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Managerial Economics:
Practice quiz (with answers)
Satisfy your curiosity -- how would YOU score on this True/False
test covering basic concepts of managerial economics?
Note: if you wish to score yourself on this test,
make your
choice before you peek at the answer that follows each question!
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"Economic costs" include the
concept of "opportunity costs."
True.
This is the key difference between "accounting costs" and
"economic costs."
-
When you are earning an "accounting
profit" you are always earning an "economic profit."
False.
Accounting profit will be computed using applicable profit-and-loss rules
for the firm, which will not include "opportunity costs."
-
If you increase revenues, you always
increase profits.
False. Profits may
decrease due to production inefficiencies or diseconomies of scale.
-
In Managerial Economics, NPV stands for
"Negative Preliminary Valence."
False.
NPV stands for Net Present Value.
-
A business decision is profitable if it
makes costs increase more than revenues.
False.
This can happen, but the decision is not profitable.
-
A business decision is profitable if it
makes one cost decrease, but another cost increases a greater amount.
False.
This phenomenon is known as "false economy."
-
Payment of $1000 today has exactly the same
NPV as the promise to pay $1000 a year from now.
False.
Cash in hand today is worth more, because you can earn interest on it
immediately.
-
Moving a cash flow further off into the
future tends to make its NPV less.
True. A
promise to pay $1,000 ten years from now has less present value than a
promise to pay $1,000 five years from now.
-
Increasing the discount rate tends to make a
future cash flow’s NPV less.
True.
$1,000 promised five years from now at a 10% discount rate has less present
value than $1,000 promised five years from now at a 2% discount rate.
-
Hired managers are sometimes called
"agents" of the firm.
True.
Persons who are authorized to act on behalf of the firm and its owners are
called agents.
-
Hired managers may have different motives
than the owners.
True. Hired managers may
put their own compensation or tenure above the best interests of the owners.
-
The costs to place checks and balances on
the behavior of agents are called "constabulatory" costs.
False.
These costs are called "agency" costs.
-
"Stockholders" and
"stakeholders" are exactly the same thing.
False.
"Stockholders" risk their capital through equity investment in the
firm. They are "residual claimants" of profits and are owed
"fiduciary responsibility" by the agents of the firm.
"Stakeholders" is a popular term used to mean suppliers,
customers, employees, lenders, and governmental units. These other
entities have contractual or legal claims on the firm which come ahead
of the "residual claimants," the stockholders.
-
In case of bankruptcy or liquidation, the
common stockholders have first claim on the assets of the firm, ahead of the
employee payroll, the IRS, bondholders, and financial lenders.
False.
The common stockholders are last, and may receive nothing whatsoever in the
situation described.
-
The banks, bondholders, and the IRS are the
"residual claimants" who are LAST in line to be paid.
False.
In a bankruptcy or liquidation, these parties are ahead of the common
stockholders.
-
The "stockholders" usually have a
contractual, risk-free guarantee of profit and dividend levels, while the
other "stakeholders" accept a higher level of relative risk.
False.
-
For any given time period, the
"accounting profit" will always be exactly the same number as the
"cash flow."
False.
"Accounting profit" recognizes many non-cash items including
depreciation, accruals, capital assets, inventory assets, payables, and
receivables, which can cause the "P&L profit" to differ from
the cash flow in any given reporting period.
-
The five classic "competitive
forces" to a firm are the threat of new entrants, the threat of
substitute products, the bargaining power of buyers, the bargaining power of
suppliers, and the rivalry among current competitors.
True.
These are the five classic forces.
-
Goals for a Not-For-Profit organization
might include maximizing benefits at a given cost.
True.
This is illustrated by an organization that tries to provide the most
service on a fixed budget.
-
Marginal analysis involves comparing
marginal benefits (such as revenues) to marginal costs.
True.
This is a description of marginal analysis, also called "incremental
analysis."
-
Risk is never a consideration in investment
decisions.
False. The level of risk is
always relevant, and is often estimated and recognized explicitly.
-
If the probabilities of a cash flow are $300
=10%, $500 = 80%, and $700 = 10%, then the expected-value cash flow is
$1500.
False.
$300 x 10% = $30;
$500
x 80% = $400;
$700 x 10% = $70,
so the expected value is $30 + $400 +
$70 which equals an expected value of $500.
-
The standard deviation is a statistical
measure of the dispersion of a variable about the mean.
True.
This is one description of the standard deviation.
-
All else equal, a smaller standard deviation
means more variation about the mean.
False.
All else equal, a smaller standard deviation means less variation about the
mean.
-
Plus and minus two standard deviations cover
roughly 95% of the area under the normal bell curve.
True.
-
The coefficient of variation is the ratio of
the standard deviation to the expected value. It is a relative measure of
variability.
True. To calculate the
coefficient of variation, divide the standard deviation by the mean.
-
If the expected value is $1,000,000 and one
standard deviation is $200,000 the coefficient of variation is 0.50.
False.
The value could be expressed as 0.20 or 20%.
-
The relationship between risk and return can
be defined as: Required return = Risk-free return + Risk premium.
True.
It is useful to compare risk-bearing investments to the return available
from investments that are for all practical purposes risk-free, such as
government bonds.
-
All else equal, investors expect a
higher-risk investment to provide a lower return.
False.
The reverse is true. Investors expect a higher probable return in
exchange for greater risk.
-
If a firm’s marginal profit decreases at
higher unit volumes, to maximize its total dollars of profit, the firm should
limit its volume to the point of highest marginal profit per unit.
False.
To maximize total dollars of profit for a calendar period, the increased
volume should be supplied up to the point where marginal costs equal
marginal revenues.
Note that this maximizes total dollars, NOT
percentages.
-
A demand schedule lists the prices and
corresponding quantities of a commodity, as would be demanded by some
individual or group of individuals at those prices.
True.
A demand schedule is a table or spreadsheet showing how unit volumes
correspond to various prices.
-
Consumer choice theory assumes that rational
individuals seek to maximize the satisfaction gained from their consumption
or expenditure decisions.
True.
-
Satisfaction may also be called
"utility."
True.
-
Marginal utility is the change in
satisfaction per unit change in consumption of a good, holding constant the
quantity of other goods.
True. This is a
definition of "marginal utility," which may also be thought of as
"incremental utility."
-
A person who is hungry when he eats his
first slice of pizza is likely to experience the same marginal utility from
eating his tenth slice later that same meal.
False.
This is an illustration of how marginal utility tends to decrease as more
and more units are consumed. Note that marginal utility can
become negative!
-
"Income effect" is illustrated by
the fact that a decrease in the price of a good has the effect of increasing
the income of a consumer of that good.
True. If a consumer saves $200 per month on mortgage interest, this
has the effect of a $200 per month increase in income.
-
The "income effect" may be
relatively insignificant if a good represents a very small portion of a
consumer’s expenditures.
True. If a consumer saves two dollars a month on apples, this effect
of increased income is probably not measurable.
-
The "substitution effect" refers
to the fact that a consumer can increase his or her utility by purchasing
more of the good whose price has declined and less of other goods.
True. In case of a drop in the price of chicken, the consumer
might purchase more chicken but less hamburger.
-
The "demand curve" shows
graphically the relationship between units demanded and various prices.
True. The prices are usually on the vertical axis, and the
quantities-demanded on the horizontal axis.
-
The market demand curve is the square root
of the squares of all of the individual demand curves.
False. The market demand curve is simply the sum of the individual
demand curves.
-
Durable goods yield benefits to their owners
over a number of future time periods.
True. This distinguishes "durable goods" from
"consumables."
-
The demand for original equipment automobile
tires is a "derived demand" from the demand for new automobiles.
True. The demanded quantity of cars drives the demanded quantity of
OEM tires.
-
"Price elasticity" refers to the
ratio of the percentage change in quantity demanded to the percentage change
in price, ceteris paribus.
True. If a price change of 5% causes a demand change of 5%, then the
price elasticity of demand is 1.
-
The phrase "ceteris paribus"
is Latin for "time flies."
False. This is the Latin phrase for the economist's assumption of
"all else the same."
-
Marginal revenue is the change in total
revenue that results from a one-unit change in quantity demanded.
True. "Marginal revenue" and "incremental revenue"
are both so defined.
-
Raising the unit price will always result in
higher total revenue.
False. If the price elasticity of demand were high (greater than 1),
raising the price would decrease the total revenue.
-
Raising the unit price may sometimes result
in lower total revenue.
True. This would happen if the price elasticity of demand were high
(for instance, if a 5% price increase caused a 10% decrease in demand).
-
Lowering the unit price will always result
in lower total revenue.
False. If the price elasticity of demand were high (greater than 1),
lowering the price would increase the total revenue.
-
Lowering the unit price may sometimes result
in higher total revenue.
True. This would happen if the price elasticity of demand were high
(for instance, if a 5% price decrease caused a 10% increase in demand).
-
Paying sales commissions only on gross
revenue, will always focus the sales force on maximizing net profit.
False. Sales commissions on gross revenue may focus the sales force on
gross revenue with little regard to price, cost, or profit.
-
The price elasticity of demand tends to be
higher for durable goods, high-priced goods, and goods that represent a high
percentage of the purchaser’s budget.
True. Apparently these items attract purchasers' attention and time, as well as motivating comparison
shopping.
-
All else equal, price elasticity of demand
tends to be higher in the long run than in the short run, because in the
long run there are more opportunities for substitution.
True. When confronted by a sudden price increase, it may take buyers
some time to find substitutes.
-
Cross elasticity refers to the ratio of the
percentage change in the quantity demanded of good A to the percentage
change in the price of good B.
True. If a 10% price rise on bananas were to cause a 10% sales
increase for apples (due to substitution), the cross-elasticity would be 1.
-
Beef and pork tend to be substitutes, but
batteries and battery-operated toys tend to be compliments.
True. "Compliments" are items whose demand quantities tend
to go together, such as batteries and the toys that need them.
-
Changes in price cause movements along the
price-demand curve, but changes in the number of producers or consumers
would tend to move the curve itself.
True. Price changes result in different price/demand point locations
along the curve. Effects from any other changes move the curve itself.
When the total revenue curve is drawn
from the point of zero price (at maximum volume), to the point of zero
volume (at maximum price), total revenue reaches its maximum somewhere in
between.
True. At zero demand resulting from maximum price, revenue is zero ( 0
x P = 0).
At maximum demand resulting from zero price, revenue is also zero (D x 0 =
0).
Therefore, revenue must be greatest somewhere between the two
extremes.
To maximize net profit, make every decision
to maximize immediate gross unit volume.
False. An obvious bad combination would be to maximize promotion
and/or minimize price when production is already near short-term
capacity.
This would raise sales costs, create expensive "crisis" conditions
in production, and forfeit profit.
A farmer selling his grain into the
commodity market faces a high price elasticity of demand.
True. The elasticity is so high, it appears infinite: At a penny
above the commodity price, the farmer can't sell anything. At a penny
below the commodity price, the farmer can sell unlimited quantities.
The only tow-truck in the county, rescuing a
family at 2 AM on a remote country road, faces a relatively low
price-elasticity of demand.
True. The demand is very inelastic. Whether the quoted price is
20% higher or 20% lower, the family still wants exactly one rescue
performed.
If your product has a high profit margin,
and a high advertising elasticity of demand, you should do little or no
advertising.
False. High profit margins and high responsiveness to advertising
means you should do a lot of advertising.
"Higher elasticity" regarding
price, advertising, or any other factor means that the demand is more
responsive, and more likely to change, with regard to that factor.
True. It is useful to think "highly responsive" when you
hear "highly elastic."
If two variables are highly correlated, it
means that one is definitely the cause of the other; correlation always
proves causation.
False. If A and B correlate highly, A might have caused B, B might
have caused A, there may exist a common cause C for both A and B, or it may
be a coincidence! In and of itself, "correlation does not prove
causation!"
A key strength of consumer surveys is that
consumers will recall and communicate their purchases and preferences with a
high degree of reliability and accuracy.
False. Imperfect recall and less-than candid responses are weaknesses
of consumer surveys. Consumers often cannot recall dates, times,
quantities, prices, and brands of purchases.
Consumers regard some purchases as intimate, embarrassing, or private, and
will not truthfully list them.
As an illustration, imagine a consumer keeping a logbook of
TV-viewing. Will he always note that he started watching
"Masterpiece Theater," but switched to "The Cartoon
Channel?"
If a consumer knows he or she is being
observed in a "consumer clinic" buying situation, the consumer may
consciously or unconsciously alter his or her behavior.
True. If a consumer knows he or she is being watched, he or she may
shop more carefully or buy different items.
If a mattress company deeply discounted its
mattresses to see how consumers responded, this would illustrate direct
market experimentation.
True. This is an illustration of conducting a "live"
experiment in the marketplace.
"Econometrics" does not use any
statistical techniques.
False. "Econometrics" relies heavily on statistical tools.
If a scatter plot shows a tight pattern of
dots that are almost on a straight 45-degree line, it suggests that the data
will have a high correlation coefficient.
True. Tight linear scatters are associated with high correlation
coefficients, while random-looking scatters are associated with low
coefficients.
Sources of data for econometric analysis
include the government, industry trade associations, and banking
institutions.
True.
The usual premise is that the dependent
variable is responding to changes in the independent variable, rather than
vice-versa.
True. The premise is that the dependent variable "depends
on," or is caused by, the independent variable.
If X predicts Y quite well between values of
50 and 200, you may assume the same relationship holds true at values of
500, 1000, or 1500, even though you have no data in that range.
False. This
practice is called "extrapolating beyond the range of data," and
is risky. A relationship may not be linear, or may not even hold true
when you go beyond the range.
To illustrate: eggs
hatch slightly sooner if they are incubated slightly warmer -- but that
doesn't mean you can hatch an egg quickly by using a blow torch!
The "null hypothesis" is the
premise that there is no difference. You "reject the null
hypothesis" by obtaining sufficient evidence that there is a
difference.
True. For many statistical tests, you attempt to "disprove"
the null hypothesis at some level of confidence (level of probability).
The "null hypothesis" may be
compared to the concept "innocent until proven guilty," in that
the accused person is hypothesized to be no different than an innocent
person unless evidence shows otherwise.
True. This is a valid metaphor.
In a time-series of consumer storable goods
purchases, if a pattern occurs showing overbuying and underbuying on
alternate time periods, this would illustrate autocorrelation.
True. Autocorrelation occurs when data points have predictive power
within their own data set. The high and low purchases would tend
to predict compensating values to follow.
We use forecasts in our everyday lives, and
some forecasts may be quite simple and informal.
True. Logic such as "Fifty people came to the picnic last year,
so let's plan for about fifty people this year," constitutes a
rudimentary forecast.
In business situations, you should use the
most expensive and complex forecasting in every case.
False. You should use the most cost-effective tool that suits the
purpose.
Names of forecasting techniques may include
the words time-series, smoothing, barometric, survey and opinion-polling,
econometric models, input-output analysis, and vector autoregression
(VAR).
True. These all name forecasting techniques.
Secular trends are long-run changes of
growth or decline.
True. This is a definition of "secular trend."
Cyclical variations are minor expansions and
contractions of less than a year in duration.
False. Cyclical variations occur over time periods greater than
a year.
Seasonal effects are major variations that
only occur over time periods greater than a year.
False. Seasonal variations occur within a year, hence the name.
To forecast the future, it is best to work
exclusively with lagging indicators.
False. Since lagging indicators occur after your data of
interest, you would be better off with leading indicators.
After collecting data pertaining to 15
months, you have enough numbers to project trends using a 3-year moving
average.
False. To calculate your first 3-year moving average point, you need 3
years of data.
Exponential smoothing is generally used to
put more weight on data from the more recent periods.
True.
There are no known techniques for
quantifying forecast error.
False. Forecast error can be readily quantified.
The mathematical or theoretical
sophistication of a forecast is more important than its ability to generate
cost-effective estimates for users.
False.
Higher barriers to entry make it easier for
new competitors to start up.
False. Higher barriers make it more difficult for new competitors to
enter.
Requirements for costly capital equipment
illustrate one kind of barrier to entry.
True.
The market concentration ratio is the total
percentage share of the top 700 firms in a given market.
False. This statistic is computed for the market share of a fairly
small number of firms, such as four or ten, with the number of firms stated.
Motor vehicle manufacturing has a very low
concentration ratio.
False. The top four firms in the U.S. have a significant combined
market share.
The Sherman Act was the United States' first
national antitrust law.
True.
The Clayton Act defines, details, and
enumerates dozens of specific anti-competitive behaviors.
False. The Clayton Act does not attempt such a listing. Rather,
it lists just a few broad types of anti-competitive behavior.
The creation of the FTC was a significant
aspect of the 1914 acts.
True. The newly-created FTC served as a mechanism for enforcement
which was previously lacking.
The Robinson-Patman Act of 1936 was
primarily about non-pricing issues.
False. The act was about anti-competitive pricing behavior.
Most antitrust cases are settled with
consent decrees.
True.
The Sherman Act legalized collusion in most
industries.
False. The Sherman act was clearly against collusion.
Considerable deregulation of trucking,
railroads, and airlines occurred between 1976 and 1980.
True. This four-year period saw landmark deregulation in all these
forms of transportation.
Licenses and patents are two examples of
government-sponsored restrictions on competition.
True. Although these items decrease competition, their other benefits
to society are believed to outweigh any disadvantages.
Under some circumstances it is legal for a
manufacturer to refuse to deal with a retailer.
True. A manufacturer can establish and enforce certain requirements
and conditions of trade within the applicable laws.
Import quotas tend to lead to lower prices
for the affected goods.
False. Items subject to quotas tend to go up in price due to the
artificial shortage.
A capital expenditure is a cash outlay
expected to generate a flow of future cash benefits over a period of less
than one year.
False. The generally accepted time period is greater than one year.
Capital expenditure projects are strictly,
and only, cost reduction projects.
False. For instance, capital expenditure projects may be implemented
for capacity expansion, maintenance of production capability, research and
development, or as part of the roll-out of a new product.
Investment alternatives should only be
considered on a pre-tax basis.
False. Taxes are a cash expense, so the cash-flow analysis of
investment alternatives should show the after-tax effects.
Sunk costs should be a primary consideration
when deciding whether to continue a project.
False. "Sunk costs" (cash payments which are already
expended and are non-recoverable) should not figure into future
decisions. Only consider the marginal cost of action choices and the
marginal benefits of those actions.
The IRR is a percentage (the discount rate)
that equates the present value of the project net cash flows with the
project's net investment.
True. IRR stands for "Internal Rate of Return" and it
expresses the value of expected investment results as a percentage.
The NPV is the present value of all positive
and negative cash flows of a project, discounted at the rate of return.
True. NPV stands for Net Present Value, and it expresses the value of
expected investment results as a lump sum.
Choosing among mutually exclusive projects,
the IRR method and the NPV method will always tell you to choose the same
project.
False. These two methods do not always express the same preference.
If project A has an IRR of 10%, and project
B has an IRR of 20%, you know with certainty that project B will definitely
deliver more total dollars of benefit than project A.
False. Project A may be a larger-scale project than B, so it may have
a larger net present value than the higher-percentage B.
If project C has an NPV of $500,000 and
project D has an NPV of $600,000 you know with certainty that project D will
deliver a higher percentage rate of return than project C.
False. Project C may be a smaller project but might have a higher
percentage return than project D.
The cost of capital is the cost of funds
that are supplied to the firm.
True.
Firms can raise equity capital internally
though retained earnings, and externally through the sale of new common
stock.
True.
The Capital Asset Pricing Model theory
involves identifying a level for a risk-free return, plus a premium, which
compensates the investor for bearing risk.
True. CAPM looks at a comparative risk-free return, such as the
interest on government securities, and adds additional return for additional
risk.
When evaluating a series of capital
projects, experts recommend matching the project costs with the cost of the
incremental capital that must be raised to fund that particular project.
True. It is misleading to qualify a string of projects with an average
cost of capital, if the true cost of capital varies as more money is
borrowed.
Cost-benefit analysis is a method for
assessing the desirability of projects.
True. This is the comparison of marginal costs with marginal benefits.
Cost-benefit analysis may involve attempts
to quantify benefits to society in money terms.
True. For instance, an attempt may be made to express the value to
society of less-polluted air and water, and to compare this value to the
cost of pollution control efforts.
Constraints on public cost-benefit solutions
may include social and religious issues.
True. Solutions must exist within socio-religious reality. The
United States' experiment of banning alcohol, "Prohibition," is
commonly cited as an ill-fated attempt to legislate public benefit against
social norms.
The "social discount rate" is the
discount-rate percentage used to compute the Net Present Value or evaluate
the Internal Rate of Return for projects that benefit society.
True. To evaluate public projects using these tools, a value must be
put on the cost of the public's money.
A significantly higher "social discount
rate" would tend to make the evaluation of a public-works project less
favorable.
True. A higher percentage has the same effect as it does when
evaluating private projects.
At a "social discount rate" of 4%,
a public-works project would appear more favorably in an evaluation than if
the "social discount rate" were 20%.
True. At an assumed 4% cost of money, a public-works project would
appear justified with smaller annual public benefits. At a 20% assumed
cost of money, the public benefits would have to be much larger to justify
the project.
Various experts do not agree on a method to
choose a "social discount rate."
True. How to set such a number has been long been debated, with no
clear winner.
Cost-effectiveness analysis is identical to
cost-benefit analysis.
False. Cost-effectiveness considers the economic costs of reaching an
objective, while cost-benefit puts a value on the objective, as well.
Cost-effectiveness analysis can be performed
without quantifying the value of the objective.
True. The objective is taken as a given, and the efficiency of
reaching that objective is the issue.
Constant-cost studies seek the maximum
output at a defined level of funding.
True. "With a budget of X, how much good can we do?"
Least-cost studies seek the lowest cost to
achieve a defined quantity of output.
True. "To accomplish Y, how little can we spend?"
Objective-level studies attempt to quantify
the costs of achieving several alternative, specified performance levels.
True. "What would it cost to reduce auto pollution 25%, 50%, or
75%?"
Cost-effectiveness analysis may be more
appropriate than cost-benefit when the need for the benefit has already been
decided, or is very impractical to quantify.
True.
An oligopoly occurs when there are a large
number of firms creating nearly-perfect competition.
False. An oligopoly involves a relatively small number of firms in a
complex form of competition in which each firm may speculate on the behavior
and interactions of their competitors in the market.
"Game Theory" has been used in an
attempt to model oligopolistic competition.
True. Because firms in oligopolistic competition
attempt to outguess and outwit each other, this form of competition is much
more difficult to model. Some attempts to do this have used various
"game theories."
A monopolist can change the price of the
good or service, and observe for an effect on the demand.
True. Since a monopolist is serving all demand, the monopolist can set
various prices and see what happens to the demand. In contrast, a
small producer in near-perfect competition cannot sell above market price.
A small producer in an environment of
perfect competition is a "price taker" because demand appears to
be perfectly price-elastic.
True. Like the farmer selling grain, no demand exists above market
price, and unlimited demand exists just below.
In manufacturing operations, increased
volume will always produce decreased unit costs.
False. Serious inefficiencies can result from attempting to run above
short-term capacity, and diseconomies of scale may occur if certain types of
facilities are built excessively large.
When firms become larger, they always become
more efficient and result in reduced unit costs.
False. Bureaucratic complexity, unfavorable social conditions, and
uneconomical layers of monitoring and control expense tend to plague certain
types of operations if they are built larger than an optimal size.
A company may not be able to change its
"fixed costs" in the short run, but in the long run "fixed
costs" can be scaled up or down.
True. In the long run, "fixed" costs can be varied!
"Beef and hides" are an example of
joint products in fixed proportions.
True.
Much U.S. industry is best classified as
oligopolistic in structure.
True.
A simple example of differential pricing is
peak-demand pricing at hotels, car-companies, and airlines.
True. This method collects more money from those buyers who are
willing and able to pay more, without losing the business of those persons
who will only buy at a lower price.
Transfer-pricing might be used by firms to
manipulate taxes.
True. By manipulating the prices charged among international business
units, the profit and value-added can be attributed to the location with the
lowest total tax rate. Governments attempt to catch firms doing this,
but are not always successful.
If a farmer refuses annual opportunities to
sell a parcel of land for $10,000,000 and instead farms the land for a
$5,000 yearly "accounting profit," you can assume that the
"economic profit" is also $5,000. (In this fictional case,
the land price is not going up.)
False. Remember that the "economic profit" includes
consideration of the "opportunity cost." The opportunity
cost of not taking the immediate $10,000,000 is higher than $5,000
per year, so you cannot assume the farmer is making any economic
profit.
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