Economics of Business E1600 Sample Midterm Questions

of Business E1600 Sample Midterm Questions
1. The Agency Problem or Principal-Agent Problem may arise when:
a. The Agent has an informational advantage over the Principal
b. An Agent with informational advantages seek to exploit it at a cost to the
c. The Principal cannot “meter” the Agent completely or without cost
d. All of the above
2. After a comprehensive study of the Hardknocks Company’s labor productivity,
students from Economics E1600 prepared the curve below relating firm
profitability to the number of employees. Point A represents the point of
inflection where the rate of increase in profitability begins to diminish; point B
where the profitability reaches a maximum; and point C where the rate of
declining profitability begins to accelerate. Which point representing profitability
and employee numbers would the students recommend?
a. Point A where diminishing returns begin setting in.
b. Point B where the greatest profitability is realized
c. Point C just before diminishing returns accelerate
d. None of the above, there is not enough information to answer the question
3. Is it possible to observe a negative s value in a “sharecropping” contract? Which
statement is most accurate?
a. No, people would not pay to work
b. No, it is illegal in most countries to require that workers pay for the
opportunity to work
c. Yes, some jobs are so good, people do them for free or even pay to do
d. Yes, workers may pay a fee to buy into fields such as taxi driving where
participation is limited to license holders or renters.
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4. The graphic below illustrates Hirshleifer’s case where internal transfer prices
between divisions A and B of a vertically integrated company are autonomously
(no central direction) determined to maximize the firm’s total profit. Which
statements are consistent with this situation?
a. The market for the final product is competitive and only complete or
finished goods are sold
b. The transfer price of intermediate good A is determined by subtracting the
marginal cost of intermediate good B, MCB, from the price received for
the final or complete good, PC.
c. The profit contribution (excess of revenues over costs) of division B is
much less than that of division A
d. Answers (a) and (b)
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5. Williamson seeks to understand how firms and markets differ in their handling of
transactions in regard to three dimensions. He asks first, “what advantages do
markets have over firms?” For non-asset specific transactions which statements
are most accurate?
a. Markets typically enjoy production cost advantages through their ability to
realize greater scale economies
b. Markets are less able to aggregate uncorrelated demands
c. Markets usually do not enjoy governance cost advantages when large
number of parties transact for commodities
d. External or market procurement is more hazardous than internal
6. Most discussions of scale economies focus only on expected production costs.
Coase long ago pointed out, and many economists have since repeated, that
diminishing returns to management may be a significant factor in firms failing to
realize fully physical scale economies and encountering limits to their size. Based
on our readings, which statements are accurate?
a. Size and complexity may increase the metering and monitoring costs
(Alchian and Demsetz) or internal transaction and governance costs
(Williamson) to the point where they offset physical or technological scale
b. In an effort to economize on metering and monitoring costs or spur
productivity, managers may impose invasive and impersonal control
technologies or techniques that enervate and alienate employees.
c. We would expect, all other things equal, to see diminishing returns to
management earlier in firms and industries where relational contracts are
important than in firms where standardized market or classical contracts
are predominately used for governance.
d. (a) and (b)
e. All of the above
of Business E1600 Sample Midterm Questions
7. Williamson builds on Alchian and Demsetz (1972) to create a framework for
employee and human resource management. Alchian and Demsetz emphasized
the metering dimension and, in particular, non-separable, team-based, cooperative
efforts (what Williamson calls primitive teams) that are difficult to meter.
Williamson adds the dimension of asset or firm-specificity. This allows
Williamson to create a two-by-two matrix (above) relating job dimensions to the
forms of governance. Which of these statements is (are) an accurate portrayal of
the different forms of internal governance structures?
a. Spot Market. Easily metered and general (or non-specific) human assets
are typically governed in a manner akin to spot markets. Since the
employees are easily replaced or can easily find new jobs, the bonds
between employee and firm are light.
b. Obligational Market. Easily metered but non-specific human assets share
an interest with the firm in continuing the relationship and so steps will be
taken to define obligations such as non-vested retirement or formal job
c. Primitive Team. Easily metered but non-specific human assets may enjoy
highly protected status within the firm due to the benefits of familiarity.
d. Relational Team. Human assets that are highly specific to the firm and
difficult to meter form relational teams that are easy to develop and
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8. Stigler (1951) built on Adam Smith’s 1776 observation that, “the division of labor
is limited by the extent of the market.” Which statements are consistent with his
model of industry life cycle and degree of vertical integration?
a. In many industries we observe firms beginning as very specialized entities
and over time bringing more and more production functions inside to
become highly vertically integrated for the remainder of their lives.
b. In their early days many firms conduct activities that exhibit decreasing
costs over the range of their output but shed those activities when the
market grows large enough to support specialized firms conducting those
c. Outsourcing is typically found in those sectors where increasing unit costs
appear at relatively low levels of production.
d. All of the above.
9. In The Republic (Part II) Plato, speaking through Socrates notes, “Society
originates, then, so far as I can see, because the individual is not self-sufficient,
but has many needs which he can’t supply himself.” Then, after enumerating the
basic needs of a state, he goes on, “It will need a farmer, a builder, a weaver, and
also, I think, a shoemaker and one or two others to provide for our bodily needs.”
Which then brings Socrates to the matter of allocation of effort and reward, “Then
should each of these men contribute the product of his labour for common use?
For instance, should the farmer provide enough food for all four of them and
devote enough time and labour to food production to provide for the needs of all
four? Or alternatively, should he disregard the others, and devote a quarter of his
time to producing a quarter of the amount of food, and the other three quarters
one to building himself a house, one to making clothes, and another to making
shoes? Should he, in other words, avoid the trouble of sharing with others and
devote himself to providing for his own needs only?” To this question,
Adeimantus replied, “The first alternative is perhaps the simpler.”
What position is most consistent with what we have learned about incentives and
opportunism (recall that Plato was a communist)?
a. Agree with Adeimantus because occupational specialization will always
produce more total wealth than would generalists
b. Disagree with Adeimantus because the assumed “contribution” or
“sharing” will not work without a pricing mechanism (even barter) to
govern transactions
c. Not sure, because even flawed specialization and division of labor is still
likely (but not certain) to produce more wealth than a community of selfsufficient people
d. Not sure, because with no market price mechanism, all of the workers
have an incentive to shirk once they’ve taken care of their own needs.
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The graphic below may be helpful for the next several questions
10. Klepper indicates that the number of entrants may rise or decline initially but
eventually must fall to zero. At what point on the graph does this decline begin?
a. Where line b intersects the net producer curve at its highest point (that is
where exiters = entrants)
b. Where line c intersect the x-axis and entrants decline to zero
c. Somewhere in region D at the point where the exiters line crosses the xaxis
d. None of the above
11. Assuming that the number of potential entrants in time t, Kt , is constant or
declines over time, what statement most accurately explains the eventual decline
in entrants, Et ?
a. The standard product price is driven down over time by the incumbents’
increasing investment in process innovation, rcit , increasing incumbent
advantage over potential entrants
b. The declining standard product price increases the entrants’ need to
generate profits from distinctive product variants
c. In each period, the declining standard product price and the increasing
level of product innovation expertise required to break-in results in
lowering the percentage of potential entrants with expected positive profits
and eventually that number reaches zero
d. None of the above
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12. Nelson and Winter introduce the concept of the “competence puzzle” to
distinguish among levels of rationality and to illuminate the reasons for different
levels of performance or competence by the same actor or organization. Which
factors tend to be associated with high competence?
a. The degree to which skills and routines can be learned through practice
b. Learning that can be guided by clear short term feedback
c. Environments with rising competitive standards
d. All of the above
13. Ronald Coase is generally credited with the first compelling explanation of why
firms rather than markets were used to conduct some transactions. What is the
fundamental reason given by Coase for the evolution of firms.
a. Firms can use hierarchy to organize and direct resources
b. Firms can take advantage of risk-sharing arrangements and capital markets
to support investment in productive assets that the market cannot
c. There are costs to using the market, for example simply determining the
price of resources
d. All of the above