Business Economics
Midterm Exam
Course Introduction
Business Economics examines the application of economic theory and methodology to business decision-making and strategy. The course explores how firms operate within markets, how they respond to changes in market conditions, and how they allocate resources to maximize profit. Topics include demand and supply analysis, production and cost theory, pricing strategies, market structures, and the impact of government policies on business. By integrating concepts from both microeconomics and macroeconomics, students gain a comprehensive understanding of the economic factors that influence managerial choices and business operations in a dynamic environment.
Recommended Textbook
Managerial Economics and Organizational Architecture 5th Edition by James Brickley
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Page 2
Chapter 1: Introduction
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Q1) From Jerome Kerviel's actions in Societe Generale, we realize that in a business organization, managers may turn a blind eye to certain "red flags" from the system if:
A) the managers themselves conduct certain illegal activities.
B) the managers know that at some point these illegal activities will fail.
C) the managers believe the no worker will unnecessarily expose himself or herself.
D) the managers embrace risk taking so long as it benefits the company.
Answer: D
Q2) What are three components of organizational architecture? Which one is most important to the success of the firm?
Answer: The three components are of organizational architecture are the assignment of decision rights, the reward system, and the performance-evaluation system. The success of a firm depends on the successful interaction all three of these components.
Q3) What was the main reason for "liar loans" to proliferate?
Answer: The incentives to mortgage brokers were such that, the more loans they generate, greater is their compensation. Obviously, the mortgage brokers had no incentive to go behind the scenes to check the viability of repayment.
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Chapter 2: Economists View of Behavior
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Q1) Robinson pays $100 for tickets to see his favorite sports team play. With 10 minutes left in the game, his team is losing heavily and has no chance of winning the game. Robinson chooses to stay until the end of game because he wants to get the full value for his admission price. As an economist, you should advise Robinson to:
A) stay until the end of the game since his intuition is correct
B) stay until the end of the game since he might be heckled on the way out
C) leave the game now if his marginal benefit of leaving is greater than marginal cost, since the admission price is a sunk cost
D) leave the game now since the line to exit the stadium is shorter now
Answer: C
Q2) Marginal analysis refers to:
A) points that lie on the budget set
B) costs that were incurred in the past and cannot be recovered, and thus should not affect current decisions
C) comparing the benefits and costs of choosing a little more or a little less of a good D) whatever must be given up to obtain something that is desired
Answer: C
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Page 4
Chapter 3: Markets, Organizations, and the Role of Knowledge
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Q1) Which of the following constitute examples of positive externalities:
A) Your neighbor's garden is always well taken care of.
B) Your neighbor's barbecue smoke coming through your window.
C) Your neighbor always listening to music at an unbearable volume.
D) You allow weeds to grow in your yard
Answer: A
Q2) Assume the market for hammers is perfectly competitive, and the current price is
$15. If, at this price, the quantity of hammers demanded is 15,000, while the quantity supplied is 25,000, then:
A) the market for hammers is in equilibrium.
B) the price of hammers is likely to increase.
C) the price of hammers is likely to decrease.
D) there would be no change in price
Answer: C
Q3) Consumer surplus is:
A) the result of a shortage.
B) the result of a surplus.
C) a measure of the quantity traded by consumers.
D) a measure of the gains from trade to consumers.
Answer: D
Page 5
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Chapter 4: Demand
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Sample Questions
Q1) The shape of a perfectly elastic demand curve is
A) Horizontal, Ed = infinity
B) Horizontal, Ed = 0
C) Horizontal, Ed = -1
D) Vertical, Ed = 0
Q2) Assume the demand function for SeatComfy's table chairs is as given in the previous question (Q = 5,000 - 25P + 4I +10P<sub>A</sub> - 15P<sub>T</sub>). Moreover, assume that currently P = 10, P<sub>A</sub> = 15, I = 500, P<sub>T</sub> = 100. Which of the following is true?
A) If SeatComfy increases its price by 1%, sales will increase as well as total revenues.
B) If SeatComfy decreases its price by 1%, sales will increase, while total revenues will decrease.
C) If SeatComfy increases its price by 1%, sales will decrease, while total revenues will increase.
D) If SeatComfy increases its price by 1%, sales will decrease as well as total revenues.
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Chapter 5: Production and Cost
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Q1) If the generic production function Q=f(K,L) displays increasing returns to scale, the value of K is fixed in the short-run, and the prices of all inputs are held constant, then:
A) the Short-Run Average Cost curve must be strictly decreasing.
B) the Long-Run Average Cost curve must be strictly decreasing .
C) the Short-Run and the Long-Run Average Cost curves will coincide.
D) the Long-Run Average Cost curve must be strictly increasing .
Q2) A firm's average total cost is minimized when it produces 10 units. When it produces 10 units, the average total cost is $5/unit. What is the marginal cost when the firm produces 10 units?
A) less than $5/unit
B) greater than $5/unit
C) $5/unit
D) $10/unit
Q3) The opportunity cost of any business decision is:
A) accounting cost divided by the level of output.
B) cost per unit.
C) the cost of the next best alternative.
D) the cost of doing business in the future.
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Chapter 6: Market Structure
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Q1) A monopoly's demand curve is P = 200 - 3 Q. It MC = $20. How many customers should be serviced by this company? What is the price paid by each customer? What will the company's gross revenue be in this venture?
Q2) While very few markets are 'purely competitive' according to the strict economics definition, market analysts often use competition as the:
A) benchmark from which to judge other market settings.
B) standard of an inefficient market structure.
C) market with poor entry and exit conditions.
D) one market with typical asymmetry in information.
Q3) A monopolist's demand curve is P = 10 - 2 Q. So its MR is
A) 5 - 2 Q
B) 10 - Q
C) 10 - 4 Q
D) 5 - Q
Q4) Explain why OPEC cannot always maintain the high price of oil by restricting production?
Q5) There are four structural components to a perfectly competitive market. Which one of the four is the most important to market operation and why?
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Chapter 7: Pricing With Market Power
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Q1) Price discrimination requires that different customers have different levels of price sensitivity and that:
A) the cost of production is different for every customer.
B) customers cannot resell the product amongst themselves.
C) demand is homogeneous amongst customers.
D) marginal costs are falling.
Q2) For decision making for the firm with market power, fixed costs are:
A) a key element in the markup.
B) irrelevant.
C) the same as marginal costs.
D) opportunity costs of production.
Q3) Calculate the markup price if MC = $10.00 and price elasticity equals 1.7.
A) $5.88
B) $17.24
C) $24.27
D) $32.42
Q4) The simple case of pricing with market power assumes (a) all consumers are charged the same price, (b) the firm sells one product, and (c) demand exists in one time period. Discuss what happens as each assumption is relaxed.
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Chapter 8: Economics of Strategy: Creating and Capturing
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Q1) Setting up of outlet malls in rural highways is an example of:
A) increased consumer transactions cost.
B) increased producer transactions cost.
C) reduced consumer transactions cost.
D) reduced producer transactions cost.
Q2) In terms of business strategy, managers will attempt to adopt business strategies that attempt to:
A) maximize transactions costs.
B) stabilize transactions costs.
C) Minimize transactions costs.
D) Invert transactions costs.
Q3) Economies of scope are said to exist when:
A) one firm produces many products rather than separate firms for each.
B) many firms produce many products rather than one firm producing all.
C) many firms produce a single product rather than one firm.
D) one firm produces multiple products rather than separate firms producing all.
Q4) Many manufacturers attempt to build fairly close relationships with the firms that supply their packaging and boxes. Why?
Page 10
Q5) What is the relation between value creation and transactions cost?
Q6) What are the key components for creating market power in order to capture value?
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Chapter 9: Economics of Strategy: Game Theory
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Q1) Actions like entering a new market, pricing a new product or making a bid to buy another company are all useful Nash-like managerial decisions because they are:
A) repeated often and the outcome depends on the coordination of decisions with rivals.
B) not repeated often and the outcome depends on the coordination of decisions with rivals.
C) repeated often and the outcome depends on the simultaneous decisions of rivals. D) not repeated often and the outcome depends on the simultaneous decisions of rivals.
Q2) Though Nash games are noncooperative, a cooperative outcome is more likely if A) long run gains are smaller than short run gains.
B) firms can easily monitor the outcomes from rival's defection.
C) firms expect the market relationship to last a long time.
D) firms expect the market relationship to last only for a short time.
Q3) What impact does excess capacity play on determining the strategic focus of managers toward competitors?
Q4) What are the key managerial insights derived from game theory? Which one is most important?
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Page 12
Chapter 10: Incentive Conflicts and Contracts
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Q1) Which one of the following is a source of conflict between owners and managers?
A) Managers and owners have a very short time horizon.
B) Managers and owners worry about the entire future cash flows.
C) Managers have very short time horizon; owners worry about the entire future cash flows.
D) Owners have very short time horizon; managers worry about the entire future cash flows.
Q2) While CEO of General Electric, Jack Welch was a very successful corporate manager. He also loaded up his retirement program with numerous unusual benefits such as rented apartments, free airplanes, and numerous club memberships. The owners (stockholders) were generally unaware of these benefits. This conflict between owners and managers involved:
A) choice of effort of Mr. Welch while he was CEO.
B) perquisite taking on the part of Mr. Welch.
C) differential risk exposure between Mr. Welch and the typical stockholder.
D) overinvestment in company offices by Mr. Welch.
Q3) A firm is focal point for a set of contracts. Explain the problems that (1) agency relationships, (2) asymmetric information, and (3) adverse selection can introduce to building a successful contract between two people.
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Page 13
Chapter 11: Organizational Architecture
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Q1) What is corporate culture?
Q2) How is the architecture within firms usually set up?
Q3) One important lesson to keep in mind during benchmarking is:
A) benchmarked firms should be made aware of the said firm's motivation.
B) differences in environments of the benchmarked firms should be taken into account.
C) differences in environments of the benchmarking firm should be taken into account.
D) differences in environments of the benchmarked firms are not important.
Q4) If a manager, who does not own the company, is allowed to make decisions for the company, then:
A) the decisions will usually be good ones.
B) the decisions will always be bad ones.
C) a control system of rewards and evaluation must be set up.
D) the manager usually assumes the same attitudes as the owner.
Q5) For benchmarking, the architecture of other firms should be viewed as:
A) competitive.
B) complements.
C) substitutes.
D) empowerment.
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Chapter 12: Decision Rights: The Level of Empowerment
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Q1) The use of hierarchies is common in the modern corporation:
A) because of the principle of comparative advantage.
B) because of the principle of separation of decision management and decision control. C) to avoid collective action problems.
D) to enhance employee buy-in.
Q2) Which of the following is not a cost of decentralization of corporate decision-making?
A) Incentive problems
B) Coordination costs and failures
C) Less effective use of central information
D) More effective use of local knowledge
Q3) Decentralized decision-making is very controversial in a corporate environment. Central office managers feel like they are losing control of managers in specific plants or regional offices. What are some of the issues that must be reviewed before making the final decision on where to place final decision-making power?
Q4) You are assigned a group project for the class, and you will be graded as a group, and your individual grade will be decided on the group's performance relative to other groups. Will you like this arrangement?
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Page 15
Chapter 13: Decision Rights: Bundling Tasks Into Jobs and Subunits
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Q1) Large MNC's are usually set up as:
A) u-form.
B) m-form.
C) network organization .
D) mixed design.
Q2) Dan Unowsky assigns his computer repairers four tasks: customer service, replacement of broken parts, clean-up of equipment, and sale of used equipment to customers. If the company provides a 10% commission for all sales made by employees, then:
A) employees will clearly emphasize the clean-up task.
B) employees may ignore other tasks when faced with a potential sale.
C) replacement of broken parts will clearly be favored by employees.
D) the entire production process will be speeded up by the sales incentive.
Q3) Some of the activities of Chase Manhattan are organized by product, some by geography and some by customer. So Chase Manhattan has A) u-form
B) m-form
C) network organization
D) mixed design
Q4) What are specialized task assignments and what are their advantages?
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Chapter 14: Attracting and Retaining Qualified Employees
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Q1) When a firm focuses on hiring only for entry-level jobs and it tends to promote from within the firm, then the firm is said to:
A) use the benchmark competitive labor market.
B) have an internal labor market.
C) hire based on human capital.
D) use compensating differentials.
Q2) Draw a graph showing the trade-off between salary and benefits. Show the employee's indifference and the firm's isocost curve. Label the equilibrium salary/benefits combination. Discuss what would happen as individual taxes fall or as firm payroll taxes rise.
Q3) To help with motivation, long-term productivity, and retention, firms with internal labor markets tend to offer all of the following except which of the following?
A) Efficiency wages.
B) Benchmark competitive wages.
C) Pay based on job seniority.
D) Internally based promotion systems.
Q4) What are efficiency wages and why are they important in internal labor markets?
Q5) Explain the effect of self-selection on compensating wage differential.
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Chapter 15: Incentive Compensation
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Q1) Dan Heath is the owner of Plain Truth Advertising. He is attempting to design salary systems for his employees, most of whom are sales agents. To get a good system, he needs to recognize the trade-offs between:
A) benefits and incentives.
B) risk sharing and benefits.
C) benefits and salaries.
D) risk sharing and incentives.
Q2) What is the role of the "informativeness principle" in designing a compensation package for an individual in a corporate environment?
Q3) The DuPont case is a good example of an incentive package gone awry. In review, it placed a portion of employee's pay into an "at-risk pool." If the division had exceeded expectations, the employees would have received a bonus from the pool. How would a "relative performance contract" have saved the DuPont bonus system?
Q4) What are the factors that favor high incentive pay for an employee? Explain which of the five factors is the most important.
Q5) Give a few examples of incentive compensation.
Q6) Why do many firms base incentive pay on group performance?
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Page 18
Chapter 16: Individual Performance Evaluation
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Q1) Make a case for 360-degree performance evaluation based on the informativeness principle. What problems may be encountered from implementation of such a system?
Q2) Objective measures included in an evaluation and incentive system might include:
A) improved quality of communications with subordinates.
B) meeting or exceeding sales goals.
C) reorganizing a department for improved human relations.
D) recognition for finding and solving problems.
Q3) Most organizations provide a standard budget for every department, which must be spent during the fiscal year, usually in mid-May. A department forfeits any unspent amount. Every department's annual allocation depends upon the previous year's allocation. Is this an efficient allocation procedure? Are there more efficient allocation rules?
Q4) Employee performance evaluation is needed because:
A) it justifies the incredibly high wages of the CEOs.
B) it justifies the incredibly high fringe benefits of the CEOs.
C) it puts the employees in their places which is important for success.
D) it determines rewards and sanctions - wages, raises, bonuses, and dismissals.
Q5) Give examples of how government intervention helps reduce moral hazard and adverse selection problems in internal labor markets.
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Chapter 17: Divisional Performance Evaluation
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Q1) What is transfer pricing?
Q2) If a company has two profit centers where one supplies the other with necessary ingredients to a company product, and if the relationship between two centers is clearly inimical to company success, then:
A) it is time to use the market-based transfer price system.
B) it is time to implement a marginal cost based transfer system.
C) the company should change its management control system.
D) the company should probably reorganize.
Q3) The accounting department had a plumbing problem and they called the maintenance department to fix this. After the job was done, the maintenance department sent the accounting department a bill for services rendered. Does this make sense? After all they are all a part of the same company?
Q4) Full-cost transfer pricing creates an incentive for:
A) distribution to be inefficient.
B) distribution to be over-efficient.
C) manufacturing to be over-efficient.
D) manufacturing to be less efficient.
Q5) What are the common transfer pricing methods?
Q6) What are the measures of performance for investment centers? How do they work?
Page 20
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Chapter 18: Corporate Governance
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Q1) The specific structure of a U.S. corporation's charter and bylaws is constrained by:
A) the union's fiduciary responsibilities.
B) preferred stock holders.
C) Securities Exchange Commission regulations.
D) the focal point for a set of contracts.
Q2) A number of hospitals have converted from nonprofit to for-profit status. What are the benefits to this conversion? What impact might conversion to C corporation status have on hospital/community relations?
Q3) Incorporation occurs:
A) initially at state and then at the federal level subject to state approval.
B) initially at federal and then at the state level subject to federal approval.
C) at the federal level only.
D) at the state level only.
Q4) A closely held corporation is one that:
A) has all of its stock trade on the New York Stock Exchange.
B) uses bonds to raise most of its capital.
C) is free of all federal taxes and regulations.
D) is owned by a small group of investors that has limited or no publicly traded stock.
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Page 21
Chapter 19: Vertical Integration and Outsourcing
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Q1) While firms buy many of their inputs through the open market, there is often a desire to produce critical inputs. A common concern in producing an input yourself (internally) is that:
A) the firm will find it too easy to manage quality.
B) the firm will not minimize costs at a high enough level of output.
C) outside competitors will learn about your inputs.
D) your firm will get prompt supply of the input.
Q2) The right of residual use of a specific asset by the owner often argues for:
A) buying in the open market.
B) long-term contracts.
C) internal ownership.
D) risk-sharing purchasing arrangements.
Q3) Why aren't all economic transactions conducted through markets?
Q4) A minor, but important reason, for using non-market transactions is that:
A) it avoids sharing proprietary information with other firms.
B) it makes sure there is proper motivation of production efficiency.
C) buying in the market is just too complicated.
D) all input are available is adequate supply in the market.
Q5) What limits the entire economy from being served by one gigantic firm that produces everything?
Page 22
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Chapter 20: Leadership: Motivating Change Within Organizations
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Q1) Which one of the following is a source of organizational power?
A) Vision setting.
B) Logrolling.
C) Coalition formation.
D) Control of budgets and resources.
Q2) In the 2001-2003 period, US airlines had a difficult time earning a positive net income. Terrorism, war, disease, and a weak economy all combined to reduce both business and tourist travel. In addition, the major airlines faced competition from the cut-rate airlines. Most airlines began a change in organizational architecture. All major airlines are organized by trade unions for pilots, clerks, mechanics, and flight attendants. What major leadership issues need to be addressed as these companies reorganize?
Q3) Three issues related to proposal design are:
A) commitment, distribution and marketing.
B) flexibility, marketing and distribution.
C) flexibility, commitment and marketing.
D) flexibility, commitment and distribution.
Q4) Why are academics way off base when it comes to organizational politics?
Q5) What are the two tasks of good leadership?
Q6) What are the three issues related to proposal design?
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Chapter 21: Understanding the Business Environment: The Economics of Regulation
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Q1) Many people believe that the supply and demand for regulation will result in the most powerful coalition group controlling the regulatory body. That powerful group is often made up of the companies that are supposed to be regulated. This theory is called:
A) the capture theory.
B) adverse selection theory.
C) the law of demand.
D) market failure theory.
Q2) If property rights are enforced and contracts in trade are legally respected, it is usually assumed that:
A) output will begin to fall.
B) investment will be encouraged.
C) transactions costs will rise.
D) government is unnecessary.
Q3) Explain how Coase's theorem is implemented by the EPA.
Q4) Draw a profit/price tradeoff curve that results from moving from a competitive to a monopoly industry organization. Show the equilibrium position for the regulator with a political support function (PS curve). What can we say about prices and profits of the regulated industry if it started as a monopoly?
Page 24
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Chapter 22: Ethics and Organizational Architecture
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Q1) The text notes that many firms that use animals in production or advertising adopt the animal treatment standards of the American Society for Prevention of Cruelty to Animals. Why do companies adopt a professional group's standard of behavior?
Q2) Ralph Nader has long argued that large corporations in oligopolistic markets should use their vast productive powers to redress social ills. Implementing this policy may put the company:
A) in conflict with the government.
B) in conflict with its trade unions.
C) in conflict with the process of wealth maximization.
D) on a list of companies disliked by religious groups.
Q3) Economist Adam Smith noted that in trade, different ethical standards seem to prevail in different situations. In a market environment where customers will never be seen again, there is a tendency towards:
A) market inefficiency.
B) sellers cheating on price or quality.
C) supply to not equal demand.
D) increased honesty in transactions.
Q4) What are some mechanisms for encouraging ethical behavior?
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Chapter 23: Organizational Architecture and the Process of Management Innovation
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Q1) Evidence suggests that, "many business may waste millions of dollars a year on quality-improvement strategies that don't improve their performance and may even hamper it". Based on this, evaluate the practice of management innovation within an architecture critically.
Q2) ABC:
A) has been very successful in recent years and is adopted widely.
B) has been very successful in recent years but is not adopted widely.
C) has been very unsuccessful but is still adopted because of legal requirements. D) has been very unsuccessful and has been replaced with traditional methods.
Q3) Of the three components of a good organizational architecture, what management technique - popular during the 1990s - seems to use all three?
A) Benchmarking.
B) TQM.
C) Economic Value Added.
D) Just-In-Time Production and Inventory Control.
Q4) What changes in the marketplace and in technology have spurred the movement toward TQM-like architecture changes in modern corporations?
Q5) Provide some examples of management innovations that came and went.
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