ECON 306 Exam 1
effect on quantity demanded of a price increase
% change Qd = Ed(% change P) next period: Q2 = Q1 + Q1[Ed(% change P)] + Q1{Ey(% change Y)]
advertising elasticity formula
% change in quantity demanded / % change in advertising expenditures
income elasticity formula
% change in quantity demanded / % change in income
cross price elasticity formula
(% change in quantity demand for good X) / (% change price Y)
magnitude of price elasticity varies a great deal across target customers and across products because of differences in:
(1) the number and perceived closeness of substitutes (also known as switching costs), (2) the percentage of the budget expended on the product, (3) the positioning of the product as income superior to that target market, and (4) the time period of adjustment
Risk Bearing Theory of Profit
compensation for the risks taken by the investor in the form of a higher rate of return
risk
A decision-making situation in which there is variability in the possible outcomes, and the probabilities of these outcomes can be specified by the decision maker.
factors can permit a firm to identify positive net present value projects for internal investment
1. Buyer preferences for established brand names 2. Ownership or control of favored distribution systems (such as exclusive auto dealerships or airline hubs) 3. Patent control of superior product designs or production techniques 4. Exclusive ownership of superior natural resource deposits 5. Inability of new firms to acquire necessary factors of production (management, labor, equipment) 6. Superior access to financial resources at lower costs (economies of scale in attracting capital) 7. Economies of large-scale production and distribution arising from a. Capital-intensive production processes b. High initial start-up costs
managerial economist may choose from a wide range of forecasting techniques
1. Deterministic trend analysis 2. Smoothing techniques 3. Barometric indicators 4. Survey and opinion-polling techniques 5. Macroeconometric models 6. Forecasting with input-output tables 7. Stochastic time-series analysis
Agency costs include the following:
1. Grants of stock options or restricted stock from Treasury stock so executive compensation aligns the incentives for management with shareholder interests. 2. Internal audits and accounting oversight boards to monitor management's actions. In addition, many large creditors, especially banks, now monitor financial ratios and investment decisions of large debtor companies on a monthly or even biweekly basis. These initiatives strengthen the firm's corporate governance. 3. Bonding expenditures and fraud liability insurance to protect the shareholders from managerial dishonesty. 4. Complex internal approval processes to limit discretion, but which prevent timely responses to business opportunities.
The Efficiency Objective in Not-for-Profit Organizations
1. Maximize the benefits for given costs. 2. Minimize the costs while achieving a fixed level of benefits. 3. Maximize the net benefits (benefits minus costs).
Forecasting technique depends on a number of factors, including the following:
1. The cost associated with developing the forecasting model 2. The complexity of the relationships that are being forecast 3. The time period of the forecast (long-term or short-term) 4. The lead time needed to make decisions based on the forecast 5. The accuracy required of the forecasting model
A company can create flexibility in their capital budgeting by:
1. facilitating follow-on projects through growth options 2. exiting early without penalty through abandonment options 3. staging investment over a learning period until better information is available through deferral options
Equilibrium price in a marketplace is related to:
1. intrinsic use value 2. production cost 3. input scarcity
Not-for-Profit objectives
1. maximizing the quantity and quality of output subject to a break-even budget constraint 2. maximizing the outcomes preferred by the NFP's contributors 3. maximizing the longevity of the NFP's administrators
best-known surveys available from private and governmental sources for forecasting macroeconomic activity:
1. plant and equipment expenditure plans 2. plans for inventory changes and sales expectations 3. consumer expenditure plans
sales forecasting variations of opinion polling
1. sales force polling 2. surveys of consumer intentions
MR formula
= P(1 + 1/Ed)
which of the following gives rise to speculative demand for a currency
A German investor buys US T-bonds expecting dollars to appreciate wrong: TheFederal Reserve buys dollars in the foreign currency markets; a US car dealership pays a Japanese manufacturer in yen
coefficient of determination
A measure of the proportion of total variation in the dependent variable that is explained by the independent variable(s).
supply curve
A relationship between price and quantity supplied per unit time, holding other determinants of supply constant.
cost-benefit analysis
A resource allocation model that can be used by public and not-for-profit sector organizations to evaluate programs or investments on the basis of the magnitude of the discounted benefits and costs.
std dev
A statistical measure of the dispersion or variability of possible outcomes.
Managers should concentrate on maximizing shareholder value alone if which of the following conditions are met
ALL of the following: complete markets, no significant asymmetric information, known recontracting costs
Managerial economics seeks to accomplish all of these goals:
ALL of the following: identify the alternatives, select the choice that accomplishes the objective most efficiently, take into account the constraints, and take into account the likely actions and reactions of rival decision makers
Managerial Efficiency Theory of Profit
Above-normal profits can arise because of exceptional managerial skills of well-managed firms.
Which of the following are factors affecting the profit performance of firms
All of the following ARE factors: differential risk, innovation, managerial skills, existence of monopoly power
Agency Costs
Costs associated with resolving conflicts of interest among shareholders, managers, and lenders.
Elasticity of demand formula with derivatives
Ed = (dQ/dP) * (P/Q)
One way in which the Southern Company has complied with the Clean Air Act has been to adopt fuel-switching technology that allows burning fuel oil when that input is cheap and burning natural gas when it is cheaper. T/F? Southern Company's shareholders will not value this strategic flexibility.
False
Unit labor costs in Germany approach the equivalent of USD 45 per hour whereas in Britain unit labor costs are only the equivalent of USD 30 per hour. Why would such a large difference persist between two members of the EU free trade area?
Germany participates in the EU social programs, which add to unit labor costs
public goods
Goods that may be consumed by more than one person at the same time with little or no extra cost, and for which it is expensive or impossible to exclude those who do not pay. include: national defense and flood control
ceteris paribus
Latin for all other things held constant
shareholder wealth
Measured by the Market Value of the shareholders common stock holdings which is equal to the PV of all expected future cash flows to equity owners discounted at the shareholders' required rate of return plus a value for the firm's embedded real options
Which of the following statements explains the principal-agent conflict between shareholders and managers?
Shareholder-principals seldom know when to blame manager-agents for weak company performance or give them credit for strong performance
marginal use value
The additional value of the consumption of one more unit; the greater the utilization already, the lower the use value remaining.
income elasticity
The ratio of the percentage change in quantity demanded to the percentage change in income, assuming that all other factors influencing demand remain unchanged.
price elasticity of demand
The ratio of the percentage change in quantity demanded to the percentage change in price, assuming that all other factors influencing demand remain unchanged.
cross price elasticity
The ratio of the percentage change in the quantity demanded of Good A to the percentage change in the price of Good B, assuming that all other factors influencing demand remain unchanged.
coefficient of variation
The ratio of the standard deviation to the expected value. A relative measure of risk.
econometrics
The use of statistical techniques to describe the relationships between economic variables; combination of theory, statistical analysis, and mathematical model building to explain economic relationships
expected value
The weighted average of the possible outcomes where the weights are the probabilities of the respective outcomes.
A closest example of a risk-free security is
U. S. Government Treasury bills
marginal analysis
a basis for making various economic decisions that analyzes the additional (marginal) benefits derived from a particular decision and compares them with the additional (marginal) costs incurred.
operating risk exposure
a change in cash flows from foreign or domestic sales resulting from currency fluctuations
transaction risk exposure
a change in cash flows resulting from contractual commitments to pay in or receive foreign currency
elastic demand
a percentage change in price is exceeded by the percentage change in quantity demanded; perfectly elastic graph is horizontal
time-series data
a series of observations taken on an economic variable at various points in time
regarding short-range exchange rate movements, which of the following statements is NOT true
are similar to those of the transaction demand determinants of long-term trends in exchange rates true: they may vary from week to week; they may vary from hour to hour; determined by arbitrage activity
substitute goods
alternative products whose demand increase when the price of the focal product rises; positive cross-price elasticity
translation risk exposure
an accounting adjustment in the home currency value of foreign assets or liabilities
the import of Apple iPads assembled in Shanghai at a $295 wholesale price ($213 cost and $82 profit margin) adds more than it should to the US trade deficit with China because
as with foreign-assembled minivans, most of the subassembly components come for the US
ratio to trend method
assumes that the trend value is multiplied by the seasonal effect
complementary goods
complements in consumption whose demand decreases when the price of the focal product rises; negative cross-price elasticity
plans for inventory changes and sales expectations
business executives' expectations about future sales and their intentions about changes in inventory levels are reported in surveys conducted by the U.S. Department of Commerce, McGraw-Hill, Dun & Bradstreet, and the National Association of Purchasing Agents
arbitrage
buying cheap and selling elsewhere for an immediate profit
speculation
buying cheap and selling later for a delayed profit (or loss)
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
barometric technique
in Chinese coastal provinces, brick housing for a fast-expanding middle class is very comparable in size to housing in the US for a family with median income of $51,000 because
bricks, trade skill workers and construction labor are very cheap in China
stochastic time-series analysis
capitalizes on the cross-sectional interdependence between various intermediate product and final product industries; attempts to remove deterministic time trends and instead model, estimate, and hopefully replicate the stochastic process generating any remaining patterns in the data across successive time periods (any remaining autocorrelation patterns)
sterilized interventions
central bank transactions in the foreign exchange market accompanied by equal offsetting transactions in the government bond market, in an attempt to alter short-term interest rates without affecting the exchange rate
marginal revenue
change in total revenue that results from a one-unit change in quantity demanded
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?
common stock
consumer expenditure plans
consumer intentions to purchase specific products - including household appliances, automobiles, and homes - are reported by the Survey Research Center at the University of Michigan and by the Census Bureau
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:
cyclical variation
variations in a time-series forecast can be caused by:
cyclical variations, secular trends, and seasonal effects
net marginal return
difference between marginal benefits and marginal costs
Consider the shareholder wealth-maximization model of a firm. If the rate of inflation increases substantially, the value of the firm is likely to
decline
if the US dollar appreciates 30 percent, a US manufacturer experiences a __________ in exporting and a ___________ in domestic sales
decrease; decrease
surveys of consumer intentions
firms conduct their own surveys of specific consumer purchases
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 patients. The optimal frequency should be where the marginal benefit of an additional pap-test:
equals the marginal cost of the test
What are the common elements of decision making that should be used by all managers?
establish the objectives, identify the problem, examination of potential solutions, analysis of the relative costs and benefits, sensitivity analysis, implementation of the decision
Temporary Disequilibrium Theory of Profit
firms may find their profits above or below the long-run normal return level because of temporary dislocations (shocks) in various sectors of the economy
sales force polling
firms survey their own salespeople in the field about their expectations for future sales by specific geographical area and product line
durable goods
goods that yield benefits to the owner over a number of future time periods
advantages of econometric forecasting techniques over time-series trend analysis, barometric models, and survey/opinion poll-based techniques
identify independent variables (such as price or advertising expenditures in a demand model) that the manager may be able to manipulate; predict not only the direction of change in an economic series but also the magnitude of that change; improvement over trend projection models that failed to identify turning points and barometric models which do not forecast the magnitudes of expected changes
income-inferior goods
income elasticity is negative
income-superior goods
income elasticity is positive
There is a sudden drop in the expected future rate of inflation. This is likely to ______________ shareholder wealth
increase
Goods having a negative calculated income elasticity are
inferior goods
purchasing power parity of PPP says the ratios composed of
inflation rates explain the direction of exchange rates
What are some hazards of employing a constant rate of growth forecasting model?
it assumes that there are no cyclical variations; it ignores seasonal trends
An increase in each of the following factors would normally provide a subsequent increase in demand except:
level of competitor loyalty programs other answers: price of substitute goods, consumer income level, consumer desires for goods and services
secular trends
long-run changes (growth or decline) in an economic time-series variable; ex: increasing population size or evolving consumer tastes
cyclical variations
major expansions and contractions in an economic series that usually are longer than a year in duration
A change in the level of an economic activity is desirable and should be undertaken as long as the marginal benefits exceed the
marginal costs
advertising elasticity
measures the responsiveness of sales to changes in advertising expenditures as measured by the ratio of the percentage change in sales to the percentage change in advertising expenditures
The form of economics most relevant to managerial decision-making within the firm is
microeconomics
Firms in the patented pharmaceutical industry earned an average return on net worth of 22 percent in 2006, compared with an average return of 14 percent earned by over 1,400 firms followed by Value Line. Which of the following theories of profit do you thing best explains the performance of the drug industry?
monopoly theory of profit
inelastic demand
percentage change in price results in a smaller percentage change in quantity demanded; perfectly inelastic graph is vertical
leading and lagging indicators
predict the direction of future change in economic activity; reveal little or nothing about the magnitude of the changes
Which of the following demand factors are under the control of management?
price of product, advertising expenses, and customers support
two basic reasons for the increase in quantity demanded as the result of a price reduction
purchasing power and substitution effects
decreased cost inflation in the US relative to its major trading partners is likely to ________________ the value of the US dollar
raise
Seasonal variations can be incorporated into a time-series model ina number of different ways, including:
ratio-to-trend method and use of dummy variables
The principal econometric techniques used in measuring demand relationships are:
regression and correlation analysis
demand function
relationship between quantity demanded per unit of time and all the determinants of demand
supply function
relationship between quantity supplied and all the determinants of supply
plant and equipment expenditure plans
surveys of business intentions regarding plant and equipment expenditures conducted by McGraw Hill, the National Industrial Conference Board, the U.S. Department of Commerce, Fortune magazine, the Securities and Exchange Commission, and a number of individual trade associations.
Required return =
risk free return + risk premium
cross-sectional data
series of observations taken on different observation units (e.g. households, states, or countries) at the same point in time
The standard deviation of the error terms in an estimated regression equation is known as:
standard error of the estimate
cointegrated
stochastic series with a common order of integration and exhibiting an equilibrium relationship such that they do not permanently wander away from one another
If the cross price elasticity measured between items A and B is positive, then the two products are referred to as:
substitutes
Innovation theory of profit
suggest that above-normal profits are the reward for successful innovations; firms that develop high-quality products or successfully identify unique market opportunities are rewarded with the potential for above-normal profits
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:
t-test
Which of the following are criteria used to select a forecasting technique:
the accuracy required of the forecasting model, the lead time needed to make decisions based on the forecast, the complexity of the relationships being forecast, and the cost associated with developing the forecasting model
opportunity cost
the costs of attracting a resource such as investment capital from its next best alternative use
The standard deviation is appropriate to compare the risk between two investments only if
the expected returns from the investments are approximately equal
What is the economic cost of an activity
the highest valued alternative opportunity that is forgone
unit elastic
the percentage change in quantity equals the percentage change in price (E=1)
marginal utility
the use value obtained from the last unit consumed
Caution must be exercised in using regression models for prediction when
the value of the independent variable lies outside the range of observations from which the model was estimated
The assumptions underlying the simple linear regression model are
the value of the variable Y is postulated to be a random variable; a theoretical straight-line relationship exists between X and the expected value of Y; associated with each value of X is a probability distribution
Regarding operating risk exposure, which of the following statements is NOT true?
they are easier to forecast than translation risk exposures true answers: they are more difficult to hedge than transaction risk exposures; they necessitate more managerial attention and extensive analysis
Economic profit is defined as the difference between revenue and
total economic cost
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.
unit elastic; price; quantity
if the US dollar were to appreciate substantially what steps could a domestic manufacturer such as Cummins Engine Co of Columbus, Indiana take in advance to reduce the effect of the exchange rate fluctuation on company profitability?
use financial derivative contracts to offset cash flow losses; demand payment is US dollars wrong: focus on the export business instead of the domestic one
dummy variable
used to capture the impact of certain qualitative factors in an econometric relationship by usually using a value of 0 or 1
leaset-squares technique
used to estimate the regression coefficients
F-test
used to test the hypothesis that ALL the independent variables in the regression equation explain a significant proportion of the variation in the dependent variable
t-test
used to test the hypothesis that a specific independent variable is useful in explaining variation in the dependent variable
seasonal effects
variations in a time series during a year that tend to appear regularly from year to year; ex: holiday effects
random fluctations
when an economic series is influenced by random factors that are unpredictable such as hurricanes, floods, and tornadoes as well as extraordinary government actions like a wage-price freeze or declaration of war
Enterprise Rental Car Co. usually charges higher prices for SUVs with one-day return than for subcompacts with one-day return. However, with gasoline prices above $4 per gallon, one day rental prices for SUVs and subcompacts have been lowered to $39 and $43, respectively. Which of the following statements is correct?
when gasoline prices rise, the demand curve for rental cars shift downward
Monopoly Theory of Profit
when one firm is effectively able to dominate the market and persistently earn above-normal rates of return; ability to dominate the market may arise form economies of scale, control of essential natural resources, control of critical patents, or governmental restrictions that prohibit competition