Chapters 14 & 15: The Basic Tools of Finance, Unemployment

What claims do advocates of unions make to argue that unions are good for the economy?

advocates of unions claim that unions balance firms' market power and protect workers from being at the mercy of the firm's owners and unions help firms respond efficiently to workers' concerns.

The total population is 195.4. The adult population is 139.7. The number unemployed is 5.7 and the number employed is 92.3 The labor force is a. 92.3 million. b. 98.0 million. c. 134.0 million. d. 139.7 million. e. none of the above.

b. 98.0 million. 92.3 + 5.7 = 98

General Electric has the opportunity to purchase a new factory today that will provide them with a $50 million return four years from now. If prevailing interest rates are 6 percent, what is the maximum that the project can cost for General Electric to be willing to undertake the project? a. $39,604,682 b. $34,583,902 c. $50,000,000 d. $53,406,002 e. $43,456,838

a. $39,604,682

Which of the following is not a characteristic of minimum-wage workers? They tend to be a. full-time. b. young. c. less educated. d. in the food service and drinking place industry.

a. full-time.

Stock prices will follow a random walk if a. markets reflect all available information in a rational way. b. people behave irrationally when choosing stock. c. stocks are undervalued. d. stocks are overvalued.

a. markets reflect all available information in a rational way.

Which of the following government policies would fail to lower the unemployment rate? a. raise the minimum wage b. reduce unemployment benefits c. establish right-to-work laws d. establish employment agencies e. establish worker training programs

a. raise the minimum wage

Which one of the following types of unemployment results from the wage being held above the competitive equilibrium wage? a. structural unemployment b. cyclical unemployment c. frictional unemployment d. sectoral unemployment e. None of the above is correct.

a. structural unemployment

Speculative bubbles may occur in the stock market a. only when people are irrational. b. because rational people may buy an overvalued stock if they think they can sell it to someone for even more at a later date. c. during periods of extreme pessimism because so many stocks become undervalued. d. when stocks are fairly valued

b. because rational people may buy an overvalued stock if they think they can sell it to someone for even more at a later date.

If people are risk averse, then a. they dislike bad things more than they like comparable good things. b. their utility functions exhibit the property of diminishing marginal utility of wealth. c. the utility they would lose from losing a $50 bet would exceed the utility they would gain from winning a $50 bet. d. all of the above are true. e. none of the above is true.

d. all of the above are true.

Sectoral shifts tend to raise which type of unemployment? a. structural unemployment b. unemployment due to efficiency wages c. unemployment due to unions d. frictional unemployment

d. frictional unemployment

If a depositor puts $100 in a bank account that earns 4 percent interest compounded annually, how much will be in the account after five years? a. $123.98 b. $120.00 c. $400.00 d. $104.00 e. $121.67

e. $121.67

Explain four ways in which a firm might increase its profits by raising the wages it pays.

A firm might increase its profits by raising the wages it pays because worker turnover will decrease, worker's health will increase, worker quality will increase, and worker health will increase, which will therefore increase productivity of the firm in the long run.

What factors should a stock analyst think about in determining the value of a share of stock?

A stock analyst will consider the future profitability of a firm when determining the value of the stock.

What is diversification? Does a stockholder get a greater benefit from diversification when going from 1 stock to 10 stocks or when going from 100 stocks to 120 stocks?

Diversification is the reduction of risk achieved by replacing a single risk with a large number of smaller unrelated risks. A stockholder will get a greater benefit from diversification going from 1 to 10 stocks than from 100 to 120 stocks.

Explain the view of those economists who are skeptical of the efficient markets hypothesis.

Economists who are skeptical of the efficient markets hypothesis believe that fluctuations in stock prices are partly psychological. People may in fact be willing to purchase a stock that is overvalued if they believe that someone will be willing to pay even more in the future. This means that the stock price may not be a rational valuation of the firm

Why is frictional unemployment inevitable? How might the government reduce the amount of frictional unemployment?

Frictional unemployment is inevitable because the economy is always changing and some firms are always shrinking while others are expanding. The government might reduce the amount of frictional unemployment by paying for programs that will match unemployed workers with job opportunities that match their tastes and skills.

Are minimum-wage laws a better explanation for structural unemployment among teenagers or among college graduates? Why?

Minimum-wage laws are a better explanation for structural unemployment among teenagers because they are younger, less qualified, and less experienced. So, their wages are typically low enough to be affected by minimum-wage laws, whereas college graduates are older, more qualified, and more experienced, which would give them higher wages.

The interest rate is 7 percent. Use the concept of present value to compare $200 to be received in 10 years and $300 to be received in 20 years.

PV = X/(1+r)^N 200/1.07^10 = $102 300/1.07^20 = $78 Given the choice between the two options, $200 to be received in 10 years is preferred to $300 to be received in 20 years.

What benefit do people get from the market for insurance? What two problems impede the insurance market from working perfectly?

Purchasing insurance allows an individual to reduce the level of risk he faces. Two problems that impeded the insurance market from working correctly are adverse selection and moral hazard. Adverse selection occurs because a high-risk person is more likely to apply for insurance than a low-risk person is. Moral hazard occurs because people have less incentive to be careful about their risky behavior after they purchase insurance.

Between stocks and government bonds, which type of asset has more risk? Which pays a higher average return?

Stocks have more risk because their value depends on the future value of the firm. Because of its higher risk, shareholders will demand a higher return than bondholders. There is a positive relationship between risk and return.

What are the three categories into which the Bureau of Labor Statistics divides everyone? How does the BLS compute the labor force, the unemployment rate, and the labor-force participation rate?

The BLS divides everyone into employed, unemployed, and not in the labor force. The labor force is computed by adding the number of employed and the number of unemployed. The unemployment rate is computed by dividing the number of unemployed by the labor force. The labor-force participation rate is computed by dividing the labor force by the adult population.

Describe the efficient markets hypothesis, and give a piece of evidence consistent with this hypothesis.

The efficient markets hypothesis suggests that stock prices reflect all available information. This means that we cannot use current information to predict future changes in stock prices. One piece of evidence that supports this theory is the fact that many index funds outperform mutual funds that are actively managed by a professional portfolio manager.

Is unemployment typically short-term or long-term? Explain.

Unemployment is typically short-term because workers are usually able to apply their skills learned at one job to another job quite easily. However, this is not always the case due to structural unemployment, which can lead to discouraged workers.

How do unions affect the natural rate of unemployment?

Unions affect insiders and outsiders in regards to the natural rate of unemployment. Unions raise the wage above equilibrium, so quantity of labor demanded is less than the quantity of labor supplied, so there is unemployment and insiders keep their jobs. Outsiders, who work non-unionized jobs, will either get another non-unionized job or wait for a unionized job to open up. As a result, the natural rate of unemployment would be higher with unions.

Using the rule of 70, if your parents place $10,000 in a deposit for you on the day you are born, approximately how much will be in the account when you retire at 70 years old if the deposit earns 3 percent per year? a. $80,000 b. $300 c. $3,000 d. $70,000 e. $20,000

a. $80,000 FV = 10,000 * (1.03)^70 = 79178

The unemployment rate is a. 5.8 percent. b. 6.2 percent. c. 3.2 percent. d. Not enough information is available to answer this question. e. 5.7 percent.

a. 5.8 percent. 5.7 / 98 = 0.581 0.581 * 100 = 5.8%

Which of the following is an example of moral hazard? a. After Joe buys fire insurance, he begins to smoke cigarettes in bed. b. Doug has been feeling poorly lately so he seeks health insurance. c. Both of Susan's parents lost their teeth due to gum disease, so Susan buys dental insurance. d. All of the above demonstrate moral hazard. e. None of the above demonstrates moral hazard.

a. After Joe buys fire insurance, he begins to smoke cigarettes in bed.

Which of the following statements about efficiency wage theory is true? a. Paying above the competitive equilibrium wage may improve worker health, lower worker turnover, improve worker quality, and increase worker effort. b. Firms do not have a choice about whether they pay efficiency wages or not because these wages are determined by law. c. Paying above the competitive equilibrium wage tends to cause workers to shirk their responsibilities. d. Paying the lowest possible wage is always the most efficient (profitable).

a. Paying above the competitive equilibrium wage may improve worker health, lower worker turnover, improve worker quality, and increase worker effort.

Which of the following statements is true? a. Prime-age men and women tend to have similar unemployment rates. b. The labor-force participation rate of men is rising. c. Blacks have a lower unemployment rate than whites. d. Most spells of unemployment are long term, but most unemployment observed at any given time is short term. e. All of the above are true.

a. Prime-age men and women tend to have similar unemployment rates.

Which of the following reduces risk in a portfolio the greatest? a. increasing the number of stocks in the portfolio from 1 to 10 b. increasing the number of stocks from 10 to 20 c. increasing the number of stocks from 20 to 30 d. All of the above provide the same amount of risk reduction.

a. increasing the number of stocks in the portfolio from 1 to 10

Unions tend to increase the disparity in pay between insiders and outsiders by a. increasing the wage in the unionized sector, which may create an increase in the supply of workers in the nonunionized sector. b. increasing the demand for workers in the unionized sector. c. increasing the wage in the unionized sector, which may create a decrease in the supply of workers in the nonunionized sector. d. decreasing the demand for workers in the unionized sector.

a. increasing the wage in the unionized sector, which may create an increase in the supply of workers in the nonunionized sector.

Unions might increase efficiency in the case where they a. offset the market power of a large firm in a "company town." b. raise the wage for insiders above the competitive equilibrium. c. threaten a strike but don't actually follow through, so there are no lost hours of work. d. lower the wage of local outsiders.

a. offset the market power of a large firm in a "company town."

Which of the following types of unemployment will exist even if the wage is at the competitive equilibrium? a. unemployment due to unions b. frictional unemployment c. unemployment due to minimum-wage laws d. unemployment due to efficiency wages

b. frictional unemployment

Diversification of a portfolio can a. increase the standard deviation of the portfolio's return. b. reduce firm-specific risk. c. reduce market risk. d. eliminate all risk.

b. reduce firm-specific risk.

If unemployment insurance were so generous that it paid laid-off workers 95 percent of their regular salary, a. the official unemployment rate would probably understate true unemployment. b. the official unemployment rate would probably overstate true unemployment. c. there would be no impact on the official unemployment rate. d. frictional unemployment would fall. e. none of the above is true.

b. the official unemployment rate would probably overstate true unemployment.

If, for any reason, the wage is held above the competitive equilibrium wage, a. the quantity of labor demanded will exceed the quantity of labor supplied and there will be a labor shortage. b. the quantity of labor supplied will exceed the quantity of labor demanded and there will be unemployment. c. unions will likely strike and the wage will fall to equilibrium. d. the quality of workers in the applicant pool will tend to fall.

b. the quantity of labor supplied will exceed the quantity of labor demanded and there will be unemployment.

If the efficient markets hypothesis is true, then a. stocks tend to be overvalued. b. the stock market is informationally efficient so stock prices should follow a random walk. c. fundamental analysis is a valuable tool for increasing one's stock returns. d. an index fund is a poor investment. e. all of the above are true.

b. the stock market is informationally efficient so stock prices should follow a random walk.

Firm-specific risk is the a. risk associated with moral hazard. b. uncertainty associated with specific companies. c. risk associated with adverse selection. d. uncertainty associated with the entire economy.

b. uncertainty associated with specific companies.

Using the rule of 70, if your income grows at 10 percent per year, your income will double in approximately a. 70 years. b. There is not enough information to answer this question. c. 7 years. d. 10 years.

c. 7 years. 70/10 = 7

It is difficult for an actively managed mutual fund to outperform an index fund because a. index funds generally do better fundamental analysis. b. stock markets tend to be inefficient. c. actively managed funds trade more often and charge fees for their alleged expertise. d. index funds are able to buy undervalued stocks. e. all of the above are true.

c. actively managed funds trade more often and charge fees for their alleged expertise.

A minimum-wage law tends to a. have no impact on unemployment as long as it is set above the competitive equilibrium wage. b. create more unemployment in high-skill job markets than in low-skill job markets. c. create more unemployment in low-skill job markets than in high-skill job markets. d. help all teenagers because they receive a higher wage than they would otherwise.

c. create more unemployment in low-skill job markets than in high-skill job markets.

An increase in the prevailing interest rate a. decreases the present value of future returns from investment and increases investment. b. increases the present value of future returns from investment and decreases investment. c. decreases the present value of future returns from investment and decreases investment. d. increases the present value of future returns from investment and increases investment.

c. decreases the present value of future returns from investment and decreases investment.

The study of a company's accounting statements and future prospects to determine its value is known as a. information analysis. b. diversification. c. fundamental analysis. d. risk management.

c. fundamental analysis.

Which of the following does not help reduce the risk that people face? a. buying insurance b. diversifying their portfolio c. increasing the rate of return within their portfolio d. All of the above help reduce risk.

c. increasing the rate of return within their portfolio

According to the Bureau of Labor Statistics, a husband who chooses to stay home and take care of the household is a. unemployed. b. employed. c. not in the labor force. d. a discouraged worker.

c. not in the labor force.

An accountant with a CPA designation who has been unable to find work for so long that she has stopped looking for work is considered to be a. employed. b. unemployed. c. not in the labor force. d. not in the adult population.

c. not in the labor force.

The amount of unemployment that the economy normally experiences is known as a. cyclical unemployment. b. efficiency wage unemployment. c. the natural rate of unemployment. d. frictional unemployment

c. the natural rate of unemployment.

If two countries start with the same real GDP per person, and one country grows at 2 percent while the other grows at 4 percent, a. next year the country growing at 4 percent will have twice the GDP per person as the country growing at 2 percent. b. the standard of living in the two countries will converge. c. the standard of living in the country growing at 4 percent will start to accelerate away from the slower growing country due to compound growth. d. one country will always have 2 percent more real GDP per person than the other.

c. the standard of living in the country growing at 4 percent will start to accelerate away from the slower growing country due to compound growth.

Some frictional unemployment is inevitable because a. efficiency wages may hold the wage above the equilibrium wage. b. of minimum-wage laws. c. there are changes in the demand for labor among different firms. d. of unions. e. of all of the above.

c. there are changes in the demand for labor among different firms.

The labor-force participation rate is a. 47.1 percent. b. 50.2 percent. c. 65.9 percent. d. 70.2 percent. e. none of the above

d. 70.2 percent. 98/139.7 = 0.701 0.701 x 100 = 70.2%

Which of the following should cause the price of a share of stock to rise? a. a reduction in market risk b. an increase in expected dividends c. a reduction in the interest rate d. All of the above should cause the price to rise. e. None of the above should cause the price to rise.

d. All of the above should cause the price to rise.

Compared to a portfolio composed entirely of stock, a portfolio that is 50 percent government bonds and 50 percent stock will have a a. higher return and a lower level of risk. b. lower return and a higher level of risk. c. higher return and a higher level of risk. d. lower return and a lower level of risk.

d. lower return and a lower level of risk.

Which of the following is an example of a reason why firms might pay efficiency wages? a. At equilibrium wages, workers often quit to find better jobs. b. At equilibrium wages, workers sleep when the boss is not looking because workers are not deeply concerned about being fired. c. At equilibrium wages, only minimally qualified workers apply for the job. d. At equilibrium wages, workers cannot afford a healthy diet so they fall asleep at work due to a lack of energy. e. All of the above are true.

e. All of the above are true.

The amount of money today needed to produce a particular sum in the future, given prevailing interest rates, is known as a. beginning value. b. compound value. c. fair value. d. future value. e. present value.

e. present value.