BUSA 6160 Sample Exam Spring 2010

BUSA 6160 Sample Exam Spring 2010
Rather than limiting the sample exam to just a few questions I’ve decided to expose you to
as many different types of questions as possible. In studying for the mid-term, work
through these questions. If you don’t understand an answer please contact me. P.Szmedra
Chapter 1
1. Which of the following is an implicit cost to a firm that produces a good or service?
A. labor costs.
B. costs of operating production machinery.
C. foregone profits of producing a different good or service.
D. costs of renting or buying land for a production site.
2. If the interest rate is five percent, the present value of $200 received at the end of five
years is:
A. $121.34.
B. $156.71.
C. $176.41.
D. $132.62.
3. A farm must decide whether or not to purchase a new tractor. The tractor will reduce
costs by $2,000 in the first year, $2,500 in the second and $3,000 in the third and final year
of usefulness. The tractor costs $9,000 today, while the above cost savings will be realized
at the end of each year. If the interest rate is seven percent, what is the net present value
of purchasing the tractor?
A. $6,764.
B. $9,362.
C. $18,362.
D. none of the statements associated with this question are correct.
4. Suppose total benefits and total costs are given by B(Y) = 100Y - 8Y2 and C(Y) = 10Y2.
What level of Y will yield the maximum net benefits?
A. 75/36.
B. 75/18.
C. 50/18.
D. 100/36.
5. Negotiations between the buyer and seller of a new house is an example of:
A. consumer-consumer rivalry.
B. consumer-producer rivalry.
C. producer-producer rivalry.
D. monopoly.
6. When MB = 300 - 12Y and TC = 12Y + 108, the optimal level of Y is:
A. 25.
B. 4.5.
C. 8.
D. 24.
7. Suppose the growth rate of the firm's profit is 5%, the interest rate is 6%, and the
current profits of the firm are 80 million dollars. What is the value of the firm?
A. $89.2 million.
B. $1,413.3 million.
C. $8,480 million.
D. none of the statements associated with this question are correct.
8. You are the manager of a Fortune 500 hotel chain and must decide where to locate a new
hotel. Based on tax considerations, your accounting department suggests that Atlantic City
is the best choice, followed closely by Las Vegas. In particular, your current year tax
savings from locating in Atlantic City are $4 million but only $3 million in Las Vegas. Your
marketing department, on the other hand, has provided you with sales estimates that
suggest that the present value of the gross (of taxes) operating profits from locating in
Atlantic City are only $10 million but are $14 million for Las Vegas. It will cost $14 million to
build the hotel in either location. Ignoring all other considerations, where should you build
the hotel? What are your firm's economic profits if you locate the hotel in Atlantic City?
Ignoring other considerations, if you build the hotel in Atlantic City your accounting profits
are zero (computed as $4 million in tax savings, plus $10 million in operating profits, minus
$14 in building costs). In contrast, if you build in Las Vegas your accounting profits are $3
million (computed as $3 million in tax savings, plus $14 million in operating profits, minus
$14 million in building costs). Your best alternative is thus to build in Las Vegas to earn $3
million in accounting (and economic) profits. If you build the hotel in Atlantic City, your
accounting profits are zero, but your implicit cost is the $3 million you give up by not
building in Las Vegas - your best alternative. Thus, your economic profits of building in
Atlantic City are -$3 million.
Chapter 2
1. Which of the following can explain an increase in the demand for housing in retirement
A. A drop in real estate prices.
B. An increase in the population of the elderly.
C. A drop in the average age of retirees.
D. Mandatory government legislation.
2. Suppose market demand and supply are given by Qd = 100 - 2P and QS = 5 + 3P. If a
price floor of $30 is set, what will be size of the resulting surplus?
A. 0.
B. 45.
C. 30.
D. 55.
3. Suppose you produce wooden desks, and government legislation protecting the spotted
owl has made it more expensive for you to purchase wood. What do you expect to happen
to the equilibrium price and quantity of wooden desks?
A. Price and quantity will increase.
B. Price will increase but quantity will decrease.
C. Price and quantity will decrease.
D. Price will decrease but quantity will increase.
4. Suppose both supply and demand decrease. What effect will this have on price?
A. It will fall.
B. It will rise.
C. It may rise or fall.
D. It will remain the same.
5. Suppose X and Y are complements and demand for X is Qxd = α0 + αXPX + αYPY + αMM +
αHH. Then we know
A. αH > 0.
B. αX > 0.
C. αY < 0.
D. αM < 0.
6. Suppose the demand for X is given by Qxd = 100 - 2PX + 4PY + 10M + 2A, where PX
represents the price of good X, PY is the price of good Y, M is income and A is the amount of
advertising on good X. Good X is
A. an inferior good.
B. a normal good.
C. a Giffin good.
D. a complement.
7. Suppose the market demand for good X is given by QXd = 20 - 2PX. If the equilibrium
price of X is $5 per unit, then the total value a consumer receives from consuming the
equilibrium quantity is
A. $100.
B. $75.
C. $50.
D. $25.
8. Consider a market characterized by the following inverse demand and supply functions:
PX = 10 - 2QX and PX = 2 + 2QX. An $8 per unit price floor will result in a
A. shortage of 1 unit.
B. surplus of 2 units.
C. shortage of 3 units.
D. surplus of 3 units.
9. You are an aide for the Senate Banking Committee Chairman. He comes to you with a bill
that proposes setting limits on what ATM owners can charge nonaccount holders, over and
above what banks charge their own customers. Currently, large banks charge noncustomers
an average fee of $1.35 per transaction in addition to the fees the customer's own bank
imposes. The Senator asks you to look at a proposal that would place a $0.50 cap on the
fees ATM owners can charge noncustomer for accessing their money. If this legislation is
enacted, what would be the likely effects?
The proposal is, in essence, an effective price ceiling of $.50. As shown in Figure 2-4, this
will create a shortage of ATMs. The amount of the shortage will equal the difference
between the quantity demanded and the quantity supplied at the price ceiling, i.e., the
difference between points A and B. Longer lines are likely to develop at ATM machines.
Including the value of lost time, the full economic price paid for ATM usage will exceed the
current price of $1.35 per transaction. The full economic price is denoted P* in Figure 2-4.
Note that the actual magnitude of the shortage and full economic price will depend on the
relative slopes of the demand and supply curves.
Figure 2-4
10. You are an economic advisor to the Treasurer of the United States. Congress is
considering increasing the sales tax on gasoline by $.03 per gallon. Last year motorists
purchased 10 million gallons of gas per month. The demand curve is such that every $.01
increase in price decreases sales by 100,000 gallons per month. You also know that for
every $.01 increase in price, producers are willing to provide 50,000 more gallons of
gasoline to the market. The legislature has stated that the $.03 tax will increase
government revenues by $300,000 per month and raise the price of gasoline by $.03 per
gallon. Is this correct?
Given the information, the supply and demand curves can be described as follows:
Qs = 10,000,000 + 5,000,000(ps - p0)
Qd = 10,000,000 - 10,000,000(pd - p0),
where p0 is the initial price and the quantity of goods is in millions of units. With an excise
tax of $.03, the price paid by a consumer is greater than the price received by a producer
by $.03. That is, pd = ps + .03. If we substitute this in for pd in the demand function we
obtain ps - p0 = -$.02 and Qs = Qd = 9.9 million. The total tax revenue is 9.9 million gallons
x $.03/gallon = $297,000 (per month). The new price paid by consumers is pd = ps + $.03
= p0 - $.02 + $.03 = p0 + $.01. Hence, the price will rise by only $.01, instead of $.03.
11. The demand for your product has been estimated to be
. The relevant price and income data are as follows:
a. Which goods are substitutes for X? Which are complements?
b. Is X an inferior or a normal good?
c. How much X will be purchased?
d. Graph the demand curve for X given the above information.
e. How will the demand curve change if M falls to 35,000?
a. Z is a substitute for X, while Y is a complement for X.
b. X is an inferior good.
d. See Figure 2-18.
Figure 2-18
chapter 3
1. The demand for good X has been estimated by Q xd = 12 - 3Px + 4Py. Suppose that good
X sells at $2 per unit and good Y sells for $1 per unit. Calculate the own price elasticity.
A. -0.2.
B. -0.3.
C. -0.5.
D. -0.6.
2. Suppose Q xd = 10,000 - 2 Px + 3 Py - 4.5M, where Px = $100, Py = $50, and M = $2,000.
What is the own-price elasticity of demand?
A. -2.34.
B. -0.78.
C. -0.21.
D. -1.21.
3. A study has estimated the effect of changes in interest rates and consumer confidence on
the demand for money to be: lnM = 14.666 + .021 lnC - 0.036 lnr, where M denotes real
money balances, C is an index of consumer confidence, and r is the interest rate paid on
bank deposits. Based on this study we know that the interest elasticity is:
A. unitary.
B. zero.
C. very elastic.
D. very inelastic.
4. Suppose the income elasticity for transportation is 1.8. Which of the following is an
incorrect statement?
A. Transportation is a normal good.
B. Expenditures on transportation grow more rapidly than income grows.
C. Expenditures on transportation will fall less rapidly than income falls.
D. Whenever the income increases by 1%, the expenditure on transportation increases by
5. The demand for which of the following commodities is likely to be more inelastic?
A. Soft drinks.
B. Beverages.
C. Cola drinks.
D. Pepsi Cola.
6. Suppose the own-price elasticity of demand for good X is -0.25, and that the quantity of
good X increases by 5%. What would you expect to happen to the total expenditures on
good X?
A. increase.
B. decrease.
C. unchanged.
D. neither increase, decrease nor remain unchanged.
7. The following estimates have been obtained for the market demand for cereal:
, where Q is the quantity of cereal, P is the price
of cereal, A is the level of advertising, and M is income. Based on this information,
determine the effect on the consumption of cereal of
a. A 5 percent reduction in the price of cereal.
b. A 4 percent increase in income.
c. A 20 percent reduction in cereal advertising.
a. Since the own price elasticity is -0.68, we use the elasticity formula to write
Solving for
we see that there will be a 3.4 percent increase in the quantity demanded of
b. There will be a 5.2 percent reduction in the demand for cereal.
c. There will be a 15 percent reduction in the demand for cereal.
Chapter 4
1. Along the same indifference curve, MRS is
A. constant as more of one good is obtained.
B. increasing as more of one good is obtained.
C. decreasing as more of one good is obtained.
D. varying irregularly as more of one good is obtained.
2. If the slope of the indifference curve is steeper than the slope of the budget line, and X is
on the horizontal axis
A. the consumer is willing to give up more of good Y to get an additional unit of good X than
is necessary under the current market prices.
B. MRS < PX /PY.
C. MRS < - PX /PY.
D. the consumer is willing to give up more of good X to get an additional unit of good Y than
is necessary under the current market prices.
3. An in-kind gift causes the budget line to
A. shift to the right in a parallel fashion.
B. shift to the left in a parallel fashion.
C. rotate counter-clockwise.
D. none of the statements associated with this question are correct.
4. When the price of one good decreases, the associated substitution effect is represented
by a
A. move from one indifference to a higher indifference curve since real income is now
B. move from one indifference to a lower indifference curve since real income is now lower.
C. move along a given indifference curve holding real income constant.
D. move along a given indifference curve since real income increases.
5. If shoes and socks are complements and both are normal goods, show graphically what
would happen to the consumption of shoes and socks if
a. the price of shoes decreased.
b. consumer incomes increased.
a. As shown in Figure 4-9a, a decrease in the price of shoes rotates the budget constraint
from 1 to 2. Since shoes and socks are complements, more of both goods are consumed as
equilibrium moves from A to B.
Figure 4-9a
b. Since both goods are normal, an increase in income leads to greater consumption of each
good, as illustrated by the movement from C to D in Figure 4-9b.
Figure 4-9b
6. Suppose a consumer derives satisfaction from consuming two types of hamburgers, X
and Y.
a. Graph the budget line of the consumer under the assumption that he is offered a "buy
two, get one free" deal for burger X (limit one free burger).
b. Graph the budget constraint under the assumption that the producer of burger Y also
offers a "buy two, get one free" deal (limit one free burger).
c. Explain in words why each of the above budget constraints looks as it does.
a. In Figure 4-13a, ABCD is the budget line under a "buy two - get one free" deal for a
burger X.
b. In Figure 4-13b, ABCD is the budget line under a "buy two - get one free" deal from the
producer of burger Y.
c. When your consumption of the good under a special deal is less than or equal to two
units, the deal has no effect on you. This explains the segment AB of your budget line. As
you buy two units of that good, you get the third free. This explains the jump from B to C.
After the third one, the deal becomes ineffective for you. Hence, CD has the same slope as
AB does.
Figure 4-13a Figure 4-13b
Chapter 5
1. Suppose the production function is given by Q = 3K + 4L. What is the average product of
capital when 5 units of capital and 10 units of labor are employed?
A. 3.
B. 4.
C. 11.
D. 45.
2. For the cost function C(Q) = 100 + 2Q + 3Q2, the marginal cost of producing 2 units of
output is
A. 2.
B. 3.
C. 12.
D. 14.
3. You are an efficiency expert hired by a manufacturing firm that uses K and L as inputs.
The firm produces and sells a given output. If w = $40, r = $100, MPL = 20, and MPK = 40
the firm:
A. is cost minimizing.
B. should use less L and more K to cost minimize.
C. should use more L and less K to cost minimize.
D. is profit maximizing but not cost minimizing.
4. If the production function is Q = K.5L.5 and capital is fixed at 1 unit, then the average
product of labor when L = 25 is
A. 2/5.
B. 1/5.
C. 10.
D. none of the statements associated with this question are correct.
5. What is the value marginal product of labor if: P = $10, MPL = $25, and APL = 40?
A. $10,000.
B. $1,000.
C. $400.
D. $250.
6. Suppose the production function is given by Q = K1/2L1/2, and that Q = 30 and K = 25.
How much labor is employed by the firm?
A. 49.
B. 6.
C. 36.
D. 25.
7. For the multiproduct cost function C(Q1,Q2) = 100 + 2Q1Q2 + 4Q12, what is the marginal
cost function for good one?
A. MC1 = 2Q2 + 4Q1 - Q22.
B. MC1 = 2Q2 + 8Q1.
C. MC1 = 100 + 2Q1Q2 + 4Q12.
D. MC1 = 4Q12 - 2 Q22.
8. The isoquants are normally drawn with a convex shape because inputs are
A. not perfectly substitutable.
B. perfectly substitutable.
C. perfect complements.
D. normal goods.
9. Congress is considering legislation that will provide additional investment tax credits to
businesses. Effectively, an investment tax credit reduces the cost to firms of using capital in
production. Would you expect labor unions to lobby for or against such a bill? (Hint: What
impact would such a plan have on the capital-to-labor ratio at the typical firm?)
An investment tax credit would reduce the price of capital relative to labor. Other things
equal, this would increase w/r, thereby making the isocost line more steep. This means that
the cost-minimizing input mix will now involve more capital and less labor, as firms
substitute towards capital. If labor unions are concerned that this higher capital/labor ratio
will translate into lost jobs, they will likely oppose the investment tax credit. On the other
hand, the marginal product of labor will likely rise as a result of the greater use of capital,
so those workers employed might receive higher wages. If the union values higher wages,
they might favor the legislation.
Chapter 6
1. A relationship-specific exchange occurs when
A. a partnership is dissolved.
B. specialized investments are important.
C. a partnership is initiated.
D. shareholders receive dividends.
2. A negative side of a revenue sharing plan is that it:
A. Does not induce hard or better work.
B. It can be costly if revenues are low.
C. It gives no incentive for workers to minimize costs.
D. It can be difficult to manage from an accounting standpoint.
3. Long-term contracts are not efficient if
A. a firm engages in relationship-specific exchange.
B. specialized investments are unimportant.
C. the contractual environment is simple.
D. managers shirk.
4. One way of alleviating opportunism is
A. spot exchange.
B. dedicated assets.
C. vertical integration.
D. contracts in complex contracting environments.
5. Suppose a new contracting environment that requires more standardized inputs is
considered. This new contract will result in
A. an increase in the marginal cost and result in a longer optimal contract.
B. an increase in the marginal cost and result in a shorter optimal contract.
C. a decrease in the marginal cost and result in a longer optimal contract.
D. a decrease in the marginal cost and result in a shorter optimal contract.
6. Managerial reputation is an _____ incentive that helps to mitigate the _______ principal
agent problem.
A. internal; manager-worker.
B. external; manager-consumer.
C. internal; owner-manager.
D. external; owner-consumer.
7. In general, automobile manufacturers produce their own engines but purchase tires from
independent suppliers. Why?
Engine manufacturing involves specific investments; by vertically integrating, the potential
for opportunism is reduced. Tires are more uniform and can usually be purchased by spot
8. Explain why people in the following occupations are compensated as they are.
a. Insurance agents.
b. Football players.
c. Authors.
d. CEOs of major corporations.
e. Food servers.
a. Insurance agents are usually compensated by a fixed base payment and a commission,
which is positively related to the amount of business brought to the company. Without the
variable part of salary, insurance agents have little incentive to find clients.
b. Football players are usually compensated by a fixed payment, along with incentives tied
to performance.
c. Authors typically receive royalties, which are revenue sharing plans whereby the author
receives a fraction of the revenues generated by the book. This compensation scheme
provides the author an incentive to write a high-quality book in order to generate lots of
sales for the firm, and thus lots of royalty income for the author.
d. A CEO of a major corporation is usually compensated by a fixed payment plus a variable
bonus positively related to the amount of profits the corporation made. Without the variable
part of the payment, the CEO will not put forth as much effort as desired by the principal.
e. Waiters and waitresses are usually paid a small fixed payment by restaurants. The
majority of their pay is derived from tips, since each customer has the ability to monitor
their server.
9. In a 1998 press release, Boeing Commercial Airplane Group (BCAG) announced that it
was signing a 10-year contract with distributor Thyssen Inc. - a distributor of raw aluminum
- valued at approximately $300 million. The contract reflects Boeing's effort to reduce costs
and production bottlenecks resulting from supply shortages. The contract specifies prices
and guarantees quantities of raw aluminum to be delivered to BCAG's suppliers. If you were
the production manager at BCAG, how would you justify the long-term nature of the contact
with Thyssen Inc.?
A contract permits it to avoid the hold-up problem in the future.
10. The management of Morris Industries is considering a plan to terminate a new
employee. The action stemmed from documented evidence supplied by the firm's
accounting department that this new employee did not add as much to the firm's overall
output as did a worker hired two weeks earlier. Based on this evidence, do you agree that
the latest worker hired should be fired? Explain.
No. In order to maximize profits, firms should hire workers up to the point where the value
marginal product equals the wage rate in the range of diminishing marginal returns. The
data suggests that the last worker added less to total output that the previous worker,
which means that the firm is indeed operating in the range of diminishing marginal returns,
as it should. The worker should be fired if his or her value marginal product is less than the
wage. Unfortunately, management is not considering this information.