Holmstrom and Tirole Note "The Economist's First Instinct Is to Set

question 13

Multiple Choice

Holmstrom and Tirole note "The economist's first instinct is to set transfer price equal to marginal cost." However,a distinct plurality of companies uses the full-cost method.That is because:

• A)most companies do not employ economists.
• B)it is simple and has a low cost of implementation.
• C)it is identical to using a marginal cost approach to transfer prices.
• D)the results are much better in the field with full-cost method.

---

Definitions:

Fixed Cost

Expenses that remain constant in total regardless of changes in the level of production or sales volume, such as rent, salaries, and insurance.

Contribution Margin Ratio

A financial metric that shows what portion of sales revenue is available to cover fixed costs and generate profit after variable costs have been paid.

Fixed Expenses

Costs that do not fluctuate with changes in production level or sales volume, such as rent, salaries, and insurance premiums.

Break-Even Point

The sales level at which a business neither makes a profit nor incurs a loss.