Chapter 3
Professor Yuna Chen
Economic
Decision
Makers
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3-1 The Household
• Demand goods and services
– Determine what gets produced
• Supply resources
– For firms to produce output
• Choices
– What to buy
– How much to save
– Where to live
– Where to work
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3-1a The Evolution of the Household
• Farm household
– Self-sufficient
• Better technology
– Increased productivity
• Factories
– Specialization; less self-sufficient
• Women in labor force
– 1950: 15%
– Today: 70%
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3-1b Households Maximize Utility
• Utility
– Satisfaction received from consumption
– Sense of well-being
– Depends on each household’s subjective
goals
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3-1c Households as Resources Suppliers
• Resource suppliers
– Labor, capital, natural resources, and
entrepreneurial ability
– To satisfy their unlimited wants
– Labor – to earn income
• Households with few resources
– Transfer payments - outright grants
• Cash transfers
• In-kind transfers
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3-1d Households as Demanders of Goods and Services
• Demanders of goods and services
– Durable goods
• Expected to last 3 or more years
• Can be reused
– Nondurable goods
• Food, clothing, gasoline
– Services
Question: Lebron believes duct tape is an example of durable goods
because it can last for a long time. Do you agree?
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Exhibit 1
Where U.S. Personal Income Comes From and Where It Goes
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3-2 The Firm
• Firms
– Economic units
– Profit seeking entrepreneurs
– Combine resources
– Produce goods and services
– Maximize profit
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3-2a The Evolution of the Firm
•
•
•
•
•
•
Specialization
Comparative advantage
Transaction costs
Entrepreneur
Cottage industry system
Technological developments
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3-2a The Evolution of Firm
• Large – scale factory production
– Efficient division of labor
– Direct supervision of production
– Reduce transportation costs
– Bigger machines
• Industrial Revolution
• Large-scale factory production
• Began in Great Britain around 1750
• Spread to: Europe, North America, Australia
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3-2b Types of Firms
• Sole proprietorship
– Single owner
• Has the right to all profits
• Bears unlimited liability for the firm’s losses
and debts
• Partnership
– Two or more owners
• Share the profits
• Bear unlimited liability for the firm’s losses
and debts
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3-2b Types of Firms
• Corporation
– Legal entity owned by stockholders
– Whose liability is limited to the value of
their stock ownership
• S corporation
– Provides owners with limited liability
– Profits are taxed only once
• A income on each shareholder’s personal
income tax return
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Exhibit 2
Percent distribution by type of firm based on number of
firms and firm sales
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3-2c Cooperatives
• Cooperatives
– People who pool their resources to buy and sell more
efficiently than they could individually
• Consumer cooperatives
– Retail business owned and operated by some or all of
its customers
– To reduce costs
• Producer cooperatives
– Producers join forces to buy supplies and equipment
and to market their output
– To reduce costs and increase profits
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3-2d Not-for-Profit Organizations
• Not-for-profit organizations
– Do not pursue profit as a goal
• Charitable; Educational
• Humanitarian; Cultural
• Professional
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3-2e Household Production
• Opportunity cost
– Below market price
• No skills or special resources are
required
• Avoid taxes
• Reduce transaction costs
• Technological advances increase
productivity
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3-3 The Government
• Role of government
– to intervene in case of market failure
• Market failure
– arises when the unregulated operation of
markets
– yields socially undesirable results
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3-3a The Role of Government
• Establish & enforce rules of the game
– Safeguard private property
– Make sure that market participants abide
by the rules of the game
• Promote competition
– Antitrust laws that prohibit
collusion (agreement among firms to divide
the market and fix the price)
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3-3a The Role of Government
• Regulate natural monopolies
– Monopoly
• Sole supplier of a product with no close
substitutes
– Natural monopoly
• One firm that can supply the entire market at
a lower per-unit cost than could two or more
firms
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3-3a The Role of Government
• Provide public goods
– Private firms cannot sell them profitably
• Private goods
– Rival in consumption (only for one to consume)
– Exclusive (You get it only if you pay for it)
• Public goods
– Nonrival in consumption (e.g. law enforcement)
– Nonexclusive (benefit all, even the ones who
don’t pay)
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3-3a The Role of Government
• Externality
– Cost or benefit on the third party rather than
sellers and buyers
• Negative externalities: someone gets hurt w/o
being paid (e.g. pollution)
• Should be discouraged
• Positive externalities: someone receives benefit
w/o paying (e.g. education)
• Should be encouraged
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3-3b Government’s Structure & Objectives
• Federal government
– National security, economic stability,
market competition
• State government
– Public higher education, prisons,
highways, welfare
• Local government
– Primary and secondary education, police,
fire protection
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3-3b Government’s Structure & Objectives
• Difficulty
– More than 89,500 jurisdictions
•
•
•
•
•
•
1 nation
50 states
3,033 counties
35,991 cities and towns
13,051 school districts
37,381 special districts
– Not one single decision maker
• ‘Vote maximization’
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3-3b Government’s Structure & Objectives
• Market - voluntary exchange
• Government coercion
– Enforced by the police
• Public goods
– Zero price
– Below the production cost
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3-4 The Rest of the World
• Rest of the world
– Foreign households, firms, governments
3-4a International trade
– Occurs because of different opportunity
costs (comparative advantage)
• Merchandise trade balance
– Exports minus imports
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3-4b Exchange Rates
• Exchange rates
– Price of one currency in terms of another
3-4c Trade restrictions
– Tariff
• Tax on imports
– Quota
• Legal limit on the quantity of a particular
product that can be imported or exported
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3-4c Trade Restrictions
• Trade restrictions
– Benefit certain domestic producers
– Raise price of imports
– Hurt domestic consumers
– Cause “trade war”
– Hurt the overall economy
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