Chapter 1: MANAGERS, PROFITS, AND MARKETS
Multiple Choice
1-1 Economic theory is a valuable tool for business decision making because it
a. identifies for managers the essential information for making a decision.
b. assumes away the problem.
c. creates a realistic, complex model of the business firm.
d. provides an easy solution to complex business problems.
1-2 Economic profit
a. is a theoretical measure of a firm’s performance and has little value in real world decision
making.
b. can be calculated by subtracting implicit costs of using owner-supplied resources from
the firm’s total revenue.
c. is negative when total costs exceed total revenues.
d. is generally larger than accounting profit.
1-3 Economic profit is the difference between
a. total revenue and the opportunity cost of all of the resources used in production.
b. total revenue and the implicit costs of using owner-supplied resources.
c. accounting profit and the opportunity cost of the market-supplied resources used by the
firm.
d. accounting profit and explicit costs.
1-4 When economic profit is positive,
a. total revenue exceeds total economic cost.
b. the firm’s owners have successfully solved the principle-agent problem.
c. the firm’s owners experience a decrease in their wealth.
d. foreign companies experience loss of market share
1-5 Consider a firm that employs some resources that are owned by the firm. When accounting profit
is zero, economic profit
a. must also equal zero.
b. is sure to be positive.
c. must be negative and shareholder wealth is reduced.
d. cannot be computed accurately, but the firm is breaking even nonetheless.
1-6 Which of the following statements is false?
a. Explicit costs of using market-supplied resources entail an opportunity cost equal to the
dollar cost of obtaining the resources in the market.
b. When economic profit is zero, the firm’s owners could not have done better putting their
resources in some other industry of comparable risk.
c. If economic profit is positive, accounting profit must also be positive.
d. If economic profit is negative, accounting profit must also be negative.
e. None of the above statements is false.
1-7 The value of a firm is
a. smaller the higher is the risk premium used to compute the firm’s value.
b. larger the higher is the risk premium used to compute the firm’s value.
c. the price for which the firm can be sold minus the present value of the expected future
profits.
d. both b and c
1-8 Suppose Marv, the owner-manager of Marv’s Hot Dogs, earned $82,000 in revenue last year.
Marv’s explicit costs of operation totaled $36,000. Marv has a Bachelor of Science degree in
mechanical engineering and could be earning $40,000 annually as mechanical engineer.
a. Marv’s implicit cost of using owner-supplied resources is $36,000.
b. Marv’s economic profit is $36,000.
c. Marv’s implicit cost of using owner-supplied resources is $30,000.
d. Marv’s economic profit is $6,000.
1-9 A risk premium is
a. a measure calculated to reflect the riskiness of future profits.
b. subtracted from the discount rate when calculating the present value of a future stream of
profits.
c. lower the more risky the future stream of profits.
d. an additional compensation paid to the workers of a business enterprise.
1-10 Owners of a firm want the managers to make business decisions which will
a. maximize the value of the firm.
b. maximize expected profit in each period of operation.
c. maximize the market share of the firm.
d. both a and b are correct when revenue and cost conditions in one time period are
independent of revenues and costs in future time periods.
1-11 The principal-agent problem arises when
a. the principal and the agent have different objectives.
b. the principal cannot enforce the contract with the agent or finds it too costly to monitor
the agent.
c. the principal cannot decide whether the firm should seek to maximize the expected future
profits of the firm or maximize the price for which the firm can be sold.
d. both a and b
1-12 Moral hazard
a. occurs when managers pursue profit maximization without regard to the interests of
society in general.
b. exists when either party to a contract has an incentive to cancel the contract.
c. occurs only rarely in modern corporations.
d. is the cause of principal-agent problems.
1-13 A price-taking firm can exert no control over price because
a. the firm’s demand curve is downward sloping.
b. of a lack of substitutes for the product.
c. the firm’s individual production is insignificant relative to total production in the industry.
d. no other firms make a product that is nearly identical to its product.
1-14 Which of the following statements is true?
a. Shareholders as a group have little or no ability to force managers to pursue
maximization of the firm’s value.
b. The effectiveness of a board of directors in monitoring managers is enhanced by
appointing members from the firm who are well-informed about the management
problems facing the firm.
c. Reducing the amount of debt financing can reduce divergence between the shareholders’
interests and the manager’s interests.
d. Equity ownership by managers is thought to be one of the most effective corporate
control mechanisms.
e. All of the above are true.
1-15 When a firm is a price-taking firm,
a. the price of the product it sells is determined by the intersection of the market demand
and supply curves for the product.
b. raising the price of the product above the market-determined price will cause sales to fall
nearly to zero.
c. many other firms produce a product that is identical to the output produced by the rest of
the firms in the industry.
d. all of the above
1-16 A price-setting firm
a. can lower the price of its product and sell more units.
b. can raise the price of its product and sell the same number of units.
c. possesses little market power.
d. sells a product that is notdifferentiated from the product sold by its rivals or sells in a
limited geographic market area with only one or a few sellers.
1-17 A market
a. raises the transaction costs of doing business.
b. is any arrangement that brings buyers and sellers together to exchange goods or services.
c. is an institution used rarely by capitalist nations.
d. is characterized by rigid prices
1-18 Which of the following is NOT one of features characterizing market structures?
a. the number and size of firms
b. the likelihood of new firm’s entering a market
c. the level of capital investment in research and development
d. the degree of product differentiation
1-19 In a perfectly competitive market,
a. all firms produce and sell a standardized or undifferentiated product.
b. the output sold by a particular firm may be quite different from the output sold by the
other firms in the market.
c. firms are price-setters.
d. it is difficult for new firms to enter the market due to barriers to entry.
1-20 Which of the following is NOT a characteristic of monopoly market structures?
a. A single firm produces the entire market output.
b. The easier consumers can find imperfect substitutes for the firm’s product the lower will
be the firm’s market power.
c. There are no barriers to entry.
d. No close substitutes for the product are available.
1-21 In markets characterized by monopolistic competition,
a. a small number of relatively small firms sell a differentiated product.
b. a small number of relatively large firms sell a standardized product.
c. entry into the market is relatively easy so that profit in the long run is zero.
d. entry into the market is restricted so that profit may be positive in the long run.
1-22 In markets characterized by oligopoly,
a. a large number of relatively large firms sell a differentiated product.
b. a small number of relatively small firms sell a standardized product.
c. mutual interdependence of firms means that actions of any one firm in the market will
have no effect on the sales of all other firms in the market.
d. entry into the market is restricted so that profit may be positive in the long run.
1-23 When a firm earns less than a normal profit,
a. revenues generated cannot pay all explicit costs and the use of owner-supplied resources.
b. accounting profit is negative.
c. economic profit is zero.
d. normal profit is negative.
1-24 Economic profit is the best measure of a firm’s performance because
a. normal profit is generally too difficult to measure.
b. economic profit fully accounts for all sources of revenue.
c. only explicit costs influence managerial decisions since, in general, only explicit costs
can be subtracted from revenue for the purposes of computing taxable profit.
d. the opportunity cost of using ALL resources is subtracted from total revenue.
1-25 A manager who does not see his or her goal as the maximization of profit
a. may nevertheless maximize the value of the firm.
b. represents a principle-agent problem.
c. will likely be replaced either by shareholders or by a takeover of the firm.
d. both b and c
1-26 Which of the following developments encouraged globalization of markets during the 1990s?
a. Eleven European countries began using the “euro” as a common currency.
b. The ability to buy and sell goods on the Internet was increased.
c. Numerous bilateral and multilateral trade agreements were reached.
d. both a and c
e. all of the above
1-27 Which of the following is an example of an implicit cost for a firm?
a. the value of time worked by the owner.
b. any wages and salaries paid to employed.
c. forgone rent on property owned by firm.
d. both a and c
e. all of the above
1-28 St. Charles Hospital, located in an upper-income neighborhood of a large city, recently received a
restored mansion as a gift from an appreciative patient. The board of directors decided to remodel
the mansion and use it as recuperative quarters for patients willing to pay for luxurious
accommodations. The cost to the hospital of using the mansion includes
a. nothing because it was a gift.
b. how much the hospital pays for upkeep—taxes, insurance, utilities, maintenance, etc.
c. how much the hospital would receive if it rented or sold the mansion.
d. both b and c
1-29 Until recently you worked as an accountant earning $30,000 annually. Then you inherited a piece
of commercial real estate bringing in $12,000 rent annually. You decided to leave your job and
operate a video rental store in the office space you inherited.
At the end of the first year, your books showed total revenues of $60,000 and total costs of
$30,000 for video purchases, utilities, taxes, and supplies. What is the total cost of operating the
video store?
a. $72,000
b. $42,000
c. $30,000
d. $12,000
1-30 At the beginning of 2015, market analysts expect Atlantis Company, holder of a valuable patent, to earn
the following stream of economic profits over the next five years. At the end of five years, Atlantis will
lose its patent protection, and analysts expect economic profit to be zero after five years.
Year
Expected Economic
Profit
20154
$ 225,000
2016
$ 325,000
2017
$ 425,000
2018
$ 200,000
2019
$ 100,000
If investors apply an annual risk-adjusted discount rate of 15%, the value of Atlantis Company in 2015 is
$______________________, which is also the maximum price investors would be willing to pay for
Atlantis Company.
a. $726,916
b. $884,912
c. $1,275,000
d. $2,215,000
e. $3,824,318
An annual income statement from Quest Realty, Inc. is shown below:
Revenues
Revenue from sales of goods and services ……………………… $80,000,000
Operating costs and expenses:
Cost of products and services sold ………………………………… $30,000,000
Selling expenses …………………………………………………………. $3,000,000
Administrative expense ……………………………………………….. $4,000,000
Total operating costs and expenses ………………………….. $37,000,000
Income from operations …………………………………………………….. $43,000,000
Interest expense (corporate bonds & loans) ………………………….. $300,000
Non-recurring expense (Legal expenses/fines in
settling a federal antitrust suit) ……………………………………… $200,000
Income taxes ……………………………………………………………………. $700,000
Net income ………………………………………………………………………. $41,800,000
During this year of operation, Quest Realty owned and occupied an office building in downtown
Indianapolis. For this year, the building could have been leased to other businesses for $2,000,000
in lease income. Quest Realty also owned undeveloped land valued at $15,000,000. Owners of
Quest Realty can earn a 14% rate of return annually on funds invested elsewhere.
1-31 Total explicit costs of using market-supplied resources for Quest Realty for this year are
a. $23,000,000
b. $37,000,000
c. $38,200,000
d. $41,100,000
e. none of the above
1-32 Total implicit costs of using owner-supplied resources for Quest Realty for this year are
a. $4,100,000
b. $19,000,000
c. $38,200,000
d. $41,000,000
e. none of the above
1-33 Total economic cost is
a. $17,000,000
b. $38,200,000
c. $41,000,000
d. $42,300,000
1-34 Quest’s accounting profit is
a. −$4,100,000
b. $9,360,000
c. $38,200,000
d. $42,300,000
e. none of the above
1-35 Economic profit is
a. $19,000,000
b. $21,800,000
c. $38,200,000
d. $41,000,000
e. none of the above
1-36 Firms with market power may try to limit entry of rival firms in the long run by setting the price
of their product below the level that maximizes profit. This kind of pricing behavior
a. is OK in theory but would not be commonly practiced in the real world because no manager will
ever price either above or below the profit-maximizing level.
b. is a business practice or tactic because pricing decisions are routine decisions made by managers
every day.
c. should always be implemented in order maximize the firm’s market share in both the short run
and long run periods.
d. is a strategic pricing decision because the manager is making the pricing decision with the goal of
altering the behavior of rival firms to protect its profit in the long run.
1-37 Microeconomics
a. is generally too complex and abstract to be of much use in making real-world business decisions.
b. studies the behavior of individual economic units or segments of the economy.
c. contributes to the understanding of ordinary business practices or tactics.
d. all of the above.
e. both b and c.
1-38 Which of the following is a common mistake managers make?
a. Using marginal analysis to make output decisions.
b. Maximizing the value of the firm instead of maximizing the firm’s profits.
c. Reducing price to increase the firm’s share of total market sales.
d. Treating implicit opportunity costs as part of the total costs of using resources.
e. all of the above.
1-39 Which of the following is a common mistake managers make?
a. Using marginal analysis to make output decisions.
b. Maximizing the value of the firm instead of maximizing the firm’s profits.
c. Treating implicit opportunity costs as part of the total costs of using resources.
d. Increasing the rate of production in order to reduce unit costs of production.
e. all of the above.
1-40 Which of the following economic forces promotes profitability in the long run?
a. Existence of strong barriers to entry.
b. A large number of complementary products
c. A large number of close substitute products.
d. Both a and b
