Pepperdine University

FINC 655

Chapter 12

Multiple Choice Questions

1)After massive promotion of Justin Bieber’s latest music album, the producers reacted by raising prices for his albums. This implies that promotion expenditures made the album demand

1. 1. more elastic. [When demand becomes more elastic, the right response is to reduce price.]
   2. unitary elastic. [The question does not indicate any specific level of elasticity, only that it changed as a result of the promotion.]
   3. the change is due to psychological pricing. [This may or not be true, but the question is how does promotion expenditure changes demand elasticity.]
   4. less elastic. [when promotion makes demand less elastic, the right response is to increase price.]

2. All the below choices are examples of promoting a firm’s product, except
   1. celebrity endorsements. [This is a common component of product promotion.]
   2. pricing [pricing often responds to changes in demand brought about by promotions]
   3. discount coupons. [These are a form of promotion designed to focus consumers on prices.]
   4. end-of-aisle displays. [These are a form of promotion designed to focus consumers on prices.]

3. A firm that acquires a substitute product can try and reduce cannibalization by
   1. doing nothing. [The prices charged prior to acquiring a substitute would no longer be optimal.]
   2. repositioning a product so that they do not directly compete with each other. [If consumers do not perceive the products as substitutes, then cannibalization is reduced.]
   3. Setting the same price on both products. [Substitute products usually have different prices (e.g., a manual and electric saw).]
   4. lowering prices on the low-margin products. [This is the opposite of the appropriate price response to acquiring a substitute product.]

4. A shoe-producing firm decides to acquire a firm that produces shoe laces. This implies that the firm’s aggregate demand (shoes + laces) will be:
   1. less elastic than the individual demands. [Aggregate demand of substitutes is less elastic than the individual demands. However, shoes and laces are likely complements.]
   2. more elastic than the individual demands. [shoes and laces are complements and aggregate demand of complements is more elastic than the individual demands.]
   3. equally elastic as the individual demands. [shoes and laces are complements, and therefore the aggregate demand is not equal to the individual demands.]

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1. 4. None of the above [common ownership of complements changes the elasticity of aggregate demand]

5. After firm A producing one good acquired another firm B producing another good, it raised the prices for both goods. One can conclude that the goods were
   1. substitutes. [to prevent cannibalization, raise price on both goods after acquiring a substitute.]
   2. complements. [when acquiring a complement, prices on both goods should be lowered, not raised.]
   3. not related. [when goods are unrelated, common ownership does not affect the optimal price.]
   4. None of the above [one of the answers is correct.]

6. Firms tend to raise the price of their goods after acquiring a firm that sells a substitute good because
   1. they lose market power. [a loss of market power generally leads to lower prices]
   2. there is an increase in the overall demand for their products. [whether or not demand increases, firms still raise prices after acquiring a substitute good.]
   3. the bundle has a more elastic demand than individual goods. [when demand becomes more elastic, the correct response is to lower prices.]
   4. the bundle has a more inelastic demand than individual goods. [the aggregate demand for substitute products is less elastic than the individual demands.]

7. For products like parking lots and hotels, costs of building capacity are mostly fixed or sunk and firms in this industry typically face capacity constraints. Therefore,
   1. if SRMR>SRMC at capacity, then the firms should price to fill capacity. [when MR>MC, it is optimal to reduce price to sell more, but one cannot sell more than capacity allows.]
   2. if SRMR<SRMC at capacity, then the firms should price to fill capacity. [when MR<MC, you are losing money and should increase price and sell less.]
   3. if LRMR>LRMC at capacity, then the firms should price to fill capacity. [long run costs and benefits help determine how much capacity to build, but not how to price once it is built.]
   4. if LRMR<LRMC at capacity, then the firms should price to fill capacity. [long run costs and benefits help determine how much capacity to build, but not how to price once it is built.]

8. A firm started advertising its product and this changed the product’s elasticity from -2 to -1.5. The firm should
   1. raise price from $10 to $15. [using the formula (P-MC)/P=1/|e|, prices rise by 50%.]
   2. reduce price from $15 to $10. [since demand became less elastic, price should increase, not decrease.]
   3. raise price from $7.5 to $10. [using the formula (P-MC)/P=1/|e| would indicate that prices would have to rise by more than 33% following the change in elasticity.]
   4. reduce price from $10 to $7.5. [since demand became less elastic, price should increase, not decrease.] 3