Chapter 2: Formal Institutions: Economic, Political and Legal Systems
TRUE/FALSE
1. South Africa represents 10% of Africa’s population and 45% of the continent’s gross domestic product
(GDP).
2. Doing business in South Africa had always been risky.
3. “Black Economic Empowerment” represents an important set of formal and informal institutions for
businesses in South Africa.
4. Institutional economics is a new line of work created in the USA in the 1970s and 1980s without
historical parallel in Europe.
5. Formal and informal policies are popularly known as “the rules of the game.”
6. Cognitive pillar is the mechanism through which norms influence individual and firm behavior.
7. Cognitive pillar is the coercive power of governments.
8. In South Africa, domestic and foreign firms failing to meet BEE (Black Economic Empowerment)
targets have to pay fines and are disqualified from government contracts.
9. Informal institutions include laws, regulations, and rules.
10. An important source of transaction cost is opportunism, defined as self-interest seeking with guile.
11. The potential for opportunism increases transaction costs.
12. Institutional transitions in countries such as China, Poland, India, Russia, and South Africa create both
huge challenges and tremendous opportunities for domestic and international firms.
13. Uncertainty surrounding economic transactions can lead to transaction costs, which are the costs
associated with economic transactions or, more broadly, the costs of doing business.
14. Managers and firms rationally pursue their interests and make choices within the formal and informal
constraints in a given institutional framework.
15. Institutions are a means to reduce the potential for opportunistic behaviour.
16. Informal institutions are only of concern in emerging economies.
17. A democracy is a country with an elected president.
18. Democracy was pioneered in Athens in ancient Greece.
19. The “invisible hand” of market forces noted by Adam Smith in the Wealth of Nations in 1776
characterizes a pure market economy.
20. The economic system of most countries in Europe is a market economy.
21. South Africa, South Korea, Taiwan, and many Latin American countries had totalitarianism regimes at
some stage in the 20th century.
22. Command economy is an economy that is characterized by “invisible hand” of market forces.
23. Civil law is derived from Roman law and the law introduced by Napoleon in France.
24. Napoleon Bonaparte has contributed to the most important legal text in the common law tradition.
25. Copyright is a form of property right.
26. Intellectual property rights (IPRs) include rights associated with patents, trademarks, and copyrights.
27. Patents are exclusive rights of firms to use specific names and brands.
28. Intellectual property rights are enforced though the informal institution system.
29. Norway has one of the highest per capita gross national incomes in the world.
30. Douglass North argued that throughout history institutional development is been an important
contributor to economic growth.
31. Political risk is important only when investing in totalitarian states.
32. Managers considering working abroad should have a thorough understanding of the formal institutions
before entering a country.
MULTIPLE CHOICE
1. An institutional framework is made up of:
a. Regulatory and cognitive pillars
b. The political, economic, and legal systems of countries
c. Formal and informal institutions
d. None of these answers
2. ________ refers to the internalized, taken for granted values and beliefs that guide individual and firm
behavior.
a. Cognitive pillar c. Regulatory pillar
b. Normative pillar d. None of these answers
3. ________ refers to the coercive power of governments.
a. Cognitive pillar c. Normative pillar
b. Regulatory pillar d. None of these answers
4. Which are the pillars of the institutional framework as described by sociologist Richard Scott?
a. Cognitive, normative, and legal c. Cognitive, legal, and regulatory
b. Legal, normative, and regulatory d. Cognitive, normative, and regulatory
5. Economic historian Douglas North distinguished which two types of institutions?
a. Formal and informal c. Cognitive and incognito
b. Regulatory and non-regulatory d. Valuable and invaluable
6. Which of the following is NOT an example of formal institutions?
a. Laws c. Rules
b. Regulations d. Ethics
7. Which of the following is NOT an example of informal institutions?
a. Culture c. Norms
b. Ethics d. Laws
8. Which of the following is an example of informal institutions?
a. Laws c. Culture
b. Rules d. Regulations
9. ________ is defined as “the act of seeking self-interest with guile.”
a. Opportunism c. Regulation
b. Formal transaction d. Informal transaction
10. The key role of institutions is to:
a. Increase opportunism c. Reduce uncertainty
b. Increase transaction costs d. Increase uncertainty
11. The institution-based view of international business focuses on the dynamic interaction among:
a. Institutions c. Firms
b. Firm behaviours d. All of these answers
12. Democracy is defined as a(n) ________ in which citizens elect representatives to govern the country
on their behalf.
a. Legal system c. Emerging economy
b. Economic system d. Political system
13. ________ had been embraced throughout Central and Eastern Europe and the former Soviet Union
until the late 80s.
a. Tribal totalitarianism c. Communist totalitarianism
b. Right-wing totalitarianism d. Theocratic totalitarianism
14. Political risk is associated with political changes that may negatively impact domestic and foreign
firms. Which statement about political risk is correct?
a. Political risk is a myth.
b. Political risk only exists in communist countries.
c. Firms operating in democracies never confront political risk.
d. Firms operating in democracies are subject to political risk.
15. Which of the following statements about democracy is false?
a. In a democracy, the government is answerable to its citizen
b. Democracy is a precondition for a market economy
c. In a democracy, important laws are approved by elected parliaments
d. In Europe, almost all countries are democracies
16. Direct democracy, where citizens vote for certain laws, is used in:
a. Finland c. France
b. Russia d. Switzerland
17. Which of the following countries does not use a first-past-the-post election system?
a. France c. UK
b. India d. Germany
18. Which of the following countries uses a direct election to elect its president?
a. Spain c. Russia
b. Germany d. UK
19. Which of the following countries is generally considered a liberal market economy?
a. Russia c. UK
b. Sweden d. Germany
20. Which of the following countries is generally not considered a coordinated market economy?
a. France c. Sweden
b. Italy d. None of these countries
21. Quebec province in Canada, the state Louisiana in the USA, and Scotland share which peculiarity of
the legal framework?
a. The law combines traditions of both common and civil law
b. The law directly regulated by the United Nations
c. The law is grounded directly in the protestant work ethic
d. The law is directly derived from the Code Napoleon of 1804
22. Which of the following countries does not have a civil law system?
a. Austria c. Ireland
b. Japan d. Spain
23. Which statement about legal systems is not correct?
a. Napoleon Bonaparte himself was involved in the writing of the French civil law code published
first in 1804.
b. Civil law is grounded in the traditions of Roman law.
c. The American declaration of independence of 1776 has greatly influenced the development of civil
law.
d. In civil law, the legal rules are codified in a book of law that may be amended from time to time
by parliament.
24. “Legal certainty” describes a situation where:
a. Businesses have face great clarity over the relevant rules that apply in a given situation
b. The courts are incorruptible
c. The outcome of a court case is not predictable
d. All of these answers
25. The legal rights to use an economic property and to derive income and benefits from it are known as:
a. Intellectual property rights c. Property rights
b. Contract d. None of these answers
26. Civil law can be best described by which of the following statements?
a. It is based on religious beliefs.
b. English in origin and shaped by precedents and traditions from previous judicial decisions.
c. Has more flexibility because judges have to resolve specific disputes based on their interpretation
of the law.
d. It is the oldest, most influential, and most widely distributed law around the world.
27. More than 80 countries practice ________ and uses comprehensive statues and codes as primary
means to form legal judgments.
a. Theocratic law c. Civil law
b. Social democracy d. Common law
28. Jewish and Islamic law are examples of:
a. Theocratic law c. Civil law
b. Common law d. Quasi-democracy
29. Civil law was derived from:
a. Celtic law c. Greek law
b. Roman law d. None of these answers
30. ________ are a form of ownership of intellectual property.
a. Trademarks c. Patents
b. Copyrights d. All of these answers
31. Intellectual property rights primarily include rights associated with:
a. Patents c. Trademarks
b. Copyrights d. All of these answers
32. ________ are exclusive legal rights of firms to use specific names, brands, and designs to differentiate
their products from others.
a. Patents c. Copyrights
b. Intellectual property rights d. Trademarks
33. ________ are exclusive legal rights of authors and publishers to publish and disseminate their work.
a. Intellectual property rights c. Trademarks
b. Patents d. Copyrights
34. Intellectual property specifically refers to ________property that is the result of intellectual activity.
a. Home c. Tangible
b. Land d. Intangible
35. A pure market economy characterized by the “invisible hand” of market forces has been noted by:
a. Aristotle c. John Stuart Mill
b. Amatya Zen d. Adam Smith
36. ________ is characterized by the “invisible hand” of market.
a. A pure command economy c. A mixed economy
b. A pure market economy d. A realistic economy
37. The government taking a “hands-off approach” is known as:
a. Command economy c. Laissez faire
b. Mixed economy d. Liberal approach
38. A pure command economy is:
a. Characterized by a government that only performs functions the private sector cannot perform
b. Characterized by the “invisible hand” of market forces
c. Defined by a government taking the “commanding height” in the economy
d. Characterized by innovation and entrepreneurial activities
39. The highest per capita income country is:
a. Norway c. Japan
b. Denmark d. USA
40. The “division of labor” thesis was first advanced by:
a. Douglass North c. Max Weber
b. Adam Smith d. Francis Fukuyama
41. Moral hazard is recklessness when organizations:
a. Are privately owned
b. Do not have to face full consequences of their actions
c. Are state owned
d. Have to face full consequences of their actions
42. The world’s largest democracy is:
a. United States c. China
b. India d. Western Europe
43. A core value of the Washington Consensus is the unquestioned belief in the superiority of ________
ownership over ________ ownership.
a. Dispersed……Concentrated c. State…..Private
b. Concentrated…..Dispersed d. Private…..State
44. According to institution-based view, in situations where ________ constraints are unclear or fail,
________ constraints will play a larger role in reducing uncertainty and providing constancy to
managers and firms.
a. Informal…..Formal c. Cultural…..Regulatory
b. Ethical…..Formal d. Formal…..Informal
ESSAY
1. Identify the basic characteristics of formal and informal institutions.
2. Define the two core propositions of the institution-based view.
3. Define political risk and describe the leading objective measure of political risk.
4. Outline the differences between democracy and totalitarianism.
5. Why should businesses be concerned about the outcome of political elections?
6. Explain the relative advantages and disadvantages of a liberal market economy (LME) and a
coordinate market economy (CME).
7. Compare and contrast a civil law and common law.
8. How can a firm protect intellectual property rights (IPR) when countries have different levels of IPR
enforcement?