?

A) P > AC B) AVC < P < AC C) P = AC D) P = AVC

Correct Answer: C

12) A firm that seeks to maximize its revenue is most likely to adhere to Among of what is listed below?

A) MR = MC B) MR =0 C) MR =P D) MR < MC

Correct Answer: B

13) Among of what is listed below is true for a monopoly?

A) P = MC B) P = MR C) P > MR D) P < MR

Correct Answer: C

14) Among of what is listed below characteristics is most important in differentiating between perfectcompetition and all other types of Trading places?

A) whether or not the product is standardized B) whether or not there is complete Trading place information about price C) whether or not firms are price takers D) All of the above are equally important.

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Correct Answer: C

15) Suppose a firm is currently maximizing its profits (i.e., following the MR=MC rule). Assuming that it wants to continue maximizing its profits, if its fixed costs increase, it should

A) maintain the same price.

B) raise its price.

C) lower its price.

D) Not enough information to Correct Answer this question.

Correct Answer: A

16) Suppose a firm is currently maximizing its profits (i.e., following the MR=MC rule). Assuming it wants to continue maximizing its profits, if its variable costs decrease, it should

A) lower its price in response to the lower costs.

B) raise its price in order to earn more profits.

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C) maintain the same price.

D) Not enough information to Correct Answer this question.

Correct Answer: A

17) Among of what is listed below is true about a monopoly?

A) Its demand curve is generally less elastic than in more competitive Trading places.

B) It will always earn economic profit.

C) It will try to charge the highest possible price.

D) It will always be subject to Country’s government regulation.

E) None of the above is true.

Correct Answer: A

18) Assume a profit maximizing firm's short-run cost is TC = 700 + 60Q. If its demand curve is P = 300 - 15Q, what should it do in the short run?

A) shut down B) continue operating in the short run even though it is losing money C) continue operating because it is earning an economic profit D) Cannot be determined from the above information.

Correct Answer: C

19) Assume a perfectly competitive firm's short-run cost is TC = 100 + 160Q + 3Q2. If the Trading place price is $196, what should it do?

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A) produce 5 units and continue operating B) produce 6 units and continue operating C) produce zero units (i.e., shut down) D) Cannot be determined from the above information.

Correct Answer: B

20) A monopoly will usually produce

A) where its demand curve is inelastic.

B) where its demand curve is elastic.

C) where its demand curve is either elastic or inelastic.

D) only when its demand curve is perfectly inelastic.

Correct Answer: B

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21) The main difference between the price-quantity graph of a perfectly competitive firm and a monopoly is A) that the competitive firm's demand curve is horizontal, while that of the monopoly is downward sloping.

B) that a monopoly always earns an economic profit while a competitive company always earns only normal profit.

C) that a monopoly maximizes its profit when marginal revenue is greater than marginal cost.

D) that a monopoly does not incur increasing marginal cost.

Correct Answer: A

22) When the slope of the total revenue curve is equal to the slope of the total cost curve

A) monopoly profit is maximized.

B) marginal revenue equals marginal cost.

C) the marginal cost curve intersects the total average cost curve.

D) the total cost curve is at its minimum.

E) Both A and B

Correct Answer: E

23) A feature of Perfect Competition is

A) use of nonprice competition by firms. B) mutual interdependence among firms.

C) unique products. D) standardized products.

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Correct Answer: D

24) Monopoly is characterized by

A) unique products.

B) Trading place entry and exit difficult or impossible.

C) nonprice competition not necessary.

D) All of the above.

Correct Answer: D

25) The fact that a perfectly competitive firm has a perfectly elastic demand curve means A) there is no limit to the firm's profits. B) there is no limit to the firm's revenues.

C) that it can sell all it wants at any price. D) None of the above

Correct Answer: B

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26) In the short run a firm should shut down if it cannot

A) make normal profits. B) make economic profits.

C) cover its variable costs. D) cover its fixed costs.

Correct Answer: C

27) Firms are 'price makers" if they

A) have sufficient Trading place power to set their product price.

B) make the Trading place price their product price.

C) make their product price competitive.

D) None of the above.

Correct Answer: A

28) If a monopoly wants to maximize it profit, it should

A) produce in the range where its average costs are declining.

B) produce in the range where its demand curve is elastic.

C) produce in the range where its marginal costs are declining.

D) produce in the range where its marginal costs are less than its average costs.

Correct Answer: B

Analytical Questions

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1) A perfectly competitive firm has total revenue and total cost curves given by: TR = 100Q TC = 5,000 + 2Q + 0.2 Q2 a. Find the profit-maximizing output for this firm. b. What profit does the firm make?

Correct Answer: a.

MR = 100 MC = 2 + .4Q 100 = 2 + .4Q Q* = 245 b. Profit = 100*245 – 5,000 – 2(245) – 0.2 (245)2 = $7,005

2) What does it mean to say that a perfectly competitive firm is a price taker? Can't a firm set any price it chooses?

Correct Answer: A firm can set any price it chooses, but it a perfectly competitive industry, it will do no good to choose anything but the Trading place price. At a higher price, no one will buy (since products are assumed to be identical) and at a lower price, you lose revenue without gaining sales, since you can presumably sell all you want to at the Trading place price. Thus the firm is said to be a price taker.

3) Why would a firm choose to remain in an industry in what it makes an economic profit of zero?

Correct Answer: Making an economic profit of zero does not mean that the firm is not making any money.

It means that it is covering all its costs, including opportunity costs. This means that all resources employed are earning just as much as they would in their next-best use, and thus that there is no gain from moving them to their next -best use.

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4) You've been hired by an unprofitable firm to determine whether it should shut down its operation. The firm currently uses 70 workers to produce 300 units of output per day. The daily wage (per worker) is $100, and the price of the firm's output is $30. The cost of other variable inputs is $500 per day. Although you don't know the firm's fixed cost, you know that it is high enough that the firm's total costs exceed its total revenue. You know that the marginal cost of the last unit is $30. Should the firm continue to operate at a loss? Carefully explain your Correct Answer.

Correct Answer: VC = $7,000 + 500. Thus AVC = 7500/300 = $25. Since P > AVC, the firm shouldcontinue to operate in the short run.

5) Suppose that a perfectly competitive industry is in long-run equilibrium, and demand increases. Explain the short- and long-run effects on the firm and the industry.

Correct Answer: Short run: An increase in demand raises equilibrium price and quantity. Existing firms produce more (because the higher price means that MR=MC at a higher quantity) and earn positive economic profits.

Long run: Positive profits attract new firms into the industry. The increase in supply reduces price and further increases quantity. Firms continue to enter until economic profits return to zero, and there is no further incentive for entry.

6) Trading place price is $50. The firm's marginal cost curve is given by: MC = 10 + 2Q a. Find the profit-maximizing output for the firm. b. At this output, is the firm making a profit? Explain your Correct Answer.

Correct Answer: 50 = 10 + 2Q Q* = 20 b. It is impossible to say without further information. We know that at a quantity of 20, the firm will maximize profit or minimize loss, but without information on total costs, we cannot tell if there is a profit or loss.

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7) A monopolist has demand and cost curves given by: QD = 1000 - 2P TC = 5,000 + 50Q a. Find the monopolist's profit-maximizing quantity and price. b. Find the monopolist's profit.

Correct Answer: a. MR = 500 – Q MC = 50 50 = 500 – Q Q* = 450 P* = $275 b. Profit = 275*450 – 5,000 – 50*450 = $96,250

8) A monopolist has demand and cost curves given by: QD = 10,000 – 20P TC = 1,000 + 10Q + .05Q2 a. Find the monopolist’s profit-maximizing quantity and price. b. Find the monopolist’s profit.

Correct Answer: a. MR = 500 – 0.1 Q MC = 10 + 0.1Q 10 + 0.1Q = 500 – 0.1 Q Q* = 2,450 P* = $377.50 b. Profit = (377.50)*2450 – 1,000 – 10*2450 – 0.05(2450)2 = $599,250

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9) True, false, or uncertain? Any firm that is not covering fixed costs should shut down in the short run.

Correct Answer: False. Fixed costs are sunk and should have no effect on short-run decisions. If a firm isnot covering variable costs, it should shut down, because those costs are avoidable.

10) A perfectly competitive firm has the cost function: TC = 1000 + 2Q + 0.1 Q2 What is the lowest price at what this firm can break even?

Correct Answer: MC = 2 + 0.2Q AC = (1000/Q) + 2 + 0.1Q Set MC = AC. for minimum AC, or 2 + 0.2Q = (1000/Q) + 2 + 0.1Q,, or Q = 100, and at that point, AC = $22. This is the lowest price at what the firm can break even.

11) Describe the difference in Trading place structure between Monopoly and Oligopoly.

Correct Answer: Monopoly has only one producer because the product is unique, or has no closesubstitutes, or Country’s government gives it the exclusive authority to produce and sell that product.

Oligopoly has relatively few large firms producing standardized or differentiated products, but for what entry into or exit from the industry is very difficult, so that they are mutually interdependent in their pricing-output decisions.

12) Explain the difference between Economic and Normal profits.

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Correct Answer: Normal profit is the sum of profit necessary to insure that a firm continues to operate in the long run, and it is based on the profit that could be earned in its next best alternative activity. It is equal to the sum of its accounting cost and opportunity cost. Economic profit is the sum of profit above normal profit: profit in excess of what could be earned in its next best alternative activity.

13) Describe the process by what the competitive Trading place establishes a price at what all firms are justearning normal profits.

Correct Answer: Above normal profits will entice new firms to enter the industry, thereby driving down Trading place price and firm profits until they reach the normal level, after what no additional firms enter the industry. Below normal profits will cause some firms to exit the industry, thereby raising Trading place price and firm profits until the normal level is reestablished, and no further firms exit the industry.

14) A monopolist’s Demand function is P = 1624 - 4Q, and its Total Cost function is TC = 22,000 + 24Q -4Q2 + ⅓Q3, where Q is output produced and sold. a. At what level of output and sales (Q) and price (P) will Total Profits be maximized? b. At what level of output and sales (Q) and price (P) will Total Revenue be maximized? c. At what price (P) should the monopolist shut down?

Correct Answer: a. Total Profits are maximized where MR = MC, and MR = dTR/dQ, with TR = P(Q), and MC = dTC/dQ. TR = 1624Q -4Q2, so MR = 1624 - 8Q. MC = 24 - 8Q + Q2.

MR = MC is 1624 - 8Q = 24 - 8Q + Q2, or 1600 = Q2, and Q = 40. With Q = 40, P = 1464. b. Total Revenue is maximized when MR = 0, or 1624 - 8Q = 0, or Q = 203 with P = 203. c. Shut down would occur whenever price(P) is less than average variable cost (AVC), or below P = AVC, or 1624 - 4Q = 24 - 4Q + ⅓Q2, or 1600 = ⅓Q2, or Q2 = 4800, or Q = 69 (approximately). When Q = 69, P = 1348, so any price below 1348 would cause the firm to shut down since it is not covering its variable costs.

15) What are the limitations in using Break-Even analysis?

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Correct Answer: It requires the use of linear cost and revenue functions; it isn't applicable if the functions are non-linear. It assumes that there are fixed costs, what means the analysis can applied only to short-run operations. It can't handle multiple product situations, unless the product mixes are constant. It can't be used to determine profit maximizing levels of operations.

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16) What is the Degree of Operating Leverage?

Correct Answer: It is an elasticity formula what calculates the percentage change in profit resulting from some percentage change in the level of operation (output and sales).

17) Explain how can break-even analysis be used to project the level of operation needed to achieve atargeted profit level?

Correct Answer: The targeted level of profit can be guideed into the break-even equation as a fixed cost, and then determine the level of output and sales at what the operating costs plus fixed costs plus desired profit would just equal sales revenue: Q = (TFC + Desired Profit)/(P - AVC), where Q = output, TFC = total fixed cost, P = sales price, and AVC = average variable cost.

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Chapter 9 Pricing and Output Decisions: Perfect Competition and Monopoly Multiple-Choice Questions

1) Among of what is listed below industries is most likely to represent the Monopolistic CompetitionTrading place structure?

A) pharmaceuticals B) tobacco products C) hair salons D) farm equipment

Correct Answer: C

2) The Kinked-Demand Curve model best reflects

A) mutual interdependence among sellers.

B) a game theory approach to price-output decisions.

C) price rigidities in oligopolistic Trading places.

D) All of the above.

Correct Answer: D

3) The Herfindahl-Hirschman (HH) Index is used to

A) measure the degree of nonprice competition.

B) measure the degree of Trading place concentration in an industry.

C) measure the extent of price leadership.

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D) None of the above.

Correct Answer: B

4) If firms are earning economic profit in a monopolistically competitive Trading place, Among of what is listed below is most likely to happen in the long run?

A) Some firms will leave the Trading place.

B) Firms will join together to keep others from entering.

C) New firms will enter the Trading place, thereby eliminating the economic profit.

D) Firms will continue to earn economic profit.

Correct Answer: C

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5) Mutual interdependence means that

A) all firms are price takers.

B) each firm sets its own price based on its anticipated reaction by its competitors.

C) all firms collaborate to establish one price.

D) all firms are free to enter or leave the Trading place.

Correct Answer: B

6) In what of these Trading places would the firms be facing the least elastic demand curve?

A) perfect competition B) pure monopoly C) monopolistic competition D) oligopoly

Correct Answer: B

7) In the long run, the most helpful action that a monopolistically competitive firm can take to maintain its economic profit is to A) continue its efforts to differentiate its product.

B) raise its price.

C) lower its price.

D) do nothing, because it will inevitably experience a decline in profits.

Correct Answer: A

8) The main difference between perfect competition and monopolistic competition is

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A) the number of sellers in the Trading place.

B) the ease of exit from the Trading place.

C) the degree of information about Trading place price.

D) the degree of product differentiation.

Correct Answer: D

9) The demand curve, what assumes that competitors will follow price decreases but not price increases, is called A) an industry demand curve. B) an inelastic demand curve.

C) a kinked demand curve. D) a competitive demand curve.

Correct Answer: C

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10) The existence of a kinked demand curve under oligopoly conditions may result in

A) price flexibility. B) price rigidity.

C) competitive pricing. D) None of the above.

Correct Answer: B

11) When a company is faced by a kinked demand curve, the marginal revenue curve

A) will be upward sloping.

B) will be horizontal.

C) will always be zero at the quantity produced.

D) will be discontinuous.

Correct Answer: D

12) Porter's "Five Forces Model" is based on

A) the laws of supply and demand.

B) the law of diminishing returns.

C) the Structure-Conduct-Performance model.

D) the key guides affecting demand.

Correct Answer: C

13) The four-firm concentration ratio

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A) indicates the total profitability among the top four firms in an industry.

B) is an indicator of the degree of monopolistic competition.

C) indicates the presence and intensity of an oligopoly Trading place.

D) is used by the Country’s government as a basis for anti-trust cases.

Correct Answer: C

Analytical Questions

1) Convenience stores with gas stations tend to sell an essentially identical variety of goods and services. Yet this is generally considered to be a monopolistically competitive industry selling differentiated products. Explain how can this be considered a differentiated product?

Correct Answer: These stores are differentiated by location.

2) Describe the transition from short-run to long-run equilibrium in a monopolistically competitive industry.

Correct Answer: In the short run, firms in a monopolistically competitive industry may make a positive profit. Explain however, since there are assumed to be no significant barriers to entry, positive profits attract entry. As more firms (or varieties) enter, the demand for each firm (or variety) decreases, and thus prices and profits fall until there is no further incentive for entry.

3) Explain how is a monopolistically competitive industry like perfect competition?

Explain how is it likemonopoly?

Correct Answer: Monopolistic competition is like perfect competition in that there are many firms and no barriers to entry (and thus long-run economic profits will be zero). It is like monopoly in that firms sell products that are not perfect substitutes for each other, and thus firms have some Trading place power, and prices will be above marginal cost.

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4) Why might a concentration ratio be a poor measure of actual industry competition?

Correct Answer: Concentration ratios measure national competition within a line of goods that are substitutes in manufacturing . Where there is much international competition, where competition is regional rather than national, where there is competition from goods that are substitutes in consumption but not manufacturing , and for other reasons listed in the text, competition ratios may be poor measures of competition.

5) When one automaker begins offering low cost financing or rebates, others tend to do the same.

What two oligopoly models might offer an explanation of this behavior?

Correct Answer: (1) Kinked demand curve: the assumption behind the kinked demand curve model is that rivals follow price decreases but not price increases. One automaker offering rebates, etc., is essentially a price cut, and so others will follow. (2) Price leadership: This could also be viewed as a price leader setting a new price and others following.

6) Fast food restaurants tend to cluster together. That is, on one corner, there may be four similar fast-food restaurants. Explain how can this be explained using a location game theory model?

Correct Answer: Similar to the beach kiosk model, restaurants cluster because they attract the most customers that way. One explanation might be: assume that customers have identical transportation costs, are distributed uniformly, and have no preference for one restaurant over another. Then they will always go to the closest restaurant. If one located far away from the other, it would attract customers on the other side of it, but only half of the ones between it and its rival. If it locates next to its rival, it gets all the customers on that side, and thus maximizes profit.

7) The following matrix sExplain hows the payoffs for an advertising game between Coke and Pepsi. The firms can choose to advertise or to not advertise. Numbers in the matrix represent profits; the first number in each cell is the payoff to Coke. (Numbers in millions.)

Coke (rows)/Pepsi (columns)

Advertise

Don’t Advertise

Advertise

(10, 10)

(500, -50)

Don’t Advertise

(-50, 500)

(100, 100)

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a. Explain why this would be described as a Prisoner's Dilemma game. b. Explain the probable outcome of this game.

Correct Answer: a. The joint profit-maximizing outcome is for neither to advertise. But there is a temptation to cheat, the dilemma, and thus the firms are likely to end up where they are collectively worst off. b. The dominant strategy for each firm is to advertise, and thus the probable outcome is that each will earn $10 million.

8) Some countries, such as Israel, have absolute policies of not negotiating with terrorists if they take hostages. Explain how does this relate to sequential games and the idea of credible commitment?

Correct Answer: Prior to the taking of hostages, it is desirable to "play tough" and state that you will not deal with terrorists. But once hostages are taken, you have an incentive to try to free them. Explain however, the terrorists can figure your incentives, too, so your threat is not credible. Absolute policies that are publicly announced and followed through may create reputation effects that make the policies credible, and thus countries may reach the desired outcome hostages are not taken because terrorists believe that they will not negotiate.

9) a. What is the grim trigger strategy, and Explain how does it solve the Prisoner's Dilemma inrepeated games? b. Under what circumstances is it likely to fail?

Correct Answer: a. The grim trigger refers to the threat to price low (or whatever the competitive strategy is) forever if the cartel member(s) deviate from the cartel strategy. It may solve the Prisoner's Dilemma because it can make the potential future loss from cheating greater than the one-period gain. b. If the one-period gain from cheating is sufficiently high relative to the discounted present value of future profits received by a cartel member, or if the firm does not value profits received in the future, the grim trigger will not be a deterrent. (It also may not be a credible threat.)

10) Microsoft has integrated many components into its Windows operating systems, such as a web

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browser, media player, etc. Explain how might this be an example of nonprice competition?

Correct Answer: There are a number of possible Correct Answers, including enhancing the attributes of the product (increasing demand), increasing switching costs to increase customer loyalty (reduce elasticity), etc.

11) Describe the guides in Michael Porter's "Five Forces Model" that affect the ability of any firm in an industry to earn a profit.

Correct Answer: Threats of new entrants into the industry, bargaining power of a firm's customers, bargaining power of a firm's suppliers, threats of substitute products from other industries, and intraTrading place rivalry from other firms in the industry.

12) Describe the structure-conduct-performance (S-C-P) paradigm.

Correct Answer: An analytical approach to examining the structure of an industry and Explain how it affects firm profitability. It holds that the types of products being sold, their price elasticities of demand, the methods use to produce them (especially the role of technology and the existence of scale economies), and the degree to what there are related products (complements and substitutes) will determine the number of firms in the industry, conditions of firm entry and exit, and the extent of product differentiation. The resultant industry structure determines firm pricing-output strategies what, in turn, determine the degree of firm profitability.

13) Explain why the "kinked-demand curve" model of oligopoly represents a game theory approach to oligopolistic behavior.

Correct Answer: Game theory usually is defined as studying Explain how individuals form strategies when they are aware that their decisions affect the decisions of other what, in turn, will affect the outcome of their decisions. The "kinked-demand curve" model is based on Explain how firms perceive their competitors will react to any changes they make in their product prices, and Explain how the expected reactions by competitive firms will affect firm profitability.

The typical assumption is that if the firm raises its product price, competitors will not raise their prices so that the firm will experience such a decrease in quantity sold that their total revenue

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and profit will decline. Explain however, if the firm lowers its product price, competitors will match the price decrease so that the firm gains little or no increase in quantity sold, resulting in a decline in total revenue and profit. Under this expected behavior by competitors, firms should not alter their product prices in response to small changes in product costs.

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Chapter 10 Special Pricing Practices Multiple-Choice Questions

1) All of the following are conditions what are favorable to the formation of cartels, except

A) the existence of a small number of firms.

B) geographic proximity of firms.

C) homogeneity of the product.

D) easy entry into the industry.

Correct Answer: D

2) Prices under an ideal cartel situation will be equal to

A) monopoly prices. B) competitive prices.

C) prices under monopolistic competition. D) marginal cost.

Correct Answer: A

3) A cartel price will be established at the quantity where

A) total cost equals the industry total revenue.

B) average cost equals the industry revenue.

C) the sum of the members' marginal costs equals industry marginal revenue.

D) marginal cost equals industry price.

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Correct Answer: C

4) Cartel agreements tend to break down

A) during economic downturns.

B) because of price "chiseling" by one or more members.

C) when there is overcapacity in the industry.

D) because of all of the above.

Correct Answer: D

5) Barometric price leadership exists when

A) one firm in the industry initiates a price change and the others may or may not follow.

B) one firm imposes its best price on the rest of the industry.

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C) when all firms agree to change prices simultaneously.

D) when one company forms a price umbrella for all others.

Correct Answer: A

6) Dominant price leadership exists when

A) one firm drives the others out of the Trading place.

B) the dominant firm decides Explain how much each of its competitors can sell.

C) the dominant firm establishes the price at the quantity where its MR = MC, and permits all other firms to sell all they want to sell at that price.

D) the dominant firm charges the lowest price in the industry.

Correct Answer: C

7) The oligopolistic situation in what a company's objective is to maximize revenue subject to a minimum profit requirement is usually referred to as A) the aggregate model. B) the Baumol model.

C) the aggressive model. D) the Marshall model.

Correct Answer: B

8) In the Baumol model, the total quantity sold will usually be larger than

A) if perfect competition prevailed. B) if total costs were minimized.

C) if profit were maximized. D) if companies were interdependent.

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Correct Answer: C

9) In the Baumol model, a change in fixed costs will

A) increase total quantity sold. B) have no effect on total quantity sold.

C) decrease total quantity sold. D) have an effect on total quantity sold.

Correct Answer: D

10) In order that price discrimination can exist,

A) Trading places must be capable of being separated.

B) Trading places must be interdependent.

C) different demand price elasticities must exist in different Trading places.

D) demand price elasticities must be identical in all Trading places.

E) Both A and C.

Correct Answer: E 11) Third-degree price discrimination exists when

A) the seller knows exactly Explain how much each potential customer is willing to pay and willcharge accordingly.

B) different prices are charged by blocks of services.

C) when the seller can separate Trading places by geography, income, age, etc., and chargedifferent prices to these different groups.

D) when the seller will bargain with buyers in each of the Trading places to obtain the best possible

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price.

Correct Answer: C

12) The result for the seller of being able to practice price discrimination will be

A) higher profits. B) lower demand elasticity.

C) lower quantity sold. D) cost minimization.

Correct Answer: A

13) The practice by a monopolist of charging each buyer the highest price he/she is willing to pay is called

A) first-degree discrimination. B) second-degree discrimination.

C) third-degree discrimination. D) fourth-degree discrimination.

Correct Answer: A

14) When state universities charge higher tuition fees to out-of-state students than to local students, the universities are practicing A) first-degree discrimination. B) second-degree discrimination.

C) third-degree discrimination. D) fourth-degree discrimination.

Correct Answer: C

15) The following are possible examples of price discrimination, except

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A) prices in export Trading places are lower than for identical products in the domestic Trading place.

B) senior citizens pay lower fares on public transportation than younger people at the same time.

C) a product sells at a higher price at location A than at location B, because transportation costs are higher from the guidey to A. D) subscription prices for a professional journal are higher when bought by a library than when bought by an individual.

Correct Answer: C 16) Under conditions of first-degree price discrimination

A) manufacturing may equal that what would exist under perfect competition.

B) manufacturing may exceed that what would prevail under perfect competition.

C) prices will be lower than under perfect competition.

D) manufacturing will always be lower than under perfect competition.

Correct Answer: A

17) If a product what costs $8 is sold at $10, the profit margin is

A) $2. B) 25%.

C) 20%. D) None of the above.

Correct Answer: C

18) If a product what costs $8 is sold at $10, the mark-up is

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A) $2. B) 25%.

C) 20%. D) None of the above.

Correct Answer: B

19) The correct expression for cost plus pricing is

A) Price = Cost (1 + profit margin). B) Price = Cost + profit margin.

C) Price = Cost (1 + mark-up). D) Price = Cost + (1 + mark-up).

Correct Answer: C

20) If the demand elasticity for a product is -2, and a profit-maximizing firm sells the product for $10, its marginal cost must be

A) $5. B) $10. C) $15. D) $8.

Correct Answer: A

21) When mark-up equals 50%, then demand elasticity will be

A) -1. B) -1.5. C) -2. D) -3.

Correct Answer: D

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22) The pricing of a product at each stage of manufacturing as the product moves through severalstages is called A) transfer pricing. B) cost plus pricing.

C) penetration pricing. D) monopolistic pricing.

Correct Answer: A

23) A company what charges a lower price than may be indicated by economic analysis to gain a foothold in the Trading place is practicing

A) price skimming. B) psychological pricing.

C) penetration pricing. D) prestige pricing.

Correct Answer: C

24) Assume that a multinational company produces components in country A, and ships them to a subsidiary in country B. In order to increase its profits, A) the company should charge a high transfer price for the components if income taxes in country B are higher than in country A. B) the company should charge a low transfer price for the components if income taxes in country B are higher than in country A. C) the company should charge a high transfer price for the components if income taxes in country A are higher than in country B. D) None of the above.

Correct Answer: A

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25) Barometric price leadership can occur when oligopolistic firms

A) compete on the basis of differentiated products.

B) want to avoid price competition and violating antitrust laws.

C) try to enforce cartel agreements.

D) All of the above.

Correct Answer: B

26) Revenue maximization occurs when a firm sells at a price

A) that is equal to its minimum average variable cost.

B) where its marginal revenue is equal to its marginal cost.

C) where its marginal revenue is zero.

D) None of the above .

Correct Answer: C 27) Second-degree price discrimination occurs when

A) different prices are charged for different blocks of services.

B) different groups of buyers are charged different prices based on their price elasticities of demand.

C) a different price is charged is charged for each sum of a product purchased.

D) None of the above.

Correct Answer: A

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28) "Tying" is a form of price discrimination what involves a buyer

A) agreeing to purchase a product at a fixed price regardless of the sum purchased.

B) paying different prices based on the sum s of a product purchased.

C) required to buy one product in order to purchase some other product.

D) All of the above.

Correct Answer: C

29) Gasoline and heating oil are examples of products what are

A) joint products in fixed proportions. B) joint products in variable proportions.

C) joint products that are complements. D) unrelated to each other.

Correct Answer: B

30) Transfer pricing is a method used to

A) determine whether a firm should make or buy a component product.

B) determine the correct value of a product as it moves from one stage of manufacturing toanother.

C) minimize a multinational firm's tax liabilities.

D) All of the above.

Correct Answer: D

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Analytical Questions

1) Why does each of the following facilitate the creation and stability of a cartel? a. High barriers to entry b. An identical product c. Similar costs

Correct Answer: a. A successful cartel implies positive profits. Positive profits attract entry, if it is possible, and increasing the number of firms in the industry erodes the cartel's control and pricing power (or makes it more difficult to negotiate with the larger number of firms in the industry). b. If products are not identical, then consumers may have brand preferences, and thus it is possible for firms to cheat on the cartel by promoting nonprice differences. c. If costs are similar, profits are similar, and the incentives of each firm will be similar, all other things equal. This makes it easier to agree on price and more "fair" in the sense that firms will receive similar profits.

2) Industry demand is given by: QD = 1000 - P All firms in the industry have identical and constant marginal and average costs of $50/unit. a. If the industry is perfectly competitive, what will industry output be? What will be the equilibrium price? What profit will each firm earn? b. Now suppose that there are five firms in the industry, and that they collude to set price. What price will they set? What will be the output of each firm? What will be the profit of each firm?

Correct Answer: a. P = 50, so Q = 950. Each firm earns an economic profit of zero. b. MR = 1000 - 2Q. Set MR = MC 50 = 1000 - 2Q

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Q = 475 P = $525 Each firm produces 1/5 the output, or q =95. Profit for each firm is $45,125.

3) Why do cartels tend to break up?

Correct Answer: There are many reasons, but one of the best is that there is an incentive to cheat.

Whilethe cartel maximizes joint profits, individual profit could be increased if the firm could sell more at the cartel price. If everyone does that, output increases and the price falls.

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4) A monopolist sells to two consumer groups, students and non-students.

Demand for students: Q = 500 - 1/2P Demand for non-students: Q = 750 - 2P MC = 20 Find the profit-maximizing price/quantity combination in each Trading place if the groups can beseparated.

Correct Answer: Students: P = 1000 - 2Q MR = 1000 - 4Q Set MR = MC. 20 = 1000 - 4Q 245 = Q, P = $510 Non-students: P = 375 - 1/2 Q MR = 375 - Q Set MR = MC. 20 = 375 - Q 355 = Q, P = $197.50 5) McDonald's charges a higher price for a Big Mac in New York City than it does in a small town in Iowa.

Is this an example of third degree price discrimination? Explain.

Correct Answer: No, or not necessarily. Costs differ between the two Trading places, because land is moreexpensive in New York City. Thus the higher price reflects that.

6) Some charge that third degree price discrimination is unfair or that it reduces social welfare.

Why does charging one group a lower price hurt anyone?

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Correct Answer: There's an equity issue about charging different prices to different people, but the real social welfare issue is not about charging a lower price to one group; it's about charging a higher price to the other. If the firm charged a single price, it would be somewhere in between the two group prices, in most cases. So some customers who would be able to buy at a lower price in the combined Trading place pay more (or do not buy at all) in the separated Trading place.

7) Firms that make game systems like Playstation and Nintendo typically charge a price close to average cost on the game system itself, and do not change that price even when the systems are scarce or demand increases. Why might this be a profit-maximizing strategy?

Correct Answer: These firms are selling two products, the systems and the games. These are complementary products. If they increase the price of the systems, they reduce the demand for games (and games are repeat purchases rather than one-time purchases). Additionally, the system is the "hook", or the loss leader that draws customers in. Once you have the system, the switching cost of moving to another system is significant. Thus the systems are cheap, and the games are expensive.

8) In the Sunday newspaper, there are usually coupons that you can clip and take to the store to save money on products. Anyone can buy a newspaper, and the value of the coupons easily exceeds the price of the newspaper for most consumers. Is this an example of price discrimination? Explain.

Correct Answer: Yes, it is. Consumers with more time are likely to have a more elastic demand for products, and thus they are willing to clip the coupons (and may not buy except at the lower price). Other consumers with less time won't deal with the coupons and thus will pay a higher price. This is essentially the same idea as movie matinee pricing.

9) Would it ever make sense for a firm to charge a price at or below the cost of the product?

Correct Answer: This might be an example of penetration pricing in what the firm is trying to gain Trading place share. (Two other reasons not discussed in the text: limit pricing to prevent entry, and predatory pricing to drive out rivals.)

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10) Superstar actors typically get contracts that specify that they get a percentage of "the gross", the total revenues that the movie brings in. Why might actors want contracts structured that way? Why might producers be willing to agree to that, and Explain how does this make the goals of actors and producers different?

Correct Answer: Actors want to maximize revenue with this sort of contract, while producers wish to maximize profit. It is clearly advantageous to the actor, since cost overruns won't impact what they receive.

But it might also suit producers, because if actors are interested in maximizing revenue, they have an incentive to promote the movie and try to increase sales (and to do a good job). This might be more of an incentive than a cut of the profits, over what they have less control.

11) A firm in an oligopolistic industry has the following demand and total cost equations: P = 600 - 20Q and TC = 700 + 160Q + 15Q2; Calculate: a. quantity at what profit is maximized. b. maximum profit. c. quantity at what revenue is maximized. d. maximum revenue. e. maximum quantity at what profit will be at least $580. f. maximum revenue at what profit will be at least $580.

Correct Answer: If revenue and cost schedules are calculated:a. 6 b. 680 c. 15 d. 4500 e. 8 f. 3520 If results are calculated with equations: a. 6.286 b. 682.86 c. 15 d. 4500 e. 8 f. 3520

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12) A monopolistic firm operates in two separate Trading places. No trade is possible between Trading place A andTrading place B. The firm has calculated the demand functions for each Trading place as follows: Trading place A p = 15 - Q; Trading place B p = 11 - QThe company estimates its total cost function to be: TC = 4Q. Calculate: a. quantity, total revenue and profit when the company maximizes its profit and charges the same price in both Trading places. b. quantity, total revenue and profit when the company charges different prices in each Trading place andmaximizes its total profit.

Correct Answer: If revenue and cost schedules are calculated: a. Q = 9; p = 8.5; TR = 76.5; TC = 36; profit = 40.5 b. Trading place A: Q = 5 to 6; p = 9 to 10; TR = 50 to 54; TC = 20 to 24; profit = 30 Trading place B: Q = 3 to 4; p = 7 to 8; TR = 24 to 28; TC = 12 to 16; profit = 12 Combined profit = 42 If equations are used: a. Q = 9; p = 8.5; TR = 76.5; TC = 36; profit = 40.5 b. Trading place A: Q = 5.5; p = 9.5; TR = 52.25; TC = 22; profit = 30.25 Trading place B: Q = 3.5; p = 7.5; TR = 26.25; TC = 14; profit = 12.25 Combined profit = 42.5

13) Briefly describe the conditions under what cartels will be formed.

Correct Answer: An industry with relatively few firms selling identical or very similar products, where entry is very difficult and cost structures are very similar. Also, geographic proximity of the firms is very

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helpful.

14) Explain the reasons firms might follow the Baumol model of maximizing revenue subject to achieving a minimum level of profits.

Correct Answer: Firms might wish to increase their Trading place shares within the industry, managers' power and prestige tend to grow with an increase in the size of a business' level of operations, eschewing profit maximization might avoid new firms entering the industry and/or pressure for Country’s government regulation, and increases in the scale of a firm's level of operation might permit capturing cost economies of scale through greater Trading place power to extract lower prices from the firm's suppliers of inputs.

15) Describe the circumstances under what a producer of joint products in fixed proportions might not sell all of one of the available joint products at the profit maximizing level of operations.

Correct Answer: At the profit maximizing level of output, the demand for that joint product would be such that the price at what it could be sold would involve negative marginal revenue and, hence, a reduction in total profits. Thus sales would be limited to an sum where the last unit sold brings in zero marginal revenue and the remaining units would not be sold (they could be held for sale at a later date if the price might be expected to increase and if the costs of holding the unsold product were less the present value of the expected revenue; otherwise the unsold product would be destroyed).

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Chapter 1 Game Theory and Asymmetric Information Multiple-Choice Questions

1) Asymmetric information represents a Trading place situation in what

A) all parties to a transaction possess less than full information.

B) one party in a transaction has more information than the other party.

C) some information possessed by the parties in a transaction may be false.

D) a zero-sum game exists.

Correct Answer: B

2) The Prisoner's Dilemma is an example of

A) Trading place signaling.

B) a zero-sum game.

C) a non-zero sum, noncooperative game with a dominant strategy.

D) adverse selection.

Correct Answer: C

3) Moral hazard is the

A) outcome of a Prisoner's Dilemma.

B) result of Trading place signaling.

C) risk associated with a Dutch auction.

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D) risk that one party to a contract may alter its post-contract behavior to the detriment of another party.

Correct Answer: D

4) Trading place signaling

A) is a way of conveying information to other parties in a transaction where asymmetric information exists.

B) represents a dominant strategy in a multi-player game.

C) results in an optimum solution to a beach kiosk scenario.

D) None of the above.

Correct Answer: A

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Analytical Questions

1) What is the "Trading place signaling"?

Correct Answer: A way of signaling information to other parties in situations where asymmetricinformation exists so that their ability to make correct decisions is improved.

2) What is "moral hazard"?

Correct Answer: The risk involved to one party when another party's behavior changes in a detrimental manner after a contract has been entered into. Usually, this is the result of asymmetric information.

3) What is "asymmetric information"?

Correct Answer: A Trading place situation in what one party in a transaction possesses more completeinformation than another party.

4) What is "adverse selection"?

Correct Answer: A situation in what the risk associated with the existence of asymmetric informationcauses one party not to enter into a contractual relationship with another party.

5) What is "game theory"?

Correct Answer: A formal mathematical approach to examining the strategies used by individuals to make decisions when they know that their actions will affect the decisions of other individuals, and the other individuals take this into account in their decision making. It is particularly useful in analyzing business decision making in oligopolistic Trading places where firms are mutually interdependent.

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6) What is a "payoff matrix"?

Correct Answer: A tabular presentation of various outcomes to each player, in a two-player situation, based on the various simultaneous decisions made by the players.

7) In game theory analysis, what is a "dominant strategy"?

Correct Answer: A strategy that would be the best one for a player in a non-cooperative game no matter what strategies are adopted by the other players in the game.

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Chapter 12 Capital Budgeting, Risk, and Uncertainty Multiple-Choice Questions

1) The term "capital budgeting" refers to decisions

A) what are made in the short run.

B) what concern the spreading of expenditures over a period lasting less than one year.

C) where expenditures and receipts for a particular undertaking will continue over a relatively long period of time.

D) where a receipt of cash will occur simultaneously with an outflow of cash.

Correct Answer: C

2) Capital budgeting projects include all of the following with the exception of

A) the purchase of a six-month treasury bill.

B) the expansion of a plant.

C) the development of a new product.

D) the replacement of a piece of equipment.

Correct Answer: A

3) If $1,000 is placed in an account earning 8% annually, the balance at the end of seven years will be

A) $1,080. B) $1,560. C) $2,000. D) $1,714.

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Correct Answer: D

4) The payback period for a project, requiring an initial outlay of $10,000 and producing ten uniform annual cash inflows of $1,500, is A) six years. B) six years and eight months.

C) six years and six months. D) seven years.

Correct Answer: B

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5) The net present value of a project is calculated as follows:

A) The future value of all cash inflows minus the present value of all outflows.

B) The sum of all cash inflows minus the sum of all cash outflows.

C) The present value of all cash inflows minus the present value of all cash outflows.

D) None of the above.

Correct Answer: C

6) A proposed project should be accepted if the net present value is

A) positive. B) negative.

C) larger than the internal rate of return. D) smaller than the internal rate of return.

Correct Answer: A

7) When future events cannot be assigned probabilities, we are talking about

A) risk. B) uncertainty.

C) a clouded future. D) financial risk.

Correct Answer: B

8) Probabilities, what can be obtained by repetition or are based on general mathematical principles are called A) statistical. B) empirical. C) a priori. D) subjective.

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Correct Answer: C

9) Other things being equal, the higher the cost of capital,

A) the higher the NPV of a project.

B) the higher the IRR of the project.

C) the lower the NPV of the project.

D) the cost of capital has no effect on the NPV of the project.

Correct Answer: C

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10) The internal rate of return of a project can be found

A) by discounting all cash flows at the cost of capital.

B) by averaging all cash inflows, and calculating the interest rate, what will make them equal to the average investment.

C) by calculating the interest rate, what will equate the present value of all cash inflows to the present value of all cash outflows.

D) None of the above.

Correct Answer: C

11) In finance, risk is most commonly measured by

A) the probability distribution.

B) the standard deviation.

C) the average deviation.

D) the square root of the standard deviation.

Correct Answer: B

12) A project whose acceptance eliminates another project from consideration is called

A) independent. B) mutually exclusive.

C) replacement D) complementary.

Correct Answer: B

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13) The internal rate of return equals the cost of capital when

A) NPV = 0. B) NPV > 0.

C) NPV < 0. D) None of the above.

Correct Answer: A

14) When two mutually exclusive projects are considered, the NPV calculations and the IRR calculations may, under certain circumstances, give conflicting recommendations as to what project to accept. The reason for this result is that in the NPV calculation, cash inflows are assumed to be reinvested at the cost of capital, while in the IRR solution, reinvestment takes place at

A) the hurdle rate. B) the accounting rate of return.

C) the prime rate. D) the project's internal rate of return.

Correct Answer: D

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15) When analyzing a capital budgeting project, the analyst must include in his calculation all of the following except A) all revenues and costs in terms of cash flows.

B) only those cash flows that will change if the proposal is accepted (i.e., incremental cash flows).

C) interest payments on debt financing connected with the project.

D) any effect (impact) the acceptance of the project under consideration will have on other projects now in operation.

Correct Answer: C

16) The use of the same cost of capital (risk adjusted discount rate) for all capital projects in a corporation A) is usually the correct procedure.

B) is incorrect since different divisions of the corporation may be faced with different levels of risk.

C) is incorrect since different capital projects, even in the same division, may be faced with different levels of risk.

D) Both B and C.

Correct Answer: D

17) If a risky cash flow of $10,000 is equivalent to a riskless cash flow of $9,300, the certainty equivalent guide is A) 0.93. B) 0.07. C) 1.07. D) 1.93.

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Correct Answer: A

18) If, at the end of the project life, a piece of equipment having a book value of $4,000 is expected to bring $3,000 upon resale, and the income tax rate is 40%, Explain how much will be the cash flow?

A) $2,800 B) $3,000 C) $3,400 D) $4,000

Correct Answer: C

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19) If the risk adjusted discount rate method and the certainty equivalent methods are to give the same results, then the certainty equivalent guide (at) must equal (where rf is the risk-free interest rate, and k is the risk adjusted cost of capital)

A) (1 + rf)t times (1 + k) t B) (1 + k) t divided by (1 + rf) t C) (1 + rf) t divided by (1 + k) t D) (1 + k) t minus (1 + r f) t

Correct Answer: C

20) Two projects have the following NPV's and standard deviations:

Project A N2P0V0 200

Standard deviation

75

Project B 200

100

A person who selects project A over project B is

A) risk seeking. B) risk indifferent.

C) risk averse. D) None of the above.

Correct Answer: C

21) An increase in net working capital required at the beginning of an expansion project must be considered to be

A) a cash inflow. B) a reallocation of assets.

C) a cash outflow. D) None of the above.

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Correct Answer: C

22) Usually, the cost of capital for newly issued stock is

the cost of retained earnings.

A) lower than B) higher than C) same as D) either higher or lower than

Correct Answer: B

23) A stock whose rate of return fluctuates less than the rate of return of a Trading place portfolio willhave a beta that equals A) 1. B) less than 1.

C) more than 1. D) Either A or C above.

Correct Answer: B

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24) The use of sensitivity analysis will generally result in

A) the calculation of a certainty equivalent NPV. B) the calculation of a best case, a base case and a worst case.

C) the calculation of the coefficient of variation.

D) the calculation of the probability of the maximum profit.

Correct Answer: B

25) A company's capital structure is made up of 40% debt and 60% common equity (both at Trading place values). The interest rate on bonds similar to those issued by the company is 8%. The cost of equity isestimated to be 15%. The income tax rate is 40%. The company's weighted cost of capital is

A) 11.5%. B) 12.2%. C) 10.9%. D) 8.9%.

Correct Answer: C

26) Capital rationing

A) exists when a company sets an arbitrary limit on the sum of investment it is willing to undertake, so that not all projects with an NPV higher than the cost of capital will be accepted.

B) generally does not permit a company to achieve maximum value.

C) seems to occur quite frequently among corporations.

D) All of the above.

Correct Answer: D

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27) The time value of money can be best described as

A) a dollar to day is worth more than a dollar tomorrow.

B) the basis on what net present values are calculated.

C) the basis on what internal rates of return are calculated.

D) All of the above.

Correct Answer: D

28) Net present value and internal rate of return capital budgeting decisions can differ because

A) the initial costs of the capital outlays differ.

B) the cash flow streams differ.

C) the discount rates differ for different time periods.

D) All of the above.

Correct Answer: D 29) Simulation analysis

A) permits the calculation of expected value and standard deviation.

B) does not permit the calculation of expected value and standard deviation.

C) is too complex to ever be used in actual business situations.

D) does not consider probabilities.

Correct Answer: A

30) The expected value is

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A) the total of all possible outcomes.

B) the arithmetic average of all possible outcomes.

C) the average of all possible outcomes weighted by their respective probabilities.

D) the total of all possible outcomes divided by the number of different possible outcomes.

Correct Answer: C

31) An advantage of the decision tree is that

A) it eliminates the need for calculating the cost of capital.

B) it eliminates the need for calculating probabilities.

C) it causes the analyst to consider important events that may occur in the course of the project, and decisions and actions that may have to be undertaken.

D) All of the above.

Correct Answer: C

32) A real option can present management with the opportunity to

A) vary output. B) abandon a project.

C) postpone a project. D) All of the above.

Correct Answer: D

33) A source of business risk is a change in

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A) technology. B) consumer preferences.

C) input prices. D) All of the above.

Correct Answer: D

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34) The certainty equivalent approach to accounting for risk in capital budgeting involves

A) adjusting the discount rate used to calculate net present values.

B) adjusting the expected cash flows.

C) estimating the coefficient of variation.

D) estimating the standard deviation of the net present values.

Correct Answer: B

35) A drawback in the use of sensitivity analysis in capital budgeting decisions is that it doesn't

A) permit evaluating alternative outcomes.

B) provide estimates of net present values.

C) assign probability values to outcomes.

D) consider different possible rates of discount.

Correct Answer: C

36) The following is an example of risk in capital budgeting on a global basis:

A) exchange rate changes B) tariff changes C) expropriation D) All of the above.

Correct Answer: D

37) The risk adjusted discount rate

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A) is the sum of the risk-free rate and the risk premium.

B) includes risk in the denominator of the present value calculation.

C) includes risk in the numerator of the present value calculation.

D) All of the above.

Correct Answer: D

38) A drawback in using the payback approach to capital budgeting decisions is

A) it doesn't account for the time value of money.

B) it ignores cash flows beyond the payback period.

C) it doesn't adjust for differences in the stream of cash flows.

D) All of the above.

Correct Answer: D

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39) The cost of capital is best described as the

A) opportunity cost of financing a capital outlay.

B) funds that must be acquired to finance a capital outlay.

C) decrease in stockholder equity due to a capital outlay.

D) All of the above.

Correct Answer: A

40) Capital rationing refers to

A) setting a minimum acceptable rate of return for a capital outlay.

B) selecting among profitable capital outlays when there are constraints on the funds available.

C) determining the maximum price to pay for a capital good.

D) None of the above.

Correct Answer: B

41) In evaluating the required rate of return for equity financing of a capital project, the Beta value is(a) the expected rate of growth in a firm's profits.

A) the expected future value of a firm's stock.

B) the volatility in the rate of return on a firm's stock compared with the volatility in the rate of return on a Trading place portfolio of stocks.

C) None of the above.

Correct Answer: B

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42) When future events cannot be assigned probabilities, we are talking about

A) risk. B) uncertainty.

C) a clouded future. D) financial risk.

Correct Answer: B

43) Probabilities, what are based on past data or experience, are called

A) a priori. B) objective. C) uncertain. D) statistical.

Correct Answer: D

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44) The use of real options in capital budgeting

A) may raise the NPV of a capital project.

B) makes the analysis of the project considerably easier.

C) allows management to make decisions more quickly.

D) eliminates the need for calculating the project's risk adjusted discount rate.

Correct Answer: A

45) The difference between sensitivity analysis and scenario analysis is

A) sensitivity analysis is a method for evaluating risk while scenario analysis is not.

B) sensitivity analysis is based on regression analysis while scenario analysis is not.

C) sensitivity analysis examines the impact on the overall results of a change in one variable while scenario analysis examines the impacts on overall results of changes in several variables at the same time.

D) None of the above.

Correct Answer: C

Analytical Questions

1) You deposit $10,000 in a savings account today. If the interest rate is 3%, what is the value in 20 years?

Correct Answer: FV = PV(1+i)n = 10,000(1.03)20 = $18,061

2) You start working at age 20 and you plan to deposit $5,000 in a savings account every year for

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the next 45 years. a. At the end of this time, Explain how much money will you have if the interest rate is 5%? b. You decide that's not enough money. Explain how much will you have to save every year if you wish to have $1,000,000 when you retire?

Correct Answer: a. FV = 5,000 {((1+ i)n – 1)/i} = $798,500 b. You will have to save $6,261 per year.

3) An aircraft company has signed a contract to deliver a plane 3 years from now. The price they will receive at the end of 3 years is $20 million. If the firm's cost of capital is 6%, what is the present value of this payment?

Correct Answer: PV = 20/(1.06)3 = $16.79 million

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4) An aircraft company has signed a contract to sell a plane for $20 million. The firm buying the plane will pay for it in 5 annual payments (at year end) of $4 million. If the firm's cost of capital is 6%, what is the net present value of this payment?

Correct Answer: PV = $16.85 million

5) A firm must spend $10 million today on a project that is expected to bring in annual revenues of $1.5 million for the next 10 years (beginning at the end of year 1). a. If the firm's cost of capital is 5%, what is the NPV of this project? b. If the firm's cost of capital is 10%, what is the NPV of this project? c. What is the internal rate of return?

Correct Answer: a. Present value of the revenues = $11.58 million, so NPV = $1.58 million. b. Present value of the revenues = $9.22 million, so NPV = -$0.78 million. c. 8.15%

6) If an expansion proposal is accepted, allowing an otherwise idle (and useless) machine with a Trading place value and book value of $2,000 to be utilized, should it be recorded as a cash outflow, and if so,Explain how much?

Correct Answer: Yes, $2,000

7) You win the $20 million state lottery, and you have a choice of taking an sum of money per year forthe next 20 years or a flat payment now. The flat payment that the state offers you is $9.82 million. a. What discount rate is the state using? b. Should you take the money or the annuity?

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Correct Answer: a. 8% (This is essentially the internal rate of return on the project.) b. In general, it depends on what return you think you can get on the money. If you think you can do better than 8%, you're better off with the cash.

8) If the interest rate is 7% and the tax rate is 15%, what is the after -tax cost of capital for the firm?

Correct Answer: .07(1 - .15) = 5.95%

9) Inc.'s stock is currently $50. The last dividend that they paid was $1. If dividends are expected to increase at a 10% annual rate, what is the firm's equity cost of capital?

Correct Answer: ke = D1/P0 + g = 1.10/50 + .10 = 12.2%

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10) If a company's stock is perceived to be more risky than average, what will happen to their equity cost of capital? Explain using the capital asset pricing model.

Correct Answer: A stock that is more volatile (riskier) than the Trading place average will have a beta of greaterthan 1. This means that the return that stockholders will require will be greater than average [kj = Rf + (km – Rf)]. In other words, the company will have to pay stockholders more since they must take a greater risk, and the equity cost of capital will rise.

11) Explain what is meant by the "weighted cost of capital" and Explain how it is used in capitalbudgeting.

Correct Answer: The proportion of each type of financing (debt, equity and retained earnings) in the firm's capital structure, and applying these percentages to the opportunity costs of capital associated with financing a prospective capital outlay. This weighted average of the opportunity cost of capital then is used to discount projected cash flows back to a net present value.

12) Describe the Capital Asset Pricing Model (CAPM) and Explain how it is used in capital budgetingdecisions.

Correct Answer: CAPM is a procedure for adjusting a measure of the required rate of return on a firm's stock for risk. This risk-adjusted measure of the required rate of return on a firm's stock is used as the opportunity cost of capital in equity financing of a capital project. The projected cash flows from the project are discounted back to a net present value using this risk-adjusted rate of return. The risk adjustment is based on the Beta value of a firm's stock: the ratio of the volatility in the rate of return on a firm's stock to the volatility in the rate of return on a Trading place portfolio of stocks.

13) What additional complexities arise when multinational corporations consider capital projects on a global basis?

Correct Answer: Considerations must be given to the impact on projected cash flows from differences in

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tax laws and tax rates, exchange rate controls and changes, limitations on repatriation of profits, tariffs and quotas on imported products, and special licensing fees. In addition, rates used to discount cash flows back to present values must be adjusted for differences in rates of inflation and taxes, and risks associated with expropriation of assets and political-social instability.

14) A firm's most recent annual dividend was $2 per share; its shares sell for $40 in the stock Trading place, and the company expects its dividend to grow at a constant rate of 5% in the foreseeable future. Using the dividend growth (Gordon) model, what would you estimate its equity cost of capital to be?

Correct Answer: 10.25% = [(2)(1.05)/(40 + .05)]

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15) What are the major sources of risk for the firm?

Correct Answer: Economic uncertainty, competition (actions of competitors), changes in demand, changes in technology, changes in input costs

16) You buy a lottery ticket for $1. If you win, you receive $3 million. The odds of your numbers coming up are 1:10,000,000. What is the expected value of this gamble?

Correct Answer: Expected value = (3 million)(0.0000001) + (-1)(0.9999999) = -$0.69, or you expect to lose 69 cents.

17) Project A and Project B both have expected values of $5,000. Project A has a standard deviation of $1,000, while Project B has a standard deviation of $3,000. Comment on the desirability of these projects.

Correct Answer: Both have the same expected value, but A has a lower standard deviation. It is 99%certain that the return from A will be between $2,000 and $8,000. Explain however, for B, it is 99% certain that the return will be between $-4,000 and $14,000. Project B is more risky and thus less desirable.

18) Project C has an expected value of $500 and a standard deviation of 50. Project D has an expected value of $300 and a standard deviation of 10. Comment on the desirability of these projects.

Correct Answer: CVC = 50/500 = 0.10 CVD = 10/300 = 0.03 Project D has a lower coefficient of variation and thus is more desirable. Even though its expected value is lower, it's lower standard deviation (and thus lower risk) makes up for this.

19) The Widget Company has estimated the following revenue possibilities for the year:

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Sales Probability 100 0.15 150 0.20 220 0.30 290 0.20 310 0.15 a. Find expected revenue. b. Find the standard deviation. c. Find the coefficient of variation.

Correct Answer: a. Expected revenue is $215.50. b. Standard deviation = 72.90 c. Coefficient of variation = 0.34

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20) Savings accounts pay very low rates of interest. The average return on the stock Trading place isabout 10-12%, in the long run. Why would anyone put money into a savings account?

Correct Answer: The stock Trading place gives a higher return for higher risk. Particularly if you are veryaverse to risk, you might find the savings account to be an attractive alternative.

21) A two-period project has the following probabilities and cash flows:

Probability Cash flow Period 1: .25 500 .50 600 .25 700

Period 2: .30 300 .50 500 .20 700

The discount rate is 7%, and the initial investment is $1,000. Explain how much is the expected NPV ofthis project?

Correct Answer: $-20.

22) Two projects have the following NPV's and standard deviations:

Project A Project B NPV 200 300 Standard deviation 75 100

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What of the two projects is more risky?

Correct Answer: Since the two projects have different NPV's and different standard deviations, relative risk can be measured by the coefficient of variation. Project A has a CV of.375, project B .333. Thus, the relative risk of project B is less.

23) In terms of capital budgeting, explain the difference between risk and uncertainty.

Correct Answer: Uncertainty involves possible future events to what no probability values can be assigned, while risk involves such events to what probabilities can be attached to their outcome. Thus, risk adjustments can be made to expected cash flow values and/or opportunity cost rates of discount. With uncertainty, no such adjustments can be made.

24) Describe the real option approach to risk-adjusted capital budgeting.

Correct Answer: Real options involve the contractional ability to make changes in capital projects, particularly once they are underway. Such options involve the ability to alter outputs (expand, contract, shutdown), alter inputs (both input types and processes using them), and postpone or abandon projects.

These options give the holder the right, but not the obligation, to exercise them and usually require the holder to pay an extra sum for this privilege. To determine whether such options are worthwhile, one would calculate the difference in the expected net present values of the capital projects with and without the option and compare it to the cost of paying for the option.

25) Explain why risk can be insured against but uncertainty cannot.

Correct Answer: The provider of insurance policies can assign probabilities to the occurrences of insurable events and calculate premium rates to charge. With uncertainty, no probabilities can be attached to such events and it isn't possible to construct the appropriate premium rates.

26) You are given risky cash flow data for a three-year project:

Year

Cash flow

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1

$2,000

2

3,000

3

4,000

The initial cash outflow is $6,000; the risk-free interest rate is 6%, and the risk-adjusted discount rate is 10%.

Calculate the NPV by both the risk-adjusted discount rate method and the certainty equivalent method in such a way that the NPV will be the same using either method.

Correct Answer: Riskless Risky Cash Flow Cash Flow CE Riskless Discounted Discounted Year Cash Flow Guide* Cash Flow at 6% at 10%1 2000 0.963636 1927 1818 1818 2 3000 0.928595 2786 2479 2479 3 4000 0.894828 3579 3005 3005 Total 7303 7303 Less initial investment 6000 6000 NPV 1303 1303

*CE guides: 1.06/1.1 = 0.963636 1.06²/1.1² = 0.928595 1.063/1.13 = 0.894828

27) What additional sources of risk come from international investments?

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Correct Answer: Exchange rate risk, and political risks such as regulation, discrimination, and expropriation

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28) The XYZ Company has estimated expected cash flows for 1996 to be as follows: Probability

Cash flow

.10

$120,000

.15

140,000

.50

150,000

.15

180,000

.10

210,000

Calculate: a. expected value b. standard deviation c. coefficient of variation d. the probability that the cash flow will be less than $100,000.

Correct Answer: a. $156,000b. $23,749 c. 0.152 d. 0.91% (z-statistic is 2.36)

29) You are given the following risky cash flows and certainty equivalent guides for a four-year project: Certainty Period

Cash Flow

Equivalent Guide

1

$2,500

.95

2

3,000

.92

3

4,000

.88

4

3,000

.84

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The initial investment for this project is $8,000, and the risk-free interest rate is 6%. Calculate the net present value of the project.

Correct Answer: $1,648

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Chapter 13 Multinational Corporation and Globalization Multiple-Choice Questions

1) Among of what is listed below are risks for multinational corporations but not risks for domestic corporations?

A) changes in Country’s government rules and regulations B) capital controls C) changes in tax laws D) Country’s government red tape and corruption

Correct Answer: B

2) Among of what is listed below represent ways in what multinational corporations can protectthemselves from exchange rate risks?

A) forward Trading places B) futures Trading places C) currency options D) All of the above.

Correct Answer: D

3) Among of what is listed below represent capital budgeting problems for multinational corporations but not for domestic corporations?

A) determining the cost of capital B) calculating after-tax cash flows C) selecting the appropriate risk-adjusted rates of return

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D) None of the above.

Correct Answer: D

4) Among of what is listed below are not arguments in favor of the globalization of business?

A) more efficient use of resources lowers operating costs and selling prices B) more products are made available and new Trading places are opened C) economic and political security is enhanced D) technology transfers improve living standards in poorer countries

Correct Answer: C

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Analytical Questions

1) What are the major risks facing multinational corporations?

Correct Answer: Sudden and unexpected changes in exchange rates; capital controls; expropriation of property; ownership and human resource restrictions; lack of protection for intellectual property; non-enforcement of contracts and business laws; civil unrest and wars; corruption; discriminatory policies against foreign personnel and businesses (including red tape and special fees and other charges); and sudden changes in Country’s government s.

2) What are the major ways that the risks of exchange rate changes can be hedged against?

Correct Answer: Offsetting transactions in the same currency; buying or selling currency in the forward or futures Trading places; call or put options; and currency swaps.

3) What are the major reasons a multinational corporation would engage in Foreign Direct Investment (FDI)?

Correct Answer: Greater profit earning opportunities in other Trading places; take advantage of economies of scale and/or scope; have direct access to natural resources; operate within a currency union and avoid restrictions and other discriminatory policies against foreign businesses operating within a country.

4) What are the ways a multinational corporation can reposition its funds to increase its profits?

Correct Answer: Transfer pricing to take advantage of differences in tax rates among countries; royalty payments, license fees and dividends to transfer funds to other more profitable entities while avoiding income taxes or to take advantage expected changes in exchange rates.

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Chapter 14 Country’s government and Industry: Challenges and Opportunitiesfor Today's Manager Multiple-Choice Questions

1) Among of what is listed below is not considered a rationale for the intervention of Country’s government in theTrading place process in the United States?

A) the redistribution of income B) the reallocation of resources C) the long-run planning of scarce resources D) the short-run stabilization of prices E) All of the above.

Correct Answer: C

2) Among of what is listed below is the best example of a good or service that provides a benefitexternality?

A) the construction of a private road that allows vehicles if a toll is paid B) a public library C) a bookstore that is open to everyone D) All of the above.

E) None of the above.

Correct Answer: B

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3) Among of what is listed below is not an example of a cost externality?

A) the dumping of industrial waste into a lake B) unsightly billboards C) a neighbor that blasts his stereo system D) the building of a new type of jet fighter bomber E) All of the above.

Correct Answer: D

4) The demand for products that provide benefit externalities is generally for products that do not.

the demand

A) greater than B) less than C) the same as D) greater or less (depending on the Trading place) than

Correct Answer: B

5) The supply for products that exhibit cost externalities is generally products that do not.

the supply for

A) greater than B) less than C) the same as D) greater or less (depending on the Trading place) than

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Correct Answer: A

6) Among of what is listed below is an example of a Country’s government action to internalize a cost externality?

A) a fine imposed on a company that pollutes a stream B) the closing of a public library C) a sales tax on jewelry D) the increase on bridge tolls

Correct Answer: A

7) When cost externalities exist, an optimal equilibrium can be attained if the Country’s government

A) restricts manufacturing .

B) levies a tax for the difference between private costs and social costs.

C) prohibits manufacturing .

D) All three above.

E) Both A and B.

Correct Answer: E

8) The Coase theorem states that, in the presence of cost externalities, an optimal equilibrium can be attained A) with Country’s government taxation.

B) by prohibiting manufacturing .

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C) by correctly defining property rights and through negotiation between the parties.

D) None of the above.

Correct Answer: C

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9) Tying arrangements that lessen competition were made illegal by

A) the Sherman Anti-Trust Act. B) the Clayton Act. C) the Celler-Kefauver Act. D) the Robinson-Patman Act.

Correct Answer: B

10) One school of anti-trust thought argues that, rather than ensuring efficiency, anti-trust laws are really aimed at A) protecting small independent firms against large corporations.

B) outlawing all monopolies whether they perform "bad acts" or not.

C) price differentiation due to differences in quality and cost.

D) restricting interlocking directorates.

Correct Answer: A

11) Among of what is listed below would NOT be considered a synergistic benefit from a merger?

A) an improvement in distribution systems B) economies of scale in manufacturing C) decreased cost of capital D) None of the above.

Correct Answer: D

12) A merger between two companies in unrelated fields of business

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A) will always lead to economies of scale.

B) will generally increase the value of the unified firm compared to the value of the two companies before the merger because of the benefits of diversification.

C) may not have any synergistic effects.

D) will necessarily lead to an increase in the Trading place power of the merged company.

Correct Answer: C

Analytical Questions

1) What are the five major reasons for Country’s government involvement in a Trading place economy?

Correct Answer: Provide the legal, monetary and social framework necessary for Trading places to operate.

Insure that Trading places operate in a competitive manner. Redistribute income and wealth in a more desired(equitable) fashion. Guarantee a more efficient use of resources when there are benefit and cost externalities. Stabilize the overall level of economic activity to counteract undesirable levels of price inflation and unemployment.

2) A function of Country’s government is to regulate "natural monopolies." Explain what is a naturalmonopoly and why it requires Country’s government regulation.

Correct Answer: Natural monopolies occur when there are large cost economies of scale such that one producer can operate in the declining range of average cost while meeting the entire Trading place demand for a product. In these situations it is more economical to have only one producer of the product, since manufacturing costs will be lower and the product can be profitably sold at lower price prices than if there were several or more producers. Thus, the economy would benefit from having only one producer, but this would permit the producer to earn monopoly profits from lack of competition. Therefore, Country’s government should permit only one producer but regulate its operations, including selling prices, so that it doesn't exploit its monopoly position.

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3) Describe the basic motives for businesses to merge.

Correct Answer: Take advantages of synergies in operations: increase overall sales, reduce operating costs, lower costs of capital. Mutual acquisition of skilled managers, as each of the businesses may have skilled personnel that the other doesn't possess. Take advantage of favorable tax consequences. Increase Trading place power so as to enhance economic profits. Diversify to reduce business risk. Increase the compensation of top executives, although this often is at the expense of stockholders and other employees.

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Chapter 15 Managerial Economics in Action: The Case of the Semiconductor Industry Multiple-Choice Questions

1) Among of what is listed below is not a feature of the semiconductor Trading place structure?

A) high concentration of Trading place power among the firms B) capital intensity C) technology driven D) cyclical swings in Trading place demand

Correct Answer: A

2) Semiconductor firms tend to be multinational because

A) cost considerations lead to manufacturing and distribution taking place in different countries.

B) labor force differences result in research and development being conducted in different countries than are manufacturing.

C) Trading placeing tends to be on a worldwide basis.

D) All of the above.

Correct Answer: D

3) Multinational subcontracting is very common in the semiconductor industry because

A) exchange rate fluctuations are frequent.

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B) specialization in manufacturing and distribution is a major cost-saving consideration.

C) Trading place demand keeps shifting.

D) None of the above.

Correct Answer: B

Analytical Questions

1) Describe the Trading place structure of the semiconductor industry.

Correct Answer: The semiconductor industry is a highly competitive one, what has experienced rapid rates of growth but what also has been plagued by dramatic upswings and downswings in Trading place demand on a rather regular basis. In addition, it's very capital intensive, technology driven, with research and development expenditures being its most important component. Further, the individual firms have very little Trading place power and experience long lead times in manufacturing . All these characteristics make this industry a very unstable and highly risky capital venture.

2) Cite the major guides that affect the degree of competitiveness in the semiconductor industry.

Correct Answer: Rapidly changing technology makes equipment and processes quickly obsolete, thereby requiring large expenditures on research and development. In order to control costs there has been increased outsourcing on a global basis of the packaging, warehousing and shipping of the end products.

Also, both the demands for and supply of the products have become more global especially with the rapid economic growth in the Asia/Pacific region (most notably China). As a business-to-business industry, semiconductor firms are dealing with highly knowledgeable and cost conscious customers, what has promoted fierce competition among firms on both the demand and supply side of the Trading place. Many analystforecast a slowing down in both the rate of technological change and the Trading places for semiconductor products. If so, this probably will lead to a shakeout in the industry with fewer firms and a more oligopolistic Trading place structure. As a result, price competition may lessen but there still should be intensive competition in product development with attendant research and development outlays. There also is the danger, as has already occurred, that Country’s government s will intervene in international trade to protect domestic firms through the use of tariffs, quotas, export subsidies and licensing restrictions.

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(Online only) Review of Mathematical Concepts Used in Managerial Economics Analytical Questions

1) The demand curve is given by: QD = 5000 - 10 P Find equations for: a. Total revenue b. Marginal revenue

Correct Answer: a. TR = P*Q = (500 – 1/10 Q)Q = 500Q – 1/10 Q2 b. MR = 500 – 1/5Q

2) The demand curve is given by: QD = 5000 - 10 P Find the price and quantity at what total revenue is maximized and the maximum revenue.

Correct Answer: MR = 500 - 1/5Q0 = 500 - 1/5Q Q = 2500 P = 250 TR = $625,000

3) For each of the following sets of supply and demand curves, calculate equilibrium price and quantity. a. QD = 1000 - P; QS = P

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b. QD = 1500 - 2P; QS = 100 + 2P c. QD = 2000 - 3P; QS = -300 + 3P

Correct Answer: a. Q = 500, P = 500 b. Q = 800, P = 350 c. Q = 850, P = 383.33

4) For each of the following cost functions, find MC, AC, and AVC. a. TC = 40,000 + 20 Q b. TC = 1000 + 2Q + 0.1 Q2

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Correct Answer: a. MC = 20 AC = (40,000/Q) + 20 AVC = 20 b. MC = 2 + 0.2Q AC = (1000/Q) + 2 + 0.1Q AVC = 2 + 0.1Q 5) For each of the following cost functions, if possible, find minimum AC and minimum AVC. a. TC = 40,000 + 20 Q b. TC = 1000 + 2Q + 0.1 Q2

Correct Answer: a. Set MC = AC. 20 = (40,000/Q) + 20 In this case, AC is decreasing everywhere, and thus there is no minimum average cost (although it will approach $20).

Set MC = AVC. 20 = 20 Q = 0, and at that point, AVC = $20. b. Set MC = AC. 2 + 0.2Q = (1000/Q) + 2 + 0.1Q Q = 100, and at that point, AC = $22.

Set MC = AVC. 2 + 0.2Q = 2 + 0.1Q Q = 0, and at that point, AVC = $2.

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