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Chapter 14: Transaction Costs, Asymmetric Information, and Behavioral Economics
True / False
1. Firms emerge when the transaction costs of using a market are less than the cost of hierarchical control.
a.
True
b.
False
False
2. If we assume perfect information, perfect mobility of resources, and no transactions costs, then there is little need for
firms.
a.
True
b.
False
True
3. Vertical integration has no effect on the internal organization of a firm; it only affects the industry.
a.
True
b.
False
False
4. When a firm is operating at its minimum efficient scale, its short-run marginal cost of production is minimized.
a.
True
b.
False
False
5. When a firm is no longer able to reduce its long-run average cost by expanding, it has achieved its minimum efficient
scale of production.
a.
True
b.
False
True
6. Managers experience bounded rationality when they focus narrowly on maximizing their firm’s profits and ignore the
broader perspective of society’s preferences.
a.
True
b.
False
False
7. A firm achieves economies of scale at all output levels beyond the minimum efficient scale of production.
a.
True
b.
False
False
8. If a firm experiences economies of scope, per-unit production costs fall as it produces more than one kind of product.
a.
True
b.
False
True
9. A firm is experiencing economies of scope if per-unit production cost falls with an increase in its output.
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Chapter 14: Transaction Costs, Asymmetric Information, and Behavioral Economics
a.
True
b.
False
False
10. If a firm that experiences economies of scope doubles its production of an item, its costs will less than double.
a.
True
b.
False
True
11. According to Stigler’s search model, Consumer Reports benefits consumers by increasing the marginal cost of
information.
a.
True
b.
False
False
12. According to Stigler’s search model, the marginal benefit of acquiring information about a product is greater for
expensive items than for cheap items.
a.
True
b.
False
True
13. The winner’s curse is more likely to occur when the value of a good at auction is uncertain.
a.
True
b.
False
True
14. When competitive bidding is coupled with imperfect information, the winning bid is usually the most reliable estimate
of the true value.
a.
True
b.
False
False
15. Asymmetric information exists when both sides of a market approach perfect information.
a.
True
b.
False
False
16. One result of asymmetric information in the market for used cars is that buyers benefit at the expense of sellers.
a.
True
b.
False
False
17. In the market for used cars, asymmetric information guarantees that very few lemons are sold.
a.
True
b.
False
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False
18. When a seller knows more about the condition of a used car than the buyer does, the information is said to be
asymmetric.
a.
True
b.
False
True
19. When sellers have better information about product quality than buyers do, better-quality products tend to become
more common in the market.
a.
True
b.
False
False
20. An employer faces the problem of adverse selection while recruiting an employee for a job that requires intangible or
immeasurable abilities.
a.
True
b.
False
True
21. In the market for used cars, owners of lemons usually sell their cars to friends and relatives.
a.
True
b.
False
False
22. An individual will prefer outsourcing a task to an agent if the latter has a higher opportunity cost of time.
a.
True
b.
False
False
23. Insurance buyers tend to be healthier than the population as a whole because of adverse selection.
a.
True
b.
False
False
24. The tendency for the poorest risks to buy health insurance at a high premium is an example of moral hazard.
a.
True
b.
False
False
25. If an employment situation is characterized by adverse selection, there is an excess supply of underqualified applicants
for each job.
a.
True
b.
False
True
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Chapter 14: Transaction Costs, Asymmetric Information, and Behavioral Economics
26. In the job market, a signal is more effective if less-productive workers find it easier to send than do more-productive
workers.
a.
True
b.
False
False
27. Screening is the attempt by the uninformed side of the market to uncover the relevant but hidden characteristics of the
informed party.
a.
True
b.
False
True
28. Neuroeconomics assumes that people have unbounded willpower.
a.
True
b.
False
False
29. The subfield of behavioral economics that examines how economic decision making affects areas of the brain is called
neuroeconomics.
a.
True
b.
False
True
30. Neuroeconomics looks at how people react to a change in their income.
a.
True
b.
False
False
31. Neuroeconomists agree with the traditional view that economic choices boil down to a simple process of utility
maximization.
a.
True
b.
False
False
Multiple Choice
32. If perfect competition existed everywhere, along with frictionless exchange, perfect information, and constant returns
to scale, ______.
a.
consumers would carry out transactions directly with resource suppliers
b.
firms would not have the information necessary to calculate the marginal productivities of resources
c.
entrepreneurs would be needed to collect information
d.
consumers would produce output and then engage in barter
e.
the economy would be organized into one large firm
a
33. If the production of a sofa requires the purchase of 3 types of inputs and the production of a harp requires the purchase
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of 30 types of inputs, ______.
a.
the harp-producing firm will buy the sofa-producing firm
b.
the sofa-producing firm will buy the harp-producing firm
c.
harp production will more likely be done through the hierarchy of firms
d.
sofa production will more likely be done through the hierarchy of firms
e.
both harp and sofa production will rely on market exchange because there is more than one input involved in
each
c
34. Which of the following statements about resource allocation is correct?
a.
Within a firm, resources are allocated by prices; in the market, resources are allocated by the decisions of
managers.
b.
Resources are allocated by prices both in the market and within the firm.
c.
Within a firm, resources are allocated by the decisions of managers; in the market, resources are allocated by
prices.
d.
Resources are allocated by the decisions of managers both within the firm and in the market.
e.
In the market, resources are allocated either by prices or by the decisions of managers; within a firm, resources
are allocated by prices.
c
35. A “do-it-yourself” approach to production is more likely when:
a.
the technology used in production is complex.
b.
inputs are difficult to identify.
c.
resources cannot be measured easily.
d.
prices of inputs are known.
e.
contracts with resource suppliers are complex.
36. For the average homeowner, which of the following tasks is most likely to be contracted?
a.
Fixing a shelf
b.
Hanging a painting
c.
Moving furniture
d.
Rewiring the kitchen lighting
e.
Repainting a bedroom
37. The firm becomes the dominant organization type when:
a.
production involves a few resource suppliers.
b.
production requires unskilled labor resources.
c.
the cost of identifying appropriate inputs is negligible.
d.
the cost of negotiating agreements with suppliers is low.
e.
the production process is complicated.
e
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38. According to Ronald Coase, firms emerge when:
a.
transaction costs in the market are less than the cost of hierarchical control.
b.
transaction costs in the market are more than the cost of hierarchical control.
c.
prices in the market are less than the cost of hierarchical control.
d.
prices in the market are more than the cost of hierarchical control.
e.
resources required for production are low-priced and can be easily identified.
39. In his article “The Nature of the Firm,” Ronald Coase argued that:
a.
market exchange is less costly than hierarchical exchange.
b.
markets are more efficient than hierarchies in producing goods that have few substitutes.
c.
firms are formed to take advantage of situations in which hierarchies are more efficient than markets.
d.
the primary role of an entrepreneur is to take orders from a central authority.
e.
markets tend to become less competitive over time.
c
40. According to Coase, the optimal allocation of resources is guided by:
a.
the decisions of a firm’s managers if the good or service is produced in a perfectly competitive environment.
b.
market prices when market transaction costs are greater than the firm’s internal organization costs.
c.
the decisions of a firm’s managers when market transaction costs are greater than the firm’s internal
organization costs.
d.
the decisions of a firm’s managers when market transaction costs are less than the firm’s internal organization
costs.
e.
entrepreneurs when the costs of negotiating contracts with resource suppliers are low.
c
41. In his article “The Nature of the Firm,” Ronald Coase:
a.
suggested that monopolies may be more innovative than competitive firms.
b.
argued that the economy should be organized into one large firm.
c.
provided an answer to the question, “Why do firms exist?”
d.
focused on the concept of adverse selection.
e.
analyzed market concentration in U.S. industry.
c
42. Production through the firm is often more efficient than market exchange when:
a.
it involves multiple transactions among many resource owners.
b.
it involves the exchange of one good or service for other goods or services.
c.
the cost of transacting business through market relations is less than the cost of undertaking the same activity
within the firm.
d.
inputs are easily identified, measured, priced, and hired.
e.
the costs of determining inputs and negotiating contracts are low.
a
43. An average consumer’s decision to purchase a good from a firm or hire resources directly in the market will:
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a.
depend only on his production skill and not on his contract negotiation skill.
b.
depend only on the opportunity cost of his time but not on his skill.
c.
not depend on the cost of identifying, measuring, and pricing inputs.
d.
not depend on the cost of negotiating contracts.
e.
depend, in part, on both his skill and the opportunity cost of his time.
44. The more complicated the process used to produce a good, _____.
a.
the greater the transaction costs of organizing production through markets
b.
the lower the transaction costs of organizing production through markets
c.
the less likely a firm will use administrative controls to organize the production process
d.
the more likely a firm will use the market to organize the production process
e.
the more likely that consumers will choose to purchase the good over other alternatives in the market
45. The simpler a production process, _____.
a.
the greater the cost of production.
b.
the greater the transaction cost of using markets.
c.
the more likely a firm is to use a market to organize production.
d.
the more likely a firm is to use centralized control to organize production.
e.
the lower the cost of hierarchal control and supervision.
46. If the minimum efficient scale in toaster production is 500,000 units per year, _____.
a.
the average cost of producing 300,000 toasters is greater than the average cost of producing 500,000
b.
the average cost of producing 200,000 toasters is less than the average cost of producing 500,000
c.
the average cost of producing 300,000 toasters is less than the average cost of producing 500,000
d.
the average cost of producing 300,000 toasters is the same as the average cost of producing 500,000
e.
the average cost of producing 500,000 toasters is zero
47. By integrating vertically, _____.
a.
firms trade with one another through markets
b.
firms trade with one another through government intermediation
c.
firms coordinate with market processes to produce a good or service most efficiently
d.
firms expand into stages of production earlier or later than those in which they specialize
e.
firms parcel out the various procedures involved in producing a good among various contractors
48. Which of the following is true of vertical integration?
a.
It occurs when firms internalize certain stages of production that were earlier contracted to suppliers.
b.
It occurs when a firm adds more layers of management to increase transparency in the accounting system.
c.
It occurs when firms try to buy up their competitors and corner the market.
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d.
It has no effect on the internal organization of a firm; it only affects outside markets.
e.
It occurs when a firm buys another firm in a completely unrelated market.
49. Spacely Sprockets, Inc. usually pays $1,000 for a million flanges, which it uses as inputs in the manufacture of
sprockets. It also spends an average of $20 per million flanges looking for manufacturers and negotiating contracts.
Spacely can make its own flanges at a cost of $980 per million. Given these costs, we can conclude that Spacely should:
a.
continue to contract out for flanges.
b.
start to manufacture its own flanges.
c.
increase the use of flanges in the production of sprockets.
d.
stop paying the additional $20 to find and negotiate contracts and just buy the flanges outright for $1,000 per
million flanges.
e.
move away from the use of flanges toward an input that it can produce by itself.
50. Don’s Pasture Apple Cider Company buys four inputs when producing apple cider: apples, glass bottles, apple presses,
and computers for record keeping. If the company decides to become vertically integrated backward, it is most likely to:
a.
start growing apples next.
b.
start making glass bottles next.
c.
start making apple presses next.
d.
start making computers next.
e.
internalize the production of all these inputs at the same time.
51. Wendy’s restaurants must decide whether to grow their own potatoes for French fries or buy them. If they buy rather
than grow, then they have opted to:
a.
integrate horizontally.
b.
allow market prices to guide resource allocation.
c.
integrate vertically.
d.
allow hierarchical control to guide resource allocation.
e.
form an authority relation.
52. The term vertical integration is used to describe:
a.
the expansion of a firm into earlier or later stages of production.
b.
an attempt by a firm to allow market prices to coordinate more transactions.
c.
an attempt by a firm to minimize shirking.
d.
an attempt by a firm to minimize the need to coordinate transactions within its boundaries.
e.
the mechanisms used by a firm to accumulate information about its competitors.
53. Wendy’s restaurant must decide whether to grow its own potatoes for French fries or procure them from suppliers.
However, growing potatoes is a very different process from running a fast food restaurant. Based on this information
alone, should Wendy’s grow its own potatoes?
a.
No, because Wendy’s managers have bounded rationality.
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b.
Yes, because Wendy’s managers have bounded rationality.
c.
No, because there are very few potato suppliers.
d.
Yes, because there are a few potato suppliers.
e.
No, because potatoes are traded in a perfectly competitive market.
54. When several resources are combined in the production of a good, _____.
a.
the marginal product of each resource can be easily determined
b.
the marginal contribution of each resource cannot be easily observed
c.
allocating revenue among the various resources is easy
d.
there is minimum competition among the resource suppliers
e.
the quality of the resources is usually uniform across suppliers
55. The term “bounded rationality” is used to explain:
a.
the output level at which economies of scale are fully exploited.
b.
the competition among rival suppliers that ensures a steady supply of a resource.
c.
the cost advantage derived from producing two or more goods in one firm rather than outside.
d.
the managerial incompetence that reduces the profitability of certain firms.
e.
the limit on the amount of information a manager can comprehend about a firm’s operation.
56. When a firm is operating at its minimum efficient scale, its:
a.
short-run average total cost of production is minimized.
b.
long-run marginal cost of production is minimized.
c.
long-run average cost of production is minimized.
d.
marginal revenue is less than the marginal cost.
e.
total revenue is just equal to the total cost.
57. If the minimum efficient scale in the production of rubber exceeds the quantity of rubber any individual tire producer
buys, _____.
a.
tire producers should pay a low price for the rubber input
b.
tire producers should increase the usage of rubber in production
c.
tire producers should not integrate backward into rubber production
d.
tire producers should be charged a price that is above the cost of producing rubber
e.
tire companies should switch their resources to fiberglass production
58. If the minimum efficient scale in microwave oven production is 100,000 units per year, it implies that:
a.
the average cost of producing 50,000 microwave ovens is greater than the average cost of producing 100,000.
b.
the average cost of producing 50,000 microwave ovens is equal to the average cost of producing 100,000.
c.
the total cost of producing 50,000 microwave ovens is greater than the total cost of producing 100,000.
d.
the firm should not produce more than 50,000 microwave ovens.
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e.
marginal cost exceeds average cost at 100,000 microwave ovens.
59. In order to focus on its area of core competency, a firm relies on:
a.
government intervention and the bounded rationality of its managers.
b.
the market price and the minimum efficient scale of production.
c.
economies of scope.
d.
the division of labor and the law of comparative advantage.
e.
the vertical integration of its production process.
60. If the minimum efficient scale in woodstove production is 200,000 units per year, _____.
a.
the long-run average cost of producing 50,000 stoves is greater than the average cost of producing 100,000
b.
the long-run average cost of producing 50,000 stoves is equal to the average cost of producing 100,000
c.
the long-run total cost of producing 50,000 stoves is greater than the total cost of producing 100,000
d.
the firm should not produce more than 200,000 woodstoves each year
e.
the short-run marginal cost exceeds the short-run average cost at 200,000 stoves
61. In order to organize and carry out transactions efficiently, firms alternate between:
a.
profit and revenue maximization.
b.
vertical and horizontal integration.
c.
economies of scale and economies of scope.
d.
internal production and market purchase.
e.
skill development and training.
62. The following figure shows the long-run average cost curve for a tire manufacturer and the long-run average cost
curve for a rubber producer. If ten pounds of rubber is required for producing one tire, which of the following is true?
Figure 14.1
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a.
The tire manufacturer should integrate backward into producing rubber.
b.
The tire manufacturer should produce more than 200,000 tires.
c.
The tire manufacturer should buy rubber rather than produce it.
d.
The rubber producer must be a monopolist.
e.
The minimum efficient scale of rubber production is 2 million pounds.
63. The following figure shows the long-run average cost curve for a tire manufacturer and the long run average cost
curve for a rubber producer. Which of the following can be concluded from the information provided in the figure given
below?
Figure 14.1
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a.
The cost of producing rubber is much lower than the cost of producing tires.
b.
The total cost of producing 100,000 tires is greater than the total cost of producing 200,000 tires.
c.
The minimum efficient scale of producing rubber is 4 million pounds.
d.
The minimum efficient scale of producing tires is greater than 200,000 tires.
e.
The marginal cost of producing the 200,000th tire must exceed the average cost of 200,000 tires.
64. The following figure shows the long-run average cost curve for a tire manufacturer and the long-run average cost
curve for a rubber producer. Which of the following is indicated by the figure given below?
Figure 14.1
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Chapter 14: Transaction Costs, Asymmetric Information, and Behavioral Economics
a.
The cost of producing rubber is much lower than the cost of producing tires.
b.
The total cost of producing 100,000 tires is greater than the total cost of producing 200,000 tires.
c.
The minimum efficient scale of producing tires is 200,000 tires.
d.
The minimum efficient scale of producing tires is greater than 200,000 tires.
e.
The marginal cost of producing the 200,000th tire must exceed the average cost of 200,000 tires.
65. One reason a computer manufacturer may make its own microchips rather than buy them is that:
a.
it can maintain control over the quality during production.
b.
the total cost of components is the same as the price of chips purchased from a chip manufacturer.
c.
there is a large number of microchip suppliers in the market.
d.
its managers place a high value on their time.
e.
all the microchip suppliers offer identical or homogenous products.
66. One reason many people make their own pickles rather than buy them is that:
a.
they can maintain control over the quality during production.
b.
the total cost of ingredients is the same as the price of store-bought pickles.
c.
firms are unaware of the technique and expertise required to preserve and store pickles over time.
d.
people place a high value on their time.
e.
firms do not produce goods that can be made at home.
67. Apple Computers is more likely to continue to use input markets rather than manufacture its own inputs internally
when:
a.
the quality of inputs is difficult to determine.
b.
switching among input suppliers is easy.
c.
there are very few firms producing the input.
d.
the input is difficult to identify and define.
e.
transaction costs go up.
68. Which of the following is likely to limit the extent of a firm’s vertical integration?
a.
The managers’ bounded rationality.
b.
A small minimum efficient scale of producing inputs relative to the firm’s input requirements.
c.
The fact that the quality of inputs is easily determined at the time of purchase.
d.
The presence of a large number of suppliers of the firm’s inputs.
e.
A high transaction cost of contracting with resource suppliers.
69. If the quality of an input is easily determined at the time of purchase, then it is likely to:
a.
result in high transaction costs of using markets.
b.
encourage vertical integration of the production process.
c.
encourage supplier firms to produce low-quality inputs.
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d.
be produced internally by a firm.
e.
be purchased in the market.
70. Which of the following is the best example of a vertically integrated firm?
a.
General Electric, which produces light bulbs, jet engines, washing machines, and so on
b.
Kinko’s, which has a photocopy store near many colleges and universities
c.
USX Corporation, which owns ore and coal mines, coke ovens, blast furnaces, mills, and foundries
d.
Intel, which makes computer chips for most of the computer manufacturers
e.
Century 21, which has real estate offices that help people sell a house in one city and buy another house in
another city
71. An ideal example of a vertically integrated firm will be:
a.
Sylvania, which produces light bulbs, notebooks, camcorders, and so on
b.
Kinko’s, which has a photocopy store near many colleges and universities
c.
American Apparel, which controls the dyeing, finishing, designing, sewing, cutting, marketing and distribution
of its product from a single building in downtown LA
d.
Intel, which makes computer chips for most of the computer manufacturers
e.
Hertz Car Rentals, which has offices that help people rent a car in one city and drop it off in another city
72. A firm that produces mouthwash branches out into producing toothpaste. If this expansion reduces its average cost of
production, which of the following can be concluded about this firm?
a.
The firm is benefiting from vertical integration.
b.
The firm is benefiting from horizontal integration.
c.
The firm is experiencing economies of scale.
d.
The firm is experiencing economies of scope.
e.
The firm is not incurring any transaction cost.
73. If a firm experiences economies of scope, _____.
a.
its average cost falls as output increases
b.
its average cost rises as output increases
c.
its average total cost falls when it produces more than one kind of product
d.
it gains larger profits through vertical integration
e.
its average total cost rises as it produces more than one kind of product
74. A company that produces furniture wax branches out into producing a dusting product like Lemon-Dust-Away. This
expansion can be called efficient if the company:
a.
benefits from vertical integration.
b.
benefits from horizontal integration.
c.
experiences economies of scale.
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d.
experiences economies of scope.
e.
incurs zero transaction cost.
75. Which of the following is an example of a producer taking advantage of economies of scope?
a.
A farmer buying more land so that he can produce more soybeans
b.
GM closing a Chevy truck plant in response to a decline in demand for trucks
c.
Disney World staying open later to serve more customers per day
d.
A dairy farmer producing cow’s milk and butter
e.
A mouthwash firm expanding production by improving managerial efficiency
76. When a multi-product firm like General Electric (GE) spreads its outlays for research, development, and marketing
over different products, per-unit costs decrease. This implies that GE is taking advantage of:
a.
government intervention.
b.
vertical integration.
c.
economies of scale.
d.
economies of scope.
e.
market power.
77. Reliable information is:
a.
costly for consumers, but not for producers.
b.
costly for both producers and consumers.
c.
freely available.
d.
costly for producers, but not for consumers.
e.
not relevant to economic decision making.
78. Most consumers consider the process of gathering information on a product or service:
a.
irrational.
b.
unproductive work.
c.
market work.
d.
nonmarket work.
e.
costless.
79. Consumers generally consider the process of learning about the efficiency and durability of various brands of
refrigerators:
a.
irrational.
b.
unproductive.
c.
a vocation.
d.
nonmarket work.
e.
costless.
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Chapter 14: Transaction Costs, Asymmetric Information, and Behavioral Economics
80. Promotional brochures of various products, computer publications, and online sites benefit consumers by:
a.
increasing the marginal benefit of information.
b.
reducing the marginal benefit of information.
c.
reducing the marginal cost of information.
d.
increasing the marginal cost of information.
e.
displaying which products are in vogue.
c
81. Publications such as Consumer Reports :
a.
increase the optimal amount of information gathered.
b.
reduce the optimal amount of information gathered.
c.
reduce the amount of common knowledge.
d.
raise the marginal benefit of information curve.
e.
make consumers perfectly informed.
a
82. The following figure shows the marginal cost and the marginal benefit of information curves. In the figure given
below, the optimal level of search is _____.
Figure 14.2
a.
I1
b.
I2
c.
I3
d.
zero
e.
not shown
83. The figure given below shows the marginal cost and the marginal benefit of information curves. In the figure given