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Chapter 1 Introduction: Multiple-Choice Questions
Chapter 1 Introduction: Multiple-Choice Questions
Multiple-Choice Questions
1) Which of the following is an example of how the question of
"what goods and services to produce?" is answered by the
command process?
Answer: A
Answer: B
Answer: A
Answer: A
Answer: A
Answer: B
Answer: B
Answer: C
Answer: D
Answer: E
Answer: C
Answer: C
13) In the text, the authors refer to "Stage II" of the process of
changing economics as
Answer: B
14) Which of the following is the best example of the "command"
process?
Answer: D
Answer: B
Answer: B
Answer: C
Answer: B
Answer: D
Answer: A
Answer: B
Analytical Questions
1) What economic conditions are relevant in managerial decision-
making?
Answer: D
A) transaction costs.
B) costs of internal operations.
C) total costs of transactions and internal operations combined.
D) variable costs.
Answer: C
Answer: B
Answer: C
Answer: D
Answer: B
Answer: B
Answer: A
Answer: D
Answer: D
Answer: D
A) profit maximization.
B) maximization of earnings per share.
C) maximization of the value of the common stock.
D) maximization of cash flows.
Answer: C
Answer: B
15) Opportunistic behavior is best described as a firm
Answer: C
Answer: A
Answer: D
Answer: B
Answer: C
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?
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%?
Answer: A
Answer: C
Answer: C
Answer: D
Answer: B
Answer: C
Answer: A
Answer: C
Answer: D
Answer: B
Answer: D
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 market, what effect
would this change have on
the equilibrium price and output for soft drinks?
Answer: B
15) Which of the following best describes the "guiding function"
of price?
A) In response to the surplus or shortage in two markets, price
serves as a "guiding
function" by decreasing in one market and increasing in the
other market in the short run.
B) The guiding function of price is the movement of resources
into or out of markets in
response to a change in the equilibrium price of a good or
service.
C) The guiding function of price occurs when the market price
changes to eliminate the
imbalance 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.
Answer: B
Answer: B
Answer: A
Answer: C
Answer: C
Answer: B
Answer: A
Answer: C
Answer: D
Answer: A
Answer: B
Answer: B
Answer: C
Answer: C
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
Answer: B
Answer: A
Answer: D
Answer: C
Answer: D
Analytical Questions
1) For each of the following changes, show the effect on the
demand curve, and state what will
happen to market 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.
e. A medical report is published showing that this product is
hazardous to your health.
f. The price of the product rises.
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, show the effect on the supply
curve, and state what will
happen to market equilibrium price and quantity in the short run.
a. The government requires pollution control filters that raise
production 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.
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.
4) Suppose that the demand for oranges increase. Explain the long
-run effects of the guiding
function of price in this scenario.
Answer: In the long run, the higher price of oranges will signal
more firms to enter the orange
market, as it will seem more profitable than some other markets.
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 market.
Answer:
a. Q = 1000, P = 500
b. Q = 275, P = 225
c. Q = 1000, P= 400
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.
Answer:
a. Qd = 30 and Qs = 50
b. Qd = 46 and Qs = 42
c. Q = 43.33 and P = $3.33
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.
Answer: C
A) price control.
B) price ceiling.
C) price floor.
D) Both A and B.
E) Both A and C.
Answer: E
Answer: D
A) normal B) superior
C) complementary D) substitute
Answer: C
Answer: C
Answer: B
A) normal B) inferior
C) complementary D) substitutes
Answer: D
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.
Answer: B
12) The demand for items that go into the production of a final
product is called
Answer: D
A) increase. B) decrease.
C) remain the same. D) either increase or decrease.
Answer: A
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
Answer: B
A) substitutable. B) complementary.
C) unique. D) ordinary.
Answer: B
Answer: C
Answer: A
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.
Answer: A
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
Answer: B
23) If the income elasticity of a particular product is -0.2, it would
be considered
Answer: C
Answer: B
A) elastic.
B) inelastic.
C) unitary.
D) None of the above.
Answer: B
Answer: D
Answer: A
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.
Answer: C
Answer: A
Answer: B
Answer: B
Answer: A
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.
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.
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, which is at a
price of $500 and
a quantity of 250.
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.
Answer:
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.
Answer: There are at least two reasons. One is that the elasticity of
substitution between skilled
workers and other factors of production is low; thus firms cannot
substitute some other factor of production 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 (which 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
factors of production, and many workers will be laid off.
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.
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
information you can gather from each of these figures.
Answer: (a) -0.429 (b) -0.667 (c) -0.538 (d) -1.000 (e) -0.818
Answer:
a. P = $30 and Q = 2250
b. Domestic producers supply 600 units and foreign producers
supply 1650 units.
Answer: B
Answer: C
Answer: B
Answer: C
Answer: A
Answer: B
A) autocorrelation
B) the identity problem
C) statistically insignificant regression coefficients
D) multicollinearity
Answer: D
Answer: C
Answer: A
Answer: D
Answer: B
Answer: C
Answer: B
Answer: A
Answer: C
Answer: D
20) A one-tail test of significance would be used to determine
whether
Answer: B
Answer: C
22) In the estimation of demand, the "identification problem"
refers to
Answer: C
Answer: B
Answer: C
25) Which of the variables does not pass the t-test at the .05 level
of significance?
A) PA
B) PB
C) A
D) I
E) All the variables pass the t-test.
Answer: B
Answer: D
Answer: C
Answer: A
29) Which indicator shows how well a regression line fits through
the scatter of data points?
A) F-test B) R2
C) t-test D) Durbin-Watson test
Answer: B
Answer: B
Answer: C
Answer: B
Answer: D
Answer: A
35) Average weekly claims for unemployment insurance, money
supply and the index of stock
prices are all examples of
Answer: A
Answer: D
Answer: B
Answer: D
Answer: A
41) The forecasting technique which involves the use of the least
squares statistical method to
examine trends, and takes into account seasonal and cyclical
fluctuations, is known as
Answer: C
Answer: D
Answer: B
Answer: D
Answer: C
A) S = a + b(t) B) S = a + bt
C) S = a + b(t) + c(t)2 D) None of the above.
Answer: B
Answer: A
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
Answer: E
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
Answer: A
Answer: D
Answer: A
Answer: B
Answer: C
56) The Trend Projection approach to forecasting is represented by
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
I = average monthly income = 4,000
2) Calculate t-statistics for each variable and explain what this tells
you.
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 two-tailed test should be used. If direction of
effect is important, then a one-tailed test should be used.
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.
11) Qd = 5,000 - 15P + 50A + 3Px - 4I, (2, 117) (2.7) (15) (2) (3)
12) What are the Key Steps for analyzing Demand functions based
on Regression results?
Answer: Check signs and magnitudes; compute elasticity
coefficients; determine statistical
significance.
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.
Answer:
a. The forecast for sales is 38,900.
b. The forecast for sales will be 39,400.
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
factors that may
disturb the trend.
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.
Answer: 2,257.3
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?
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?
Answer: 817
20) 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
If the exponential smoothing forecasting method is used, and the
smoothing factor is .6, what
will be the forecast for period 7?
Answer: 761
24) What are the four different characteristics that data exhibit
when undertaking time-series
forecasts?
Answer: B
Answer: D
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 production process.
E) All of the above are true.
Answer: D
A) when AP = 0 B) when MP = 0
C) when MP = AP D) when MP starts to diminish
Answer: B
A) when AP = 0 B) when MP = 0
C) when MP = AP D) when MP starts to diminish
Answer: C
6) Which of the following statements about the short-run
production function is true?
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,
Answer: A
Answer: B
9) Decreasing returns to scale
Answer: E
Answer: B
A) oil and natural gas B) sugar and high fructose corn syrup
C) computers and clerks D) keyboards and computers
Answer: C
12) In the short run, finding the optimal amount of variable input
involves which relationship?
A) MP = MC B) AP = MP C) MP = 0 D) MRP = MFC
Answer: D
Answer: C
Answer: B
Answer: B
Answer: C
Answer: D
Answer: A
Answer: B
20) If a firm used a combination of inputs that was to the left of its
isocost line, it would indicate
that
Answer: B
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.
Answer: A
Answer: B
Answer: B
A) Cobb-Douglas B) Straight-line
C) Quadratic D) Cubic
Answer: D
Answer: A
26) The following is not one of the strengths of the Cobb-Douglas
production function:
Answer: C
Answer: A
Answer: B
Answer: C
Answer: D
Answer: A
Answer: C
Answer: A
Answer: C
36) Isocost curves represent
Answer: B
Analytical Questions
Number Of Output
Workers
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 shows the weekly relationship between output
and number of workers for a
factory 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 production.
Answer:
0 0 -- --
1 50 50 50
2 110 60 55
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, how many workers should the firm hire?
Answer:
0 0 -- --
1 50 50 $250
2 110 60 $300
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 amount 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? Show
how you know.
b. If it is not, what should the firm do?
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.
Answer:
a. Constant returns to scale.
b. Decreasing returns to scale.
c. Increasing returns to scale.
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.
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 amount of output that
can be produced, and identify the expansion path.
Answer: MPL = ½ K1/2L-1/2
MPK = ½ K-1/2L1/2
Optimization requires:
MPL/w = MPK/r
This results in K=L, which 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
________.
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
13) Given the Production Function: Q = 72X + 15X2 - X3, where Q
= Output and X = Input
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
Chapter 7 The Theory and Estimation of
Cost
(Appendices 7A and 7B)
Multiple-Choice Questions
1) Which of the following cost functions indicates that the law of
diminishing returns takes effect
as soon as production begins?
Answer: A
2) Which of the following relationships is correct?
Answer: D
Answer: B
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.
Answer: B
Answer: D
Answer: A
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.
Answer: A
A) replacement cost
B) sunk cost
C) historical cost
D) fixed cost
E) All of the above are relevant.
Answer: A
Answer: C
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.
Answer: C
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.
Answer: A
14) When a firm increased its output by unit, its AFC decreased.
This is an indication that
Answer: D
A) opportunity cost.
B) fixed cost.
C) variable cost.
D) All of the above help to explain the difference.
Answer: A
Answer: C
Answer: B
Answer: D
19) Which of the following actions has the best potential for
experiencing economies of scope?
Answer: D
Answer: B
Answer: C
Answer: D
23) If a firm's rent increases, it will affect its cost structure in the
following way:
A) AVC will increase. B) MC will increase.
C) TFC will increase. D) All of the above will increase.
Answer: C
Answer: A
A) MC = AC B) MC = AVC
C) AC = AFC + AVC D) MC > AC
Answer: B
26) The marginal cost will intersect the average variable cost curve
Answer: C
Answer: A
28) If total cost equals $2,000 and quantity produced is 100 units,
Answer: D
Answer: C
Answer: A
31) MC increases because
Answer: D
Answer: C
Answer: D
34) A Production Function represents
Answer: B
Answer: C
Answer: D
Answer: A
Answer: C
Answer: C
Answer: D
41) The method of estimating long-run costs in which
knowledgeable professionals familiar with
production facilities and processes calculate optimal combination
of inputs to produce given
quantities and then estimate costs is known as
Answer: A
Answer: C
Answer: C
Answer: A
Answer: C
Answer: B
Answer: A
Answer: D
Answer: B
Analytical Questions
1) You have opened your own word-processing service. You
bought a personal computer, and paid $5,000 for it. 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, which
should you do? Explain and show any relevant calculations.
Answer:
Option 1:
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.
Number Of Output
Workers
0 0
1 50
2 110
3 300
4 450
5 590
6 665
7 700
8 725
9 710
10 705
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, which cost $20,000.
Each worker costs $5.00 per
hour. Based on this information, fill in the table below.
Number
of Output Marginal Fixed Variable Total Marginal
Worker Product Cost Cost Cost Cost
Hours
0 0 -- 20,000 --
50 400 20,250
Answer:
Number
of Output Marginal Fixed Variable Total Marginal
Worker Product Cost Cost Cost Cost
Hours
0 0 -- 20,000 0 20,000 --
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.
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 amount 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.
9) For each of the following cost functions, find MC, AC, and
AVC.
a. TC = 20,000 + 10 Q
b. TC = 18,000 + Q + 0.2 Q2
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
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.
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
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
________.
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)
Answer:
a. AFC = 100/Q
b. AVC = 40 -15Q + 5Q2
c. MC = 40 - 30Q + 15Q2
A) automobiles B) apples
C) soap D) video cassettes
Answer: B
Answer: A
Answer: C
Answer: B
Answer: B
A) $30.
B) $150.
C) $105.
D) Cannot be determined from the above information.
Answer: A
A) maximum. B) normal.
C) above normal. D) Not enough information is provided.
Answer: D
9) When a firm has the power to establish its price,
Answer: C
Answer: B
11) In the short run, which of the following would indicate that a
perfectly competitive firm is
producing an output for which it is receiving a normal profit?
Answer: C
A) MR = MC B) MR =0 C) MR =P D) MR < MC
Answer: B
A) P = MC B) P = MR C) P > MR D) P < MR
Answer: C
Answer: C
Answer: A
Answer: A
Answer: A
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.
Answer: C
Answer: B
Answer: B
Answer: A
22) When the slope of the total revenue curve is equal to the slope
of the total cost curve
Answer: E
Answer: D
A) unique products.
B) market entry and exit difficult or impossible.
C) nonprice competition not necessary.
D) All of the above.
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
Answer: B
Answer: C
Answer: A
Answer: B
Analytical Questions
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?
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
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.
6) Market 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 answer.
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.
Answer:
a. MR = 500 – Q
MC = 50
50 = 500 – Q
Q* = 450
P* = $275
b. Profit = 275*450 – 5,000 – 50*450 = $96,250
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
Answer: False. Fixed costs are sunk and should have no effect on
short-run decisions. If a firm is
not covering variable costs, it should shut down, because those
costs are avoidable.
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 which the firm can break even.
Answer: Above normal profits will entice new firms to enter the
industry, thereby driving down
market price and firm profits until they reach the normal level,
after which no additional firms enter the industry. Below normal
profits will cause some firms to exit the industry, thereby raising
market price and firm profits until the normal level is
reestablished, and no further firms exit the industry.
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.
Answer: The targeted level of profit can be factored into the break-
even equation as a fixed cost, and then determine the level of
output and sales at which 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.
Answer: C
Answer: D
Answer: B
Answer: C
Answer: B
Answer: B
Answer: A
Answer: D
Answer: C
Answer: B
Answer: D
Answer: C
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. How can this be considered a differentiated
product?
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.
9) a. What is the grim trigger strategy, and how does it solve the
Prisoner's Dilemma in
repeated games?
b. Under what circumstances is it likely to fail?
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 browser, media player, etc. How
might this be an example of nonprice competition?
Answer: D
Answer: A
Answer: C
Answer: D
Answer: A
Answer: C
Answer: B
Answer: C
Answer: D
Answer: E
11) Third-degree price discrimination exists when
Answer: C
12) The result for the seller of being able to practice price
discrimination will be
Answer: A
Answer: C
Answer: C
16) Under conditions of first-degree price discrimination
Answer: A
A) $2. B) 25%.
C) 20%. D) None of the above.
Answer: C
A) $2. B) 25%.
C) 20%. D) None of the above.
Answer: B
Answer: C
Answer: A
Answer: D
Answer: A
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,
Answer: A
Answer: B
Answer: A
Answer: C
29) Gasoline and heating oil are examples of products which are
Answer: B
Answer: D
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
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.
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
Q = 475
P = $525
Each firm produces 1/5 the output, or q =95. Profit for each firm is
$45,125.
Answer: There are many reasons, but one of the best is that there is
an incentive to cheat. While
the 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.
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
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.
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?
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 how does this make the goals of actors and
producers different?
14) Explain the reasons firms might follow the Baumol model of
maximizing revenue subject to
achieving a minimum level of profits.
Answer: B
A) market signaling.
B) a zero-sum game.
C) a non-zero sum, noncooperative game with a dominant
strategy.
D) adverse selection.
Answer: C
Answer: D
4) Market signaling
Answer: A
Analytical Questions
1) What is the "market signaling"?
Answer: C
Answer: A
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
Answer: B
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.
Answer: C
A) positive. B) negative.
C) larger than the internal rate of return. D) smaller than the
internal rate of return.
Answer: A
A) risk. B) uncertainty.
C) a clouded future. D) financial risk.
Answer: B
Answer: C
Answer: C
Answer: C
Answer: B
Answer: B
13) The internal rate of return equals the cost of capital when
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 which
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
Answer: D
Answer: C
16) The use of the same cost of capital (risk adjusted discount rate)
for all capital projects in a
corporation
Answer: D
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%, how much will be the cash flow?
Answer: C
19) If the risk adjusted discount rate method and the certainty
equivalent methods are to give the
same results, then the certainty equivalent factor (at) must equal
(where rf is the risk-free interest rate, and k is the risk adjusted cost
of capital)
Answer: C
Project A Project B
NPV
200 200 200
Answer: C
22) Usually, the cost of capital for newly issued stock is ________
the cost of retained earnings.
Answer: B
23) A stock whose rate of return fluctuates less than the rate of
return of a market portfolio will
have a beta that equals
A) 1. B) less than 1.
C) more than 1. D) Either A or C above.
Answer: B
Answer: C
Answer: D
Answer: D
28) Net present value and internal rate of return capital budgeting
decisions can differ because
Answer: D
29) Simulation analysis
Answer: A
Answer: C
Answer: C
Answer: D
Answer: D
Answer: B
Answer: C
Answer: D
Answer: D
Answer: A
Answer: B
Answer: B
42) When future events cannot be assigned probabilities, we are
talking about
A) risk. B) uncertainty.
C) a clouded future. D) financial risk.
Answer: B
Answer: D
Answer: A
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?
Answer:
a. FV = 5,000 {((1+ i)n – 1)/i} = $798,500
b. You will have to save $6,261 per year.
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%
7) You win the $20 million state lottery, and you have a choice of
taking an amount of money per year for the 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?
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?
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?
12) Describe the Capital Asset Pricing Model (CAPM) and how it
is used in capital budgeting
decisions.
14) A firm's most recent annual dividend was $2 per share; its
shares sell for $40 in the stock
market, 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?
15) What are the major sources of risk for the firm?
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?
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.
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.
Answer:
a. Expected revenue is $215.50.
b. Standard deviation = 72.90
c. Coefficient of variation = 0.34
20) Savings accounts pay very low rates of interest. The average
return on the stock market is
about 10-12%, in the long run. Why would anyone put money into
a savings account?
Answer: The stock market gives a higher return for higher risk.
Particularly if you are very
averse to risk, you might find the savings account to be an
attractive alternative.
The discount rate is 7%, and the initial investment is $1,000. How
much is the expected NPV of
this project?
Answer: $-20.
Project A Project B
NPV 200 300
Standard deviation 75 100
25) Explain why risk can be insured against but uncertainty cannot.
26) You are given risky cash flow data for a three-year project:
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%.
Answer:
Riskless Risky
Cash Flow Cash Flow
CE Riskless Discounted Discounted
Year Cash Flow Factor* 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
28) The XYZ Company has estimated expected cash flows for
1996 to be as follows:
.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.
Answer: a. $156,000
b. $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 factors for a four-year
project:
Certainty
Cash Flow Equivalent Factor
Period
1 $2,500 .95
2 3,000 .92
3 4,000 .88
4 3,000 .84
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.
Answer: $1,648
Answer: B
Answer: D
Answer: D
Analytical Questions
1) What are the major risks facing multinational corporations?
2) What are the major ways that the risks of exchange rate changes
can be hedged against?
Answer: C
Answer: B
Answer: D
A) greater than
B) less than
C) the same as
D) greater or less (depending on the market) than
Answer: B
A) greater than
B) less than
C) the same as
D) greater or less (depending on the market) than
Answer: A
Answer: A
A) restricts production.
B) levies a tax for the difference between private costs and
social costs.
C) prohibits production.
D) All three above.
E) Both A and B.
Answer: E
Answer: C
Answer: B
Answer: A
Answer: D
12) A merger between two companies in unrelated fields of
business
Answer: C
Analytical Questions
1) What are the five major reasons for government involvement in
a market economy?
Answer: A
Answer: D
Answer: B
Analytical Questions
1) Describe the market structure of the semiconductor industry.
Answer:
a. TR = P*Q = (500 – 1/10 Q)Q = 500Q – 1/10 Q2
b. MR = 500 – 1/5Q
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
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
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.