Exam 1 Managerial Economics

A consumer values a car at $525,000 and a producer values the same car at $485,000. If sales tax is 8% and is levied on the seller, then the seller's bottom-line price is (rounded to the nearest thousand)

$527,000 = ($525,000X8%)= $42,000 + $485,000.

Taxes

1) Impede the movement of assets to higher-valued uses. 2) Reduce incentives to work. 3) Decrease the number of wealth-creating transactions.

The biggest advantage of capitalism is that

1) It allows the market to self-regulate. 2) It allows a person to follow his self interest. 3)It allows voluntary transaction, which create wealth.

To test your understanding of the distinction between fixed and variable costs, designate which of the following statements is true.

1) Payment to your accountant to prepare your tax returns are fixed. 2)Electricity to run the candy-making machines are variable.

Money-making opportunities result from:

Assets in lower-valued uses

Memorial Hospital's CEO conducted performance reviews of the hospital's departments and discovered that the average cost of deliveries ($5,000) was above their average revenue, and that the hospital was losing $700 on each delivery. From the information on how much the hospital is losing on deliveries, what is the change in profit for each extra delivery?

$1,300

A consumer values a car at $20,000 and it costs a producer $15,000 to make the same car. If the transaction is completed at $18,000, the transaction will generate

$2,000 worth of buyer surplus and $3,000 of seller surplus.

If GDP is expected to increase at a steady rate of 3% per year, how many years would it take for living standards to double? a. 10 b. 20 c. 24 d. 30

24

The expression "6/10, net 45" means that the customers receive a 6% discount if they pay within 10 days; otherwise, they must pay in full within 45 days. What would the seller's cost of capital have to be in order for the discount to be cost justified?

62.5714% = 6% (discount) X 365 (days)/ 35(days see notes of how to get this). 45 days - 10 days ( part of the 6% discount if they pay within 10 days) = 35(days).

a. A firm sells 1,000 units per week. Suppose the average variable cost is $30, and the average cost is $65. In the short run, the break-even price is$_____. In the long run, the break-even price is$65.00. b. Suppose the firm charges a price of $15 per unit. Use the following table to indicate whether the firm will shut down or continue to produce in the short run and the long run. Time Continue to Produce Shut Down Short Run * Long Run *

a. short-run break even $30.00 Long- run break even $65.00 b. Shut down (both short and long run) Since the price of $15 is less than the average variable cost, the firm will shut down in the short run. Similarly, since the price is less than the average cost of $65 per unit, the firm will shut down in the long run.

What company would a rational actor rather work for?

A company who gives raises/bonuses based on a clear effort scale.

A buyer willingly buys if the price of a good is:

Below his value

Re Break-even analysis, which of the following statements is false?

Break-even analysis asks the question whether entry into an industry is profitable

Total costs increase from $1,500 to $1,800 when a firm increases output from 40 to 50 units. Which of the following is true if MC is constant?

FC= $300 : ($1,800-$1,500)

Wealth generating activities always:

Increase total surplus

Did they have enough information to make a good decision?

Maybe

Did he have the incentive to make a good decision?

No, because he was evaluated and rewarded based on the average cost of electricity produced.

Opportunity costs arise due to

Resource Scarcity

A firm is thinking of hiring an additional worker to their organization who can increase total productivity by 100 units a week. The cost of hiring him is $1,500 per week. If the price of each unit is $12,

The firm should not hire the worker since MR<MC. 100units X $12 = $1,200 (MR) $1,200 - $1,500 (cost of hire, MC) = -$300 (MR<MC)

A firm produces 500 units per week. It hires 20 full-time workers (40 hours/week) at an hourly wage of $15. Raw materials are ordered weekly, and they cost $10 for every unit produced. The weekly cost of the rent payment for the factory is $2,250. How do the overall costs break down?

Total variable cost is $17,000; total fixed cost is $2,250; total cost is $19,250. Workers: 20workers X 40hrs/week =800hrs/week Weekly labor: 800(hrs/week) X $15hr = $12,000 Materials: $10 (raw material/unit) X 500(units/week) =$5,000 Total variable cost $12,000+ $5,000 = $17,000 Fixed cost: $2,250 (rent) Total cost: $12,000+ $5,000 + $2,250 = $19,250

Hidden-Cost Fallacy occurs when:

You ignore relevant costs, those costs that do vary with the consequences of your decision.

Suppose an initial investment of $100 will return $55/year for three years (assume the $55 is received each year at the end of the year). At a discount rate of 30%, this investment ____ profitable.

is not EXPLANATION: 1) $55/(1+30%)=$42.31 $55/(1+30%)^2=$32.54 $55/(1+30%)^3= $25.03 2) $42.31 + $32.54 + $25.03 − $100= −$0.12 The NPV rule states that if the present value of the net cash flows of a project is greater than zero, the project is profitable (the investment earns more than the cost of capital), whereas if the present value of the net cash flows is less than zero, the project is not profitable. Since the NPV is less than zero, the investment is not profitable.

You expect to sell 500 cell phones a month, which have a marginal cost of $50. If your fixed costs are $5,000 per month, what is the break-even price? a. $10 b. $50 c. $60 d. $100

$60

A local coffee shop is hoping to make use of its excess restaurant capacity in the evenings by experimenting with selling beer and wine. It speculates that the only additional costs are hiring more of the same sort of workers to cover the additional hours and costs of the new line of beverages. Which of the following are examples of hidden costs that are likely to emerge from this decision? Check all that apply.

1) The forgone revenues that could be earned by renting the coffee shop out for other events during evening hours. 2) Training costs for new and existing employees on beer and wine serving procedures. 3) The costs involved with the increased usage of utilities, such as electricity and gas, during evening hours. Explanation: Any cost not taken into account that varies with the consequences of a decision is a hidden cost. Costs such as increased insurance premiums (due to the presence of alcohol), increased utility usage due to the increased hours of operation, forgone revenues of renting out the space of the coffee shop (for other uses), as well as costs of training new and existing employees in how to serve beer and wine, are all costs incurred due to the decision to extend hours and serve beer and wine. As these costs are likely to arise and are not being considered by the coffee shop, they are hidden costs.

Wealth-creating transactions are more likely to occur

1) With private property rights. 2)With strong contract enforcement. 3)With black markets.

Which of the following will increase the break-even Which of the following will increase the break-even quantity? a. A decrease in overall fixed costs b. A decrease in the marginal costs c. A decrease in the price level d. An increase in price level

A decrease in the price level

When economists speak of "marginal," they mean

Incremental

There are three levers one can push to correct bad decision-making. Which of the following is NOT such a lever?

Let someone else who has no relationship to the problem make the decision.

Regarding compounding and discounting, which of the following statements is/are true? a. All investment decisions involve a trade-off between future sacrifice and current gain. b. Compounding utilizes the rule of 72. c. Both of these statements are true. d. None of these statements is true.

None of these statements is true.

Who made the bad decision?

Plant Manager

The absence of property rights contributes to:

Poverty

Managers often have to decide between two competing strategies to achieve the same end. Which of the following statements is true?

The manager can use marginal analysis to compare the marginal cost of alternatives.

The higher the discount rates: a. the more value individuals place on future dollars. b. the more value individuals place on current dollars. c. the more investments will take place. d. does not affect the investment strategy

The more value individuals place on current dollars.

The one thing that Unites all economists is their use of :

The rational-Actor Paradigm

Regarding compounding, discounting and the rule of 72, which of the following statements is incorrect?

The rule of 72 is used to calculate compounding, but not discounting

Your company is contemplating bidding on an RFP (Request For Proposal) to produce 100,000 units of a specialized part. Suppose, however, that the requesting company really needs only 90,000 units of the part. Also assume that, because the part is specialized, potential suppliers do not yet possess the machines and factories needed to produce it and that overhead expenses involved in production have yet to be incurred. Suppose the average costs of all potential suppliers are as follows: Units Average Total Cost (Dollars Per Unit) 90,000 4 100,000 3 True or False: The requesting company can solicit lower bids by requesting 100,000 units as opposed to 90,000.

True

In 2008, the Labour Party in Britain promised that patients would have to wait for no more than four hours to be seen in an emergency room. True or False: This policy does not incentivize hospitals to bring patients immediately into the emergency room upon their arrival at the hospital.

True : To meet this performance goal, seriously ill patients were kept in ambulances instead of being brought into emergency rooms immediately, to ensure that time spent waiting would not technically occur inside the emergency room. Thousands of people per year had to wait outside emergency rooms and not allowed in until they could be treated within four hours, in accordance with the Labour Party pledge and government targets. In addition to keeping people outside, these stipulations reduced the ability of ambulances to respond to emergency calls, leading to serious problems throughout the region.

Sarah's Machinery Company is deciding to dump its current technology A for a new technology B with smaller fixed costs but bigger MCs. The current technology has fixed costs of $500 and MCs of $50 whereas the new technology has fixed costs of $250 and marginal costs of $100. At what quantity is Sarah's Machinery Company indifferent between two technologies? a. 5 b. 6 c. 7 d. 8

a. 5

A university spent $1.8 million to install solar panels atop a parking garage. These panels will have a capacity of 200 kilowatts (kW) and have a life expectancy of 20 years. Suppose that the discount rate is 10%, that electricity can be purchased at $0.20 per kilowatt-hour (kWh), and that the marginal cost of electricity production using the solar panels is zero. Hint: It may be easier to think of the present value of operating the solar panels for 1 hour per year first. Approximately how many hours per year will the solar panels need to operate to enable this project to break even? If the solar panels can operate only for 4,757 hours a year at maximum, the project ________ break even. Continue to assume that the solar panels can operate only for 4,757 hours a year at maximum. In order for the project to be worthwhile (i.e., at least break even), the university would need a grant of at least $________

a.5,285.72 hours 1) 200 kilowatts X $.20/kw = $40 2)present value= $40/(1+10%)+$40/(1+10%)^2+$40/(1+10%)^3....$40/(1+10%)^20= $340.54 3) $1,800,000/$340.54per hr = 5,285.72 hours b. would not the solar panels would need to be run for 5,285.72 hours per year. Thus, operating the solar panels for fewer hours per year than that would cause the project to fall short of breaking even. c. $180,051.22 4,757 hours per year×$340.54 per hour=$1,619,948.78 the grant would need to be at least $1,800,000−$1,619,948.78 = $180,051.22

Calculate the correct figure for the blank cell below in the Variable/3,000 cell.. Which of the following statements is correct?Table 3.1 Candy Factory Costs COSTS Outputs Fixed Variable Total 0 1,000,000 0 1,000,000 1,000 1,000,000 500,500 1,500,500 2,000 1,000,000 1,001,000 2,001,000 3,000 1,000,000 ? 2,501,500 4,000 1,000,000 2,002,000 3,002,000 5,000 1,000,000 2,502,500 3,502,500

$1,501,500 = Total: $2,501,500 - Fixed: 1,000,000.

The rational-actor paradigm is:

A tool for analyzing behavior

Food Fanatics caters meals where their cost of producing an extra meal is $25. Each of their meals is standard and sells for $20. At this rate what should the company do?

Produce fewer meals and increase their profit

Which of the following are examples of a price floor?

Minimum wages

An individual's value for a good or service is

The amount of money he or she is willing to pay for it.

When might an effort-based incentive scheme not work?

When effort is tied to costs/benefits that are out of the worker's control

Which of the following is an example of an extent decision?

How many workers should be hired?

Managers undertake an investment only if...

Marginal benefits are greater than marginal costs.

Last year, a toy manufacturer introduced a new toy truck that was a huge success. The company invested $7.50 million in a plastic injection molding machine (which can be sold for $7 million immediately) and $100,000 in plastic injection molds specifically for the toy (not valuable to anyone else). The cost of labor and materials necessary to make each truck runs about $3. This year, a competitor has developed a similar toy, significantly reducing demand for the toy truck. Now, the original manufacturer is deciding whether it should continue production of the toy truck. If the estimated demand is 100,000 trucks, the break-even price is $________ per truck.

$73.00 $7,000,000 / 100,000 units + $3 per unit = $73 per unit.

All the following are examples of variable costs, except

Accounting fees

The U.S. government bought 112,000 acres of land in southeastern Colorado in 1968 for $17,500,000. The cost of using this land today exclusively for the reintroduction of the black-tailed prairie dog

Is equal to the market value of the land.

If a firm's average cost is rising, then

Marginal cost is greater than average cost.

The fixed-cost fallacy occurs when

1) A firm considers irrelevant costs. 2) A firm considers overhead or depreciation costs to make short-run decisions.

A company is producing 15,000 units. At this output level, marginal revenue is $22, and the marginal cost is $18. The firm sells each unit for $48 and average total cost is $40. What can we conclude from this information?

The company needs to increase production.

Children in poor neighborhoods often have bleak outlooks on life and see little gain from studying. In a recent experiment, children in poor neighborhoods were paid $100 for each A they earned during a six-week grade reporting cycle. Suppose a participant in this experiment was expending $0 worth of effort in studying for each class before the experiment. Over the next 6 weeks, the student has a math class and an English class, where getting an A in math would require the student to exert $94 worth of effort, while getting an A in English would require the student to exert $103 worth of effort. In this experiment, the student ____ increase time studying for math, and the student ____ increase time studying for English.

Would, Would not Explanation: For the mathematics course, the cash payment for earning an A is greater than the cost of effort required to earn an A ($94). Thus, all else equal, the cash payment should induce the student to study more for the mathematics course. On the other hand, for the English course, the cost of effort required to earn an A is greater than the benefit of earning an A ($103). Thus the cash payment does not offer a strong enough incentive to induce the student to increase study time for English.

Economic Value Added helps firms avoid the hidden-cost fallacy.

by taking all capital costs into account, including the cost of equity.

What is the net present value of a project that requires a $100 investment today and returns $50 at the end of the first year and $80 at the end of the second year? Assume a discount rate of 10%. a. $10.52 b. $11.57 c. $18.18 d. $30.00

$11.57

If you suspect that the magazine may try to hold you up during the second year of the contract, how much should you ask for in the first year? a. $8 per million copies b. $14 cost per million copies c. $12 cost per million copies d. $10 cost per million copies

$14 cost per million copies

In early 2008, you purchased and remodeled a 120-room hotel to handle the increased number of conventions coming to town. By mid-2008, it became apparent that the recession would kill the demand for conventions. Now, you forecast that you will be able to sell only 20,000 room-nights, which cost $40 per room per night to service. You spent $25.00 million on the hotel in 2008, and your cost of capital is 20%. The current going price to sell the hotel is $20 million. If the estimated demand is 20,000 room-nights, the break-even price is $________ per room, per night. (Hint: Remember that the cost of capital is the opportunity cost, or true cost, of making an investment.)

$240.00 $20,000,000 X 20% / 20,000 rooms-nights +$40 per unit = $240 per room, per night.

A business owner makes 1,000 items a day. Each day she contributes eight hours to produce those items. If hired, elsewhere she could have earned $250 an hour. The item sells for $15 each. Production does not stop during weekends. If the explicit costs total $150,000 for 30 days, the firm's accounting profit for the month equals

$300,000 = 1,000 (Items)X $15ea = $15,000 X 30 (days) = $450,000 - $150,000 (explicit costs).

A retailer has to pay $9 per hour to hire 13 workers. If the retailer only needs to hire 12 workers, a wage rate of $7 per hour is sufficient. What is the marginal cost of the 13th worker?

$33 $9hr X 13workers = $117 $7hr X 12workers = $84 $117-$84 = $33

A business incurs the following costs: • Labor: $135/unit• Materials: $40/unit• Rent: $200,000/month Assume the firm produces 2 million units per month. The total variable cost, per month, is _____ million. The total fixed cost, per month, is ______ million. The total cost is _____ million

$350,000,000 or $350 millions = (2,000,000 (units) X $135 (labor)/ 1 (unit)) = $270,000,000 + (2,000,000(units) X $40(materials)/1 (unit) = $80,000,000. $0.20 or $ .20 million = $200,000 (rent)/$1,000,000 $350.20 = Sum of total fixed cost + variable cost ( $350 million + .20 million).

You purchased two tickets to an upcoming concert for $74 apiece when the concert was first announced three months ago. Recently, you found that similar seats were selling for $275 apiece when purchased on QuickTickets, a website where people can resell their tickets to others. Based on the information presented here, the cost of attending the concert (for two persons) is

$550 = 2 (tickets) X $275 (resell price). The sunk-cost fallacy occurs when you consider irrelevant costs in making a decision, as such costs will not vary with the consequences of your decision.

Mr. D's Barbeque of Pickwick, TN, produces 10,000 dry-rubbed rib slabs per year. Annually Mr. D's fixed costs are $50,000. The average variable cost per slab is a constant $2. The average total cost per slab then is

$7 = $50,000(fixed cost)/10,000 (Production- year) = $5 + $2 (Average variable cost).

Suppose you have won a free ticket to see a Bruce Springsteen concert. This ticket has no resale value. Also suppose that U2 has a concert the same night. The U2 concert represents your next-best alternative activity to the Springsteen concert. Tickets to the U2 concert cost $30, and on any particular day, you would be willing to pay up to $113 to see U2. Assume that there are no additional costs of seeing either show. Based on the information presented here, the opportunity cost of seeing Bruce Springsteen is

$83 = $113 (Normally willing to pay) - $30 (Concert cost).

George's T-Shirt Shop produces 10,000 custom-printed T-shirts per month. George's fixed costs are $30,000 per month. The marginal cost per T-shirt is a constant $2. George's break-even price is ___ per shirt. Suppose George sells 50% more T-shirts per month. At this quantity of shirts, George's break-even price is ____ per shirt.

1) $5 $30,000(fixed cost)/10,000 (t-shirts)= $3 $3 + $2 (marginal cost) = $5. 2) $4 $30,000/15,000 = $2 $2+ $2(marginal cost)= $4

Planes frequently push back from the gate on time, but then wait 2 feet away from the gate until it is time to queue up for takeoff. This increases fuel consumption, and increases the time that passengers must sit in a cramped plane awaiting takeoff. Which of the following performance metrics would, if emphasized in evaluations, incentivize airlines to remedy these issues? Check all that apply.

1) A performance metric that gives positive marks for minimizing fuel consumption. 2)A performance metric that measures timeliness of the flight, where flights are considered "on time" as long as the plane takes off by the scheduled departure time

Determining whether a policy is good or bad requires that we look:

1) At those who benefit from the policy. 2) Those who lose because of the policy.

Which of these actions creates value?

1) Buying a struggling firm and selling off its assets for more than the purchase price. 2) Baseball slugger drawing paying fans into the ballpark 3)Student increasing his decision making ability with an MBA.

The zero sum fallacy is:

1) Often used to justify limits on profitability. 2) Means that if one person is making money, someone else is losing money.

If people behave rationally, optimally, and self-interestedly, a bad decision occurs for which of these reason(s)?

1) The decision-maker did not have enough information to make a good decision. 2) The decision -maker did not have the incentive to make a good decision.

You are considering opening a new business to sell dartboards. You estimate that your manufacturing equipment will cost $100,000, facility updates will cost $250,000, and on average it will cost you $80 (in labor and material) to produce a board. If you can sell dartboards for $100 each, what is your break-even quantity? a. 1,000 b. 3,500 c. 4,375 d. 17,500

17,500

Regarding accounting profit and economic profit, which of the following statements is/are true? Cost of capital= (4 billion Pounds*(1+green cell)- 4 billion Pounds

A firm may have a negative economic profit and a positive accounting profit simultaneously.

Georgetown Public Media is trying to determine the optimum amount for its advertising budget. Calculating the marginal revenue of adding another listener can be computed as the probability of becoming a member times the revenue expected from each member. This is a crude estimate, but it is the only information we have. Using the following spreadsheet, calculate the optimal level of advertising. What is it? Advertising MR MC Listeners Profit $10,000 $12 $5 2,000 $32,000 $20,000 $21 $10 3,386 $51,112 At this level, the marginal cost of acquiring a customer is $21, equal to the marginal revenue of acquiring a customer. Note also that as the advertising level increases its effectiveness drops. This is reflected in the increasing marginal cost of acquiring another customer and is typical of many extent decisions. You pick the low hanging fruit first, and then you move to the more costly, higher hanging fruit.

About $42,000

To determine whether investments are profitable, follow these steps: a. Discount and add up the future benefits of an investment b. Compare the future benefits of an investment to the current cost of the investment c. If the difference is positive, then the investment is profitable d. All of these statements are correct

All of these statements are correct

In a 2015 National Bureau of Economic Research (NBER) working paper, researchers found that decreases in unemployment benefits lead to higher employment. Which of the following arguments best explains the findings of this paper?

Decreasing unemployment benefits reduces incentives to remain unemployed.

Your insurance firm processes claims through its two facilities: facility A and facility B. Each month, facility A handles 9,000 claims and incurs in $108,000 fixed costs and $153,000 in variable costs. Each month, facility B handles 2,000 and incurs $156,000 in fixed costs and $28,000 in variable costs. Hint: Be careful not to commit the sunk-cost fallacy in your analysis. If you anticipate a moderate decrease in the number of claims, you should lay off workers in facility _____ in order to decrease costs.

Facility A A: $153,000/9,000 = 17 B: $28,000/2,000 = 14 Since the average variable cost per claim is higher in facility A, that is where you would lay-off workers.

Students doing poorly in courses often consider dropping the courses. Many universities will offer a refund if the student drops a course before a deadline. True or False: Prior to the deadline, students should not take this refund option into account when deciding to drop the course.

False Explanation: Students should take this opportunity cost, brought about by the refund policy, into consideration when deciding to continue in the course. Ignoring such costs would be an example of the hidden-cost fallacy.

In the short-run, a firm's decision to shut-down should not take into consideration a. Avoidable costs b. Variable costs c. Fixed costs d. Marginal costs

Fixed costs

Consider a football game. You buy a ticket for $20, but at game time, scalpers are selling tickets for $50 because your team is playing its cross-state rivals who have legions of fans willing to pay over $50 to go to the game. Even though you do not value the tickets at $50 (indeed - you value them for much less!), you go anyway because, you say, "These tickets cost me only $20." In this case, you should:

Go to the game if the benefit of going to the game is bigger than $50.

When a firm ignores the opportunity cost of capital when making investment or shutdown decisions, this is a case of

Hidden-cost Fallacy

A copy company wants to expand production. It currently has 20 workers who share eight copiers. Two months ago, the firm added two copiers, and output increased by 20,000 pages per day. One month ago, the firm added five workers, and productivity also increased by 25,000 pages per day. A copier costs about four times as much as a worker. Assume these increases in productivity per worker and productivity per copier are good proxies for future increases in productivity when hiring additional workers or purchasing additional copiers. Based on this information, the copy company should __________ in order to expand output.

Hire another worker when 2 more In the past, when 2 more copiers were purchased, copied pages per day increased by 20,000. This means that, on average, each copier added (20,000 pages/2 copiers)= 10,000 pages/copier. When 5 workers were hired, pages increased by 25,000/day. (25,000 pages/5 workers)= 5,000 pages per worker. 10,000 pagesxcopier/5,000 pagesxworker = 2 each copier is two times as productive as each worker. The company should hire another worker, since copiers are two times as productive but are more than two times as expensive.

Which of the following statements is correct? a. Sunk costs can be avoided with planning b. If cost includes all your costs, including your opportunity cost of capital, you are earning zero profit when P=AC c. Post-investment hold-up is unavoidable d. Before investing, look back and reason ahead

If cost includes all your costs, including your opportunity cost of capital, you are earning zero profit when P=AC

Assume a firm has the following cost and revenue characteristics at its current level of output: price = $10.00, average variable cost = $8.00, and average fixed cost = $4.00. This firm is a. incurring a loss of $2.00 per unit and should shut down. b. realizing only a normal profit. c. realizing an economic profit of $2.00 per unit. d. incurring a loss per unit of $2.00 but should continue to operate in the short run.

Incurring a loss per unit of $2.00 but should continue to operate in the short run.

What is the opportunity cost of an alternative?

Is the profit you give up to pursue it.

The owners of a small manufacturing company have hired a vice president to run the company with the expectation that he will buy the company after five years. In this initial contract, compensation of the new vice president is a flat salary plus 75% of the first $150,000 profit, then 10% of profit over $150,000. The goal of the owners of the firm is to maximize profits. A contract that allowed the vice president to keep 81% of profits above $150,000 would make the incentives of the vice president _____ aligned with the goals of the firm, as compared to the original contract.

More : The initial contract did not align the incentives of the vice president with the profit goals of the firm, since the vice president had a much weaker incentive to increase profits above $150,000. However, increasing the percentage of profit kept by the vice president, from 10% to 81% of every dollar above $150,000, would give the vice president a stronger incentive to increase profits above $150,000. In fact, profits above $150,000 are likely more difficult to earn than profits below $150,000, so a stronger incentive (than the 75% on lower profit levels) is likely needed to induce the vice president to expend more effort to achieve profit levels above the $150,000 threshold. Thus, this contract would make the incentives of the vice president more aligned with the goals of the firm, compared with the original contract.

Suppose you are advising a regional commercial printer, who is negotiating with a national magazine. For them, using a regional printer reduces shipping costs, but to take on the work, the regional printer must purchase a $12 million rotogravure printing press, which has no resale value. Assume $8 is the average cost of printing one million copies per year over a two year period. Now suppose that the magazine accepts your offer, and immediately hands you a purchase order for $8,000,000, for the first-year production. Do you accept the purchase order? a. Yes b. No c. No decision can be made from the data available d. Yes, but only if the regional printer buys a cheaper printer

No

John Deere's choice of competing technologies teaches us that: a. The correct way to choose between competing technologies is to choose the one with lowest fixed costs b. The correct way to choose between competing technologies is to choose the one with lowest marginal costs c. The correct way to make the decision is to use break-even analysis to justify higher prices or greater output d. None of these is correct

None of these is correct

A well-designed organization is one in which employee incentives are aligned with:

Organizational Goals

After graduating from college, Jim had three choices, listed in order of preference: (1) move to Florida from Philadelphia, (2) work in a car dealership in Philadelphia, or (3) play soccer for a minor league in Philadelphia. His opportunity cost of moving to Florida includes

The income he could have earned at the car dealership.

A manager of a clothing firm is deciding whether to add another factory in addition to one already in production. The manager would compare

The incremental benefit expected from the second factory to the cost of the second factory.

Break-even quantity is a point where a. the level of profit is maximized b. the level of cost is minimized c. Only variable costs are covered d. There are zero profits

There are zero profits

Perhaps the most important kind of capital is human capital. For example, most lawyers spend years learning to practice law. Lawyers are willing to make large investments in their human capital because they expect to be compensated for doing so when they begin work. Suppose the government nationalizes the market for legal services, resulting in lower compensation for lawyers. Assume lawyers cannot easily move to other countries. True or False: The investment in human capital for lawyers is subject to post-investment hold-up.

True Since part of lawyers' human capital investments is thereby expropriated, this is a form of investment hold-up.

The owners of a small manufacturing concern have hired a vice president to run the company with the expectation that he will buy the company after five years. Compensation of the new vice president is a flat salary plus 75% of the first $150,000 profit, then 10% of profit over $150,000. The goal of the owners of the firm is to maximize profits. True or False: This contract does not align the incentives of the new vice president with the profitability goals of the firm's owners.

True : This contract does not incentivize the vice president to increase profits and reach the firm's profitability goals. Since the vice president keeps $0.75 of each dollar earned up to $150,000, he has a strong incentive to increase profits up to $150,000. However, since he only keeps $0.10 of each dollar earned after $150K, there are weak incentives to increase profit beyond $150,000. Moreover, increasing profit likely becomes more difficult as the overall level of profit rise. That is, earning the first $150,000 in profit likely requires less effort than earning profit levels in excess of $150,000. Since the percentage of profit that the vice president receives decreases at higher levels of company profit, the contract does not align the incentives of the vice president with profit goals of the firm.

Because of the housing bubble, many houses are now selling for much less than their selling price just two to three years ago. There is evidence that homeowners with virtually identical houses tend to ask for more if they paid more for the house. True or False: Homeowners asking for a higher selling price are committing the fixed-cost fallacy.

True. The fixed-cost fallacy, also known as the sunk-cost fallacy, occurs when one considers irrelevant costs and benefits in making a decision. The homeowners who paid higher prices at the peak of the bubble are now asking for higher selling prices in order to avoid or offset some of the accounting losses incurred from selling their houses now at market prices. However, the original purchase price of a home is a sunk cost and does not vary with a decision about whether or not to sell the house. Taking such sunk, fixed, or otherwise irrelevant costs into account when making a decision is an example of the fixed-cost, or sunk-cost, fallacy

A price ceiling

is an implicit tax on producers and an implicit subsidy to consumers.

If a firm is earning negative economic profits, it implies

that more information is needed to determine accounting profits.