 Economics of Business E1600 Sample Midterm Questions 1. The Agency Problem or Principal-Agent Problem may arise when: a. The Agent has an informational advantage over the Principal b. An Agent with informational advantages seek to exploit it at a cost to the Principal c. The Principal cannot “meter” the Agent completely or without cost d. All of the above 2. After a comprehensive study of the Hardknocks Company’s labor productivity, students from Economics E1600 prepared the curve below relating firm profitability to the number of employees. Point A represents the point of inflection where the rate of increase in profitability begins to diminish; point B where the profitability reaches a maximum; and point C where the rate of declining profitability begins to accelerate. Which point representing profitability and employee numbers would the students recommend? a. Point A where diminishing returns begin setting in. b. Point B where the greatest profitability is realized c. Point C just before diminishing returns accelerate d. None of the above, there is not enough information to answer the question 3. Is it possible to observe a negative s value in a “sharecropping” contract? Which statement is most accurate? a. No, people would not pay to work b. No, it is illegal in most countries to require that workers pay for the opportunity to work c. Yes, some jobs are so good, people do them for free or even pay to do them d. Yes, workers may pay a fee to buy into fields such as taxi driving where participation is limited to license holders or renters. 1 Economics of Business E1600 Sample Midterm Questions 4. The graphic below illustrates Hirshleifer’s case where internal transfer prices between divisions A and B of a vertically integrated company are autonomously (no central direction) determined to maximize the firm’s total profit. Which statements are consistent with this situation? , a. The market for the final product is competitive and only complete or finished goods are sold b. The transfer price of intermediate good A is determined by subtracting the marginal cost of intermediate good B, MCB, from the price received for the final or complete good, PC. c. The profit contribution (excess of revenues over costs) of division B is much less than that of division A d. Answers (a) and (b) 2 Economics of Business E1600 Sample Midterm Questions 5. Williamson seeks to understand how firms and markets differ in their handling of transactions in regard to three dimensions. He asks first, “what advantages do markets have over firms?” For non-asset specific transactions which statements are most accurate? a. Markets typically enjoy production cost advantages through their ability to realize greater scale economies b. Markets are less able to aggregate uncorrelated demands c. Markets usually do not enjoy governance cost advantages when large number of parties transact for commodities d. External or market procurement is more hazardous than internal production 6. Most discussions of scale economies focus only on expected production costs. Coase long ago pointed out, and many economists have since repeated, that diminishing returns to management may be a significant factor in firms failing to realize fully physical scale economies and encountering limits to their size. Based on our readings, which statements are accurate? a. Size and complexity may increase the metering and monitoring costs (Alchian and Demsetz) or internal transaction and governance costs (Williamson) to the point where they offset physical or technological scale economies. b. In an effort to economize on metering and monitoring costs or spur productivity, managers may impose invasive and impersonal control technologies or techniques that enervate and alienate employees. c. We would expect, all other things equal, to see diminishing returns to management earlier in firms and industries where relational contracts are important than in firms where standardized market or classical contracts are predominately used for governance. d. (a) and (b) e. All of the above 3 Economics of Business E1600 Sample Midterm Questions 7. Williamson builds on Alchian and Demsetz (1972) to create a framework for employee and human resource management. Alchian and Demsetz emphasized the metering dimension and, in particular, non-separable, team-based, cooperative efforts (what Williamson calls primitive teams) that are difficult to meter. Williamson adds the dimension of asset or firm-specificity. This allows Williamson to create a two-by-two matrix (above) relating job dimensions to the forms of governance. Which of these statements is (are) an accurate portrayal of the different forms of internal governance structures? a. Spot Market. Easily metered and general (or non-specific) human assets are typically governed in a manner akin to spot markets. Since the employees are easily replaced or can easily find new jobs, the bonds between employee and firm are light. b. Obligational Market. Easily metered but non-specific human assets share an interest with the firm in continuing the relationship and so steps will be taken to define obligations such as non-vested retirement or formal job protections. c. Primitive Team. Easily metered but non-specific human assets may enjoy highly protected status within the firm due to the benefits of familiarity. d. Relational Team. Human assets that are highly specific to the firm and difficult to meter form relational teams that are easy to develop and nurture. 4 Economics of Business E1600 Sample Midterm Questions 8. Stigler (1951) built on Adam Smith’s 1776 observation that, “the division of labor is limited by the extent of the market.” Which statements are consistent with his model of industry life cycle and degree of vertical integration? a. In many industries we observe firms beginning as very specialized entities and over time bringing more and more production functions inside to become highly vertically integrated for the remainder of their lives. b. In their early days many firms conduct activities that exhibit decreasing costs over the range of their output but shed those activities when the market grows large enough to support specialized firms conducting those activities. c. Outsourcing is typically found in those sectors where increasing unit costs appear at relatively low levels of production. d. All of the above. 9. In The Republic (Part II) Plato, speaking through Socrates notes, “Society originates, then, so far as I can see, because the individual is not self-sufficient, but has many needs which he can’t supply himself.” Then, after enumerating the basic needs of a state, he goes on, “It will need a farmer, a builder, a weaver, and also, I think, a shoemaker and one or two others to provide for our bodily needs.” Which then brings Socrates to the matter of allocation of effort and reward, “Then should each of these men contribute the product of his labour for common use? For instance, should the farmer provide enough food for all four of them and devote enough time and labour to food production to provide for the needs of all four? Or alternatively, should he disregard the others, and devote a quarter of his time to producing a quarter of the amount of food, and the other three quarters one to building himself a house, one to making clothes, and another to making shoes? Should he, in other words, avoid the trouble of sharing with others and devote himself to providing for his own needs only?” To this question, Adeimantus replied, “The first alternative is perhaps the simpler.” What position is most consistent with what we have learned about incentives and opportunism (recall that Plato was a communist)? a. Agree with Adeimantus because occupational specialization will always produce more total wealth than would generalists b. Disagree with Adeimantus because the assumed “contribution” or “sharing” will not work without a pricing mechanism (even barter) to govern transactions c. Not sure, because even flawed specialization and division of labor is still likely (but not certain) to produce more wealth than a community of selfsufficient people d. Not sure, because with no market price mechanism, all of the workers have an incentive to shirk once they’ve taken care of their own needs. 5 Economics of Business E1600 Sample Midterm Questions The graphic below may be helpful for the next several questions A Number of Firms B a b C c D Net Number of Producers Entrants (+) Exiters (‐‐‐) 0 Time Product Life Cycle 10. Klepper indicates that the number of entrants may rise or decline initially but eventually must fall to zero. At what point on the graph does this decline begin? a. Where line b intersects the net producer curve at its highest point (that is where exiters = entrants) b. Where line c intersect the x-axis and entrants decline to zero c. Somewhere in region D at the point where the exiters line crosses the xaxis d. None of the above 11. Assuming that the number of potential entrants in time t, Kt , is constant or declines over time, what statement most accurately explains the eventual decline in entrants, Et ? a. The standard product price is driven down over time by the incumbents’ increasing investment in process innovation, rcit , increasing incumbent advantage over potential entrants b. The declining standard product price increases the entrants’ need to generate profits from distinctive product variants c. In each period, the declining standard product price and the increasing level of product innovation expertise required to break-in results in lowering the percentage of potential entrants with expected positive profits and eventually that number reaches zero d. None of the above 6 Economics of Business E1600 Sample Midterm Questions 12. Nelson and Winter introduce the concept of the “competence puzzle” to distinguish among levels of rationality and to illuminate the reasons for different levels of performance or competence by the same actor or organization. Which factors tend to be associated with high competence? a. The degree to which skills and routines can be learned through practice b. Learning that can be guided by clear short term feedback c. Environments with rising competitive standards d. All of the above 13. Ronald Coase is generally credited with the first compelling explanation of why firms rather than markets were used to conduct some transactions. What is the fundamental reason given by Coase for the evolution of firms. a. Firms can use hierarchy to organize and direct resources b. Firms can take advantage of risk-sharing arrangements and capital markets to support investment in productive assets that the market cannot c. There are costs to using the market, for example simply determining the price of resources d. All of the above 7