BUSINESS 702 MANAGERIAL ECONOMICS MULTIPLE CHOICE QUESTIONS (30 pts, 1pt each) 1.

> A typical annual rate of return on invested capital is: A. B. C. D. 5%. 10%. 15%. 20%.

FIRST EXAM KEY

SPRING 1997

2.

Warren Buffett looks for "wonderful businesses" that feature: A. B. C. D. ongoing innovation. large capital investment. consistent earnings growth. complicated business strategies.

> 3. >

Business profit is: A. B. C. D. the residual of sales revenue minus the explicit accounting costs of doing business. a normal rate of return. economic profit. the return on stockholders' equity.

4.

According to frictional profit theory, above-normal profits: A. B. C. D. are sometimes caused by barriers to entry that limit competition. arise as a result of successful invention or modernization. can sometimes be seen as a reward to efficient operations. are observed following unanticipated changes in product demand or cost conditions..

> 5. >

The primary virtue of managerial economics lies in its: A. B. C. D. logic. usefulness. consistency. mathematical rigor.

6.

The optimal decision produces: A. B. C. D. maximum revenue. maximum profits. minimum average costs. a result consistent with managerial objectives.

> 7. >

An equation is: A. B. C. D. an analytical expressions of functional relationships. a visual representation of data. a table of electronically stored data. a list of economic data.

8. >

A dependent variable is: A. B. C. D. an X-variable determined separately from the Y-variable. a Y-variable determined by X values. a Y-variable determined prior to X values. a Y-variable determined with X values.

9. >

Inflection is: A. B. C. D. a line that touches but does not intersect a given curve. a point of maximum slope. a measure of the steepness of a line. an activity level that generates highest profit.

10.

The comprehensive impact resulting from a decision is the:

2 A. B. C. D. gain or loss associated with a given managerial decision. change in total cost. change in total profit. incremental change.

> 11. >

Statistics are: A. B. C. D. descriptive measures for a sample. summary measures for the population. predetermined variables. endogenous variables.

12. >

The "middle" observation is the: A. median. B. average. C. mean. D. mode. A normally distributed test statistic with zero mean and standard deviation of one is the: A. B. C. D. z-statistic. t-statistic. F-statistic. S.E.E.

13. >

14.

A relation known with certainty is called a: A. B. C. D. statistical relation. multiple regression. deterministic relation. simple regression.

> 15.

The standard deviation of the dependent Y-variable after controlling for all X-variables is the: A. B. C. D. correlation coefficient. coefficient of determination. F-statistic. standard error of the estimate.

> 16. >

Derived demand is directly determined by: A. B. C. D. utility. the profitability of using inputs to produce output. the ability to satisfy consumer desires. personal consumption.

17.

A demand curve expresses the relation between the quantity demanded and: A. B. C. D. income. advertising. price. all of the above.

> 18. >

Change in the quantity demanded is: A. B. C. D. a movement along a single demand curve. an upward shift from one demand curve to another. a reflection of change in one or more of the nonprice variables in the product demand function. a downward shift from one demand curve to another.

19.

A supply curve expresses the relation between the quantity supplied and: A. B. C. D. technology. wage rates. price. all of the above.

> 20.

Change in the quantity supplied reflects a:

3 > A. B. C. D. change in price. switch from one supply curve to another. change in one or more nonprice variables. shift in supply.

21. >

Elasticity is the: A. B. C. D. percentage change in a dependent variable, Y, resulting from a one-percent change in the value of an independent variable, X. change in a dependent variable, Y, resulting from a change in the value of an independent variable, X. change in an independent variable, X, resulting from a change in the value of a dependent variable, Y. percentage change in an independent variable, X, resulting from a one-percent change in the value of a dependent variable, Y.

22. >

Point elasticity measures elasticity: A. B. C. D. over a given range of a function. at a spot on a function. along an arc. before non-price effects.

23. >

With elastic demand, a price increase will: A. B. C. D. lower marginal revenue. lower total revenue. increase total revenue. lower marginal and total revenue.

24. >

With inelastic demand, a price increase produces: A. B. C. D. a less than proportionate decline in quantity demanded. lower total revenue. lower marginal revenue. lower marginal and total revenue.

25. >

A direct relation between the price of one product and the demand for another holds for all: A. B. C. D. complements. substitutes. normal goods. inferrior goods.

26. >

The concept of cross-price elasticity is used to examine the responsiveness of demand: A. B. C. D. to changes in income. for one product to changes in the price of another. to changes in "own" price. to changes in income.

27. >

When the cross-price elasticity e PX = 3: A. B. C. D. demand rises by 3% with a 1% increase in the price of X. the quantity demanded rises by 3% with a 1% increase in the price of X. the quantity demanded rises by 1% with a 3% increase in the price of X. demand rises by 1% with a 3% increase in the price of X.

28. >

Goods for which e I > 1 are often referred to as: A. B. C. D. cyclical normal goods. noncyclical normal goods. being relatively unaffected by changing income. inferrior goods.

29. >

If e P = -3 and MC = $1.32, the profit-maximizing price is: A. B. C. D. $3.00. $1.98. $1.32. $1.76.

30.

If MR = $25,000 - $300Q and MC = $5,000 + $100Q, the profit-maximizing price is:

4 A. B. C. D. $50. $25,000. $17,500. $10,000.

>

SHORT PROBLEMS (20 pts, 2 pts each) 31. If QY = -4PY + 2.5PX, calculate the point cross-price elasticity when PY = $200 and PX = $400. e PX = 5, where QY = -4($200) + 2.5($400) = 200, e PX = dQ Y /dP X PX/Q Y = 2.5 $400/200 = 5. If QY = 1.5PY -2PX2.5AY 3AX1I1.5, describe the relation between the demand for Y and X. Substitutes since bP = 2.5 > 0.
X

32. 33.

If MR = $200 - $0.5Q and MC = $100 + $0.3Q, calculate the profit-maximizing price-output combination. P = $168.75, Q = 125. Set MR = MC, where $200 - $0.5Q = $100 + $0.3Q; 100 = 0.8Q; Q = 125, and P = $200 - $0.25(125) = $168.75. 1 1 1 % eP 1 1 & 1 5

34.

If eP = -5 and MC = $1.59, calculate the profit-maximizing price. P = $1.99, where

P( ' MC

' $1.59

= $1.99.

For the next four short problems, assume that TR = $100Q - $0.06Q 2 and TC = $3,200 + $20Q + $0.02Q 2. Calculate: 35. 36. 37. optimal profits. p = $16,800. p = TR - TC = $100Q - $0.06Q 2 - $3,200 - $20Q - $0.02Q 2 = -$0.08Q 2 + $80Q - $3,200. dp/dQ = -0.16Q + 80 = 0, Q = 500. Therefore, p = -$0.08(5002) + $80(500) - $3,200 = $16,800. the revenue-maximizing price-output combination. P = $50, Q = 833.33. MR = dTR/dQ = $100 - $0.12Q = 0; Q = 833.33, and P = $100 $0.06(833.33) = $50. the average-cost minimizing price-output combination. P = $76, Q = 400. Set MC = AC, or $20 + 0.04Q = $3,200/Q + $20 + $0.02Q; 0.02Q = 3,200/Q; Q2 = 160,000; Q = 38. 160,000 = 400. P = $100 - $0.06Q = $100 - $0.06(400) = $76.

the total-cost minimizing output level. Q = 0, where variable cost is zero. For the next two short problems, assume that Q = 16 - 0.002P. Calculate the:

39. 40.

price-output combination where eP = -1. P = $4,000 and Q = 8, where P = $8,000 - $500Q, MR = $8,000 - $1,000Q = 0, Q = 8 and P = $8,000 $500(8) = $4,000. arc price elasticity associated with a price decrease from $6,500 to $5,500. E P = -3, where Q1 = 16 - 0.002($6,500) = 3 and Q2 = 16 - 0.002($5,500) = 5. EP = [(Q2 - Q1)/(P2 - P1)] [(P2 + P1)/(Q2 + Q1)] = [(5 - 3)/($5,500 - $6,500)] [($5,500 + $6,500)/(5 + 3)] = -3.

LONGER PROBLEMS (50 pts, 10 pts each) (See P2.1) Marginal Analysis. Characterize each of the following statements as true or false, and explain your answer. 41. A. B. C. D. E. 41. If marginal revenue is greater than average revenue, the demand curve is downward sloping. Profit is minimized when total revenue equals total cost. Given a downward-sloping demand curve and positive marginal costs, profit-maximizing firms always sell more output at lower prices than revenue-maximizing firms. Marginal cost must be less than average cost for average cost to decline as output expands. Marginal profit is the difference between marginal revenue and marginal cost, and always exceeds zero at the profit-maximizing activity level.

SOLUTION A. B. False. Since average revenue is falling along a downward sloping demand curve, marginal revenue must be less than average revenue for the demand curve to slope downward. False. Profits are maximized when marginal revenue equals marginal cost. Profits equal zero at the breakeven point where total revenue equals total cost. Profits are maximized when the difference between total revenue and total cost is at a maximum.

5 C. False. Profit maximization involves setting marginal revenue equal to marginal cost. Revenue maximization involves setting marginal revenue equal to zero. Given a downward sloping demand curve and positive marginal costs, revenue maximizing firms charge lower prices and offer greater quantities of output than profit maximizers. True. Average cost falls as output expands so long as marginal cost is less than average cost. If this condition is met, average costs decline whether marginal costs are falling, rising or constant. False. Marginal profit equals marginal revenue minus marginal cost, and equals zero at the profit maximizing activity level.

D. E. 42.

(See P4.2) Demand and Supply Concepts. Describe the effects of each of the following influences on demand and/or supply conditions in the newhire market for MBAs. A. B. C. D. E. An economic recession (fall in national income). An increase in MBA graduate salaries. An increase in the availability of low-cost student loans. A rise in tuition costs. A rise in relative productivity of MBA versus BA/BS job candidates.

42.

SOLUTION A. Decrease demand/leftward shift in demand curve and increase supply/rightward shift in supply curve. With a fall in national income, the profitability of added employment will fall, thereby causing a decline in the demand for labor. A recession can also reduce job opportunities for BAs and BSs, thereby reducing the income loss incurred while in graduate school, and thus can actually increase the supply of MBAs. Despite this often observed counter-cyclical relation between enrollment and economic activity, recessions can also limit the return to an MBA and thereby limit MBA supply. Thus, the net effect on supply can be uncertain. Decrease in the quantity demanded/upward movement along demand curve and increase the quantity supplied/upward movement along supply curve. Rising prices cut the quantity demanded while increasing the quantity supplied. Increase supply/rightward shift in supply curve. An increase in student loan availability will cut the cost of an MBA education, and increase the expected net return, and increase supply at every expected wage level. Decrease supply/leftward shift in supply curve. A rise in tuition costs increases the cost of an MBA education, cuts the expected net return, and will decrease supply at each expected wage level. Increase demand/rightward shift in demand. An increase in the relative productivity of MBAs will increase demand for MBAs at every price level.

B. C. D. E. 43.

(See P6.1) Demand Concepts. Identify each of the following as true or false and explain why. A. B. C. D. E. The effect of a one-unit change in advertising is constant along a linear demand curve. An increase in income increases the quantity demanded for normal goods and services. A demand curve is revealed if prices fall while demand conditions are held constant. The price elasticity of demand is constant along a linear demand curve. A rise in price tends to reduce the quantity demanded.

43.

SOLUTION A. B. C. D. E. True. The effect of a one-unit change in advertising is constant, but the advertising elasticity of demand varies along a linear demand curve. False. An increase in income causes an upward shift in the demand curve for normal goods and services. True. A demand curve is revealed if prices fall while demand conditions are held constant. False. The effect of a one-unit change in price is constant, but the elasticity of demand varies along a linear demand curve. True. A rise in price causes an upward movement along the demand curve and a decrease in the quantity demanded.

44.

(See P2.6) Marginal Analysis: Tables. Mary Hartman is a regional media consultant for Creative Images, Inc., a Boston-area marketing firm. Hartman has gathered the following data on weekly advertising media expenditures and gross sales for a major client, Danish Design, Ltd.

Gross Sales Following Promotion in the Following Media: Advertising Expenditure $0 100 200 300 400 500 A. B. C. 44. Newspaper $10,000 12,000 13,800 15,400 16,600 17,200 Radio $10,000 14,000 17,600 20,200 22,000 22,400 Television $10,000 13,000 15,600 18,000 18,600 18,800

Construct a table showing marginal sales following promotion in each media. (Assume here and throughout the problem that there are no synergistic effects across different media.) If Danish Design has an advertising budget of $500 per week, how should it be spent? Why? Calculate the profit maximizing advertising budget and media allocation assuming Danish Design enjoys an average profit contribution before media expenditures of 6% on store-wide sales. How much are maximum weekly profits (before taxes)?

SOLUTION A. A table showing marginal sales generated by promotion in each media appears as follows: Marginal Sales Following Promotion in the Following Media: Advertising Expenditure $0 100 200 300 400 500 B. Newspaper --$2,000 1,800 1,600 1,200 600 Radio --$4,000 3,600 2,600 1,800 400 Television --$3,000 2,600 2,400 600 200

Using the data in Part A, and given a $500 advertising budget, gross sales and profit contribution are maximized by allocating $300 to radio and $200 to television advertising. Irrespective of whether Danish Design seeks to maximize revenues or profit, this expenditure allocation is optimal. Given an average profit contribution before media expenditures of 6% on store-wide sales, an additional dollar of advertising will be profitable so long as it returns more than $16.67 in additional revenues. That is, the profit contribution on additional revenues of $16.67 is just sufficient to cover media costs of $1 (= $16.67 0.06). The profit maximizing advertising budget is $900 per week allocated as: $200 on newspaper, $400 on radio, and $300 on television. Maximum weekly profits are: Base sales + Newspaper sales + Radio sales + Television sales Gross margin Gross profit - Media costs Net profit $10,000 3,800 12,000 8,000 $33,800 0.06 2,028 900 $ 1,128

C.

45.

(See P6.3) Demand Curve Analysis. Game-Gear, Inc., is a leading supplier of video games for hand-held video game players. Average wholesale price and unit sales data for the "Game-Gear Football" over the past five-month period are as follows: June Price ($) $36 July $34 August $33 Sept. $35 Oct. $34

7 Units sold A. Month June July August Sept. Oct. B. 45. 350,000 400,000 425,000 375,000 400,000

Complete the following table, and use these data to derive intercept and slope coefficients for a linear demand curve. Price $36 34 33 35 34 Quantity 350,000 400,000 425,000 375,000 400,000 ? Price --? Quantity --Slope = ? P/? Q ---

Assuming that demand conditions are held constant, use the preceding data to plot a linear demand curve.

SOLUTION A. Month June July August Sept. Oct. A linear demand curve is based on the assumption that a one-unit change in price leads to a constant change in the quantity demanded. From the monthly price/output data note that: Price $36 34 33 35 34 Quantity 350,000 400,000 425,000 375,000 400,000 ? Price ---$2 -1 2 -1 ? Quantity --50,000 25,000 -50,000 25,000 Slope = ? P/? Q ---0.00004 -0.00004 -0.00004 -0.00004

When a linear demand curve is written as: P = a + bQ a is the intercept and b is the slope coefficient. By definition, slope equals ? P/? Q. From the above data note: b = ? P/? Q = -0.00004 Therefore, P = a - $0.00004Q Under the assumption of a liner demand relation, each of the data points given in the table fall exactly along the linear demand curve. The value of the intercept term can therefore be easily calculated using data for any of the data points given in the table. For example, using the June data point where P = $36 and Q = 350,000, P = $36 = $36 = a = Therefore, in general: P = $50 - $0.00004Q or Q = B. 1,250,000 - 25,000P a - $0.00004Q a - $0.00004(350,000) a - $14 $50

Assuming that demand conditions are held constant, the linear demand curve can be plotted as: