Chapter 1

1. Why might performance compensation caps be bad?

A. Different pay rates promote dissent
B. Compensation caps can discourage employees from being productive after the cap
C. Compensation caps can discourage employees from being productive before the cap
D. Both a and c

2. What is a possible consequence of a performance compensation reward scheme?

A. It creates productive incentives
B. It creates harmful incentives
C. Both a and b
D. Neither a nor b

3. Which of the following is not one of the three problem-solving principles laid out in Chapter 1?
A. Under whose jurisdiction is the problem?
B. Who is making the bad decision?
C. Does the decision maker have enough information to make a good decision?
D. Does the decision maker have the incentive to make a good decision?

4. Why might it be bad for hotels to not charge higher prices when rooms are in high demand?
A. Arbitrageurs might establish a black market by reserving rooms and then selling the reservations to
customers
B. Rooms may be rationed
C. Without the profit from these high demand times, hotels would have less of an incentive to build or
expand, making the long-run scarcity problem even worse
D. All of the above
5. The rational-actor paradigm assumes that people do not
A. act rationally
B. Use rule of thumbs
C. Act self-interestedly
D. Act optimally

6. The problem-solving framework analyzes firm problems

A. From the organization’s point of view
B. From the manager’s point of view
C. From the worker’s point of view
D. From society’s point of view

7. Why might welfare for low-income households reduce the propensity to work?
A. It will not
B. It reduces the incentive to work
C. It is unfair
D. It encourages jealousy

8. Why might a bonus cap for executives be a bad policy for the company?
A. It isn’t. Executives shouldn’t make more than a certain amount
B. It would sow discontent
C. It would encourage shirking after the executives reached the cap
D. The cap could be set too high, so executives may work too hard and not reach it

9. What might happen if a car dealership is awarded a bonus by the manufacturer for selling a certain
number of its cars monthly, but the dealership is just short of that quota near the end of the month?
A. It may sell the remaining cars at huge discounts to hit the quota
B. It creates an incentive to sell cars from different manufacturers
C. It would ruin the relationship between the dealer and the manufacturer
D. Potential buyers will lose buying power at the dealer
10. Why might a supermarket advertise low prices on certain high-profile items and sell them at a loss?
A. It is a way for companies to be charitable
B. The store will sell other groceries to the same customers, often at a markup
C. It would not
D. This reduces incentives of trade

Chapter 2
1. An individual’s value for a good or service is
A. The amount of money he or she used to pay for a good
B. The amount of money he/she is willing to pay for it
C. The amount of money he/she has to spend on goods
D. None of the above

2. The biggest advantage of capitalism is that

A. It allows the market to self-regulate
B. It allows a person to follow his self-interest
C. It allows voluntary transactions, which create wealth
D. All of the above

3. Wealth-creating transactions are more likely to occur

A. With private property rights
B. With strong contract enforcement
C. With black markets
D. All of the above

4. Which of these actions creates value?

A. Buying a struggling firm and selling off its assets for more than the purchase price
B. A baseball slugger drawing paying fans into the ballpark
C. A student increasing his decision-making ability with an MBA
D. All of the above
5. Which of the following are examples of a price floor?
A. Minimum wages
B. Rent controls in New York
C. Both a and B
D. None of the above

6. A price ceiling
A. Is a government-set maximum price
B. Is an implicit tax on producers and an implicit subsidy to consumers
C. Will create a surplus
D. Causes an increase in consumer and producer surplus

7. Taxes
A. Impede the movement of assets to higher-valued uses
B. Reduce incentives to work
C. Decrease the number of wealth-creating transactions
D. All of the above

8. A consumer values a car at $20,000 and it costs a producer $15,000 to make the same car. If the
transaction is completed at $18,000, the transaction will generate
A. No surplus
B. $5,000 worth of seller surplus and unknown amount of buyer surplus
C. $2,000 worth of buyer surplus and $3,000 of seller surplus
D. $3,000 worth of buyer surplus and unknown amount of seller surplus

9. A consumer values a car at $525,000 and a seller values the same car at $485,000. If sales tax is 8%
and is levied on the seller, then the seller’s bottom-line price is
A. $527,000
B. $524,000
C. $525,000
D. $500,000
10. Voluntary transactions
A. Always produce gains for both parties
B. Produce gains for at least one party
C. Always increase wealth for everyone
D. Are inefficient

Chapter 3
1. A business owner makes 1,000 items a day. Each day she contributes eight hours to produce those
items. If hired elsewhere, she could have earned $250 and hour. The item sells for $15 each. Production
does not stop during weekends. If the explicit costs total $150,000 for 30 days, the firm’s accounting profit
for the month equals,
A. $300,000
B. $60,000
C. $450,000
D.$240,000

2. If a firm is earning negative economic profits, it implies

A. That the firm’s accounting profits are zero
B. That the firm’s accounting profits are positive
C. That the firm’s accounting profits are negative
D. That more information is needed to determine accounting profits

3. Opportunity cost arises due to

A. Resource scarcity
B. Lack of alternatives
C. Limited wants
D. Abundance of resources

4. After graduating from college, Jim had three choices, listed in order of preference; (1) move to Florida
from Philadelphia, (2) work in a car dealership in Philadelphia, (3) Play soccer for a minor league in
Philadelphia. His opportunity cost of moving to Florida includes:
A. The benefits he could have received from playing soccer
B. The income he could have earned at the car dealership
C. Both A and B
D. Cannot be determined from the given information

5. Economic Value Added helps firms avoid the hidden-cost fallacy

A. By ignoring the opportunity costs of using capital
B. By differentiating between sunk and fixed costs
C. By taking all capital costs into account, including the cost of equity
D. None of the above
6. The fixed-cost fallacy occurs when
A. A firm considers irrelevant costs
B. A firm ignores relevant costs
C. A firm considers overhead or depreciation costs to make short-run decisions
D. Both A and C

7. Mr. D’s Barbeque of Pickwick, TN, produces 10,000 dry-rubbed rib slabs per year. Annually Mr. D’s fixed
costs are $50,000. The average variable cost per slab is a constant $2. The average total cost per slab is
A. $7
B. $2
C. $5
D. Impossible to determine

8. All the following are examples of variable costs, except

A. Hourly labor costs
B. Cost of raw materials
C. Accounting fees
9. The US government bought $112,000 acres of land in southeastern Colorado in 1968 for $17,500,000.
The cost of using this land today exclusively for the reintroduction of the black-tailed prairie dog
A. Is zero, because they already own the land
B. Is zero, because the land represents a sunk cost
C. Is equal to the market value of the land
D. Is equal to the total dollar value the land would yield if used for farming and ranching

10. When a firm ignores the opportunity cost of capital when making investment or shutdown decisions, this
is a case of
A. Fixed-cost fallacy
B. Sunk-cost fallacy
C. Hidden-cost fallacy
D. None of the above
 Chapter 4
1. When economies speak of “marginal” they mean
A. opportunity
B. scarcity
C. incremental
D. unimportant

2. Managers undertake an investment only if

A. marginal benefits of the investments are greater than zero
B. MCs of the investment are greater than the marginal benefits of the investment
C. marginal benefits are greater than MCs
D. investment decisions do not depend on marginal analysis

3. A firm produces 500 units per week. It hires 20 full-time workers (40 hours/week) at an hourly wage of
$15. Raw materials are ordered weekly, and they cost $10 for every unit produced. The weekly cost of the
rent payment for the factory is $2,250. How do the overall costs break down?
A. Total variable cost is $17,000; total fixed cost is $2,250; and total cost is $19,250
B. Total variable cost is $12,000; total fixed cost is $7,250; and total cost is $19,250
C. Total variable cost is $5,000; total fixed cost is $14,250; and total cost is $19,250
D. Total variable cost is $5,000; total fixed cost is $2,250; and total cost is $7,250
Variable cost = Direct Labor + Direct Materials
Direct Labor = 20 x 40 x 15 = $12,000
Direct Materials = 500 x 10 = $5,000
Variable Cost = 12,000 + 5,000 = $17,000
Fixed Cost (Rental) = $2,250
Total Cost = Variable Cost + Fixed Cost
Total Cost = 17,000 + 2,250 = $19,250

4. Total costs increase from $1,500 to $1,800 when a firm increases output from 40 to 50 units. Which of
the following is true if MC is constant?
A. FC = $100
B. FC = $200
C. FC = $300
D. FC = $400
Marginal Cost = 50 – 40 = $10
Fixed Cost = 1,800 – 1,500 = $300
Fixed Cost/Marginal Cost = 300/10 = 30
1,500/40 = 37.50/30 = 750
750 x 40 = $300

5. A manager of a clothing firm is deciding whether to add another fact in addition to one already in
production. The manager would compare
A. the total benefits gained from the two factories to the total costs of running two factories
B. the incremental benefit expected from the second factory to the total costs of running the two factories
C. the incremental benefit expected from the second factory to the cost of the second factory
D. the total benefits gained from the two factories to the incremental costs of running the two factories

6. A firm is thinking of hiring an additional worker to their organization who can increase total productivity by
100 units a week. The cost of hiring him is $1,500 per week. If the price of each unit is $12,
A. the MR of hiring the worker is $1,500
B. the MC of hiring the worker is $1,200
C. the firm should not hire the worker since MR < MC
D. all of the above

7. A retailer has to pay $9 per hour to hire 13 workers. If the retailer only needs to hire 12 workers, a wage
rate of $7 per hour is sufficient. What is the MC of the 13 th worker?
A. $117
B. $9
C. $33
D. $84
13 x 9 = $117
12 x 7 = $84
Marginal Cost = 117 – 84 = $33

8. If a firm’s AC is rising, then

A. MC is less than AC
B. MC is rising
C. MC is greater than AC
D. the firm is making an economic profit

9. A company is producing 15,000 units. At this output level, MR is $22, and the MC is $18. The firm sells
each unit for $48 and average total cost is $40. What can we conclude from this information?
A. The company is making a loss
B. The company needs to cut production
C. The company needs to increase production
D. Not enough information needed

10. Food Fanatics caters meals where its cost of producing an extra meal is $25. Each of its meals sells for
$20. At this rate, what should the company do?
A. Produce more meals and increase its profit
B. produce fewer meals and increase its profit
C. not change production
D. none of the above

Chapter 5
1. Which of the following will increase the break-even quantity?
A. A decrease in overall fixed costs
B. A decrease in the marginal costs
C. a decrease in the price level
D. an increase in price level

2. The higher the discount rates,

A. the more value individuals place on future dollars
B. the more value individuals place on current dollars
C. the more investments will take place
D. does not affect the investment strategy

3. Assume a firm has the following cost and revenue characteristics at its current level of output: price =
$10, average variable cost = $8, and average fixed cost = $4. The firm is
A. incurring a loss of $2 per unit and should shut down
B. realizing only a normal profit
C. realizing an economic profit of $2 per unit
D. incurring a loss per unit of $2 but should continue to operate in the short run

4. Sarah’s Machinery Company is deciding to dump its current technology A for new technology B with
smaller fixed costs but bigger MCs. The current technology has fixed costs of $500 and MCs of $50,
whereas the new technology has fixed costs $250 and MCs of $100. At what quantity is Sarah’s Machinery
Company indifferent between two technologies?
A. 5
B. 6
C. 7
D. 8
500 + 50Q = 250 + 100Q
250Q = 50Q
Q=5
5. What is the net present value of a project that requires a $100 investment today and returns $50 at the
end of the first year and $80 at the end of the second year? Assume a discount rate of 10%.
A. $10.52
B. $11.57
C. $18.18
D. $30.00
50 / (1.10) = 45.45
80 / (1.10)2 = 66.12
45.45 + 66.12 = $111.57
111.57 – 100 = $11.57

6. You expect to sell 500 cell phones a month, which have an MC of $50. If your fixed costs are $5,000 per
month, what is the break-even price?
A. $10
B. $50
C. $60
D. $100
P = FC/Q + VC
500 = 5,000 / (x – 50)
X = $60

7. You are considering opening a new business to sell dartboards. You estimate that your manufacturing
equipment will cost $100,000, facility updates will cost $250,000, and on average, it will cost you $80 (in
labor and material) to produce a board. If you can sell dartboards for $100 each, what is your break-even
quantity?
A. 1,000
B. 3,500
C. 4,375
D. 17,500
(100,000 + 250,000) / 100 – 80
350,000 / 20 = $17,500
8. If GDP is expected to increase at a steady rate of 3% per year, how many years would it take for living
standards to double?
A. 10
B. 20
C. 24
D. 30
72/3 = 24

9. Break-even quantity is a point where

A. the level of profit is maximized
B. the level of cost is minimized
C. only variable costs are covered
D. there are zero profits

10. In the short run, a firm’s decision to shut down should not take into consideration
A. Avoidable costs
B. variable costs
C. fixed costs
D. MCs

5-2 Net Present Value

50 / 1.20 = 41.67
50 / (1.20)2 = 34.72
50 / (1.20)3 = 28.94
41.67 + 34.72 + 28.94 = $105.33
105.33 – 100 = $5.33 (Profitable)

Chapter 6
1. Jim has estimated elasticity demand for gasoline to be -0.7 in the short run and -1.8 in the long run. A
decrease in taxes on gasoline would
A. lower tax revenue in both the short and long run
B. raise tax revenue in both the short and long run
C. raise tax revenue in the short one but lower tax revenue in the long run
D. lower tax revenue in the short run but raise tax revenue in the long run

2. Its lunch time, you are hungry and would like to have some pizza. By the law of diminishing marginal
value,
A. you would pay more for your first slice of pizza than your second
B. you would pay more for your second slice of pizza than your first
C. You would pay an equal amount of money for both the slices since they are identical
D. None of the above

3. Jim recently graduated from college. His income increased tremendously from $5,000 a year to $60,000
a year. Jim decided that instead of renting, he will buy a house. This implies that
A. houses are normal goods for Jim
B. Houses are inferior goods for Jim
C. renting and owning are complementary for Jim
D. need information on the price of houses

4. Which of the following goods has a negative income elasticity of demand?

A. Cars
B. Items from dollar stores
C. shoes
D. bread

5. An economist estimated the cross-price elasticity for peanut butter and jelly to be 1.5. Based on this
information, we know the goods are
A. Inferior goods
B. complements
C. inelastic
D. substitutes

6. Christine has purchased five bananas and is considering the purchase of a sixth. It is likely she will
purchase the sixth banana if
A. the marginal she gets from the sixth banana is lower than its price
B. the marginal benefit of the sixth banana exceeds the price
C. the average value of the sixth banana exceeds the price
D. the total personal value of six bananas exceeds the total expenditure to purchase six bananas

7. Buyers consider Marlboro cigarettes and Budweiser beer to be complements. If Marlboro just increased
its prices, what would you expect to occur in the Budweiser market?
A. demand would rise, and Budweiser would reduce price
B. Demand would fall, and Budweiser would reduce price
C. Demand would fall, and Budweiser would increase price
D. demand would rise, and Budweiser would increase supply

8. Which of the following is the reason for the existence of consumer surplus?
A. consumers can purchase goods that they want in addition to what they need
B. consumers can occasionally purchase products for less than their production cost
C. some consumers receive temporary discounts that result in below-market prices
D. some consumers are willing to pay more than the price

9. A bakery currently sells chocolate chip cookies at a price of $16/dozen. The MC is $8/dozen. The
cookies are becoming more popular with customers, and so the bakery owner is considering raising the
price to $20/dozen. What percentage of customers must be retained to ensure that the price increase is
profitable?
A. 28.0%
B. 33.3%
C. 66.6%
D. 72.0%
(16-8) / (20-8) = 0.6667 or 66.6%

10. Suppose your firm adopts a technology that allows you to increase your output by 15%. If the elasticity
of demand is -3, how should you adjust price if you want to sell all of your output?
A. 5% lower
B. 0.5% lower
C. 15% higher
D. 15% lower