Econ151_Introduction to Economics Professor: Chen Wu

BU5210 _ ECONOMIC ANALYSIS Dr. Chen Wu

Problem Set 1 (KEAT CH1: Introduction to Managerial EconomicsKEAT CH2: The Firm and Its Goals)

These questions are designed to facilitate your study of lecture notes, textbook and other course materials. The problem set will be graded. You are encouraged to discuss them with your classmates and learn from each other. Feel free to ask me questions during my office hours, and you should always consider me for your primary source of help. Please be advised some questions in the problem set may appear in exams.

Part One: Multiple Choice Questions (2 points * 16 = 32 points)

__B__ 1) Managerial economics is best defined as the economic study ofA) how businesses can make the most profits.B) how businesses can decide on the best use of scarce resources.C) how businesses can operate at the lowest costs.D) how businesses can sell the most products.

_D___ 2) Scarcity is a condition that exists whenA) there is a fixed supply of resources relative to the demand for the product.B) there is a large demand for a product.C) resources are not able to meet the entire demand for a product.D) All of the above

__A__ 3) Which of the following is not considered as a factor of production?A) moneyB) machinery and equipmentC) landD) unskilled labor

__A__ 4) Which of the following is the best example of how the question of "what goods and services to produce?" is answered by the command process?A) government subsidies for windmill energy productionB) laws regarding equal opportunity in employmentC) government allowance for the deduction of interest payments on private mortgagesD) government regulations concerning the dumping of hazardous waste

__C__ 5) Which of the following is the best example of "how goods and services should be produced?"A) complying with the technical specifications in the production of an aircraftB) the production of jet aircraft for the air force or for a commercial airlineC) the use of additional workers versus the use of machines in the production of goodsD) the production of a new manufacturing facility

_D___ 6) Which of the following is the best example of the "command" process?A) United Airlines buys Northwest Airlines.B) Striking auto workers force General Motors to shut down its factories.C) Banks raise their fees on late payments by credit card holders.D) The FCC requires local telephone companies to provide access to their local networks before being able to offer long distance service.

___B_ 7) In the text, the key question in the "economics of a business" isA) whether the need to grow revenues is being met.B) should the firm be in the business in which it is operating.C) whether the firm faces rising labor costs.D) can the firm affect its market share.

___b_ 8) The economic concept of "opportunity cost" is most closely associated with which of the following management considerations?A) market structureB) resource scarcityC) product demandD) technology

_C___ 9) A company will strive to minimizeA) transaction costs.B) costs of internal operations.C) total costs of transactions and internal operations combined.D) variable costs.

___D_ 10) A large corporation's profit objective may not be profit or wealth maximization, becauseA) stockholders have little power in corporate decision making.B) management is more interested in maximizing its own income.C) managers are overly concerned with their own survival and may not take all prudent risks.D) All of the above

__B__ 11) Goals which are concerned with creating and maintaining employee and customer satisfaction and social responsibility are referred to as ________ objectives.A) social B) noneconomic C) welfare D) public relations

__B__ 12) Financial risk is associated with changes inA) the demand for a firm's products.B) a firm's debt.C) a firm's labor costs.D) government regulations of a firm's activities.

_B___ 13) Unlike an accountant, an economist measures costs on a(n) ________ basis.A) explicitB) replacementC) historicalD) conservative

__D__ 14) The calculation of stockholder wealth involvesA) the time-value of money concept.B) the cash flow stream.C) business and financial risk.D) All of the above

__A__ 15) Accounting costsA) are historical costs.B) are replacements costs.C) usually include implicit costs.D) usually include normal profits.

__C__ 16) A firm's "normal profit" is best characterized by theA) average of a firm's profits over the past five years.B) amount of profit necessary to keep the price of a firm's stock from changing.C) amount of profit a firm could earn in its next best alternative activity.D) the average amount of profit earned in the firm's industry.

Part Two: Analytical Questions (6 points * 3 = 18 points)

Question 1 (Introduction to Managerial Economics)Elaborate on the basic economic questions of what, how and for whom. Following are examples of typical economic decisions made by the managers of a firm. Determine whether each is an example of what, how, or for whom.a. Should the company make its own spare parts or buy them from an outside vendor?b. Should the company continue to service the equipment that it sells or ask customers to use independent repair companies?c. Should a company expand its business to international markets or concentrate on the domestic market?d. Should the company replace its own communications network with a virtual private network that is owned and operated by another company?e. Should the company buy or lease the fleet of trucks that is uses to transport its products to market?

Question 2 (The Firm and Its goals)Discuss the meaning of the term principal-agent problem. Why does this problem exist? What are some of the forces that cause managers to act in the interest of shareholders?

Question 3 (The Firm and Its Goals)A company has 2 million shares outstanding. It paid a dividend of $2 during the past year, and expects that dividends will grow at 6 percent annually in the future. Stockholders require a rate of return of 13 percent. What would you expect the price of each share to be today, and what is the value of the companys common stock?

Question 1

a) How, it is one of the important managerial decisions for a company decide how it is going to produce goods , it can range from buying raw material to build something from scratch or buying spare parts from a vendor as stated in the example. Option that is more viable and the one that keeps the transaction costs down is the best one to chooseb) What, is one of the first questions a company has to answer as to what goods the company wants to produce or similarly what services. And when it is going to discontinue production of a good /service and begin producing a new and different product. c) Whom , this question helps managers decide what segment of market to focus on ,analysis of current and future market demands helps in finding out a target market which has a demand for a product that is being produced as it is essential for maximization of profit.d) How, another part of the question as to how a company should produce goods , is hiring staffing , procurement and capital budgeting , as long as it is more economically feasible it can be a good decision to outsource some functions of the company as in the example.e) How, this also an example of how a company decides to produce goods and supply to the market

Question 2 Principal-agent is a term that is used to describe a problem that arises due to the difference in objectives between the owner that are the stockholders and the management of a company /business. It is a complimentary relationship. This problem arises because the Agent (management) sometimes may not act in the best interest of the principal (stockholder) even though that that might be a good decision from managements point of view. There are few factors that can cause managers to act in favor of stockholders.As Banks , insurance companies and mutual funds buy large amounts of stock of big corporations as suggested by their expert analysts . If such a corporation and its management underperform, they might not show signs of future growth , that can lead these institutions to sell these stocks and the corporations stock prices will fall. This can result in takeovers and change of management. This is something the management would want to avoid. Other large stockholders play a vital role in such situations similar to one described above and can influence management through proxy if they dont perform up to the mark. Competitive pressure from other companies also stimulates management to perform and if they dont a common average stockholders sells off his share as its value and the dividends he receives decrease. This can lead to fall in stock prices. Now shareholders have more say in functioning of a corporation for example in electing directors and how much pay executives get since the passing of Sarbanes-Oxley 2002 Another motivational factor for Managers is that mangers who perform well have a higher demand in Manager labor market and will have more value than managers who underperform. In Addition to all this managements remunerations and compensation packages are tied to the objectives of stockholders in a way that if the corporations perform well their profits and stock value increases their remunerations and compensation packages further improve. These are some of the forces that cause mangers to act in favor of stockholders.

Question 3

P = D / (k g)

P = 2 / (0.13 0.06)

P = 28.57

Value Of company stock = 28.57 x 2 = $57.14 million 5 / 5