Exam7_ss2007_Econ101_Lulu (30 points total)

Name______ID______

Part I Please choose the best answer. (1 point each, 20 points total)

1.Sarah and Marisa are the only two baby-sitters available in a small town. Figure 10-15 indicates different combinations of hourly rates charged by the two teenagers, along with their weekly net earnings. If Marisa is the acknowledged price leader, then

a. / in equilibrium, both will charge $4 per hour
b. / in equilibrium, both will charge $5 per hour
c. / in equilibrium, Sarah will charge $5 per hour; Marisa will charge $4 per hour
d. / in equilibrium, Sarah will charge $4 per hour; Marisa will charge $5 per hour
e. / there is no predictable equilibrium

ANS:ADIF:2TOP:Cooperative Behavior in Oligopoly

2. In the airline industry, tit-for-tat strategies have frequently led to

a. / reciprocal hiring practices
b. / cost-reducing innovations
c. / profit-destroying price wars
d. / pricing policies that encouraged the entry of new firms
e. / profit-enhancing wage bargains

ANS:CDIF:2TOP:Cooperative Behavior in Oligopoly

3.An oligopolistic industry in which one firm sets the price is

a. / a cartel
b. / a duopoly
c. / a monopoly
d. / price leadership
e. / a price-discriminating duopolist

ANS:DDIF:1TOP:Cooperative Behavior in Oligopoly

4.Collusive arrangements tend to collapse when

a. / there is a small number of sellers
b. / the benefits of cheating are great and the costs are low
c. / inflation is high
d. / interest rates are low
e. / there is a powerful price leader

ANS:BDIF:2TOP:Cooperative Behavior in Oligopoly

5.Which of the following is an example of a cartel?

a. / AFL-CIO
b. / OPEC
c. / United Auto Workers Union
d. / NATO
e. / Organization of American States

ANS:BDIF:1TOP:Cooperative Behavior in Oligopoly

6. If there are a large number of sellers in a market,

a. / it is difficult for firms to cheat on a collusive agreement
b. / a cartel is unlikely to break down
c. / prices are higher than in smaller markets
d. / a cartel is likely to break down
e. / perfect competition occurs in the long run

ANS:DDIF:2TOP:Cooperative Behavior in Oligopoly

7.Antitrust policies attempt to protect consumers by

a. / imposing criminal sanctions on firms with excessive economic profits
b. / ensuring that firms do not produce more than the socially desirable level of output
c. / making sure that there is a sufficient amount of competition in markets
d. / requiring all products to have an implied warranty
e. / disseminating rules and regulations for consumers to use in the marketplace

ANS:CDIF:2TOP:The Future of Oligopoly

8. The amount of money that someone would pay today for the right to receive a future payment is called

a. / the present value of the future payment
b. / the determinate value of the future payment
c. / the interest rate
d. / the principal
e. / the time discount

ANS:ADIF:2TOP:The Value of Future Dollars

9. You have a bond that you can redeem for $10,000 one year from now. The interest rate is 10 percent (0.10) per year. How much is the bond worth today?

a. / $9,090.91
b. / $10,000.00
c. / $8,264.46
d. / $9,523.81
e. / $9,000.00

ANS:ADIF:2TOP:The Value of Future Dollars

10. A car rental company will earn a net income of $6,000 per year on a new car for the first three years of its life. After three years, the car will be worthless. If the interest rate is 10 percent (0.10) per ear, what is the present value of the car to the car rental company? (Assume that each year's income is received at the end of the year.)

a. / $16,413.22
b. / $14,921.11
c. / $18,000.00
d. / $16,363.62
e. / $13,523.67

ANS:BDIF:3TOP:The Value of Future Dollars

11.A new computer will generate $1,000 in net revenue for a firm during its first year, $500 during its second year, $250 during its third year, and nothing thereafter. If the interest rate is 10 percent (0.10) per year, what is the present value of the computer to the firm? (The first payment will be received at the end of this year.)

a. / $1,590.91
b. / $1,510.14
c. / $1,750.00
d. / $1,446.28
e. / $1,661.16

ANS:EDIF:3TOP:The Value of Future Dollars

12. With one year of study, Rob Sanchez can earn a master's degree, which will cost him $15,000 in tuition and $20,000 in lost wages. The degree will increase his yearly income by $20,000 per year for three years after receiving the degree. The interest rate is 10 percent (0.10) per year. What should Rob do? (Assume that costs are incurred and income is received at the end of the year.)

a. / he should obtain the degree because education always pays off
b. / because the cost of tuition and lost wages ($35,000) is less than the extra income ($60,000), he should obtain the degree
c. / he should subtract the present value of tuition from the total present value of the additional income. If the number is positive, he should obtain the degree
d. / he should subtract the total present value of the tuition and lost wages from the total present value of the additional income. If the number is positive, he should obtain the degree
e. / he should subtract the present value of lost wages from the total present value of additional income. If the number is positive, he should obtain the degree

ANS:DDIF:2TOP:The Decision to Invest in General Human Capital

13. A bond with a face value of $10,000 (and no coupon payments) is always worth

a. / $10,000
b. / less than $10,000 before the maturity date
c. / more than $10,000 if the interest rate is high enough
d. / $10,000 on the date of purchase
e. / $9,090.91 two years before the maturity date

ANS:BDIF:2TOP:The Bond Market

14. You have two bonds, both with a face value of $7,000. One of them matures one year from today, while the other matures one year after that. If the interest rate is 8 percent (0.08) per year, what is the difference in value between the two bonds?

a. / $480.11
b. / $578.52
c. / $317.46
d. / zero
e. / $925.92

ANS:ADIF:3TOP:The Bond Market

15. Which of the following will lower the present value of a bond?

a. / a fall in the interest rate
b. / an increase in the principal
c. / a shorter time to maturity
d. / an increased risk of default
e. / none of the above

ANS:DDIF:2TOP:The Bond Market

16. Which of the following types of bond typically has the highest yields? (The letters are Moody's ratings.)

a. / a federal government bond
b. / a corporate bond rated Aaa
c. / a corporate bond rated Aa
d. / a corporate bond rated A
e. / a corporate bond rated Baa

ANS:EDIF:1TOP:The Bond Market

17.Stretchy Socks, Inc., is expected to earn $2,000,000 in after-tax profits each year forever. The interest rate is 0.1. What is the total value of all shares of stock in Stretchy Socks?

a. / $1,818,182
b. / $2,000,000
c. / $16,528,926
d. / $18,181,818
e. / $20,000,000

ANS:EDIF:2TOP:The Stock Market

18. Which of the following would increase the value of a firm's stock?

a. / a decrease in the firm's present profit
b. / a decrease in the anticipated growth rate of future profits
c. / an increase in the perceived riskiness of future profits
d. / a fall in the interest rate
e. / an anticipated increase in the interest rate

ANS:DDIF:2TOP:The Stock Market

19.The price/earnings (PE) ratio of a stock is found by

a. / dividing the most recent year's dividend by the current stock price
b. / dividing the current stock price by the after-tax profit per share
c. / dividing the most recent year's dividend by retained earnings
d. / dividing the current stock price by the Dow Jones Industrial Average
e. / dividing the current stock price by the present value of the firm

ANS:BDIF:1TOP:The Stock Market

20. Walker Construction is a corporation that is expected to earn after-tax profits of $500,000 each year, forever. What is the total present value of all shares of Walker Construction stock?

a. / $7.5 million
b. / $5 million
c. / It depends on the interest rate
d. / $10 million
e. / It depends on how many shares have been issued

ANS:CDIF:3TOP:The Stock Market

Part II (10 points)

A drug manufacturer is considering how many of four new drugs to develop. Suppose it takes one year and $10 million to develop a new drug, with the entire cost being paid upfront (immediately). The expected yearly profits from the new drugs will begin in the second year，and are given in the table below:

Drug / Annual Profit
A / $ 7 million
B / $5.5 million
C / $ 5 million
D / $ 4 million

These profits accrue only while the drug is protected by a patent; once the patent runs out, profit is zero.

  1. If the interest rate is 10 percent and patents are granted for just two years, which drugs should be developed? Show the detailed steps for your conclusion. (3 points)

Only drug A should be developed, because it is the only drug with a positive present value. The present value of drug A = -$10 million + $7 million two years from now + $7 million three years from now = -$10 million + ($7 million/(1.10)2) + ($7 million/(1.10)3) = $1,044,327.57.

  1. If the interest rate is 10 percent and patents are granted for 3 years, which drugs should be developed? (3 points)

Drugs A, B, and C should be developed. Their present values are $5,825,421.76, $2,434,259.95, and $1,303,872.68, respectively.

  1. Answer (a) and (b) again, this time assuming the interest rate is 5%. (3 points)

With an interest rate of 5%, and a two-year patent, only drug A should be developed. With an interest rate of 5%, and a three-year patent, drugs A, B, C, and D should be developed.

  1. Based on your answers above, what is the relationship between new drug development and (1) the interest rate; (2) the duration of patent protection? (1 points)

There is an inverse relationship between new drug development and the interest rate, and a positive relationship between new drug development and the duration of patent protection.