Chapter 12

Test your understanding answers

Test your understanding 1

B
As it has the highest NPV

Test your understanding 2

C
Fixed costs are $1,000; variable costs are $2.50

Test your understanding 3

D
Directors, who are placed in control of resources that they do not own
and are effectively agents of the shareholders, should be working in the
best interests of the shareholders. However, they may be tempted to act
in their own interests, for example by voting themselves huge salaries.
The background to the agency problem is the separation of ownership
and control – in many large companies the people who own the company
(the shareholders) are not the same people as those who control the
company (the board of directors).

Test your understanding 4

A
Import quotas will tend to reduce the level of competition in the market,
leading to higher prices for consumers.

Test your understanding 5

D
As the new price is a maximum above the current equilibrium, there
would be no effect. If it had been set below the equilibrium then demand
would outstrip supply.

Test your understanding 6

C
Asset prices, such as those of shares, and interest rates are inversely
related.

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Test your understanding 7

The stakeholders in a company are all those who have an interest in the
strategy and behaviour of the company. Their interest may not always
coincide with those of the shareholders who are principally interested in
profits. The task of management is to attempt to reconcile these
conflicting interests.

Test your understanding 8

A
Change in income = $2,000 × 10% = $200
Change in consumption = $1,600 × 8.75% = $140
MPC = change in consumption/change in income
MPC = $140/$200 = 0.7

Test your understanding 9

A
112/32 = 3.5. The frequency is 3.5 times the bar height.
28/3.5 = 8

Test your understanding 10

B
With a PED of –2.5, the quantity demanded will proportionately change
2.5 times as much as the price when the price is changed.
A rise in price from $10 to $11 is a 10% change, so the demand will fall
(because the PED is negative) by 25% to 7,500 units.
Old revenue = 10,000 × $10 = $100,000. New revenue = 7,500 × $11 =
$82,500, a fall of $17,500.

Test your understanding 11

A
A real life example of this is a pension. In other words, you are living off
the interest and the capital remains.
PV = 1/interest rate
$4,000 × (1/0.05) = $80,000

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Test your understanding 12

B
The modern view is that being socially responsible can offer business
benefits. This is particularly true of the oil industry where major UK and
US companies have attracted very substantial criticism as a result of an
apparent failure to adequately protect the environment from oil spills.

Test your understanding 13

C
Initially, for the same price the producer will receive a lower income as
some of the sales value is now passed on to the tax authorities.
An indirect tax is paid by the consumer so the producer does not decide
how much is passed on to the consumer.
However, the producer may choose to raise the price in order to sustain
their income levels. How much they choose to raise the price by will
depend on the price elasticity of demand. The greater it is, the more a
price rise will compromise their overall revenue and so would lead the
supplier to consider a smaller price rise.
A smaller price elasticity of supply would mean that a change in price
doesn’t affect the level of supply that much.

Test your understanding 14

(a) (i) Externalities
(b) (iii) Public goods and services

Test your understanding 15

A
The business has a choice of either reducing its costs or passing the cost
increase onto the consumer. If the product is price elastic then increasing
the price to cover the cost increase will compromise the business’s
revenue from the product, so the business would be encouraged to look
instead to cutting the wage cost by reducing the number of employees.

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Mock Assessment

Test your understanding 16

C
(A) would lead to other businesses benefitting from better trained staff
once those staff have moved jobs. (B) would mean that even
unvaccinated individuals would benefit from lower instances of the
disease. (D) would lead to negative pollution externalities.

Test your understanding 17

C
A shift to the left means a drop in demand at the same price level.
Raising the price of good B would normally lead to a contraction of
demand for good B. if demand for good A also falls but without a price
change then it is probably bought in conjunction with good B, i.e. it is a
complementary good.

Test your understanding 18

A

Test your understanding 19

Statement Supply Demand

Payments for imports into the country. X
Inflows of capital into the country. X
Purchases of foreign currency by the
X
country's central bank.

Test your understanding 20

B
A simple bar chart could not hold this amount of information.

Test your understanding 21

B
The bank wishes to keep a cash ratio of 20% (or 0.2). Using the credit
multiplier this means that cash deposits will multiply by 1/0.2 = 5 times.
Therefore $1,000 of extra assets would be multiplied to $5,000.

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Test your understanding 22

C
Assets that are more profitable tend to be less liquid and vice versa. For
instance a long-term bond will tend to have a higher yield than a short-
term one but cash is tied up for longer.

Test your understanding 23

A
A rise in the exchange rate can be caused by an increase in demand for
the currency or a decrease in supply. If the balance of payments starts to
shift towards a surplus it means that exports are increasing and/or
imports are decreasing. If exports are increasing then demand for the
home currency will rise. If imports are decreasing then the supply of the
home currency will fall. Either way the shift will tend to push the exchange
rate up.

Test your understanding 24

A
In the additive model, value Y= trend T + seasonal S. The seasonally
adjusted value estimates the trend Y – S = 423,700 – 81,500 = 342,200
in this case.
The errors were: in B, adding instead of subtracting S, and in C and D,
getting confused with the multiplicative model and multiplying or dividing
by 0.81500.

Test your understanding 25

A
Quarter 'Real' sales
1 (109/100) × 100 = 109.0
2 (120/110) × 100 = 109.1
3 (132/121) × 100 = 109.1
4 (145/133) × 100 = 109.0
The 'real' series is approximately constant and keeping up with inflation.

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Mock Assessment

Test your understanding 26

A
The price of shares is determined by demand and supply. (B) and (C)
would raise the demand for shares and (D) would reduce the supply.
However, a rise in interest rates would reduce the demand for shares as
alternative investments have become more attractive.

Test your understanding 27

Effects Yes No
Sales volume would increase. X
The volume of supply would increase. X

Test your understanding 28

B
Low interest rates encourage borrowing and therefore spending and
investment and they discourage savings. The nominal rate of interest is
dependent on both the real rate and the inflation rate. So if inflation is
high then even at low real rates the nominal rate will be high.

Test your understanding 29

C
A budget deficit (when government spending is greater than government
income from tax receipts) is designed to boost aggregate demand in the
economy. Government spending is an injection into the circular flow.

Test your understanding 30

B and C
An index of 104 means that prices have risen by 4 per cent, which in turn
means that current values are 1.04 times their values in the base year, on
average.

Test your understanding 31

(i) Company. Internal economies arise from the advantages of large
scale production within the business.
(ii) Too large. Diseconomies of scale occur when a business becomes
too big, the others can occur in a business of any size.

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Test your understanding 32

A negative supply shock would shift the aggregate supply curve to the
left and cause the rate of inflation to increase. However the level of
national output would fall.

Test your understanding 33

D
All are sources of political risk.

Test your understanding 34

Answer: 320,500
The additive model is A = T + S and seasonal component provides an
estimate of T = A – S = 238,500 – (–82,000) = 238,500 + 82,000.

Test your understanding 35

B

Test your understanding 36

B
Multiplicative model forecast = T × S
Sales last quarter 240(Q2)
Seasonality for Q2 = +50% S = 150
Trend = (240/150) × 100 = 160 for Q3
Seasonality = –50% S = 50
Forecast = 160 × (50/100) = 80

Test your understanding 37

A
A coefficient of determination between output and production costs tells
us that 89 per cent of the variation in production costs from one month to
the next can be explained by corresponding variation in output. It also
tells us that the linear relationship between output and costs is very
strong (not weak, as in C). Only a positive correlation can tell us that
costs increase as output increases and we cannot assume this form the
coefficient of determination.

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Mock Assessment

Test your understanding 38

C
Current cost = ($5 × 430)/150 = $14.33

Test your understanding 39

Statement True False

(i) A deficit on a country's balance of
payments current account can be financed X
by a surplus of invisible earnings.
(ii) Flows of profits and interest on capital
X
appear in the Capital Account.
(iii) Flexible exchange rate systems should, in
principle, prevent persistent current account X
imbalances.
(iv) Current account deficits tend to worsen in
X
periods of rapid economic growth.

Test your understanding 40

B
Increases in government spending tend to raise aggregate demand. If
firms are operating at full capacity then they will struggle to increase
output (at this point the price elasticity of supply will be low). The
consequence of this is an increase in the equilibrium price.

Test your understanding 41

A Correct
B Correct
C Incorrect: x = 0 is outside the range of the data
D Incorrect: when x increases by 1, y increases by 4.3 from the
regression equation

Test your understanding 42

C

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Test your understanding 43

Event Raise Lower Leave

inflation inflation inflation
unchanged
(i) A rise (appreciation) in the
exchange for the country's X
currency.
(ii) A significant increase in the
X
money supply.
(iii) A rise in business
expectations leading to an X
increase in investment.

Test your understanding 44

Price Rise Fall Remain

unchanged
Domestic price of imported goods. X
Foreign price of imported goods. X

Test your understanding 45

A
Present value = $8,000 + present value of an annuity of $8,000 for 9
years at 12 per cent.
Present value = $50,626

Test your understanding 46

C
High positive. It is unlikely to be perfect as there may be other factors that
impact the cost, such as price rises and people accidentally leaving lights
on overnight.

Test your understanding 47

A
A rise in US interest rates is likely to prompt a flow of funds from UK to
US increasing the relative demand (and value) of the dollar, meaning a
corresponding relative fall in value of sterling.

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Mock Assessment

Test your understanding 48

B

Test your understanding 49

A B C D E F G H
d 0 –1 –1 1 1 1 –1 0
d2 0 1 1 1 1 1 1 0
Σd2 = 6; n = 8
6 × Σd2
Rank correlation –1 –
n(n2 –1)
6 × 6
– 1 – = 0.929
8 × 63

Test your understanding 50

A
The supplier's maintenance contract is a year end annuity of $13,000 per
year. Discounting at 10 per cent and using the cumulative discount factor
table gives a present value of $13,000 × 4.868 = $63,284

Test your understanding 51

C
Seasonally adjusted value (T) = actual value (Y)/seasonal component
(S).
So seasonal component = actual value divided by seasonally adjusted
value = Y/T = 547/495 = 1.105

Test your understanding 52

A
Statements 1 and 2 are correct. IRR is calculated using cash flows rather
than profits so statement 3 is incorrect.

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Test your understanding 53

C
• Percentage change in price = ($60 – $48)/$54 = –22.22%
• Percentage change in demand = (21,000 – 20,000)/20,500 =
+4.878%
• PED = (+4.878)/(–22.22) = –0.2195 = –0.22

Test your understanding 54

C
Economic exposures are strategic exposures to currency risk. An
economic exposure gives rise to transaction exposures. In this example,
transaction exposures will arise whenever the company buys supplies in
the euro zone for payment in euros and whenever it sells to customers in
the US for payment in dollars.

Test your understanding 55

Statements True False

If the demand curve for Good A shifts to the
right when the price of Good B falls we can X
conclude that A and B are substitute goods.
If the demand for a good is price inelastic, a fall
in its price will leave sales volume unchanged X
and total revenue reduced.

Test your understanding 56

Situations Definition
The emission of dangerous fumes from car exhausts. B
Premature death of consumers of tobacco. D

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Test your understanding 57

Indicators Rise Fall Remain

unchanged
The rate of inflation. X
The rate of unemployment. X

Test your understanding 58

D
All these statements are true of futures contracts, when compared to
forward contracts.

Test your understanding 59

A
Translation risk.

Test your understanding 60

A
One form of political risk is government measures to improve the
competitiveness of national companies. The other statements are false.

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