National Bureau of Economic Research (NBER) Working Paper

National Bureau of Economic Research (NBER) Working Paper

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National Bureau of Economic Research (NBER) Working Paper

1. Individual Problems 1-1

The owners of a small manufacturing concern have hired a vice president to run the company with the expectation that he will buy the company after five years. For the first $150,000 of profit, the vice president’s compensation is a flat annual salary of $50,000 plus 50% of company profits. Beyond the first $150,000 in profits, the vice president’s compensation is the salary he receives at $150,000 profit plus 20% of company profits in excess of $150,000.

On the following graph, use the purple points (diamond symbols) to plot the vice president’s salary as a function of annual profit, for the profits levels of $0, $50,000, $100,000, $150,000, $200,000, $250,000, and $300,000.

2. Individual Problems 1-2

The owners of a small manufacturing concern have hired a vice president to run the company with the expectation that he will buy the company after five years. Compensation of the new vice president is a flat salary plus 75% of the first $150,000 profit, then 10% of profit over $150,000. The goal of the owners of the firm is to maximize profits.

True or False: This contract aligns the incentives of the new vice president with the profitability goals of the firm’s owners.

True

False

3. Individual Problems 1-3

The owners of a small manufacturing concern have hired a vice president to run the company with the expectation that he will buy the company after five years. In this initial contract, compensation of the new vice president is a flat salary plus 75% of the first $150,000 profit, then 10% of profit over $150,000. The initial contract also stipulates that, after a five-year period, the purchase price of the company will be 4.5 times earnings (profit), computed as average annual profitability over the next five years. Assume the company will be worth $10 million in five years. The goal of the owners of the firm is to maximize profits.

A contract that fixes the purchase price of the firm after five years at $2 million would make the incentives of the vice president    aligned with the goals of the firm, compared with the original contract.

4. Individual Problems 1-4

In a 2015 National Bureau of Economic Research (NBER) working paper, researchers found that decreases in unemployment benefits lead to higher employment.

Which of the following arguments best explains the findings of this paper?

Decreasing unemployment benefits increases incentives to remain unemployed.

Decreasing unemployment benefits reduces incentives to remain unemployed.

Decreasing unemployment decreases the costs of remaining unemployed.

5. Individual Problems 1-5

Planes frequently push back from the gate on time but then wait 2 feet from the gate until it is time to queue up for takeoff. This increases fuel consumption and increases the time that passengers must sit in a cramped plane awaiting takeoff.

Which of the following performance metrics would, if emphasized in evaluations, incentivize airlines to engage in such practices?

A performance metric that measures timeliness of the flight, where a flight is considered “on time” as long as the plane takes off by the scheduled departure time.

A performance metric that measures customer satisfaction, based on customer comfort while on the plane

A performance metric that measures timeliness of the flight, where a flight is considered “on time” as long as the flight is boarded and away from the gate by the scheduled departure time

6. Individual Problems 1-6

In 2008, the Labour Party in Britain promised that patients would have to wait for no more than four hours to be seen in an emergency room.

True or False: This policy incentivizes hospitals to make patients wait outside before allowing them to enter the emergency room upon their arrival at the hospital.

True

False

7. Individual Problems 2-1

Suppose the government is considering penalizing airlines $27,500 per passenger each time passengers are made to remain on the plane on the tarmac for more than three hours before a flight.

True or False: The threat of this fine could increase delays by forcing airlines to deplane and reboard more than necessary.

True

False

8. Individual Problems 2-2

Suppose you recently sold your used car. Assume that no new production was involved in this transaction.

Wealth was created because the buyer’s willingness to pay was    the value of your willingness to sell.

Suppose you sold the car for $21,000.

If the minimum price, or “bottom line,” you would accept for the car is $12,000 and the most the buyer is willing to pay is $37,000, then the seller surplus is

and the buyer surplus is

. The total surplus created by the transaction is

9. Individual Problems 2-3

Suppose an individual is looking to build a house in a plain that is prone to flooding. Because of the risk of damage due to flooding, the buyer’s top dollar for building the house is only $270,000. Suppose the cost of building a house in this area is $320,000.

A wealth-creating transaction is not possible since the seller’s bottom line (or the cost of building the house) is    the buyer’s top dollar. The difference between the cost of building the house minus the buyer’s top dollar is

.

Suppose the government subsidizes flood insurance for homes in the flood plain. Because of this, the buyer has access to very cheap insurance, worth an expected $60,000. Without such a subsidy, the high likelihood of flood results in extremely high rates for flood insurance.

With this subsidy, the individual    incentivized to build a house in the flood plain.

10. Individual Problems 2-4

In 2013, France’s labor unions won a case against Sephora to prevent the retailer from staying open late and forcing its workers to work “antisocial hours.” The cosmetic store does about 20 percent of its business after 9 p.m., and the 50 sales staff who work the late shift are paid an hourly rate that is 25 percent higher than the rate paid to workers on the day shift. Many of the late-hour workers are students or part-time workers, who are put out of work by these new laws.

Forcing the retailer to close earlier forces the store’s assets, such as the building and merchandise, to be moved from    -valued activities to    -valued activities.

True or False: In order to profit from this law, an individual could purchase Sephora products during the day and sell them at a higher price during normal store hours.

True

False

11. Individual Problems 2-5

Suppose Apple recently made a bid to acquire Netflix. As a result, the market value of Netflix rose. Furthermore, suppose the market value of Apple fell, but the decrease was smaller in magnitude than the rise in the market value of Netflix.

The market believes that Apple’s bid was     the present value of the expected future profits from Netflix.

12. Individual Problems 2-6

Two similar surgeries, breast reconstruction and breast augmentation, have different prices. Breast augmentation is cosmetic surgery not covered by health insurance. Patients who want the surgery must pay for it themselves. Breast reconstruction following breast removal due to cancer is covered by insurance. The price of one of the surgeries has increased by about 10% each year since 1995, whereas the price of the other has increased by only 2% per year.

Breast    surgery likely has the lower rate of inflation, since insurance coverage offers a stronger incentive to undergo breast    , driving up prices.

13. Individual Problems 3-1

Suppose you have won a free ticket to see a Bruce Springsteen concert. This ticket has no resale value.

Also suppose that U2 has a concert the same night. The U2 concert represents your next-best alternative activity to the Springsteen concert. Tickets to the U2 concert cost $21, and on any particular day, you would be willing to pay up to $115 to see U2. Assume that there are no additional costs of seeing either show.

Based on the information presented here, the opportunity cost of seeing Bruce Springsteen is

.

14. Individual Problems 3-2

You purchased two tickets to an upcoming concert for $108 apiece when the concert was first announced three months ago. Recently, you found that similar seats were selling for $277 apiece when purchased on QuickTickets, a website where people can resell their tickets to others.

Based on the information presented here, the cost of attending the concert (for two persons) is

.

15. Individual Problems 3-3

Because of the housing bubble, many houses are now selling for much less than their selling price just two to three years ago.

There is evidence that homeowners with virtually identical houses tend to ask for more if they paid more for the house.

True or False: Homeowners asking for a higher selling price are committing the fixed-cost fallacy.

True

False

16. Individual Problems 3-4

The expression “4/10, net 45” means that the customers receive a 4% discount if they pay within 10 days; otherwise, they must pay in full within 45 days.

What would the seller’s cost of capital have to be in order for the discount to be cost justified?

41.7143%

38.7143%

43.7143%

37.7143%

17. Individual Problems 3-5

A local coffee shop is hoping to make use of its excess restaurant capacity in the evenings by experimenting with selling beer and wine. It speculates that the only additional costs are hiring more of the same sort of workers to cover the additional hours and costs of the new line of beverages.

Which of the following are examples of hidden costs that are likely to emerge from this decision? Check all that apply.

Increased insurance premiums due to the presence of alcohol at the coffee shop

Training costs for new and existing employees on beer and wine serving procedures

The costs involved with the increased usage of utilities, such as electricity and gas, during evening hours

The cost of purchasing wine and beer to serve to customers

The cost of interviewing new employees

18. Individual Problems 3-6

Students doing poorly in courses often consider dropping the courses. Many universities will offer a refund if the student drops a course before a deadline.

True or False: After the deadline, students should not take this refund option into account when deciding to drop the course.

True

False

19. Individual Problems 3-7

A business incurs the following costs:

•	Labor: $150/unit
•	Materials: $35/unit
•	Rent: $200,000/month

Assume the firm produces 2 million units per month.

The total variable cost, per month, is

million.

The total fixed cost, per month, is

million.

The total cost is

million.

Managerial Economics Required Texts Froeb, McCann, Ward, & Shor (2017). Managerial Economics (5th ed.). ISBN: 978133746801

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