Economics 104 Chapter 3 Review Questions Answers ANSWERS TO QUESTIONS FOR REVIEW 1 Households as Demanders of Goods and Services Classify each of the following as a durable good a nondurable good or a service a A gallon of milk b A lawn mower c A smartphone d A manicure e A pair of shoes f An eye exam g A personal computer h A neighborhood teenager mowing a lawn a Nondurable b Durable c Durable d Service e Nondurable f Service g Durable h Service 2 Evolution of the Firm Explain how production after the Industrial Revolution differed from production under the cottage industry system In the cottage industry system production was decentralized Raw material was provided to rural households each of which specialized in only one stage of production and was unsupervised Transportation costs were relatively high since the raw material had to be transported to each of the households and the finished goods collected from each After the Industrial Revolution production became more centralized and urbanized Technological developments allowed the organization of large factories which led to a more efficient division of labor and direct supervision Centralizing production led to reduced transportation costs The use of machinery far larger in size than was possible in the cottage industry system permitted increased worker productivity and greater specialization of labor 3 Household Production What factors does a householder consider when deciding whether to produce a good or service at home or buy it in the marketplace The householder must consider factors such as 1 whether production requires specialized skills or resources that the householder does not have 2 whether home production would allow the householder to avoid taxes 3 whether transaction costs can be lowered through production at home and 4 the availability of technological advances that make home production more efficient In general a householder performs a task if his or her opportunity cost is lower than the price of buying the good or service in the market 4 Corporations How did the institution of the firm get a boost from the advent of the Industrial Revolution What type of business organization existed before this With the Industrial Revolution it became more efficient to organize several stages of production under a single entity Prior to the Industrial Revolution the main form of business organization was the cottage industry in which households turned raw materials into finished goods 5 Sole Proprietorships What are the disadvantages of the sole proprietorship form of business The owner of a sole proprietorship faces unlimited liability for the debts of the firm meaning that the owner s personal assets may be sold off to pay for the firm s debts Raising money for the business can also be difficult Because there is seldom a clear system for maintaining the business after the death of the owner the firm usually goes out of business at such time 6 Cooperatives How do cooperatives differ from typical businesses The goal of a typical business is profit maximization Consumer cooperatives consist of many consumers who team up to minimize the cost of a product Producer cooperatives consist of many producers usually farmers trying to minimize their cost ad in that way maximize the profit of each member 7 Case Study User Generated Product Why are users willing to help create certain products even though few if any users are paid for their efforts Usually just for the fun of it Software developers work on open source software because of the challenge of solving problems for the same reason that people work on crossword puzzles Social network members enjoy participation in interactive sites such as MySpace and Facebook Those who supply original videos to YouTube likely had fun making them and enjoy having others see their work Some may hope their talent is discovered 8 Government Often it is said that government is necessary when private markets fail to work effectively and fairly Based on your reading of the text discuss how private markets might break down 1 Private markets may fail to safeguard private property and enforce contracts In a completely private market firms may collude to avoid competition 2 Certain industries may be most efficiently organized as monopolies but the private market may allow such industries to charge prices higher than are socially optimal 3 Private firms may not find it profitable to produce public goods 4 Prices set freely by the market often fail to reflect the costs or benefits imposed by externalities 5 Private markets can lead to a very unequal distribution of income 6 Finally private markets do not guarantee full employment price stability and economic growth 9 Externalities Suppose there is an external cost or negative externality associated with production of a certain good What s wrong with letting the market determine how much of this good will be produced An external cost is a cost not reflected in the price of the good and therefore is ignored by the buyers of the good Consequently too much of the good is produced and purchased because the market allocates resources without regard to this externality 10 Government Revenue What are the sources of government revenue in the United States Which types of taxes are most important at each level of government Which two taxes provide the most revenue to the U S federal government Federal state and local governments in the United States receive revenues from taxes income sales property etc user fees and borrowing The federal government relies on the individual income tax state governments rely on income and sales taxes local governments rely mainly on property taxes The two greatest sources of tax revenue for the U S federal government are personal income taxes 47 percent and payroll taxes 32 percent 11 Objectives of the Economic Decision Makers In economic analysis what are the assumed objectives of households firms and the government Households are assumed to make decisions to maximize utility or their overall level of satisfaction With the exception of nonprofit institutions firms are assumed to make decisions for the purpose of maximizing profits Government objectives are more difficult to define because there is no single consistent decision maker One theory is that government officials choose actions to maximize the number of votes that they expect to receive in the next election 12 International Trade Why does international trade occur What does