Deck 14: Transaction Costs, Imperfect Information, and Behavioral Economics

Question 1

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.

Answer 1

C

Question 2

Suppose that you can either buy a radio from a firm for $50 or find and purchase the components yourself and then either assemble them yourself or hire someone to do so. You should

A) buy the radio because it's possible to do so
B) assemble the radio yourself because it's possible to do so
C) assemble the radio yourself only if you know how to do so
D) assemble the radio yourself only if the total price of all the components is less than $50
E) assemble the radio yourself only if the total price of all the components plus the value of your own time is less than $50

Answer 2

E

Question 3

If transaction costs of market exchange are small, then a firm will expand to produce more of its product internally.

Answer 3

False

Question 4

Firms emerge when transaction costs of using the market are less than the cost of hierarchical control.

Question 5

Production through the firm is often more efficient than market exchange when

A) production requires many transactions among many resource owners
B) production requires few transactions between two resource owners
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

Question 6

According to Coase, the optimal allocation of resources is guided by

A) the decisions of a firm's managers
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

Question 7

Ronald Coase's study, "The Nature of the Firm," argued that

A) market exchange is less costly than hierarchical exchange
B) markets are more efficient than hierarchies
C) firms are formed to take advantage of situations in which hierarchies are more efficient than markets
D) the role of the entrepreneur is primarily to deal with central authority
E) markets tend to be less competitive over time

Question 8

According to 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) implicit contracts in the market can be made explicit in a firm

Question 9

In a world of perfect information, if consumers could costlessly contract with private contractors to produce a good and there were no economies of scale,

A) firms would be unnecessary
B) markets would be unnecessary
C) consumers would be unnecessary
D) consumers would face greater production costs
E) firms would be more efficient than the market

Question 10

Ronald Coase's insight regarding the firm was that

A) firms tend to be more profitable when economies of scale are greater
B) uncertainty and information are the keys to perfect competition
C) perfectly competitive firms tend to displace monopolies
D) economic activity is best understood in terms of the transaction costs of exchange
E) consumers often carry out transactions directly with resource suppliers

Question 11

For the average homeowner, which of the following tasks is most likely to be contracted for?

A) fixing a shelf
B) hanging a painting
C) moving furniture
D) rewiring the kitchen lighting
E) repainting a bedroom

Question 12

According to Coase, firms

A) exist because the entrepreneur must prevent shirking
B) should not exist
C) should not exist if all participants in a market have perfect information
D) exist because of the transaction costs of coordinating many resources through markets
E) increase production costs and should therefore be limited

Question 13

Ronald Coase's study, "The Nature of the Firm," argued that firms are formed to take advantage of situations in which hierarchies are more efficient than markets.

Question 14

If the production of a sofa requires the purchase of 3 types of inputs and the production of a harp requires the purchase 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 is more likely to be done by firms than sofa production is
D) sofa production is more likely to be done by firms than harp production is
E) both harp and sofa production will always be done by firms because there is more than one input involved in each

Question 15

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 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

Question 16

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 concentration in U.S. industry

Question 17

The firm becomes the dominant organization type whenever

A) markets exist
B) markets don't exist
C) the net value of centralized, organized production exceeds the net value of market-arranged production
D) the net value of market-arranged production exceeds the net value of centralized, organized production
E) private enterprise eliminates shirking

Question 18

It is not uncommon for people to buy all the components for a computer and assemble them rather than purchase a fully assembled computer. What does this behavior demonstrate?

A) computers are easy to assemble
B) people are irrational
C) many people have the knowledge necessary to assemble computers
D) the total price of the computer components is less than the price of the computer
E) the total price of all the computer components plus the value of the person's time is less than the price of the computer

Question 19

A do-it-yourself approach to production is more likely when

A) technology is complex
B) inputs are difficult to identify
C) resources cannot easily be measured
D) the price of inputs is known
E) contracts are complex

Question 20

If we assume perfect information, perfect mobility of resources, and no transactions costs, then there is little need for firms.

Question 21

If the minimum efficient scale in toaster production is 500,000 units per year, the average cost of producing 300,000 toasters is greater than the average cost of producing 500,000.

Question 22

Jack F. Altrades's decision whether to purchase a good from a firm or hire resources directly in the market will

A) depend, in part, on his production skill but not on his contract negotiation skill
B) depend, in part, 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

Question 23

Vertical integration has no effect on the internal organization of a firm; it only affects the outside markets.

Question 24

One reason a computer manufacturer may produce its own microchips rather than buy them is that it can maintain control over production quality.

Question 25

Vertical integration is

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) a way for a firm to accumulate information about its competitors

Question 26

When several resources are combined in the production of a good,

A) it is easy to determine the marginal products of the various resources
B) the marginal contribution of each input often cannot be observed
C) allocating revenue among the various resources is easy
D) there is more competition for each of the resources used
E) there is less competition for each of the resources used

Question 27

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.

Question 28

Wendy's must decide whether to grow its own potatoes for French fries. 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.
B) Yes, because Wendy's managers have bounded rationality.
C) No, because there is a small number of potato suppliers.
D) Yes, because there is a small number of potato suppliers.
E) No, because it is easy to observe the quality of potatoes.

Question 29

Don's Pasture Apple Cider Company buys four inputs: apples, glass bottles, apple presses, and computers for record keeping. If the company decides to become more vertically integrated, it will

A) probably start growing apples next
B) probably start making glass bottles next
C) probably start making apple presses next
D) probably start making computers next
E) have to grow apples and make glass bottles, apple presses, and computers

Question 30

When a firm is operating at its minimum efficient scale, its short-run average total cost of production is minimized.

Question 31

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 on finding manufacturers and negotiating contracts. Spacely is capable of making its own flanges at a cost of $980 per million. Given these costs,

A) Spacely should continue to contract out for flanges
B) Spacely should start to manufacture its own flanges
C) it's not possible to say what Spacely should do
D) Spacely should stop paying the additional $20 to find and negotiate contracts and just buy the flanges outright for $1,000 per million
E) Spacely should move away from the use of flanges and toward an input that it can produce by itself

Question 32

By integrating vertically,

A) firms trade with one another through markets
B) firms trade with one another through government intermediation
C) firm and market processes are connected to produce a good or service most efficiently
D) the various procedures involved in producing a good are collected within one firm
E) the various procedures involved in producing a good are parceled out among various contractors

Question 33

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

Question 34

The more complicated a production process is,

A) the lower the transactions cost of using markets
B) the lower the cost of production
C) the more likely the market will be used to organize production
D) the more likely that transaction costs decrease through centralized control of production
E) the more likely that transaction costs decrease through use of markets

Question 35

Managers experience bounded rationality when they focus narrowly on maximizing their firm's profits and ignore the broader perspective of society's preferences.

Question 36

If the minimum efficient scale in the production of aluminum exceeds the quantity of aluminum any individual siding producer buys, siding producers should integrate backward into aluminum production.

Question 37

Which of the following is true of vertical integration?

A) It leads to the formation of larger firms from smaller ones.
B) It occurs when a firm adds more layers of management.
C) It occurs when firms try to buy up their competitors and corner the market.
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.

Question 38

The more complicated the process used to produce a good,

A) the greater are the transaction costs of organizing production through markets
B) the lower are 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 consumers will choose to purchase the good over other alternatives in the market

Question 39

The simpler a production process is,

A) the greater the cost of production
B) the greater the transaction cost of using markets
C) the more likely a firm will use the market to organize production
D) the more likely a firm will used centralized control to organize production
E) the more likely that transaction costs increase by using centralized control of production

Question 40

Which of the following is the best example of vertical integration

A) an auto firm acquires a tire manufacturer
B) a farmer buys the neighboring farm
C) a retail store buys an internet retailer
D) a software company buys a soft drink manufacturer
E) a hotel chain buys a fast food chain

Question 41

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) firms do not make high-quality microchips
D) managers at the computer firm place a high value on their time
E) firms do not produce goods for the market that can be made in-house

Question 42

If the minimum efficient scale in the production of rubber exceeds the quantity of rubber any individual tire producer buys,

A) tire producers should integrate backward into rubber production
B) there will be a monopoly in rubber production
C) tire producers should not integrate backward into rubber production
D) tire producers will be charged prices above what the cost of producing rubber themselves would be
E) tire companies will switch to fiberglass

Question 43

If the minimum efficient scale in woodstove production is 100,000 units per year,

A) the average cost of producing 50,000 stoves is greater than the average cost of producing 100,000
B) the average cost of producing 50,000 stoves is equal to the average cost of producing 100,000
C) the 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 100,000 woodstoves
E) MC exceeds AC at 100,000 stoves

Question 44

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 do not make high-quality pickles
D) people place a high value on their time
E) firms do not produce goods that can be made at home

Question 45

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 300,000 toasters is equal to the average cost of producing 500,000
C) the total cost of producing 300,000 toasters is greater than the total cost of producing 500,000
D) the firm should not produce more than 500,000 toasters
E) MC exceeds AC at 500,000 toasters

Question 46

Exhibit 14-1
Which of the following is indicated in Exhibit 14-1?

A) Rubber is cheaper to produce than 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 the 200,000th tire must exceed the average cost of 200,000 tires.

Question 47

The McDonald's restaurants in Russia grow their own potatoes to guarantee that they are grown correctly. Growing potatoes is very different from running a fast-food restaurant. One could say of McDonald's decision to grow its own potatoes for the Russian franchise that

A) the bounded rationality criterion outweighs the need for quality control
B) the bounded rationality criterion is outweighed by the need for quality control
C) both bounded rationality and the need for quality control are factors that make it rational for McDonald's to grow its own potatoes
D) growing potatoes is irrational
E) there must not be many potato suppliers in Russia

Question 48

If the quality of an input is easily determined at the time of purchase, then it is likely to

A) be the cause of high transaction costs of using markets
B) encourage vertical integration of a firm
C) encourage supplier firms to produce low-quality inputs
D) be produced internally by the firm
E) be purchased in the market

Question 49

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) long-run profit is maximized
E) profit is at a maximum

Question 50

The limit on the amount of information a manager can comprehend about a firm's operation is known as

A) adverse selection
B) bounded rationality
C) diseconomies of scope
D) managerial incompetence
E) moral hazard

Question 51

Which of the following would not limit the extent of a firm's vertical integration?

A) the managers' bounded rationality
B) a large 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) many interchangeable suppliers of the firm's inputs
E) high transaction costs of contracting with resource suppliers

Question 52

Exhibit 14-1
In Exhibit 14-1, suppose each tire produced requires ten pounds of rubber. Which of the following is true?

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.

Question 53

Suppose there is only one producer of frames, a necessary component in manufacturing computer monitors. Because of the threat of entry, this firm charges its customers a price equal to average cost. One reason that a producer of computer monitors may make rather than buy frames is

A) the frame supplier may be unreliable
B) the total cost of the components of frames is the same as the price of frames purchased in the market
C) the frame manufacturer has no incentive to make high-quality frames
D) managers at the computer monitor firm place a high value on their time
E) the frame manufacturer will soon go out of business because firms do not produce goods for the market that can be made in-house

Question 54

Used car dealers are able to make a profit by buying used cars at a low price and selling them at a higher price because

A) they sell lemons
B) they can take advantage of unsuspecting consumers
C) they are attempting to maximize their profits
D) the transaction costs to some buyers is less than it would be without the used car dealers
E) there are no transaction costs associated with the process of buying a used car

Question 55

If the minimum efficient scale in aluminum production exceeds the quantity of aluminum any individual aluminum siding producer buys,

A) siding producers should integrate backward into aluminum production
B) there will be a monopoly in aluminum production
C) siding producers should not integrate backward into aluminum production
D) siding producers will be charged prices above what the cost of producing aluminum themselves would be
E) siding companies will switch to vinyl

Question 56

Apple Computer 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

Question 57

One reason many people make their own Hollandaise sauce rather than buy it 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 sauce
C) firms do not make high-quality Hollandaise sauce
D) people place a high value on their time
E) firms do not produce goods that can be made at home

Question 58

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

Question 59

The Criminal Records Corporation is operating at its minimum efficient scale, selling 10,000 records per month via late-night cable TV advertising. It currently buys pressed records from Hole-in-the-Middle, Inc., which has a minimum efficient scale of 100,000 records per month. Which of the following should Criminal Records do?

A) Continue to buy 10,000 records from Hole-in-the-Middle, which can make the records more cheaply.
B) Buy 100,000 records from Hole-in-the-Middle, so that company can reach its minimum efficient scale too.
C) Buy Hole-in-the-Middle and use its facilities to manufacture the 10,000 records it needs.
D) Buy Hole-in-the-Middle and stop operating as Criminal Records because Hole-in-the-Middle is the more efficient business.
E) Buy Hole-in-the-Middle and stop operating as Criminal Records because Hole-in-the-Middle is the larger business.

Question 60

Exhibit 14-1
Which of the following is indicated in Exhibit 14-1?

A) Rubber is cheaper to produce than 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 the 200,000th tire must exceed the average cost of 200,000 tires.

Question 61

If a firm experiences economies of scope,

A) its average cost falls as it increases output
B) its average cost rises as it increases output
C) average production costs fall when it produces more than one kind of product
D) it should integrate vertically
E) average production costs rise as it produces more kinds of products

Question 62

If a firm that experiences economies of scope doubles its production of an item, its costs will less than double.

Question 63

Economies of scope exist when it is less expensive to produce two or more product lines in a single firm than it is to produce them separately.

Question 64

For most consumers, the process of learning about the efficiency and durability of various brands of refrigerators can be considered

A) irrational
B) unproductive
C) a vocation
D) nonmarket work
E) costless

Question 65

According to the search model, Consumer Reports magazine benefits consumers by increasing the marginal benefit of information.

Question 66

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) Americam Apparel, which from a single building in downtowm LA, controls the dyeing, finishing, designing, sewing, cutting, marketing and distribution of the company's product.
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

Question 67

If a firm experiences economies of scope, per unit production costs fall as it produces more than one kind of product.

Question 68

Suppose a company that produces mouthwash branches out into producing toothpaste. If this expansion reduces the average cost per unit, the company must

A) benefit from vertical integration
B) benefit from horizontal integration
C) experience economies of scale
D) experience economies of scope
E) have no transaction costs

Question 69

The optimal searcher is likely to not even attempt to secure perfect information even if it is possible to achieve it.

Question 70

Suppose a company that produces furniture wax branches out into producing a dusting product like Lemon-Dust-Away. If this expansion is efficient, the company must

A) benefit from vertical integration
B) benefit from horizontal integration
C) experience economies of scale
D) experience economies of scope
E) have no transaction costs

Question 71

A horizontally integrated firm produces products in a variety of industries (e.g., General Electric, which produces jet engines, air conditioners and microwave ovens).

Question 72

Reliable information is

A) costly for consumers, but not for producers
B) costly for producers and consumers
C) freely available
D) costly for producers, but not for consumers
E) not relevant to economic decision making

Question 73

A tire manufacturer decides to expand into the production of rubber roofing and as a result finds that its per unit production costs for tires falls. This is an example of economies of scope.

Question 74

Which of the following is an example of a producer taking advantage of economies of scope?

A) A farmer buys more land so he can produce more soybeans.
B) GM closes a Chevy truck plant in response to a decline in the demand for trucks.
C) Disney World stays open later to serve more customers per day.
D) A dairy farmer produces cow's milk and butter.
E) A mouthwash firm expands production by improving management efficiency.

Question 75

For most consumers, the process of gathering information can be considered

A) irrational
B) unproductive
C) a vocation
D) nonmarket work
E) costless

Question 76

A farmer doubles her acreage of corn and as a result finds that her costs per bushel of corn drop. She has experienced economies of scope.

Question 77

Which of the following is the most likely result when there are economies of scope?

A) outsourcing
B) vertical integration
C) natural monopoly
D) multi-product firms
E) adverse selection

Question 78

If a firm experiences economies of scope, per unit production costs fall as it produces more and more of its product.

Question 79

Economies of scope is the term used to describe an industry that is composed of firms having substantial economies of scale.

Question 80

According to the search model, the marginal benefit of acquiring information about a product is greater for expensive items than for cheap items.