Economics 104Chapter 3 Review Questions & AnswersANSWERS TO QUESTIONS FOR REVIEW1. (Households as Demanders of Goods and Services) Classify each of the following as a durable good, anondurable good, or a service:a. A gallon of milkb. A lawn mowerc. A smartphoned. A manicuree. A pair of shoesf. An eye examg. A personal computerh. A neighborhood teenager mowing a lawna. Nondurableb. Durablec. Durabled. Servicee. Nondurablef. Serviceg. Durableh. Service 2. (Evolution of the Firm) Explain how production after the Industrial Revolution differed from productionunder the cottage industry system.In the cottage industry system, production was decentralized. Raw material was provided to ruralhouseholds, 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 thehouseholds and the finished goods collected from each.After the Industrial Revolution, production became more centralized and urbanized. Technologicaldevelopments allowed the organization of large factories, which led to a more efficient division of laborand direct supervision. Centralizing production led to reduced transportation costs. The use of machineryfar larger in size than was possible in the cottage industry system permitted increased worker productivityand greater specialization of labor.3. (Household Production) What factors does a householder consider when deciding whether to produce agood 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 canbe lowered through production at home, and (4) the availability of technological advances that makehome production more efficient. In general, a householder performs a task if his or her opportunity cost islower 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 IndustrialRevolution? What type of business organization existed before this?With the Industrial Revolution it became more efficient to organize several stages of production under asingle entity. Prior to the Industrial Revolution, the main form of business organization was the cottageindustry, 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 theowner’s personal assets may be sold off to pay for the firm’s debts. Raising money for the business canalso be difficult. Because there is seldom a clear system for maintaining the business after the death of theowner, 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 consumerswho team up to minimize the cost of a product. Producer cooperatives consist of many producers, usuallyfarmers, 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 thoughfew 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 challengeof solving problems—for the same reason that people work on crossword puzzles. Social network membersenjoy participation in interactive sites such as MySpace and Facebook. Those who supply original videosto YouTube likely had fun making them and enjoy having others see their work. Some may hope theirtalent is discovered.8. (Government) Often it is said that government is necessary when private markets fail to work effectivelyand 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 privatemarket, firms may collude to avoid competition. (2) Certain industries may be most efficiently organizedas monopolies, but the private market may allow such industries to charge prices higher than are sociallyoptimal. (3) Private firms may not find it profitable to produce public goods. (4) Prices set freely by themarket often fail to reflect the costs or benefits imposed by externalities. (5) Private markets can lead to avery unequal distribution of income. (6) Finally, private markets do not guarantee full employment, pricestability, and economic growth. 9. (Externalities) Suppose there is an external cost, or negative externality, associated with production of acertain 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 ofthe good. Consequently, too much of the good is produced and purchased because the market allocatesresources without regard to this externality.10. (Government Revenue) What are the sources of government revenue in the United States? Which types oftaxes are most important at each level of government? Which two taxes provide the most revenue to theU.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; stategovernments rely on income and sales taxes; local governments rely mainly on property taxes. The twogreatest 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. Withthe exception of nonprofit institutions, firms are assumed to make decisions for the purpose of maximizingprofits. Government objectives are more difficult to define because there is no