Deck 8: Governing Business

Question 1

Which of the following is true of the principal-agent problem?

A) It arises when the interests of the agent and the principal differ.
B) It arises when it is relatively easy for the principal to monitor the agent's performance.
C) When there is a principal-agent problem, agency costs are zero.
D) When there is a principal-agent problem, the agent is usually worse off.

Answer 1

It arises when the interests of the agent and the principal differ.

Question 2

Which of the following would be an example of moral hazard?

A) An employee is hired to work 10 hours a day, but instead shirks work and leaves early.
B) A taxi driver takes a passenger on a longer-than-usual route hoping to generate a higher
C) A manager informs shareholders that the ?rm's pro?ts may not be as high as expected due to an increase in costs
D) The owner of a ?rm monitors his employees through performance-linked pay and sales

Answer 2

An employee is hired to work 10 hours a day, but instead shirks work and leaves early.

Question 3

Under the piece-rate system, wages are paid _____.

A) according to the output produced
B) as a percentage of the total sales of the ?rm
C) according to the number of hours of labour
D) as a percentage of the pro?ts earned by the ?rm

Answer 3

according to the output produced

Question 4

For performance contracts to be successful:

A) workers should be able to unduly in?uence the measure.
B) workers must be willing to receive greater reward for greater risk.
C) worker performance is focused on a single objective.
D) there needn't be a strong link between worker effort and the performance measure.

Question 5

Which of the following explains why diversi?cation of a business is in the managers' interest?

A) It protects the shareholders from risk.
B) It is an example of expense preference behaviour.
C) It maximizes the ?rm's pro?ts.
D) It diversi?es a risk that only managers face.

Question 6

Managers, and not owners, will seek to maximize growth because:

A) growth maximization is the same as pro?t maximization.
B) measuring the growth of a ?rm can be subjective.
C) a manager's pay is usually linked to the size of the business.
D) growth maximization will allow the ?rm to satis?ce on various targets.

Question 7

Which of the following correctly describes moral hazard-type behaviour by managers?

A) Managers disclose complete information about their behaviour to the shareholders.
B) Managers offer to increase sales and pro?ts but, once hired, act in their own interests.
C) Managers reduce the monitoring costs through good performance.
D) Managers help in the expansion of the business and increase pro?ts.

Question 8

Moral hazard can be reduced at the workplace by _____.

A) setting and monitoring targets for managers
B) aiming to maximize growth and not sales
C) paying managers higher salaries
D) increasing the number of managers in the ?rm

Question 9

Pro?ts may decline when sales increase if:

A) there are diseconomies of scale.
B) costs remain constant.
C) there are increasing returns to scale.
D) the variable cost of production falls.

Question 10

The senior manager at a ?rm sets a sales target of 20 000 units for the month. Most other ?rms in the market also have similar targets. However, the maximum possible sales in the market was found to be 35 000 units per month. This suggests that:

A) growth maximization is the ?rm's goal.
B) the ?rm does not have principal-agent problems.
C) the senior manager exhibits satis?cing behaviour.
D) salaries at this ?rm are linked to pro?ts.

Question 11

Which of the following is an example of expense preference behaviour by managers in a ?rm?

A) Consumption of perquisites.
B) Goal setting.
C) Satis?cing.
D) Sales maximization.

Question 12

Which of the following could explain why bad management teams continue to be employed by a ?rm?

A) The shareholdings in the ?rm are highly dispersed.
B) Ownership and control in the ?rm are not separate.
C) The shareholders' objective is to maximize the ?rm's pro?ts.
D) The objectives of managers and workers in the ?rm are closely aligned with each other.

Question 13

Which of the following forms of organization is likely to face problems of ownership and control?

A) A family-run sole proprietorship ?rm.
B) A small not-for-pro?t organization that employs only 10 people.
C) A partnership ?rm where each partner is also a manager.
D) A large corporation where each shareholder owns less than 1% of the total stock.

Question 14

The principal-agent problem arises when:

A) principals and agents have the same objectives.
B) principals have more information than agents.
C) it is di?cult for the principal to monitor the agent.
D) the agents disclose full information regarding their behaviour.

Question 15

Which of the following is a solution to the principal-agent problem within a ?rm?

A) Provide the managers with shares in the company.
B) Increase the managers' annual sales target.
C) Increase the ?xed component of an employee's salary.
D) Allow the government to set rules on performance.

Question 16

_____ is most likely to be a free rider.

A) A managing director of a ?rm, who also owns a substantial percentage of the ?rm's stocks
B) A manager whose pay is linked to the pro?ts earned by the company
C) An employee who is compensated solely on the basis of his team's aggregate performance
D) A factory worker whose daily work can be easily monitored

Question 17

Satis?cing behaviour would NOT involve:

A) separation of ownership and control.
B) attaining average levels of performance.
C) setting and achieving the highest target possible.
D) trade-offs between managers and owners.

Question 18

How might an employer reduce the agency costs associated with an employment contract?

A) Reduce the effort and cost spent in monitoring the employee's work.
B) Reduce the employee's probation period.
C) Link the employee's pay to the level of output.
D) Increase the number of levels in the management hierarchy.

Question 19

According to _____, managers use the company's funds to ?nance a prestigious image makeover and lifestyle.

A) the expense preference behaviour theory
B) Maslow's heirarchy of needs
C) Porter's ?ve forces model
D) the human capital and development theory

Question 20

The costs of _____ are termed agency costs.

A) research and development
B) advertising
C) monitoring performance
D) producing a good

Question 21

When a good generates a negative externality in the market:

A) society's scarce resources are allocated e?ciently.
B) its marginal social cost is greater than its marginal private cost.
C) the good's price accurately re?ects the cost of the externality.
D) the quantity demanded of the good will be equal to zero.

Question 22

Which of the following could create a negative externality?

A) A ?rm using pollution-intensive machinery.
B) An individual gaining a university degree.
C) A ?rm increasing the number of training programmes.
D) An individual being vaccinated against a disease.

Question 23

In the following graph, MPC and MSC represent the marginal private cost and marginal social cost of producing a good respectively. QD represents the demand for the good. Refer to the graph to answer the question. Which of the following statements is true?

A) The MPC of production is greater than the MSC of producing the good.
B) The quantity of the good produced in the market will be higher than the socially optimal
C) For the market to produce the socially optimal level of output, the government should provide a subsidy.
D) There is a positive externality associated with the production and consumption of this

Question 24

Under a performance contract, a dentist would be paid:

A) according to the number of hours spent at the dental clinic.
B) according to the number of days worked in a month.
C) a ?xed amount every month.
D) according to the number of dental treatments provided to patients.

Question 25

An externality exists in the production of a good or service when:

A) the marginal cost to society of consuming an extra unit of a good equals the marginal social bene?t.
B) resources are allocated such that no one can be made better off without making someone
C) the marginal social cost differs from the marginal private cost of production.
D) markets are allocatively and productively e?cient.

Question 26

If either consumers or producers have incomplete information about the safety of a good, then:

A) the market price would differ from the marginal social cost and marginal social bene?t of the good.
B) the quantity of the good demanded and supplied would be equal to zero.
C) the quantity demanded of the good would exceed the quantity supplied.
D) there would be a persistent surplus of the good on the market since producers will

Question 27

In the following graph, MPC and MSC represent the marginal private cost and marginal social cost of producing a good respectively. QD represents the demand for the good. Refer to the graph to answer the question. The socially optimum level of output is _____ of the good.

A) 400 units
B) 1000 units
C) 1600 units
D) 2200 units

Question 28

Which of the following is likely to generate a positive externality?

A) An industry dumping chemical waste into a local river.
B) An individual planting ?owers in his garden.
C) A teenager playing loud music at home.
D) A tree being hit by lightning.

Question 29

Which of the following is true of Pareto e?ciency?

A) It is consistent with productive and allocative e?ciency.
B) It is an example of a pricing strategy by a price leader.
C) It is achieved when ?rms make the highest possible level of output.
D) It is a measure of accounting e?ciency.

Question 30

Market failure is likely in markets that:

A) are perfectly competitive.
B) have complete information.
C) are e?cient in production
D) have negative externalities.

Question 31

In the following graph, MPC and MSC represent the marginal private cost and marginal social cost of producing a good respectively. QD represents the demand for the good. Refer to the graph to answer the question. The private ?rm will maximize pro?ts by producing _____ of the good.

A) 1000 units
B) 400 units
C) 1600 units
D) 2200 units

Question 32

Which of the following is true of perfect competition?

A) Pareto e?ciency holds in perfect competition.
B) Firms operate at the highest point on their long-run cost curve.
C) The price in the market is higher than the marginal cost.
D) Firms make the highest level of output at the highest possible cost.

Question 33

Pareto e?ciency is achieved when:

A) producers are price-setters in the market.
B) market prices are greater than marginal cost.
C) the marginal cost of a good equals the marginal bene?t from a good.
D) marginal social costs are greater than marginal private costs.

Question 34

When would stock options offered to an employee be ineffective in reducing the principal-agent problem?

A) When the link between worker effort and the share price of the ?rm is clear.
B) When stock options form a large proportion of the worker's pay.
C) When the share price of the ?rm is affected by external factors.
D) When the worker is unable to in?uence the share price of the ?rm.

Question 35

When there is an externality in the production of a good:

A) the value that consumers get from consuming the good is equal to the cost of producing the good.
B) some costs are passed on to individuals not involved in production or consumption.
C) the market for the good is likely to be perfectly competitive.
D) resource allocation is likely to be allocatively e?cient.

Question 36

Pareto e?ciency holds in a(n) _____.

A) monopoly
B) oligopoly
C) perfectly competitive market
D) monopolistically competitive market

Question 37

When _____, there is market failure.

A) the costs of production are minimized
B) market price is greater than marginal cost
C) the demand for a good is high
D) the supply of a good is perfectly inelastic

Question 38

A Pareto e?cient outcome is one where:

A) each individual's welfare depends on the quantity of resources that he owns.
B) each individual receives an equal share of the total resources.
C) an individual cannot be made better off without making another individual worse off.
D) an individual's welfare is maximized at the cost of society's overall welfare.

Question 39

If the marginal private cost of a good is greater than its marginal social cost, then the good is said to have _____.

A) a positive externality
B) economies of scale
C) Pareto e?ciency
D) a dead-weight loss

Question 40

Which of the following is true of the private level of output of goods with negative externalities?

A) The private level of output will be lower than the socially-optimal level.
B) The private ?rm will produce that level of output where marginal social bene?t equals
C) The private ?rm will produce that level of output where marginal social cost equals marginal private bene?t.
D) The private level of output will be higher than the socially-optimal level.

Question 41

In the following graph, MPC and MSC represent the marginal private cost and marginal social cost of producing a good respectively. QD represents the demand for the good. Refer to the graph to answer the question. The amount of tax that the government should levy to bring output to the socially optimum level is equal to the distance between the points _____.

A) A and B
B) B and D
C) B and C
D) A and C

Question 42

Which of the following is an example of a menu cost?

A) The cost of printing new price lists.
B) The cost of advertising and brand development.
C) The cost of monitoring the performance of an employee.
D) The cost of producing an additional unit of a good.

Question 43

Which of the following is true of a monopoly?

A) A monopoly market is Pareto e?cient.
B) The level of consumer surplus is greater in monopoly compared to perfect competition.
C) The level of producer surplus is higher in monopoly compared to perfect competition.
D) There is no dead-weight loss in a monopoly.

Question 44

Under the European system of carbon emissions caps:

A) all industries can pollute an unspeci?ed quantity if they pay a one-time fee.
B) industries with a surplus of permits trade with those that have a shortage.
C) polluting industries have an incentive to invest in pollution-generating technology.
D) the marginal private costs of pollution for polluting ?rms are reduced.

Question 45

In the following graph, MR and AR represent the marginal revenue and average revenue curves of a monopoly ?rm respectively. MC represents the marginal cost curve of the ?rm. Refer to the ?gure to answer the question. When the price in the market is P2, consumer surplus is equal to the area _____.

A) A + B
B) C + D + E
C) E + F
D) F

Question 46

Which of the following is a function of the Competition and Markets Authority in the UK?

A) Promoting cartels.
B) Promoting monopoly.
C) Encouraging large scale mergers to increase competition.
D) Encouraging fair trade and competition.

Question 47

Which of the following statements is true?

A) Price volatility can make budgetary planning for households and ?rms very di?cult.
B) An increase in supply when demand is inelastic will cause an increase in price.
C) The price volatility of consumer products tends to be higher than price volatility in agricultural produce.
D) When supply is elastic an increase in demand drives prices higher than when supply is

Question 48

Which of the following is a drawback of cost-bene?t analysis?

A) Costs and bene?ts that accrue over time cannot be assessed.
B) It may be di?cult to measure costs and bene?ts in monetary terms.
C) The costs of an activity are usually greater than the bene?ts.
D) Cost-bene?t analysis can only be used to assess government interventions.

Question 49

In the following graph, MR and AR represent the marginal revenue and average revenue curves of a monopoly ?rm respectively. MC represents the marginal cost curve of the ?rm. Refer to the ?gure to answer the question. The pro?t-maximizing monopoly ?rm will produce output at the point where:

A) marginal cost is decreasing.
B) the marginal cost curve intersects the marginal revenue curve.
C) the average revenue curve intersects the marginal cost curve.
D) marginal cost is zero.

Question 50

An increase in the cost of obtaining higher education with no change in the bene?ts received will result in:

A) an increase in the supply of graduates.
B) a decrease in the rate of return to higher education.
C) a relatively lower level of income for college graduates.
D) an increase in the demand for higher education.

Question 51

In the following graph, MR and AR represent the marginal revenue and average revenue curves of a monopoly ?rm respectively. MC represents the marginal cost curve of the ?rm. Refer to the graph to answer the question. When price is P2, the dead-weight loss in the market is equal to the area _____.

A) A + B
B) C + D + E
C) E + F
D) F

Question 52

In the following graph, MR and AR represent the marginal revenue and average revenue curves of a monopoly ?rm respectively. MC represents the marginal cost curve of the ?rm. Refer to the graph to answer the question. When the price in the market is P2, producer surplus is equal to the area _____.

A) A + B
B) C + D + E
C) E + F
D) F

Question 53

Which of the following is an example of a public good?

A) A street light.
B) An apple.
C) A house.
D) A car.

Question 54

When the supply of a good is inelastic, an increase in demand will:

A) increase prices by more than when supply is elastic.
B) not affect quantity supplied.
C) not affect the equilibrium price.
D) increase quantity by more than when supply is elastic.

Question 55

Which of the following measures by the government would increase the level of education in the country?

A) Increase the level of tax on education.
B) Subsidize the rate of interest on education loans.
C) Provide subsidies to ?rms so they can hire more workers.
D) Increase the level of income tax in the economy.

Question 56

If a competitive market becomes a monopoly _____.

A) society's welfare increases
B) producer surplus does not change
C) there is a dead-weight loss in the market
D) consumer surplus in the monopoly will increase

Question 57

The environmental Kuznets curve shows:

A) a direct relationship between the emission of carbon dioxide and marginal private costs.
B) a negative relationship between the level of pollution and the demand for a product.
C) a u-shaped relationship between consumer income and the demand for environmentally friendly goods.
D) an n-shaped relationship between production of greenhouse gases and real GDP per

Question 58

Which of the following is a feature of a public good?

A) Rivalrous consumption.
B) Excludable consumption.
C) Low levels of consumption.
D) Non-rivalrous and non-excludable consumption.

Question 59

In a market economy, the ideal solution to the problem of externalities would be to:

A) prohibit all production involving spillover costs.
B) regulate both the amount people may consume and the price they pay for goods whose
C) charge or tax producers of a good the precise marginal cost of the externality generated in production.
D) offer subsidies to the industries causing a negative externality.

Question 60

Which of the following statements is true?

A) There are likely to be merit and demerit goods in a market where there is complete information.
B) Merit goods provide consumers with more bene?ts than they may expect.
C) Education and health care are examples of demerit goods.
D) Smoking and drinking are examples of merit goods.

Question 61

The stronger the link between worker effort and the performance measure, the stronger the incentive for the worker to work hard.

Question 62

Within a firm, managers are the principals, hired on behalf of the shareholders who are the agents.

Question 63

The separation of ownership from control explains why firms aim to maximize profits.

Question 64

The separation of ownership from control exists where the shareholders, who own the company, are a different set of individuals from the managers that control the business on a day-to-day basis.

Question 65

The market for public goods is subject to market failure.

Question 66

When people are made better off without making others worse off, the total well-being of society improves.

Question 67

Standard deviation is a measure of how much a variable differs from its average value over time.

Question 68

A free rider benefits from the actions of others without having to contribute to the costs of these actions.

Question 69

Under the expense preference behaviour theory, managers prefer to maximize the profits of the firm.

Question 70

When a tax is levied on pollution, a polluting firm has an incentive to reduce the level of pollution that it emits.

Question 71

To increase the number of people installing solar panels, the government should subsidise firms that produce solar panels.

Question 72

Undertaking diversification of the firm's product line is more in the interests of managers than shareholders.

Question 73

Air pollution from a paper mill is an example of an externality in the production of paper.

Question 74

Satisficing behaviour by managers is the attainment of maximum levels of performance.

Question 75

A negative externality occurs if production, or consumption, by one group reduces the well-being of third parties.

Question 76

Subsidies are provided to goods for which the private level of output is more than the socially optimal level of output.

Question 77

Managers who are employed to run companies are subject to the principal-agent problem.

Question 78

Paying labour with piece rate wages is a strategy that can reduce the agency costs of the firm.

Question 79

Through the fair fuel stabilizer, the UK government manages volatility in the prices of petrol and diesel.

Question 80

A stock option that is offered to a manager gives him the right to buy a share in the company at the future share price.