Chapter 1—Introduction and Goals of the Firm
MULTIPLE CHOICE
1. The form of economics most relevant to managerial decision-making within the firm is:
a. macroeconomics
b. welfare economics
c. free-enterprise economics
d. microeconomics
e. none of the above
ANS: D
PTS: 1
2. If one defines incremental cost as the change in total cost resulting from a decision, and incremental
revenue as the change in total revenue resulting from a decision, any business decision is profitable if:
a. it increases revenue more than costs or reduces costs more than revenue
b. it decreases some costs more than it increases others (assuming revenues remain constant)
c. it increases some revenues more than it decreases others (assuming costs remain constant)
d. all of the above
e. b and c only
ANS: D
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3. In the shareholder wealth maximization model, the value of a firm's stock is equal to the present value
of all expected future ____ discounted at the stockholders' required rate of return.
a. profits (cash flows)
b. revenues
c. outlays
d. costs
e. investments
ANS: A
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4. Which of the following statements concerning the shareholder wealth maximization model is (are)
true?
a. The timing of future profits is explicitly considered.
b. The model provides a conceptual basis for evaluating differential levels of risk.
c. The model is only valid for dividend-paying firms.
d. a and b
e. a, b, and c
ANS: D
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5. According to the profit-maximization goal, the firm should attempt to maximize short-run profits since
there is too much uncertainty associated with long-run profits.
a. true
b. false
ANS: B
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6. According to the innovation theory of profit, above-normal profits are necessary to compensate the
owners of the firm for the risk they assume when making their investments.
a. true
b. false
ANS: B
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7. According to the managerial efficiency theory of profit, above-normal profits can arise because of
high-quality managerial skills.
a. true
b. false
ANS: A
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8. Which of the following (if any) is not a factor affecting the profit performance of firms:
a. differential risk
b. innovation
c. managerial skills
d. existence of monopoly power
e. all of the above are factors
ANS: E
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9. Agency problems and costs are incurred whenever the owners of a firm delegate decision-making
authority to management.
a. true
b. false
ANS: A
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10. Economic profit is defined as the difference between revenue and ____.
a. explicit cost
b. total economic cost
c. implicit cost
d. shareholder wealth
e. none of the above
ANS: B
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11. Income tax payments are an example of ____.
a. implicit costs
b. explicit costs
c. normal return on investment
d. shareholder wealth
e. none of the above
ANS: B
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12. Various executive compensation plans have been employed to motivate managers to make decisions
that maximize shareholder wealth. These include:
a. cash bonuses based on length of service with the firm
b. bonuses for resisting hostile takeovers
c. requiring officers to own stock in the company
d. large corporate staffs
e. a, b, and c only
ANS: C
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13. The common factors that give rise to all principal-agent problems include the
a. unobservability of some manager-agent action
b. presence of random disturbances in team production
c. the greater number of agents relative to the number of principals
d. a and b only
e. none of the above
ANS: D
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14. The Saturn Corporation (once a division of GM) was permanently closed in 2009. What went wrong
with Saturn?
a. Saturn’s cars sold at prices higher than rivals Honda or Toyota, so they could not sell many cars.
b. Saturn sold cars below the prices of Honda or Toyota, earning a low 3% rate of return.
c. Saturn found that young buyers of Saturn automobiles were very loyal to Saturn and GM.
d. Saturn implemented a change management view that helped make first time Saturn purchasers
trade up to Buick or Cadillac.
e. all of the above
ANS: B
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15. A Real Option Value is:
a. An option that been deflated by the cost of living index makes it a “real” option.
b. An opportunity cost of capital.
c. An opportunity to implement a new cost savings or revenue expansion activity that arises from
business plans that the managers adopt.
d. An objective function and a decision rule that comes from it.
e. Both a and b.
ANS: C
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16. Which of the following will increase (V0), the shareholder wealth maximization model of the firm:
V0∙(shares outstanding) = t=1 ( t ) / (1+ke)t + Real Option Value.
a.
b.
c.
d.
e.
Decrease the required rate of return (ke).
Decrease the stream of profits (t).
Decrease the number of periods from  to 10 periods.
Decrease the real option value.
All of the above.
ANS: A
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17. The primary objective of a for-profit firm is to ___________.
a.
maximize agency costs
b.
minimize average cost
c.
maximize total revenue
d.
set output where total revenue equals total cost
e
maximize shareholder value
ANS: E
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18. Possible goals of Not-For-Profit (NFP) enterprises include all of the following EXCEPT:
a. maximize total costs
b. maximize output, subject to a breakeven constraint
c. maximize the happiness of the administrators of the NFP enterprise
d. maximize the utility of the contributors
e. a. and c.
ANS: A
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19. The flat-screen plasma TVs are selling extremely well. The originators of this technology are earning
higher profits. What theory of profit best reflects the performance of the plasma screen makers?
a. risk-bearing theory of profit
b. dynamic equilibrium theory of profit
c. innovation theory of profit
d. managerial efficiency theory of profit
e. stochastic optimization theory of profit
ANS: C
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20. To reduce Agency Problems, executive compensation should be designed to:
a. create incentives so that managers act like owners of the firm.
b. avoid making the executives own shares in the company.
c. be an increasing function of the firm's expenses.
d. be an increasing function of the sales revenue received by the firm.
e. all of the above
ANS: A
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21. Recently, the American Medical Association changed its recommendations on the frequency of papsmear exams for women. The new frequency recommendation was designed to address the family
histories of the patients. The optimal frequency should be where the marginal benefit of an additional
pap-test:
a. equals zero.
b. is greater than the marginal cost of the test
c. is lower than the marginal cost of an additional test
d. equals the marginal cost of the test
e. both a and b.
ANS: D
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Chapter 2—Fundamental Economic Concepts
MULTIPLE CHOICE
1.
A change in the level of an economic activity is desirable and should be undertaken as long as the
marginal benefits exceed the ____.
a. marginal returns
b.
c.
d.
e.
total costs
marginal costs
average costs
average benefits
ANS: C
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2. The level of an economic activity should be increased to the point where the ____ is zero.
a. marginal cost
b. average cost
c. net marginal cost
d. net marginal benefit
e. none of the above
ANS: D
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3. The net present value of an investment represents
a. an index of the desirability of the investment
b. the expected contribution of that investment to the goal of shareholder wealth
maximization
c. the rate of return expected from the investment
d. a and b only
e. a and c only
ANS: B
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4. Generally, investors expect that projects with high expected net present values also will be projects
with
a. low risk
b. high risk
c. certain cash flows
d. short lives
e. none of the above
ANS: B
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5. An closest example of a risk-free security is
a. General Motors bonds
b. AT&T commercial paper
c. U.S. Government Treasury bills
d. San Francisco municipal bonds
e. an I.O.U. that your cousin promises to pay you $100 in 3 months
ANS: C
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6. The standard deviation is appropriate to compare the risk between two investments only if
a. the expected returns from the investments are approximately equal
b. the investments have similar life spans
c. objective estimates of each possible outcome is available
d. the coefficient of variation is equal to 1.0
e. none of the above
ANS: A
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7. The approximate probability of a value occurring that is greater than one standard deviation from the
mean is approximately (assuming a normal distribution)
a.
b.
c.
d.
e.
68.26%
2.28%
34%
15.87%
none of the above
ANS: D
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8. Based on risk-return tradeoffs observable in the financial marketplace, which of the following
securities would you expect to offer higher expected returns than corporate bonds?
a. U.S. Government bonds
b. municipal bonds
c. common stock
d. commercial paper
e. none of the above
ANS: C
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9. The primary difference(s) between the standard deviation and the coefficient of variation as measures
of risk are:
a. the coefficient of variation is easier to compute
b. the standard deviation is a measure of relative risk whereas the coefficient of variation is a
measure of absolute risk
c. the coefficient of variation is a measure of relative risk whereas the standard deviation is a
measure of absolute risk
d. the standard deviation is rarely used in practice whereas the coefficient of variation is
widely used
e. c and d
ANS: C
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10. The ____ is the ratio of ____ to the ____.
a. standard deviation; covariance; expected value
b. coefficient of variation; expected value; standard deviation
c. correlation coefficient; standard deviation; expected value
d. coefficient of variation; standard deviation; expected value
e. none of the above
ANS: D
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11. Sources of positive net present value projects include
a. buyer preferences for established brand names
b. economies of large-scale production and distribution
c. patent control of superior product designs or production techniques
d. a and b only
e. a, b, and c
ANS: E
12.
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Receiving $100 at the end of the next three years is worth more to me than receiving $260 right now,
when my required interest rate is 10%.
a.
True
b.
False
ANS: B
13.
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The number of standard deviations z that a particular value of r is from the mean ȓ can be computed as
z = (r - ȓ)/ Suppose that you work as a commission-only insurance agent earning $1,000 per week
on average. Suppose that your standard deviation of weekly earnings is $500. What is the probability
that you zero in a week? Use the following brief z-table to help with this problem.
Z value
-3
-2
-1
0
a.
b.
c.
d.
e.
Probability
.0013
.0228
.1587
.5000
1.3% chance of earning nothing in a week
2.28% chance of earning nothing in a week
15.87% chance of earning nothing in a week
50% chance of earning nothing in a week
none of the above
ANS: B PTS: 1
t
T
14. Consider an investment with the following payoffs and probabilities:
State of the Economy
Probability
Return
Stability
.50
1,000
Good Growth
.50
2,000
Determine the expected return for this investment.
a. 1,300
b. 1,500
c. 1,700
d. 2,000
e. 3,000
ANS: B
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15. Consider an investment with the following payoffs and probabilities:
State of the Economy
Probability
Return
GDP grows slowly
.70
1,000
GDP grow fast
.30
2,000
Let the expected value in this example be 1,300. How do we find the standard deviation of the
investment?
a.  =  { (1000-1300)2 + (2000-1300)2 }
b.  =  { (1000-1300) + (2000-1300) }
c. =  { (.5)(1000-1300)2 + (.5)(2000-1300)2 }
d. =  { (.7)(1000-1300) + (.3)(2000-1300) }
e. =  { (.7)(1000-1300)2 + (.3)(2000-1300)2 }
ANS: E
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16. An investment advisor plans a portfolio your 85 year old risk-averse grandmother. Her portfolio
currently consists of 60% bonds and 40% blue chip stocks. This portfolio is estimated to have an
expected return of 6% and with a standard deviation 12%. What is the probability that she makes less
than 0% in a year? [A portion of Appendix B1 is given below, where z = (x - with as the mean
and as the standard deviation.]
a.
2.28%
b.
6.68%
c.
15.87%
d.
30.85%
e.
50%
Table B1 for Z
Z
Prob.
-3
.0013
-2.5
.0062
-2.
.0228
-1.5
.0668
-1
.1587
-.5
..3085
0
.5000
ANS: D
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17. Two investments have the following expected returns (net present values) and standard deviations:
PROJECT
Expected Value
Standard Deviation
Q
$100,000
$20,000
X
$50,000
$16,000
Based on the Coefficient of Variation, where the C.V. is the standard deviation dividend by the
expected value.
a.
All coefficients of variation are always the same.
b.
Project Q is riskier than Project X
c.
Project X is riskier than Project Q
d.
Both projects have the same relative risk profile
e.
There is not enough information to find the coefficient of variation.
ANS: C
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PROBLEMS
1. Suppose that the firm's cost function is given in the following schedule (where Q is the level of
output):
Output
Q (units)
0
1
2
3
4
5
6
7
8
Total
Cost
7
25
37
45
50
53
58
66
78
9
10
96
124
Determine the (a) marginal cost and (b) average total cost schedules
ANS:
(a)
Marginal
Cost
(TC)
Q
(b)
Average Total
Cost
TC
Q
7
25
37
45
50
53
58
66
78
96
124
-18
12
8
5
3
5
8
12
18
28
-25.00
18.50
15.00
12.50
10.60
9.67
9.43
9.75
10.67
12.40
Output
Total
Profit
Marginal
Profit
Average
Profit
0
1
2
3
4
5
6
7
8
9
10
48
26
8
6
16
22
24
22
16
6
8
0
______
______
______
______
______
______
______
______
______
______
______
______
______
______
______
______
______
______
______
______
______
Output
Total
Cost
Q
0
1
2
3
4
5
6
7
8
9
10
PTS: 1
2.Complete the following table.
ANS:
Output
Total
Profit
Marginal
Profit
0
1
2
3
4
5
6
7
8
9
10
48
26
8
6
16
22
24
22
16
6
8
0
22
18
14
10
6
2
2
6
10
14
Average
Profit
--26.
4.
2.
4.
4.40
4.
3.14
2.
0.67
0.80
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3. A firm has decided to invest in a piece of land. Management has estimated that the land can be sold in
5 years for the following possible prices:
Price
Probability
10,000
15,000
20,000
25,000
.20
.30
.40
.10
(a)
(b)
(c)
ANS:
(a)
(b)
Determine the expected selling price for the land.
Determine the standard deviation of the possible sales prices.
Determine the coefficient of variation.
(c)
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Chapter 3—Demand Analysis
MULTIPLE CHOICE
1. Suppose we estimate that the demand elasticity for fine leather jackets is -.7 at their current prices. Then
we know that:
a. a 1% increase in price reduces quantity sold by .7%.
b. no one wants to buy leather jackets.
c. demand for leather jackets is elastic.
d. a cut in the prices will increase total revenue.
e. leather jackets are luxury items.
ANS:
A
PTS: 1
2. If demand were inelastic, then we should immediately:
a. cut the price.
b. keep the price where it is.
c. go to the Nobel Prize Committee to show we were the first to find an upward sloping demand curve.
d. stop selling it since it is inelastic.
e. raise the price.
ANS:
E
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3. In this problem, demonstrate your knowledge of percentage rates of change of an entire demand
function (HINT: %Q = EP•%P + EY•%Y). You have found that the price elasticity of motor
control devices at Allen-Bradley Corporation is -2, and that the income elasticity is a +1.5. You have
been asked to predict sales of these devices for one year into the future. Economists from the
Conference Board predict that income will be rising 3% over the next year, and AB’s management is
planning to raise prices 2%. You expect that the number of AB motor control devices sold in one year
will:
a. fall .5%.
b. not change.
c. rise 1%r.
d. rise 2%.
e. rise .5%.
ANS: E
4
PTS: 1
A linear demand for lake front cabins on a nearby lake is estimated to be: QD = 900,000 - 2P. What is
the point price elasticity for lake front cabins at a price of P = $300,000? [HINT: Ep = (Q/P)(P/Q)]
a. EP = -3.0
b. EP = -2.0
c. EP = -1.0
d. EP = -0.5
e. EP = 0
ANS: B
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5. Property taxes are the product of the tax rate (T) and the assessed value (V). The total property tax
collected in your city (P) is: P = T•V. If the value of properties rise 4% and if Mayor and City Council
reduces the property the tax rate by 2%, what happens to the total amount of property tax collected?
[HINT: the percentage rate of change of a product is approximately the sum of the percentage rates of
change.}
a. It rises 6 %.
b. It rises 4 %.
c. It rises 3 %.
d. It rises 2 %
e. If falls 2%.
ANS: D
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6. Demand is given by QD = 620 - 10·P and supply is given by QS = 100 + 3·P. What is the price and
quantity when the market is in equilibrium?
a. The price will be $30 and the quantity will be 132 units.
b. The price will be $11 and the quantity will be 122 units.
c. The price will be $40 and the quantity will be 220 units.
d. The price will be $35 and the quantity will be 137 units
e. The price will be $10 and the quantity will be 420 units.
ANS: C
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7. Which of the following would tend to make demand INELASTIC?
a. the amount of time analyzed is quite long
b. there are lots of substitutes available
c. the product is highly durable
d. the proportion of the budget spent on the item is very small
e. no one really wants the product at all
ANS: D
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8. Which of the following best represents management's objective(s) in utilizing demand analysis?
a. it provides insights necessary for the effective manipulation of demand
b. it helps to measure the efficiency of the use of company resources
c. it aids in the forecasting of sales and revenues
d. a and b
e. a and c
ANS: E
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9. Identify the reasons why the quantity demanded of a product increases as the price of that product
decreases.
a. as the price declines, the real income of the consumer increases
b. as the price of product A declines, it makes it more attractive than product B
c. as the price declines, the consumer will always demand more on each successive price
reduction
d. a and b
e. a and c
ANS: D
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10. An increase in the quantity demanded could be caused by:
a. an increase in the price of substitute goods
b. a decrease in the price of complementary goods
c. an increase in consumer income levels
d. all of the above
e. none of the above
ANS: D
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11. Iron ore is an example of a:
a. durable good
b. producers' good
c. nondurable good
d. consumer good
e. none of the above
ANS: B
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12. If the cross price elasticity measured between items A and B is positive, the two products are referred
to as:
a. complements
b. substitutes
c. inelastic as compared to each other
d. both b and c
e. a, b, and c
ANS: B
13.
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When demand is ____ a percentage change in ____ is exactly offset by the same percentage change in
____ demanded, the net result being a constant total consumer expenditure.
a. elastic; price; quantity
b. unit elastic; price; quantity
c. inelastic; quantity; price
d. inelastic; price; quantity
e. none of the above
ANS: B
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14. Marginal revenue (MR) is ____ when total revenue is maximized.
a. greater than one
b. equal to one
c. less than zero
d. equal to zero
e. equal to minus one
ANS: D
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15. The factor(s) which cause(s) a movement along the demand curve include(s):
a. increase in level of advertising
b. decrease in price of complementary goods
c. increase in consumer disposable income
d. decrease in price of the good demanded
e. all of the above
ANS: D
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16. An increase in each of the following factors would normally provide a subsequent increase in quantity
demanded, except:
a. price of substitute goods
b. level of competitor advertising
c. consumer income level
d. consumer desires for goods and services
e. a and b
ANS: B
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17. Producers' goods are:
a. consumers' goods
b. raw materials combined to produce consumer goods
c. durable goods used by consumers
d. always more expensive when used by corporations
e. none of the above
ANS: B
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18. The demand for durable goods tends to be more price elastic than the demand for non-durables.
a. true
b. false
ANS: A
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19. A price elasticity (ED) of 1.50 indicates that for a ____ increase in price, quantity demanded will
____ by ____.
a. one percent; increase; 1.50 units
b.
c.
d.
e.
one unit; increase; 1.50 units
one percent; decrease; 1.50 percent
one unit; decrease; 1.50 percent
ten percent; increase; fifteen percent
ANS: C
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20. Those goods having a calculated income elasticity that is negative are called:
a. producers' goods
b. durable goods
c. inferior goods
d. nondurable goods
e. none of the above
ANS: C
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21. An income elasticity (Ey) of 2.0 indicates that for a ____ increase in income, ____ will increase by
____.
a. one percent; quantity supplied; two units
b. one unit; quantity supplied; two units
c. one percent; quantity demanded; two percent
d. one unit; quantity demanded; two units
e. ten percent; quantity supplied; two percent
ANS: C
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22. When demand elasticity is ____ in absolute value (or ____), an increase in price will result in a(n)
____ in total revenues.
a. less than 1; elastic; increase
b. more than 1; inelastic; decrease
c. less than 1; elastic; decrease
d. less than 1; inelastic; increase
e. none of the above
ANS: D
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23. Empirical estimates of the price elasticity of demand [in Table 3.4] suggest that the demand for
household consumption of alcoholic beverages is:
a. highly price elastic
b. price inelastic
c. unitarily elastic
d. an inferior good
e. none of the above
ANS: B
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PROBLEM
1. The manager of the Sell-Rite drug store accidentally mismarked a shipment of 20-pound bags of
charcoal at $4.38 instead of the regular price of $5.18. At the end of a week, the store's inventory of
200 bags of charcoal was completely sold out. The store normally sells an average of 150 bags per
week.
(a)
(b)
What is the store's arc elasticity of demand for charcoal?
Give an economic interpretation of the numerical value obtained in part (a)
ANS:
(a)
Q1 = 150
(b)
P1 = $5.18
Q2 = 200
P2 = $4.38
A 1 percent increase in price will result in a 1.71 percent decrease in demand for
charcoal.
PTS: 1
2. The Future Flight Corporation manufactures a variety of Frisbees selling for $2.98 each. Sales have
averaged 10,000 units per month during the last year. Recently Future Flight's closest competitor,
Soaring Free Company, cut its prices on similar Frisbees from $3.49 to $2.59. Future Flight noticed
that its sales declined to 8,000 units per month after the price cut.
(a)
(b)
What is the arc cross elasticity of demand between Future Flight's and Soaring Free's
Frisbees?
If Future Flight knows the arc price elasticity of demand for its Frisbees is 2.2, what
price would they have to charge in order to obtain the same level of sales as before
Soaring Free's price cut?
ANS:
(a)
QA1 = 10,000
PB1 = $3.49
QA2 = 8,000
PB2 = $2.59
(b)
ED = 2.2
Q1 = 8,000
P1  2.98
Q2 = 10,000
PTS: 1
3. The British Automobile Company is introducing a brand new model called the "London Special."
Using the latest forecasting techniques, BAC economists have developed the following demand
function for the "London Special":
QD = 1,200,000  40P
What is the point price elasticity of demand at prices of (a) $8,000 and (b) $10,000?
ANS:
(a)
(b)
PTS: 1
4. Hanna Corporation markets a compact microwave oven. In 2010 they sold 23,000 units at $375 each.
Per capita disposable income in 2010 was $6,750. Hanna economists have determined that the arc
price elasticity for this microwave oven is 1.2.
(a)
In 2011 Hanna is planning to lower the price of the microwave oven to $325. Forecast
(b)
sales volume for 2011 assuming that all other things remain equal.
However, in checking with government economists, Hanna finds that per capita
disposable income is expected to rise to $7,000 in 2011. In the past the company has
observed an arc income elasticity of +2.5 for microwave ovens. Forecast 2011 sales
given that the price is reduces to $325 and that per capita disposable income increases to
$7,000. Assume that the price and income effects are independent and additive.
ANS:
(a)
Q1 = 23,000
(b)
P1 = $375
P2 = $325
Price effect
Income effect
Y2 = 7,000
Y1 = 6,750
Net effect = Price effect + Income effect = .1714 + .0909 = .2623
Using the initial quantity (Q1 = 23,000) as the base in computing the percentage change yields:
Using the average quantity [(Q1 + Q2)/2] as the base in computing the percentage change
yields:
PTS: 1
Chapter 4—Estimating Demand
MULTIPLE CHOICE
1. Using a sample of 100 consumers, a double-log regression model was used to estimate demand for
gasoline. Standard errors of the coefficients appear in the parentheses below the coefficients.
Ln Q = 2.45 -0.67 Ln P + . 45 Ln Y - .34 Ln Pcars
(.20)
(.10)
(.25)
Where Q is gallons demanded, P is price per gallon, Y is disposable income, and Pcars is a price index
for cars. Based on this information, which is NOT correct?
a. Gasoline is inelastic.
b. Gasoline is a normal good.
c. Cars and gasoline appear to be mild complements.
d. The coefficient on the price of cars (Pcars) is insignificant.
e. All of the coefficients are insignificant.
ANS: E
PTS: 1
2. In a cross section regression of 48 states, the following linear demand for per-capita cans of soda was
found: Cans = 159.17 – 102.56 Price + 1.00 Income + 3.94Temp
Intercept
Price
Income
Temperature
R-Sq = 54.1%
Coefficients
159.17
-102.56
1.00
3.94
Standard
Error
94.16
33.25
1.77
0.82
t Stat
1.69
-3.08
0.57
4.83
R-Sq(adj) = 51.0%
From the linear regression results in the cans case above, we know that:
a. Price is insignificant
b. Income is significant
c. Temp is significant
d. As price rises for soda, people tend to drink less of it
e. All of the coefficients are significant
ANS: D
PTS: 1
3. A study of expenditures on food in cities resulting in the following equation:
Log E = 0.693 Log Y + 0.224 Log N
where E is Food Expenditures; Y is total expenditures on goods and services; and N is the size of the
family. This evidence implies:
a. that as total expenditures on goods and services rises, food expenditures falls.
b. that a one-percent increase in family size increases food expenditures .693%.
c. that a one-percent increase in family size increases food expenditures .224%.
d. that a one-percent increase in total expenditures increases food expenditures 1%.
e. that as family size increases, food expenditures go down.
ANS: C
PTS: 1
4. All of the following are reasons why an association relationship may not imply a causal relationship
except:
a. the association may be due to pure chance
b. the association may be the result of the influence of a third common factor
c. both variables may be the cause and the effect at the same time
d. the association may be hypothetical
e. both c and d
ANS: D
PTS: 1
5. In regression analysis, the existence of a significant pattern in successive values of the error term
constitutes:
a.
b.
c.
d.
e.
heteroscedasticity
autocorrelation
multicollinearity
nonlinearities
a simultaneous equation relationship
ANS: B
PTS: 1
6. In regression analysis, the existence of a high degree of intercorrelation among some or all of the
explanatory variables in the regression equation constitutes:
a. autocorrelation
b. a simultaneous equation relationship
c. nonlinearities
d. heteroscedasticity
e. multicollinearity
ANS: E
PTS: 1
7. When using a multiplicative power function (Y = a X1b1 X2b2 X3b3) to represent an economic
relationship, estimates of the parameters (a, and the b's) using linear regression analysis can be
obtained by first applying a ____ transformation to convert the function to a linear relationship.
a. semilogarithmic
b. double-logarithmic
c. reciprocal
d. polynomial
e. cubic
ANS: B
PTS: 1
8. The correlation coefficient ranges in value between 0.0 and 1.0.
a. true
b. false
ANS: B
PTS: 1
9. The coefficient of determination ranges in value between 0.0 and 1.0.
a. true
b. false
ANS: A
PTS: 1
10. The coefficient of determination measures the proportion of the variation in the independent variable
that is "explained" by the regression line.
a. true
b. false
ANS: B
PTS: 1
11. The presence of association between two variables does not necessarily imply causation for the
following reason(s):
a. the association between two variables may result simply from pure chance
b. the association between two variables may be the result of the influence of a third common
factor
c. both variables may be the cause and the effect at the same time
d. a and b
e. a, b, and c
ANS: E
PTS: 1
12. The estimated slope coefficient (b) of the regression equation (Ln Y = a + b Ln X) measures the ____
change in Y for a one ____ change in X.
a. percentage, unit
b. percentage, percent
c. unit, unit
d. unit, percent
e. none of the above
ANS: B
PTS: 1
13. The standard deviation of the error terms in an estimated regression equation is known as:
a. coefficient of determination
b. correlation coefficient
c. Durbin-Watson statistic
d. standard error of the estimate
e. none of the above
ANS: D
PTS: 1
14. In testing whether each individual independent variables (Xs) in a multiple regression equation is
statistically significant in explaining the dependent variable (Y), one uses the:
a. F-test
b. Durbin-Watson test
c. t-test
d. z-test
e. none of the above
ANS: C
PTS: 1
15. One commonly used test in checking for the presence of autocorrelation when working with time
series data is the ____.
a. F-test
b. Durbin-Watson test
c. t-test
d. z-test
e. none of the above
ANS: B
PTS: 1
16. The method which can give some information in estimating demand of a product that hasn’t yet come
to market is:
a. the consumer survey
b. market experimentation
c. a statistical demand analysis
d. plotting the data
e. the barometric method
ANS: A
PTS: 1
17. Demand functions in the multiplicative form are most common for all of the following reasons except:
a. elasticities are constant over a range of data
b. ease of estimation of elasticities
c. exponents of parameters are the elasticities of those variables
d. marginal impact of a unit change in an individual variable is constant
e. c and d
ANS: D
PTS: 1
18. The Identification Problem in the development of a demand function is a result of:
a. the variance of the demand elasticity
b. the consistency of quantity demanded at any given point
c. the negative slope of the demand function
d. the simultaneous relationship between the demand and supply functions
e. none of the above
ANS: D
PTS: 1
19. Consider the following linear demand function where QD = quantity demanded, P = selling price, and
Y = disposable income:
QD = 36 2.1P + .24Y
The coefficient of P (i.e., 2.1) indicates that (all other things being held constant):
a. for a one percent increase in price, quantity demanded would decline by 2.1 percent
b. for a one unit increase in price, quantity demanded would decline by 2.1 units
c. for a one percent increase in price, quantity demanded would decline by 2.1 units
d. for a one unit increase in price, quantity demanded would decline by 2.1 percent
e. none of the above
ANS: B
PTS: 1
20. Consider the following multiplicative demand function where QD = quantity demanded, P = selling
price, and Y = disposable income:
The coefficient of Y (i.e., .2) indicates that (all other things being held constant):
a. for a one percent increase in disposable income, quantity demanded would increase by .2
percent
b. for a one unit increase in disposable income, quantity demanded would increase by .2
units
c. for a one percent increase in disposable income quantity demanded would increase by .2
units
d. for a one unit increase in disposable income, quantity demanded would increase by .2
percent
e. none of the above
ANS: A
PTS: 1
21. One shortcoming of the use of ____ in demand analysis is that the participants are generally aware that
their actions are being observed and hence they may seek to act in a manner somewhat different than
normal.
a. market experiments
b. consumer clinics
c. statistical (econometric) methods
d. a and b
e. none of the above
ANS: B
PTS: 1
22. The constant or intercept term in a statistical demand study represents the quantity demanded when all
independent variables are equal to:
a. 1.0
b. their minimum values
c. their average values
d. 0.0
e. none of the above
ANS: D
PTS: 1
23. Novo Nordisk A/S, a Danish firm, sells insulin and other drugs worldwide. Activella, an estrogen and
progestin hormone replacement therapy sold by Novo-Nordisk, is examined using 33 quarters of data
Y = -204 + . 34X1 - .17X2
(17.0) (-1.71)
Where Y is quarterly sales of Activella, X1 is the Novo’s advertising of the hormone therapy, and X2 is
advertising of a similar product by Eli Lilly and Company, Novo-Nordisk’s chief competitor. The
parentheses contain t-values. Addition information is: Durbin-Watson = 1.9 and R2 = .89.
Using the data for Novo-Nordisk, which is correct?
a. Both X1 and X2 are statistically significant.
b. Neither X1 nor X2 are statistically significant.
c. X1 is statistically significant but X2 is not statistically significant.
d. X1 is not statistically significant but X2 is statistically significant.
e. The Durbin-Watson statistic shows significant problems with autocorrelation
ANS: A
PTS: 1
24. In which of the following econometric problems do we find Durbin-Watson statistic being far away
from 2.0?
a. the identification problem
b. autocorrelation
c. multicollinearity
d. heteroscedasticity
e. agency problems
ANS: B
PTS: 1
25. When there is multicollinearity in an estimated regression equation,
a. the coefficients are likely to be small.
b. the t-statistics are likely to be small even though the R2 is large.
c. the coefficient of determination is likely to be small.
d. the problem of omitted variables is likely.
e. the error terms will tend to have a cyclical pattern.
26. When two or more "independent" variables are highly correlated, then we have:
a. the identification problem
b. multicollinearity
c. autocorrelation
d. heteroscedasticity
e. complementary products
ANS: B
PTS: 1
27. Which is NOT true about the coefficient of determination?
a. As you add more variables, the R-square generally rises.
b. As you add more variables, the adjusted R-square can fall.
c. If the R-square is above 50%, the regression is considered significant.
d. The R-square gives the percent of the variation in the dependent variable that is explained by the
independent variables.
e. The higher is the R-square, the better is the fit.
ANS: C
PTS: 1
PROBLEMS
1. Phoenix Lumber Company uses the number of construction permits issued to help estimate demand
(sales). The firm collected the following data on annual sales and number of construction permits
issued in its market area:
Year
2003
2004
2005
2006
2007
2008
2009
(a)
(b)
(c)
(d)
(e)
No. of Construction
Permits Issued (000)
Sales
(1,000,000)
6.50
6.20
6.60
7.30
7.80
8.20
8.30
10.30
10.10
10.50
10.80
11.20
11.40
11.30
Which variable is the dependent variable and which is the independent variable?
Determine the estimated regression line.
Test the hypothesis (at the .05 significance level) that there is no relationship between
the variables.
Calculate the coefficient of determination. Give an economic interpretation to the value
obtained.
Perform an analysis of variance on the regression including an F-test (at the .05
significance level) of the overall significance of the results.
(f)
Suppose that 8,000 construction permits are expected to be issued in 2010. What would
be the point estimate of Phoenix Lumber Company's sales for 2010?
ANS:
(a)
(b)
Dependent variable (Y)  Sales
Independent variable (X)  No. of construction permits issued
Obs.
(i)
Year
Xi
Yi
XiYi
Xi2
Yi2
1
2
3
4
5
6
7
2003
2004
2005
2006
2007
2008
2009
6.50
6.20
6.60
7.30
7.80
8.20
8.30
50.90
Xi
10.30
10.10
10.50
10.80
11.20
11.40
11.30
75.60
Yi
66.95
62.62
69.30
78.84
87.36
93.48
93.79
552.34
XiYi
42.25
38.44
43.56
53.29
60.84
67.24
68.89
374.51
Xi2
106.09
102.01
110.25
116.64
125.44
129.96
127.69
818.08
Yi2
Alternatively, this project can be done using regression software or Excel.
(c)
From the t-distribution, the t.025 value with 72 degrees of freedom is 2.571. Since the calculated tvalue (14.726) is greater than the value from the table, we reject the hypothesis that there is no
relationship between the variables.
(d)
i
Xi
Yi
Yi = 6.4648 + .5962Xi
1
2
3
4
5
6
7
6.50
6.20
6.60
7.30
7.80
8.20
8.30
10.30
10.10
10.50
10.80
11.20
11.40
11.30
10.34010
10.16124
10.39972
10.81706
11.11516
11.35364
11.41326
Explained
SS
Unexplained
SS
Total
SS
.21151
.40801
.16022
.00029
.09933
.30652
.37609
1.56197
.00161
.00375
.01006
.00029
.00720
.00215
.01283
.03789
.25000
.49000
.09000
.00000
.16000
.36000
.25000
1.60000
The regression equation "explains" 97.6% of the variation in the company's sales.
(e)
Source of
Variation
Regression
Residual
Total
Sum of
Squares
1.56197
.03789
1.60000*
Degrees of
Freedom
1
5
6
Mean Squares
1.56197
.007578
*Difference is due to round-off error
The value of F(.05; 1,5) from the F-distribution is 6.61. Since the calculated F is greater than the value
from the table, we reject the null hypothesis that there is no relationship between the company's sales
and the number of construction permits issues.
(f)
Estimated sales for Phoenix Lumber Company in 2010 would be $11.234 million.
PTS: 1
NOTE: This problem requires the use of statistical tables.
2. Lenny's, a national restaurant chain, conducted a study of the factors affecting demand (sales). The
following variables were defined and measured for a random sample of 30 of its restaurants:
Y
X1
X2
X3
X4
X5
= Annual restaurant sales ($000)
= Disposable personal income (per capita) of residents within 5 mile radius
= License to sell beer/wine (0 = No, 1 = Yes)
= Location (within one-half mile of interstate highway--0 = No, 1 = Yes)
= Population (within 5 mile radius)
= Number of competing restaurants within 2 mile radius
The data were entered into a computerized regression program and the following results were
obtained:
MULTIPLE R
.889
R-SQUARE
STD. ERROR OF EST.
.79
.40
ANALYSIS OF VARIANCE
Regression
Error
Total
Variable
Constant
X-1
X-2
X-3
X-4
X-5
DF
5
24
29
Coefficient
.363
.00275
76.65
164.3
.00331
46.2
Sum Squares
326.13
86.17
412.30
Mean Sqr.
65.226
3.590
Std. Error
.196
.00104
93.70
235.4
.00126
12.1
F-Stat
18.17
T-Value
1.852
2.644
.818
.698
2.627
3.818
Questions:
(a)
(b)
(c)
(d)
(e)
Give the regression equation for predicting restaurant sales.
Give an interpretation of each of the estimated regression coefficients.
Which of the independent variables (if any) are statistically significant at the .05 level in
"explaining" restaurant sales?
What proportion of the variation in restaurant sales is "explained" by the regression
equation?
Perform an F-test (at the .05 significance level) of the overall explanatory power of the
regression model.
ANS:
(a)
Y = .363 + .00275X1 + 76.65X2 + 164.3X3 + .00331X4  46.2X5
(b)
a = .363
b1 = .00275
b2 = 76.65
b3 = 164.3
b4 = .00331
b5 = 46.2
(c)
Value of dependent variable (Y) when all independent variables (X's)
are equal to zero.
For a one dollar increase in per capita disposable income, expected
restaurant sales will increase by .00275( $1000) = $2.7
Expected annual restaurant sales are 76.65( $1000) = $76,650 higher
for a restaurant with a license to sell beer/wine than for one without such
a license.
Expected annual restaurant sales are 164.3( $1000) = $164,300 higher
for a restaurant located within one-half mile of an interstate highway.
For a one person increase in population, expected restaurant sales will
increase by .00331( $1000) = $3.31.
For a one unit increase in the number of restaurants within a 2-mile
radius, expected annual restaurant sales decrease by 46.2( $1000) =
$46,200.
H0:  i = 0
H1:  i  0
Reject H0 if t > t.025, 24 = 2.064 or t < 2.064.
The t-values of X1 and X4 are greater than +2.064 (and the t-value of X5 is less than
2.064). Therefore X1, X4, and X5 are statistically significant at the .05 level in
"explaining" restaurant sales.
(d)
According to the R-SQUARE statistic, 79 percent of the variation in restaurant sales is
"explained" by the regression equation.
(e)
H0: All bi = 0 (no relationship)
H1: At least one bi  0
Reject H0 if F > F .05, 5, 24 = 2.62
The F-STAT is equal to 18.18, which exceeds 2.62. Therefore, one rejects the null
hypothesis (at the .05 significance level) and concludes that the five independent
variables "explain" a significant proportion of the variation in restaurant sales.
PTS: 1
NOTE: This problem requires the use of statistical tables.
3. The following demand function has been estimated for Fantasy pinball machines:
QD = 3,500  40P + 17.5Px + 670U + .0090A + 6,500N
where
(a)
(b)
ANS:
(a)
P = monthly rental price of Fantasy pinball machines
Px = monthly rental price of Old Chicago pinball machines (their largest competitor)
U = current unemployment rate in the 10 largest metropolitan areas
A = advertising expenditures for Fantasy pinball machines
N = fraction of the U.S. population between ages 10 and 30
What is the point price elasticity of demand for Fantasy pinball machines when P =
$150, Px = $100, U = .12, A = $200,000 and N = .35?
What is the point cross elasticity of demand with respect to Old Chicago pinball
machines for the values of the independent variables given in part (a)?
(b)
PTS: 1
4. Given the following demand function:
Q = 2.0 P1.33 Y2.0 A.50
where
Q = quantity demanded (thousands of units)
P = price ($/unit)
Y = disposable income per capita ($ thousands)
A = advertising expenditures ($ thousands)
determine the following when P = $2/unit, Y = $8 (i.e., $8000), and A = $25 (i.e., $25,000)
(a)
(b)
(c)
Price elasticity of demand
The approximate percentage increase in demand if disposable income percentage
increases by 3%.
The approximate percentage increase in demand if advertising expenditures are
increased by 5 percent.
ANS:
(a)
ED = 1.33 (independent of other variables)
(b)
Since EY = 2.0, a 3% increase in disposable income would yield an approximate
or a 6% increase in demand.
(c)
Since EA = 0.50, a 5% increase in advertising expenditures would yield an approximate
or a 2.5% increase in demand
PTS: 1
Chapter 5—Business and Economic Forecasting
MULTIPLE CHOICE
1. Time-series forecasting models:
a. are useful whenever changes occur rapidly and wildly
b. are more effective in making long-run forecasts than short-run forecasts
c. are based solely on historical observations of the values of the variable being forecasted
d. attempt to explain the underlying causal relationships which produce the observed
outcome
e. none of the above
ANS: C
PTS: 1
2. The forecasting technique which attempts to forecast short-run changes and makes use of economic
indicators known as leading, coincident or lagging indicators is known as:
a. econometric technique
b. time-series forecasting
c. opinion polling
d. barometric technique
e. judgment forecasting
ANS: D
PTS: 1
3. The use of quarterly data to develop the forecasting model Yt = a +bYt1 is an example of which
forecasting technique?
a. Barometric forecasting
b. Time-series forecasting
c. Survey and opinion
d. Econometric methods based on an understanding of the underlying economic variables
involved
e. Input-output analysis
ANS: B
PTS: 1
4. Variations in a time-series forecast can be caused by:
a. cyclical variations
b. secular trends
c. seasonal effects
d. a and b only
e. a, b, and c
ANS: E
PTS: 1
5. The variation in an economic time-series which is caused by major expansions or contractions usually
of greater than a year in duration is known as:
a.
b.
c.
d.
e.
secular trend
cyclical variation
seasonal effect
unpredictable random factor
none of the above
ANS: B
PTS: 1
6. The type of economic indicator that can best be used for business forecasting is the:
a. leading indicator
b. coincident indicator
c. lagging indicator
d. current business inventory indicator
e. optimism/pessimism indicator
ANS: A
PTS: 1
7. Consumer expenditure plans is an example of a forecasting method. Which of the general categories
best described this example?
a. time-series forecasting techniques
b. barometric techniques
c. survey techniques and opinion polling
d. econometric techniques
e. input-output analysis
ANS: C
PTS: 1
8. In the first-order exponential smoothing model, the new forecast is equal to a weighted average of the
old forecast and the actual value in the most recent period.
a. true
b. false
ANS: A
PTS: 1
9. Simplified trend models are generally appropriate for predicting the turning points in an economic
time series.
a. true
b. false
ANS: B
PTS: 1
10. Smoothing techniques are a form of ____ techniques which assume that there is an underlying pattern
to be found in the historical values of a variable that is being forecast.
a. opinion polling
b. barometric forecasting
c. econometric forecasting
d. time-series forecasting
e. none of the above
ANS: D
PTS: 1
11. Seasonal variations can be incorporated into a time-series model in a number of different ways,
including:
a. ratio-to-trend method
b. use of dummy variables
c. root mean squared error method
d. a and b only
e. a, b, and c
ANS: D
PTS: 1
12. For studying demand relationships for a proposed new product that no one has ever used before, what
would be the best method to use?
a. ordinary least squares regression on historical data
b. market experiments, where the price is set differently in two markets
c. consumer surveys, where potential customers hear about the product and are asked their opinions
d. double log functional form regression model
e. all of the above are equally useful in this case
ANS: C
PTS: 1
13. Which of the following barometric indicators would be the most helpful for forecasting future sales for
an industry?
a. lagging economic indicators.
b. leading economic indicators.
c. coincident economic indicators.
d. wishful thinking
e. none of the above
ANS: B
PTS: 1
14. An example of a time series data set is one for which the:
a. data would be collected for a given firm for several consecutive periods (e.g., months).
b. data would be collected for several different firms at a single point in time.
c. regression analysis comes from data randomly taken from different points in time.
d. data is created from a random number generation program.
d. use of regression analysis would impossible in time series.
ANS: A
PTS: 1
15. Examine the plot of data.
Sales










Time
It is likely that the best forecasting method for this plot would be:
a. a two-period moving average
b. a secular trend upward
c. a seasonal pattern that can be modeled using dummy variables or seasonal adjustments
d. a semi-log regression model
e. a cubic functional form
ANS: C
PTS: 1
16. Emma uses a linear model to forecast quarterly same-store sales at the local Garden Center. The
results of her multiple regression is:
Sales = 2,800 + 200•T - 350•D
where T goes from 1 to 16 for each quarter of the year from the first quarter of 2006 (‘06I) through the
fourth quarter of 2009 (‘09 IV). D is a dummy variable which is 1 if sales are in the cold and dreary
first quarter, and zero otherwise, because the months of January, February, and March generate few
sales at the Garden Center. Use this model to estimate sales in a store for the first quarter of 2010 in
the 17th month; that is: {2010 I}. Emma’s forecast should be:
a. 5,950
b. 6,200
c. 6,350
d. 6,000
e. 5,850
ANS: E
PTS: 1
17. Select the correct statement.
a. Qualitative forecasts give the direction of change.
b. Quantitative forecasts give the exact amount or exact percentage change.
c. Diffusion forecasts use the proportion of the forecasts that are positive to forecast up or down.
d. Surveys are a form of qualitative forecasting.
e. all of the above are correct.
ANS: E
PTS: 1
18. If two alternative economic models are offered, other things equal, we would
a. tend to pick the one with the lowest R2.
b. select the model that is the most expensive to estimate.
c. pick the model that was the most complex.
d. select the model that gave the most accurate forecasts
e. all of the above
ANS: D
PTS: 1
19. Mr. Geppetto uses exponential smoothing to predict revenue in his wood carving business. He uses a
weight of  = .4 for the naïve forecast and (1-) = .6 for the past forecast. What revenue did he
predict for March using the data below? Select closet answer.
MONTH REVENUE
FORECAST
Nov
100
100
Dec
90
100
Jan
115
---Feb
110
---MARCH ?
?
a. 106.2
b. 104.7
c. 103.2
d. 102.1
e. 101.7
ANS: A
PTS: 1
20. Suppose a plot of sales data over time appears to follow an S-shape as illustrated below.


Sales


 
Time
Which of the following is likely that the best forecasting functional form to use for sales data above?
a. A linear trend, Sales = a + b T
b. A quadratic shape in T, using T-squared as another variable, Sales = a + b T + cT2.
c. A semi-log form as sales appear to be growing at a constant percentage rate, Ln Sales = a + bT
d. A cubic shape in T, using T-squared and T-cubed as variables, Sales = a + b T + cT2 + d T3.
e. A quadratic shape in T and T-squared as variables, Sales = a + b T + cT2
ANS: D
PTS: 1
PROBLEM
1. The Accuweather Corporation manufactures barometers and thermometers for weather forecasters. In
an attempt to forecast its future needs for mercury, Accuweather's chief economist estimated average
monthly mercury needs as:
N = 500 + 10X
where N = monthly mercury needs (units) and X = time period in months (January 2008= 0). The
following monthly seasonal adjustment factors have been estimated using data from the past five
years:
Month
January
April
July
September
December
(a)
Adjustment Factor
15%
10%
20%
5%
10%
Forecast Accuweather's mercury needs for January, April, July, September, and
December of 2010.
(b)
The following actual and forecast values of mercury needs in the month of November
have been recorded:
Year
2008
2009
2007
Actual
456
324
240
Forecast
480
360
240
What seasonal adjustment factor should the firm use for November?
ANS:
(a)
Unadjusted
Forecast
500 + 10(24) = 740
500 + 10(27) = 770
500 + 10(30) = 800
500 + 10(32) = 820
500 + 10(35) = 850
Month
January 2010
April 2010
July 2010
September 2010
December 2010
(b)
Year
2008
2009
2007
Actual
456
324
240
Adjusted
Forecast
740(1.15) = 851
770(1.10) = 847
800(.80) = 640
820(1.05) = 861
850(.90) = 765
Forecast
480
360
240
Total
Actual/Forecast
.95
.90
1.00
2.85
PTS: 1
2. Milner Brewing Company experienced the following monthly sales (in thousands of barrels) during
2010:
Jan.
100
(a)
(b)
(c)
Feb.
92
Mar.
112
Apr.
108
May
116
June
116
Develop 2-month moving average forecasts for March through July.
Develop 4-month moving average forecasts for May through July.
Develop forecasts for February through July using the exponential smoothing method
(with w = .5). Begin by assuming
.
ANS:
Month
Actual
Sales
(a) 2-month
Moving Average
(b) 4-month
Moving Average
(c) Exponential
Smoothing
w = .5
Jan.
Feb.
Mar.
100
92
112
-----
-------
--100
100 + .5(82100) = 96
April
108
---
96 + .5(11296) = 104
May
116
104 + .5(108104) = 106
June
116
106 + .5(116106) = 111
July
---
111 + .5(116111) = 113.5
PTS: 1
Chapter 6—Managing Exports
MULTIPLE CHOICE
1. Using demand and supply curves for the Japanese yen based on the $/¥ price for yen, an increase in US
INFLATION RATES would
a. Decrease the demand for yen and decrease the supply of the yen.
b. Increase the demand for yen and decrease the supply of the yen.
c. Increase the demand and increase the supply of yen.
d. Decrease both the supply and the demand of yen.
e. Have no impact on the demand or supply of the yen.
ANS:
A
PTS: 1
2. If the British pound (₤) appreciates by 10% against the dollar:
a. both the US importers from Britain and US exporters to Britain will be helped by the appreciating
pound.
b. the US exporters will find it harder to sell to foreign customers in Britain.
c. the US importer of British goods will tend to find that their cost of goods rises, hurting its bottom
line.
d. both US importers of British goods and exporters to Britain will be unaffected by changes in
foreign exchange rates.
e. all of the above.
ANS: C
PTS: 1
3. Purchasing power parity or PPP says the ratios composed of:
a. interest rates explain the direction of exchange rates.
b. growth rates explain the direction of exchange rates.
c. inflation rates explain the direction of exchange rates.
d. services explain the direction exchange rates.
e. public opinion polls explain the direction of exchange rates.
ANS: C
PTS: 1
4. If Ben Bernanke, Chair of the Federal Reserve Board, begins to tighten monetary policy by raising US
interest rates next year, what is the likely impact on the value of the dollar?
a. The value of the dollar falls when US interest rates rise.
b. The value of the dollar rises when US interest rates rise.
c. The value of the dollar is not related to US interest rates.
d. This is known as Purchasing Power Parity or PPP.
e. The Federal Reserve has no impact at all on interest rates.
ANS: B
PTS: 1
5. If the domestic prices for traded goods rises 5% in Japan and rises 7% the US over the same period,
what would happened to the Yen/US dollar exchange rate? HINT: S1/S0 = (1+h) / (1+ f) where S0 is
the direct quote of the yen at time 0, the current period.
a. The direct quote of the yen ($/¥) rises, and the value of the dollar falls.
b. The direct quote of the yen ($/¥) falls, and the value of the dollar rises.
c. The direct quote of the yen would remain the same.
d. Purchasing power parity does not apply to inflation rates.
e. Both a and d.
ANS: B
PTS: 1
6. US and Canada can both grow wheat and can do mining. Use the following table to look for which
country has a comparative advantage in mining. (HINT: Find the cost of mining in terms of wheat in
each country.)
Wheat
Mining
a.
b.
c.
d.
e.
Absolute Cost in US
$5
$10
Absolute Cost in Canada
C$8
C$12
Canada has a comparative advantage in mining.
The US has a comparative advantage in mining.
No comparative advantage in mining exists for either nation.
We must first know the exchange rate to be able to answer this question.
Both a and b.
ANS: A
PTS: 1
7. The optimal currency area involves a trade-off of reducing transaction costs but the inability to use
changes in exchange rates to help ailing regions. If the US, Canada, and Mexico had one single currency
(the Peso-Dollar) we would tend to see all of the following EXCEPT:
a. Even more intraregional trade of goods across the three countries.
b.
c.
d.
e.
Lower transaction costs of trading within North America.
A greater difficulty in helping Mexico as you can no longer deflate the Mexican peso.
Less migration of workers across the three countries.
An elimination of correlated macroeconomic shocks across the countries.
ANS: D
PTS: 1
8. If the value of the U.S. dollar rises from 1.0 per dollar to 1.3 per dollar,
a. imports of automobiles from Germany will decline
b. American inflation will increase
c. German exports of all traded goods will decline
d. American exports to Germany will decrease
e. sales by American manufacturers for the export markets will increase.
ANS: D
PTS: 1
9. An appreciation of the U.S. dollar has what impact on Harley-Davidson (HD), a U.S. manufacturer of
motorcycles?
a. domestic sales of HD motorcycles increase and foreign sales of HD motorcycles increase
b. domestic sales of HD motorcycles decrease and foreign sales of HD motorcycles increase
c. domestic sales of HD motorcycles increase and foreign sales of HD motorcycles decrease
d. domestic sales of HD motorcycles decrease and foreign sales of HD motorcycles decrease
e. only manufacturers who produce traded goods are affected
ANS: D
PTS: 1
10. In the last twenty-five years, the Yen and German mark and now the Euro have
a. fluctuated widely against the dollar
b. appreciated against the dollar and then depreciated against the dollar
c. exchanged without restrictions
d. all of the above
e. none of the above
ANS: D
11.
PTS: 1
In an open economy with few capital restrictions and substantial import-export trade, a rise in interest
rates and a decline in the producer price index of inflation will
a. raise the value of the currency
b. lower the nominal interest rate
c. increase the volume of trading in the foreign exchange market
d. lower the trade-weighted exchange rate
e. increase consumer inflation.
ANS: A
PTS: 1
12. When a manufacturer's home currency appreciates substantially,
a. domestic sales decline
b. foreign sales decline
c. company-owned foreign plant and equipment will increase
d. margins often decline
e. all of the above
ANS: E
PTS: 1
13. An increase in the exchange rate of the U.S. dollar relative to a trading partner can result from
a. higher anticipated costs of production in the U.S.
b. higher interest rates and higher inflation in the U.S.
c. higher growth rates in the trading partner's economy
d. a change in the terms of trade
e. lower export industry productivity
ANS: C
PTS: 1
14. The purchasing power parity hypothesis implies that an increase in inflation in one country relative to
another will over a long period of time
a. increase exports
b. reduce the competitive pressure on prices
c. lower the value of the currency in the country with the higher inflation rate
d. increase foreign aid
e. increase the speculative demand for the currency
ANS: C
PTS: 1
15. Trading partners should specialize in producing goods in accordance with comparative advantage, then
trade and diversify in consumption because
a. out-of-pocket costs of production decline
b. free trade areas protect infant industries
c. economies of scale are present
d. manufacturers face diminishing returns
e. more goods are available for consumption
ANS: E
PTS: 1
16. European Union labor costs exceed U.S. and British labor costs primarily because
a. worker productivity is lower in the EU
b. union wages are higher in the EU
c. layoffs and plant closings are more restrictive in the U.S. and Britain
d. the amount of paid time off is higher in the EU
e. labor-management relations are better in the EU
ANS: D
PTS: 1
17. Companies that reduce their margins on export products in the face of appreciation of their home
currency may be motivated by a desire to
a. sacrifice market share abroad but build market share at home
b. increase production volume to realize learning curve advantages
c. sell foreign plants and equipment to lower their debt
d. reduce the costs of transportation
e. all of the above
ANS: B
PTS: 1
18. In a recession, the trade balance often improves because
a. service exports exceed manufactured good exports
b. banks sell depressed assets
c. fewer households can afford luxury imports
d. direct investment abroad declines
e. the capital account exceeds the current account
ANS: C
PTS: 1
PROBLEM
1. Suppose nominal interest rates in the U.S. rise from 4.6% to 5% and decline in Britain from 6% to
5.5%, while U.S. consumer inflation remains unchanged at 1.9% and British inflation declines from
4% to 3%. In addition suppose, real growth in the U.S. is forecasted for next year at 4% and in Britain
real growth is forecasted at 5%. Finally, suppose producer price inflation in the U.S. is declining from
2% to 1% while in Britain producer price inflation is rising from 2% to 3.2%. Explain what effect each
of these factors would have on the long-term trend exchange rate ( per $) and why?
ANS:
Nominal interest rates should be adjusted for anticipated inflationary purchasing power loss using
current consumer inflation rates as a forecast of future consumer inflation. Hence in the U.S. real rates
of interest are 0.4% higher while British real rates have risen by 0.5%, an insignificant difference.
Should the higher real growth rate forecast in Britain prove correct, this factor will cause British
imports to increase, American exports to increase, transaction demand for U.S. dollars to increase, and
the dollar to appreciate. If the forecasts are reliable, speculators may drive the dollar higher now in
anticipation of these events.
Falling producer prices in the U.S. and rising producer prices in Britain imply that American exports
will expand again, causing dollar appreciation. The reason is that the PPI measures the expected costs
that manufacturers of exports will want to recover in long-term supply contracts written today. So
buyers around the world will likely get lower, more attractive prices from American exporters than
from British exporters and, therefore, will execute more purchase contracts with American companies.
Two of the three factors suggest longer-term appreciation of the dollar.
PTS: 1
Chapter 7—Production Economics
MULTIPLE CHOICE
1. What’s true about both the short-run and long-run in terms of production and cost analysis?
a. In the short-run, one or more of the resources are fixed
b. In the long-run, all the factors are variable
c. The time horizon determines whether or not an input variable is fixed or not
d. The law of diminishing returns is based in part on some factors of production being fixed, as they
are in the short run.
e. All of the above
ANS: E
PTS: 1
2. The marginal product is defined as:
a. The ratio of total output to the amount of the variable input used in producing the output
b. The incremental change in total output that can be produced by the use of one more unit of the
variable input in the production process
c. The percentage change in output resulting from a given percentage change in the amount
d. The amount of fixed cost involved.
e. None of the above
ANS: B
PTS: 1
3. Fill in the missing data to solve this problem.
Variable
Total
Average
Marginal
Input
Product
Product
Product
4
?
70
---5
?
?
40
6
350
?
?
What is the total product for 5 units of input, and what is the marginal product for 6 units of input?
a.
320 and 30
b.
350 and 20
c.
360 and 15
d.
400 and 10
e.
430 and 8
ANS: A
PTS: 1
4. The following is a Cobb-Douglas production function: Q = 1.75K0.5∙L0.5. What is correct here?
a. A one-percent change in L will cause Q to change by one percent
b. A one-percent change in K will cause Q to change by two percent
c. This production function displays increasing returns to scale
d. This production function displays constant returns to scale
e. This production function displays decreasing returns to scale
ANS: D
PTS: 1
5. Suppose you have a Cobb-Douglas function with a capital elasticity of output (α) of 0.28 and a labor
elasticity of output (β) of 0.84. What statement is correct?
a. There are increasing returns to scale
b. If the amount of labor input (L) is increased by 1%, the output will increase by 0.84%
c. If the amount of capital input (K) is decreased by 1%, the output will decrease by 0.28%
d. The sum of the exponents in the Cobb-Douglas function is 1.12.
e. All of the above
ANS: E
PTS: 1
6. The Cobb-Douglas production function is: Q = 1.4*L0.6*K0.5. What would be the percentage change
in output (%∆Q) if labor grows by 3.0% and capital is cut by 5.0%?
[HINT: %∆Q = (EL * %∆L) + (EK * %∆K)]
a. %∆Q = + 3.0%
b. %∆Q = + 5.0%
c. %∆Q = - 0.70%
d. %∆Q = - 2.50%
e. %∆Q = - 5.0%
ANS: C
PTS: 1
7. If the marginal product of labor is 100 and the price of labor is 10, while the marginal product of
capital is 200 and the price of capital is $30, then what should the firm?
a. The firm should use relatively more capital
b. The firm should use relatively more labor
c. The firm should not make any changes – they are currently efficient
d. Using the Equimarginal Criterion, we can’t determine the firm’s efficiency level
e. Both c and d
ANS: B
PTS: 1
8. The marginal rate of technical substitution may be defined as all of the following except:
a. the rate at which one input may be substituted for another input in the production process,
while total output remains constant
b. equal to the negative slope of the isoquant at any point on the isoquant
c. the rate at which all combinations of inputs have equal total costs
d. equal to the ratio of the marginal products of X and Y
e. b and c
ANS: C
PTS: 1
9. The law of diminishing marginal returns:
a. states that each and every increase in the amount of the variable factor employed in the
production process will yield diminishing marginal returns
b. is a mathematical theorem that can be logically proved or disproved
c. is the rate at which one input may be substituted for another input in the production
process
d. none of the above
ANS: D
PTS: 1
10. The combinations of inputs costing a constant C dollars is called:
a. an isocost line
b. an isoquant curve
c. the MRTS
d. an isorevenue line
e. none of the above
ANS: A
PTS: 1
11. In a relationship among total, average and marginal products, where TP is maximized:
a. AP is maximized
b. AP is equal to zero
c. MP is maximized
d. MP is equal to zero
e. none of the above
ANS: D
PTS: 1
12. Holding the total output constant, the rate at which one input X may be substituted for another input Y
in a production process is:
a. the slope of the isoquant curve
b. the marginal rate of technical substitution (MRTS)
c. equal to MPx/MPy
d. all of the above
e. none of the above
ANS: D
PTS: 1
13. Which of the following is never negative?
a. marginal product
b. average product
c. production elasticity
d. marginal rate of technical substitution
e. slope of the isocost lines
ANS: B
PTS: 1
14. Concerning the maximization of output subject to a cost constraint, which of the following statements
(if any) are true?
a. At the optimal input combination, the slope of the isoquant must equal the slope of the
isocost line.
b. The optimal solution occurs at the boundary of the feasible region of input combinations.
c. The optimal solution occurs at the point where the isoquant is tangent to the isocost lines.
d. all of the above
e. none of the above
ANS: D
PTS: 1
15. In a production process, an excessive amount of the variable input relative to the fixed input is being
used to produce the desired output. This statement is true for:
a. stage II
b. stages I and II
c. when Ep = 1
d. stage III
e. none of the above
ANS: D
PTS: 1
16. Marginal revenue product is:
a. defined as the amount that an additional unit of the variable input adds to the total revenue
b. equal to the marginal factor cost of the variable factor times the marginal revenue resulting
from the increase in output obtained
c. equal to the marginal product of the variable factor times the marginal product resulting
from the increase in output obtained
d. a and b
e. a and c
ANS: A
PTS: 1
17. The isoquants for inputs that are perfect substitutes for one another consist of a series of:
a. right angles
b. parallel lines
c. concentric circles
d. right triangles
e. none of the above
ANS: B
PTS: 1
18. In production and cost analysis, the short run is the period of time in which one (or more) of the
resources employed in the production process is fixed or incapable of being varied.
a. true
b. false
ANS: A
PTS: 1
19. Marginal revenue product is defined as the amount that an additional unit of the variable input adds to
____.
a. marginal revenue
b. total output
c. total revenue
d. marginal product
e. none of the above
ANS: C
PTS: 1
20. Marginal factor cost is defined as the amount that an additional unit of the variable input adds to ____.
a. marginal cost
b. variable cost
c. marginal rate of technical substitution
d. total cost
e. none of the above
ANS: D
PTS: 1
21. The isoquants for inputs that are perfect complements for one another consist of a series of:
a. right angles
b. parallel lines
c. concentric circles
d. right triangles
e. none of the above
ANS: A
PTS: 1
22. Given a Cobb-Douglas production function estimate of Q = 1.19L.72K.18 for a given industry, this
industry would have:
a. increasing returns to scale
b. constant returns to scale
c. decreasing returns to scale
d. negative returns to scale
e. none of the above
ANS: C
PTS: 1
23. The primary purpose of the Cobb-Douglas power function is to:
a. allow one to make estimates of cost-output relationships
b. allow one to make predictions about a resulting increase in output for a given increase in
the inputs
c. aid one in gaining accurate empirical values for economic variables
d. calculate a short-run linear total cost function
e. a and b
ANS: B
PTS: 1
24. The original Cobb-Douglas function was given as
a.
b.
c.
d.
e.
. It was subsequently rewritten as
. What benefit was derived in the revision?
the function becomes a non-linear relationship so it would fit to production curves having
an "S" shape
returns to scale can be shown in the revision
returns to scale become constant
a and b only
a, b, and c
ANS: B
PTS: 1
25. The Cobb-Douglas production function has which of the following properties?
a. output is a linear increasing function of each of the inputs
b. it provides a good fit to the traditional S-shaped production function
c. the elasticity of production is constant and equal to 1 minus the exponent of the
appropriate variable
d. all of the above
e. none of the above
ANS: B
PTS: 1
26. In the Cobb-Douglas production function (
):
a. the marginal product of labor (L) is equal to 1
b. the average product of labor (L) is equal to 2
c. if the amount of labor input (L) is increased by 1 percent, the output will increase by 1
percent
d. a and b
e. a and c
ANS: C
PTS: 1
PROBLEMS
1. Emco Company has an assembly line of fixed size A. Total output is a function of the number of
workers (crew size) as shown in the following schedule:
Crew Size
(No. of Workers)
Total Output
(No. of Units)
0
0
1
2
3
4
5
6
7
8
10
35
50
56
59
60
60
58
Determine the following schedules:
(a)
(b)
(c)
marginal productivity of labor
average productivity of labor
elasticity of production with respect to labor
ANS:
Crew Size
Total Output
L
Q
0
1
2
3
4
5
6
7
8
0
10
35
50
56
59
60
60
58
(a)
(b)
(c)
-+10
+25
+15
+6
+3
+1
0
2
-10
17.5
16.67
14
11.8
10
8.57
7.25
-1.00
1.43
.90
.43
.25
.10
.00
.28
PTS: 1
2. A certain production process employs two inputs--labor (L) and raw materials (R). Output (Q) is a
function of these two inputs and is given by the following relationship:
Q = 6L2 R2.10L3 R3
Assume that raw materials (input R) are fixed at 10 units.
(a)
(b)
(c)
(d)
(e)
(f)
(g)
ANS:
(a)
Determine the total product function (TPL) for input L.
Determine the marginal product function for input L.
Determine the average product function for input L.
Find the number of units of input L that maximizes the total product function.
Find the number of units of input L that maximizes the marginal product function.
Find the number of units of input L that maximizes the average product function.
Determine the boundaries for the three stages of production.
(b)
(c)
(d)
L = 4 (L = 0 is not a maximum, since d2 (TPL)/dL2 > 0)
(e)
(f)
(g)
Stage I
0-3
APL increasing
Stage II
3-4
MPL > 0
Stage III
4-
MPL  0
PTS: 1
3. An industry can be characterized by the following production function:
Q = 2.5L.60 C.40
(a)
(b)
(c)
What is the algebraic expression for the marginal productivity of labor?
What is the algebraic expression for the average productivity of labor?
How would you characterize the returns-to-scale in the industry?
ANS:
(a)
(b)
(c)
This production function is of the Cobb-Douglas form and the sum of the exponents of
the labor and capital variables indicate the returns to scale. Since the sum of the
exponents is 1.0 (.60 + .40), this production function exhibits constant returns to scale,
i.e., a -factor increase in each of the inputs will yield exactly a -factor increase in
output.
PTS: 1
Chapter 8—Cost Analysis
MULTIPLE CHOICE
1. Economies of Scope refers to situations where per unit costs are:
a. Unaffected when two or more products are produced
b. Reduced when two or more products are produced
c. Increased when two or more products are produced
d. Demonstrating constant returns to scale
e. Demonstrating decreasing returns to scale
ANS: B
PTS: 1
2. Economies of scale exist whenever long-run average costs:
a. Increase as output is increased
b. Remain constant as output is increased
c. Decrease as output is increased
d. Decline and then rise as output is increased
e. None of the above
ANS: C
PTS: 1
3. Which of the following is true with regards to a long-run cost function?
a. The shape of the firm’s long-run cost function is important in decisions to expand the scale of
operations
b. The long-run average cost curve is U-shaped
c. The long-run average cost curve is flatter than the short-run average cost curve.
d. The curve consists of the lower boundary of all the short-run cost curves
e. All of the above
ANS: E
PTS: 1
4. If TC = 321 + 55Q - 5Q2, then average total cost at Q = 10 is:
a. 10.2
b. 102
c. 37.1
d. 371
e. 321
ANS: C
PTS: 1
5. Suppose that total cost is cubic: TC = 200 + 5Q – 0.4Q2 + 0.001Q3
a. Fixed cost (FC) is $200
b. Variable cost (VC) is 5Q – 0.4Q2 + 0.001Q3
c. Average variable cost (AVC) is 5 – 0.4Q + 0.001Q2
d. Marginal cost (MC) is 5 – 0.8Q +.003Q2
e. All of the above are correct
ANS: E
6.
PTS: 1
What method of inventory valuation should be used for economic decision-making problems?
a. book value
b. original cost
c. current replacement cost
d. cost or market, whichever is lower
e. historical cost
ANS: C
PTS: 1
7. According to the theory of cost, specialization in the use of variable resources in the short-run results
initially in:
a. decreasing returns and declining average and marginal costs
b.
c.
d.
e.
increasing returns and declining average and marginal costs
increasing returns and increasing average and marginal costs
decreasing returns and increasing average and marginal costs
none of the above
ANS: B
PTS: 1
8. For a short-run cost function which of the following statements is (are) not true?
a. The average fixed cost function is monotonically decreasing.
b. The marginal cost function intersects the average fixed cost function where the average
variable cost function is a minimum.
c. The marginal cost function intersects the average variable cost function where the average
variable cost function is a minimum.
d. The marginal cost function intersects the average total cost function where the average
total cost function is a minimum.
e. b and c
ANS: B
PTS: 1
9. The cost function is:
a. a means for expressing output as a function of cost
b. a schedule or mathematical relationship showing the total cost of producing various
quantities of output
c. similar to a profit and loss statement
d. incapable in being developed from statistical regression analysis
e. none of the above
ANS: B
PTS: 1
10. Which of the following statements about cost functions is true?
a. Variable costs will always increase in direct proportion to the quantity of output produced.
b. The less capital equipment employed in the production process relative to labor and other
inputs, the longer will be the period of time required to increase significantly the scale of
operation.
c. The shape of the firm's long-run cost function is important in decisions to expand the scale
of operations.
d. none of the above
ANS: C
PTS: 1
11. Which of the following statements concerning the long-run average cost curve of economic theory is
true?
a. It is L-shaped
b. It is -shaped
c. It is -shaped
d. It is -shaped
e. It is M-shaped
ANS: C
PTS: 1
12. Possible sources of economies of scale (size) within a production plant include:
a. specialization in the use of capital and labor
b. imperfections in the labor market
c. transportation costs
d. a and b
e. a and c
ANS: A
PTS: 1
13. The existence of diseconomies of scale (size) for the firm is hypothesized to result from:
a. transportation costs
b. imperfections in the labor market
c. imperfections in the capital markets
d. problems of coordination and control encountered by management
e. All of the above
ANS: D
PTS: 1
14. The relevant cost in economic decision-making is the opportunity cost of the resources rather than the
outlay of funds required to obtain the resources.
a. true
b. false
ANS: A
PTS: 1
15. ____ are defined as costs which are incurred regardless of the alternative action chosen in a decisionmaking problem.
a. Opportunity costs
b. Marginal costs
c. Relevant costs
d. Sunk costs
e. None of the above
ANS: D
PTS: 1
16. ____ include the opportunity costs of time and capital that the entrepreneur has invested in the firm.
a. Implicit costs
b. Explicit costs
c. a and b
d. None of the above
ANS: A
PTS: 1
17. A cottage industry exists in the home-manufacture of ‘country crafts’. Especially treasured are
handmade quilts. If the fourth completed quilt took 30 hours to make, and the eighth quilt took 28
hours. What is the percentage learning? Hint: Percentage learning = 100% - (c2/c1)•100%.
a.
5%
b.
6.7%
c.
10%
d.
100%
e.
122%
ANS: B
PROBLEMS
PTS: 1
1. During the last few days the Superior Company has been running into problems with its computer
system. The last run of the production cost schedule resulted in the incomplete listing shown below.
From your knowledge of cost theory, fill in the blanks.
Q
0
1
2
3
4
5
6
7
8
9
10
TC
TFC
_____
_____
_____
_____
_____
_____
_____
_____
_____
_____
_____
TVC
_____
_____
20
_____
_____
40
_____
_____
96
_____
_____
ATC
40
_____
_____
_____
_____
_____
_____
_____
_____
_____
_____
TC
TFC
TVC
ATC
x
52
_____
21.33
_____
_____
15.67
_____
_____
_____
_____
AFC
x
_____
_____
_____
_____
_____
_____
_____
_____
_____
_____
AVC
x
_____
_____
_____
_____
_____
_____
10
_____
15
_____
MC
x
_____
_____
_____
4
_____
_____
_____
_____
_____
45
ANS:
Q
0
1
2
3
4
5
6
7
8
9
10
40
52*
60
64
68*
80
94
110
136
175
220*
40*
40
40
40
40
40
40
40
40
40
40
0*
12
20
24
28
40
54
70
96
135
180
x
52
30
21.33
17
16
15.67
15.71
17
19.44
22
AFC
x
40
20
13.33
10
8
6.67
5.71
5
4.44
4
AVC
x
12
10
8
7
8
9
10
12
15
18
MC
x
12
8
4
4
12
14
16
26
39
45
* Determination of these costs is critical in completing the table correctly and should be given points
in assigning partial credit.
PTS: 1
2. The Jones Company has the following cost schedule:
Output
(Units)
0
50
100
150
200
250
300
350
400
450
Total Cost
($)
3000
3750
4275
4675
5000
5300
5700
6250
7050
8225
Prepare (a) average total cost and (b) marginal cost schedules for the firm.
ANS:
Output
0
50
100
150
200
250
300
350
400
450
Total Cost
$3000
3750
4275
4675
5000
5300
5700
6250
7050
8225
(a)
Average
Total Cost
--$75.00/unit
42.75
31.17
25.00
21.20
19.00
17.86
17.63
18.28
(b)
Marginal Cost
--$15.00/unit
10.50
8.00
6.50
6.00
8.00
11.00
16.00
23.50
PTS: 1
3. A firm has determined that its variable costs are given by the following relationship:
VC = .05Q35Q2 + 500Q
where Q is the quantity of output produced.
(a)
(b)
ANS:
(a)
Determine the output level where average variable costs are minimized.
Determine the output level where marginal costs are minimized.
(b)
PTS: 1