Managerial Economics

Multiple Choice

Identify the letter of the choice that best completes the statement or answers the question.

____ 1. Statement 1: “Employees at an automotive repair center are found to be exaggerating the amount of repairs that cars need. According to the ‘happy-is-productive’ approach, it is likely that these employees are being paid based on commission and have to much reward for misleading customers about needed repairs.”

Statement 2: “Since the economist’s view of behavior suggests that employees are exclusively interested in monetary rewards, it is unlikely that an employee’s preference for telling the truth would be considered when analyzing why automotive repair workers would exaggerate the amount of repair cars need.”

a.	Both statements are true
b.	Both statements are false
c.	Statement 1 is true, but 2 is false
d.	Statement 2 is true, but 1 is false

____ 2. Employees in a factory are found to be less productive than their counterparts elsewhere. A consultant is brought in to analyze the problem and suggests that managers send out surveys to all workers that assess what bothers them most about their circumstances on the job. Which of the following theories of worker behavior is most likely being used by this consultant?

a.	The economic view of behavior
b.	The only money matters view of behavior
c.	The happy-is-productive view of behavior
d.	The product-of-the-environment view of behavior
e.	The good citizen model

____ 3. Statement 1: “When management professors use the term ‘strategy’ they typical refer to the way one firm’s decisions cause other firms to alter their behavior.”

Statement 2: “The concept of the ‘long run’ as used in microeconomics is not a period of time. In fact, in some cases it may be as short as a few months while in others it might last for a decade or two.”

a.	Both statements are false
b.	Both statements are true
c.	Statement 1 is true but 2 is false
d.	Statement 2 is true but 1 is false

____ 4. Which of the following is not a method of creating value as described in the Brickley, Smith and Zimmerman (BSZ) text?

a.	Reducing the time it take consumers to identify product characteristics.
b.	Reducing the costs of negotiation when purchasing your firm’s product.
c.	Improving product quality.
d.	Increasing the price of complementary products.
e.	All of the above methods are devices for a firm to create value as described in the BSZ textbook.

____ 6. Statement 1: “There is always a single non-cooperative Nash equilibrium in a simultaneous choice game.”

Statement 2: “Suppose that Alice can pick one of three strategies in a two-player, simultaneous choice game. Call the strategies A, B, and C. If Strategy B is better for Alice than strategy A for every possible choice of her opponent, then we say that strategy A is a ‘dominated strategy’.”

a.	Both statements are true
b.	Both statements are false
c.	Statement 1 is true, but 2 is false
d.	Statement 2 is true, but 1 is false

____ 7. Statement 1: “Sam works in an office which has what he thinks is the best view of the Pacific ocean anyone ever had. In fact, this is common at his firm because of the ocean side location of his employer’s location. Unfortunately, Sam and others at his firm get paid less than others with similar skills in their industry. This is an example of what economists call the theory of compensating differentials.”

Statement 2: “Sam’s firm hire new employees when they graduate from college, and promotes people internally to all senior positions. This approach to hiring employees is call the ‘efficiency wage’ approach by economists.”

a.	Both statements are true
b.	Both statements are false
c.	Statement 1 is true, but 2 is false
d.	Statement 2 is true, but 1 is false

____ 8. Statement 1: “Firms that use internal labor markets are more likely to have problems getting employees to invest in firm specific human capital.”

Statement 2: “Firms that pay employees using the ‘efficiency wage’ approach are likely to have higher rates of employer turnover.”

a.	Both statements are true
b.	Both statements are false
c.	Statement 1 is true, but 2 is false
d.	Statement 2 is true, but 1 is false

____ 9. Statement 1: “When economists discuss the most profitable combination of fringe benefits and salary, the general strategy is to try and make employees as happy as they can be for a given amount spent on them.”

Statement 2: “Bob runs a guitar store and is considering reducing pay to employees in the store, but giving them substantial discounts on the purchase of guitars in the store. Most of his employees are guitar enthusiasts. Economists would regard this move as an obviously bad move because employees will clearly prefer the salary to this particular fringe benefit.”

a.	Both statements are true
b.	Both statements are false
c.	Statement 1 is true, but 2 is false
d.	Statement 2 is true, but 1 is false

____ 10. Which of the following is not an advantage of internal labor markets?

a.	Employees tend to accumulate more skills that are valuable only at this firm.
b.	There is less incentive for employees to say bad things about the firm to outsiders
c.	Managers often know a great deal about employees when considering promotions
d.	There is better access to employees of all skill types than is available to other types of firms.

____ 11. Statement 1: “Economists believe that all firms use some form of incentive pay.”

Statement 2: “Economists suggest that incentive pay can increase employee effort, but is often very expensive for firms to use as employees must be compensated for the extra risk.

a.	Both statements are true
b.	Both statements are false
c.	Statement 1 is true, but 2 is false
d.	Statement 2 is true, but 1 is false

____ 12. Which of the following does not limit the use of employee ownership of the firm to correct incentives to work hard in the firm?

a.	Significant wealth constraints that prevent employees from purchasing part of ownership through a franchise or some similar device.
b.	Employee aversion to risk.
c.	Team production can make it difficult to separate the contributions of individual team members to profit.
d.	All of the above limit the usefulness of employee ownership devices to correct incentives in the firm.

____ 13. Statement 1: “Employee effort increase the amount of goods and services produced by the firm. Therefore, managers should try to get the greatest amount of effort possible out of their employees.”

Statement 2: “If the firm’s compensation scheme was chosen entirely for optimal risk sharing, the stockholders would bear all of the profit risk, and the employees would be paid a straight salary.”

a.	Both statements are true.
b.	Both statements are false.
c.	Statement 1 is true, but 2 is false.
d.	Statement 2 is true, but 1 is false.

____ 14. Statement 1: “Incentive pay is always desirable...at least if you talk to economists. They argue that rewarding employers for increased productivity will always increase the firm’s profitability.”

Statement 2: “The most profitable amount of effort from a firm’s employee occurs when the gain in revenue from the extra output produced by that effort, is matched by the extra money that must be paid to them to keep them at your firm.”

a.	Statement 1 is true, but 2 is false
b.	Statement 2 is true, but 1 is false
c.	Both statements are true
d.	Both statements are false

____ 15. If you worry only about optimal sharing of risks between stockholders, management and labor, then which of the following is true?

a.	No incentive pay should be used allowing Stock holders to absorb all the risk.
b.	Stock options should be paid to management so that they will be more concerned about the firm’s profitability.
c.	Incentive pay should be paid to labor so that they have incentive to increase productivity.
d.	Incentive pay should be paid to both labor and management to increase both profitability and productivity.

____ 16. Suppose that over the summer you forget much of what you learned in your managerial economics class. Which of the following phrases best describes this forgetfulness in the language of economics?

a.	You are investing in your human capital.
b.	Your human capital is depreciating
c.	You are dis-investing in specific human capital
d.	None of the above phrases would be used...even by goofy economists.

____ 17. Statement 1: “Some jobs are pleasant so they can pay their employees more. This is an example of the concept economists call ‘compensating differentials.’”

Statement 2: “Some jobs are less pleasant so firms must pay employees more. This is an example of the concept economists call ‘compensating differentials.’”

a.	Statement 1 is true, but 2 is false
b.	Statement 2 is true, but 1 is false
c.	Both statements are true
d.	Both statements are false

____ 18. Statement 1: “Firms that pay efficiency wages have lower turnover, and absenteeism. All firms should pursue this strategy.”

Statement 2: “Firms that use internal labor markets are less likely to have employees that accumulate firm specific human capital.”

a.	Statement 1 is true, but 2 is not
b.	Statement 2 is true, but 1 is not
c.	Both statements are true
d.	Both statements are false

____ 19. Bob and Alice are playing the sequential game drawn below. Bob moves first and picks either A or B. Alice moves second and picks either C or D.

Which of the following statements best describes the situation in this game?

a.	Bob has a big first mover advantage.
b.	Alice has a big second mover advantage.
c.	The game should be solved by examining Bob’s decision before looking at Alice’s decision since he moves first.
d.	None of the above are true statements about the situation described in this game.

____ 20. You work for BigFatFridgeCo. The firm would like to use create value for its customers so that it can increase its profitability. It has chosen to do this by lowering what economists call “consumer borne transactions costs.” Which of the following would not reduce consumer borne transactions costs?

a.	Making it easier for consumers to buy the product on the Internet.
b.	Making it easier for consumers to get information about the product.
c.	Insisting that customers negotiate over price prior to purchase.
d.	Making it easier for customers to get the product from the store to their home.

____ 21. Wal-Mart significantly upgraded its web-site in 1999 to get a significant increase in its Internet sales. Which of the following statements hypothetically made in 1999 would be the most persuasive argument that profit for Wal Mart would increase over a large number of years?

a.	The web site would be valuable to customers because they could shop from home and didn’t need to drive to the store.
b.	The web site would be well organized and things would be easy to find.
c.	The web site would use the best and most recent technical tricks to display products.
d.	The Wal-Mart web-site would allow the firm to ship items to bulky for UPS and US mail from local Wal-Mart stores using the inexpensive shipping system that Wal Mart already had developed.

____ 22. Suppose that productivity is low at your firm and a consultant suggests that you should send out employee satisfaction surveys to all employees to identify the source of the problem. Which of the following theories of workers is most like to be followed by this consultant?

a.	The happy is productive theory
b.	The good citizen model.
c.	The economists view of behavior
d.	The product of the environment model

Essay

23. Fred has been running BlamCo--a maker of curiously cute handmade stuffed animals--for the last 10 years. One portion of the production process involves employees that sew together the animals leaving open an hole to stuff them. Another has employees stuffing the animals, and a final stage has employees packaging the finished products. The three groups of employees are called Sewers, Stuffers, and Packagers.

Fred would like to pay them using a piece-work pay system based on the number of animals sewed, stuffed, or packaged by each employee. To keep costs under control, he plans to lower employee salaries, but he figures that with levels of effort comparable to what he is used to seeing from them, they could earn about the same amount of money as they did in the past.

Using material from class and the text, discuss the advantages and disadvantages of using piece-work pay in this situation.

24. Allen-Edmonds Shoe Company manufactures expensive shoes. For many years it paid workers using a piece rate system, but in 1990 it switched to a system of fixed hourly wages. Use concepts developed in class to discuss the likely benefits and costs to Edmonds coming from this change over. Make a recommendation for or against switching to hourly wages based on class concepts.

25. Enterprise rent-a-car uses the internal labor market approach to hiring new employees. Many other firms do not use this approach. Assuming that Enterprise has chosen the appropriate model for their purposes explain why other firms would not want to use this approach. What would be different about firms that are better off not using the internal labor market approach?

1. In the simultaneous choice game below Frank has 5 choices (A, B, C, D, and E) while Bob has 2 choices (A and B). If this game is non-cooperative, what is the likely outcome? Use concepts presented in class.

a.	Bob picks B, Frank picks A
b.	Bob picks B, Frank picks E
c.	Bob picks A, Frank picks B
d.	Bob picks A, Frank picks D
e.	None of the above answers is correct.

3. In the game drawn below, Bob moves first and must pick either A or B. Mary moves second and has three choices that are labeled D, E and F (if Bob chose A) and G, H and I (if Bob chose B). The numbers at the far right are the rewards for Bob and Mary in each of the 6 possible outcomes. What is the likely outcome of this game if both Bob and Mary play optimally?

a.	Bob will pick B and Mary will pick G
b.	Bob will pick A and Mary will pick F
c.	Bob will pick A and Mary will pick D
d.	Bob will pick B and Mary will pick H
e.	None of the above answers is correct.

Essay Questions:

1. In some sequential games it is an advantage to move first, while in others it is better to move second. Provide a clear example of each and intuitively identify why there is an advantage to move first or second. Write your entire answer within the box below.

2. “For the last 10 years you’ve been working in the health food business. You have talked to many customers who have suggested a new restaurant concept. The restaurant would feature a variety of low calorie meals (under 500) made from healthy ingredients (e.g., organic fruits and vegetables and steroid/hormone free meat). The restaurant would include a bar with an extensive organic wine list and trendy décor. There would be an emphasis on high quality, friendly service, and colorful meal presentation. Your customers suggest that they would be willing to pay around $50 to eat a meal and have a glass of wine at this type of restaurant. They lament the fact that their community has no upscale restaurants that offer this type of fare. [..Some text has been removed…]

Several friends with MBA’s argue that you would be crazy to start this business. They claim that there are few entry barriers to the restaurant industry and that ‘every person with business training knows you can’t make money in a competitive industry. Should you drop the idea of opening this business based on this argument?”[footnoteRef:1] Explain using concepts discussed in class and in the text. Your answer should be contained completely in the box below. [1: Brickley, Smith, and Zimmerman; Managerial Economics and Organization Architecture, fifth edition, 2009, McGraw Hill-Irwin, p. 256.]

BobABAliceCDBob gets $250Alice loses $250Bob loses $500Alice gets $500Bob gets $500,Alice loses $500

10*, 4**15*, 16**10*, 14**10*, 15**12*, 30**Bob: B

22*, 5**10*, 32**25*, 28**15*, 30**10*, 15**Bob: A

Frank: EFrank: DFrank: CFrank: BFrank: A

10*, 4**15*, 16**10*, 14**10*, 15**12*, 30**Bob: B

22*, 5**10*, 32**25*, 28**15*, 30**10*, 15**Bob: A

Frank: EFrank: DFrank: CFrank: BFrank: A

* Payoff To Bob; **Payoff to Frank

Bob

A

B

Mary

Mary

D

E

F

G

H

I

Bob: $20; Mary $10

Bob: $30; Mary $-9

Bob: $40; Mary $12

Bob: $90; Mary $15

Bob: $70; Mary $-8

Bob: $50; Mary $-7