ECO 550 (NEW Strayer) MID-Term Exam (Chapter 1 to Chapter 8)

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Chapter 1—Introduction and Goals of the Firm




1. The form of economics most relevant to managerial decision-making within the firm is:

  1. macroeconomics
  2. welfare economics
  3. free-enterprise economics
  4. microeconomics
  5. none of the above


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:

  1. 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



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


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


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


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



7. According to the managerial efficiency theory of profit, above-normal profits can arise because of high-quality managerial skills.

a. true

b. false


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


9. Agency problems and costs are incurred whenever the owners of a firm delegate decision-making authority to management.

a. true

b. false


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



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


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


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


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


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.


16. Which of the following will increase (V0), the shareholder wealth maximization model of the firm:

V0∙(shares outstanding) = S¥t=1 (p t ) / (1+ke)t   + Real Option Value.

a. Decrease the required rate of return (ke).

b. Decrease the stream of profits (pt).

c. Decrease the number of periods from ¥ to 10 periods.

d. Decrease the real option value.

e. All of the above.


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


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.


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


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


21. Recently, the American Medical Association changed its recommendations on the frequency of pap-smear 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.



Chapter 2—Fundamental Economic Concepts




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. total costs

c. marginal costs

d. average costs

e. average benefits



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


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


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


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


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


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. 68.26%

b. 2.28%

c. 34%

d. 15.87%

e. none of the above


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


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


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


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


12. 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


13.  The number of standard deviations z that a particular value of r is from the mean ȓ can be computed as z = (r – ȓ)/ s.  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 Probability

-3 .0013

-2 .0228

-1 .1587

0 .5000


a. 1.3% chance of earning nothing in a week

b. 2.28% chance of earning nothing in a week

c. 15.87% chance of earning nothing in a week

d. 50% chance of earning nothing in a week

e. none of the above


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



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. s = Ö { (1000-1300)2 + (2000-1300)2 }

b. s = Ö { (1000-1300) + (2000-1300) }

c. s= Ö { (.5)(1000-1300)2 + (.5)(2000-1300)2 }

d. s= Ö { (.7)(1000-1300) + (.3)(2000-1300) }

e. s= Ö { (.7)(1000-1300)2 + (.3)(2000-1300)2 }


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 – m)/s,with mas the mean and sas 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


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.



1. Suppose that the firm’s cost function is given in the following schedule (where Q is the level of output):


Output Total

Q (units) Cost

0   7

1 25

2 37

3 45

4 50

5 53

6 58

7 66

8 78

9 96

10   124


Determine the (a) marginal cost and (b) average total cost schedules


2. Complete the following table.


Total Marginal Average

Output Profit Profit Profit


0 -48             0 ______

1 -26   ______ ______

2 -8 ______ ______

3   6 ______ ______

4 16 ______ ______

5 22 ______ ______

6 24 ______ ______

7 22 ______ ______

8 16 ______ ______

9   6 ______ ______

10   -8 ______ ______



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 .20

15,000 .30

20,000 .40

25,000 .10

(a) Determine the expected selling price for the land.

(b) Determine the standard deviation of the possible sales prices.

(c) Determine the coefficient of variation.

Chapter 3—Demand Analysis




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.


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.


3. In this problem, demonstrate your knowledge of percentage rates of change of an entire demand function (HINT: %DQ = EP•%DP + EY•%DY).  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%.


4 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


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%.


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.


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


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

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


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


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


Chapter 4—Estimating Demand


Chapter 5—Business and Economic Forecasting


Chapter 6—Managing Exports


Chapter 7—Production Economics


Chapter 8—Cost Analysis

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