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CHAPTER 3
ECONOMIC DECISION MAKERS
In this chapter, you will find:
Chapter Outline with PowerPoint Script
Chapter Summary
Teaching Points (as on Prep Card)
Answers to the End-of-Book Questions and Problems for Chapter 3
Supplemental Cases, Exercises, and Problems
INTRODUCTION
This chapter introduces the four economic decision makers and presents their roles in the economy.
Because students have grown up with the three economic institutions of households, firms, and
government, they take them for granted. This chapter presents a fresh approach by explaining why these
three institutions have evolved as they have and why the fourth, the rest of the world, is becoming
increasingly important. Although households are highlighted as the most important economic units,
governments actually receive the most coverage in this chapter.
LEARNING OUTCOMES
1 Explain the role of the household in an economic system.
Households play the starring role in a market economy. Their demand for goods and services determines what
gets produced and their supplies of labor, capital, natural resources, and entrepreneurial ability produce that output. As demanders of goods and services and suppliers of resources, households make all kinds of choices in an
attempt to maximize utility.
2 Identify the different types of firms and describe their roles in the economy.
Firms are economic units formed by entrepreneurs who combine labor, capital, and natural resources to produce
goods and services in an attempt to maximize profit. For-profit firms organize in one of three ways: as a sole
proprietorship, as a partnership, or as a corporation. Not-for-profit organizations engage in activities that often
have a social purpose, while cooperatives are groups that organize with the goal of minimizing costs.
3 Outline the ways governments affect their economies.
Governments attempt to improve society’s overall welfare by intervening in cases of market failure. Beneficial
government interventions in markets include establishing and enforcing the rules of the game, promoting competition, regulating natural monopolies, providing public goods, dealing with externalities, more equally distributing income, and pursuing full employment, price stability, and economic growth.
4 Outline the international influences on an economy.
The rest of the world affects what U.S. households consume and what U.S. firms produce. U.S. households and
firms are consumers and suppliers of manufactured goods and raw materials from and to foreign economies, and
these transactions impact U.S. prices, wages, and profits. International trade, exchange rates, and trade restrictions all affect the U.S. economy.
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted
in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Chapter 3
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36
CHAPTER OUTLINE WITH POWERPOINT SCRIPT
USE POWERPOINT SLIDES 2-3 FOR THE FOLLOWING SECTION
THE HOUSEHOLD: HOUSEHOLDS PLAY THE STARRING ROLE IN THE ECONOMY.
The Evolution of the Household
 In earlier times: Self-sufficient
 Today:
– 70% of women with children under 18 are in the labor force.
– Rise of two-earner households
– Households produce less for themselves.
– Increased demand for goods and services from the market
USE POWERPOINT SLIDE 4 FOR THE FOLLOWING SECTION
Households Maximize Utility: the satisfaction derived from consumption
USE POWERPOINT SLIDES 5-7 FOR THE FOLLOWING SECTION
Households as Resource Suppliers
 Use limited resources: Labor, capital, natural resources, and entrepreneurial ability to satisfy unlimited
wants
 Use these resources to produce goods and services in the home
 Sell these resources in the resource market to earn income
– Over two thirds of U. S. personal income is from labor earnings
 Households with few resources can receive transfer payments, also known as grants, from the
government
Households as Demanders of Goods and Services
 Households spend over 80 percent of their income on consumption goods which include:
– Durable goods (expected to last three years or more, i.e., automobiles, refrigerators, etc.)
– Nondurable goods (i.e., food, clothing, gasoline, etc.)
– Services (i.e., haircuts, air travel, medical care, etc.)
THE FIRM
USE POWERPOINT SLIDES 8-10 FOR THE FOLLOWING SECTION
Evolution of the Firm: Economic unit formed by a profit-seeking entrepreneur
 Cottage industry system: “Putting out” raw material to rural households that turned it into finished
goods
 Entrepreneurs: Organize all the stages of production under one roof
– Industrial Revolution: Development of large-scale factory production that 1) promoted more
efficient division of labor; 2) allowed for the direct supervision of production; 3) reduced
transportation costs; and 4) facilitated the use of machines far bigger than anything used in the home.
Types of Firms
USE POWERPOINT SLIDES 11-17 FOR THE FOLLOWING SECTIONS
Sole Proprietorships: Single-owner firms facing unlimited liability; most common form of U.S. business
organization in terms of total numbers: 72% of businesses, but only 4% of U.S. sales.
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted
in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Chapter 3
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37
Partnerships: Multiple-owner firms with each owner bearing unlimited liability; continuity problems
exist with death or departure of one partner.
Corporations:
 Legal entities established through articles of incorporation.
 Liability limited to the value of stock holdings.
 Life apart from those of the owners.
 Disadvantages: 1) Stockholders’ influence on corporate policy is limited to voting for board of
directors; and 2) Corporate income is taxed twice.
 Most important form of U.S. business organization in terms of total sales: 84%.
COOPERATIVES:



A group of people who cooperate by pooling resources to buy and sell more efficiently
Consumer cooperatives are retail businesses owned and operated by customers to reduce costs. (i.e.,
credit unions, apartment buildings, grocery stores, etc.)
Producer cooperatives are producers who join forces to buy supplies and equipment and to market
output. (Only farmers allowed by law to operate cooperatively; i.e., Sunkist)
NOT-FOR-PROFIT ORGANIZATIONS:


Engage in charitable, educational, humanitarian, cultural, professional, and other activities, often with
a social purpose.
Private organizations that do not have profit as a goal but must somehow pay for the resources they
employ.
Why Does Household Production Still Exist? The opportunity cost of performing some tasks is below
the market price of those tasks.
 No Skills or Specialized Resources Are Required
 Household Production Avoids Taxes
 Household Production Reduces Transaction Costs
 Technological Advances Increase Household Productivity
THE GOVERNMENT
USE POWERPOINT SLIDES 18-24 FOR THE FOLLOWING SECTION
The Role of Government: Enters the market in cases of market failure
Establishing and Enforcing the Rules of the Game
Promoting Competition
Regulating Natural Monopolies
Providing Public Goods:
 Private goods are rival in consumption (the amount consumed by one person is unavailable for others)
and exclusive (those who fail to pay can be excluded from consumption).
 Public goods are nonrival (the amount consumed by one person does not diminish the amount
available to others) and are nonexclusive. (They are available to all, regardless of who pays and who
does not.)
Dealing With Externalities: Costs or benefits that fall on third parties
A More Equal Distribution of Income
Full Employment, Price Stability, and Economic Growth
 Fiscal policy: Taxing and spending
 Monetary policy: Regulating the money supply
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted
in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Chapter 3
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38
USE POWERPOINT SLIDES 25-27 FOR THE FOLLOWING SECTION
GOVERNMENT’S STRUCTURE AND OBJECTIVES: FEDERAL SYSTEM OF GOVERNMENT;
RESPONSIBILITIES ARE SHARED ACROSS LEVELS OF GOVERNMENT.
Difficulty in Defining Government Objectives
 What is government’s goal? It doesn’t act as a simple, consistent decision maker.
Voluntary Exchange Versus Coercion
 Market exchange relies on voluntary behavior of buyers and sellers. Political markets involve some
government coercion.
No Market Prices
 The selling price of public output is usually zero or below the cost of providing it. In-state tuition
probably covers only half of actual costs.
USE POWERPOINT SLIDES 28-31 FOR THE FOLLOWING SECTION
SIZE AND GROWTH OF U.S. GOVERNMENT
IN 1929 ALL GOVERNMENT OUTLAYS TOTALED 10% OF GDP VERSUS 42% TODAY IN THE U.S.
SOURCES OF GOVERNMENT REVENUE: FEDERAL GOVERNMENT – INCOME TAX; STATE
GOVERNMENT – INCOME AND SALES TAX; AND LOCAL GOVERNMENT – PROPERTY TAX
USE POWERPOINT SLIDES 32-36 FOR THE FOLLOWING SECTION
TAX PRINCIPLES AND TAX INCIDENCE





Tax incidence: Who actually bears the burden of the tax
Proportional taxation: all income levels pay same percent of income in taxes
Progressive taxation: percentage of income paid in taxes increases as income increases
Marginal tax rate: Percentage of each additional dollar of income that goes to taxes
Regressive taxation: Percentage of income paid in taxes decreases as income increases
USE POWERPOINT SLIDES 37-40 FOR THE FOLLOWING SECTION
THE REST OF THE WORLD
International Trade: Occurs because the opportunity cost of producing specific goods differs across
countries.
 Merchandise trade balance: The value of exported goods minus the value of imported goods
 Balance of payments: Record of all economic transactions between a country’s residents and the
residents of the rest of the world
 Exchange Rate: The price of one currency in terms of another. To facilitate international trade
funded by different currencies, a market for foreign exchange has developed.
Trade Restrictions: Interfere with free flow of products across borders; tend to hurt overall economy
 Tariffs: Taxes on imports
 Quotas: Legal limits on the quantity of a particular good that can be imported
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted
in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Chapter 3
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39
CHAPTER SUMMARY
Most household income arises from the sale of labor, and most household income is spent on personal
consumption, primarily services.
Household members once built their own homes, made their own clothes and furniture, grew their own
food, and supplied their own entertainment. Over time, however, the efficiency arising from comparative
advantage resulted in a greater specialization among resource suppliers.
Firms bring together specialized resources and in the process reduce the transaction costs of bargaining
with all these resource providers. U.S. firms can be organized in three different ways: as sole
proprietorships, partnerships, or corporations. Because corporations are typically large, they account for
the bulk of sales.
When private markets yield undesirable results, government may intervene to address these market
failures. Government programs are designed to (a) protect private property and enforce contracts; (b)
promote competition; (c) regulate natural monopolies; (d) provide public goods; (e) discourage negative
externalities and encourage positive externalities; (f) promote a more even distribution of income; and (g)
promote full employment, price stability, and economic growth.
In the United States, the federal government has primary responsibility for providing national defense,
ensuring market competition, and promoting stability of the economy. State governments provide public
higher education, prisons, and—with aid from the federal government—highways and welfare. And local
governments provide police and fire protection, and, with help from the state, local schools.
The federal government relies primarily on the personal income tax, states rely on income and sales taxes,
and localities rely on the property tax. A tax is often justified based on (a) the individual’s ability to pay or
(b) the benefits the taxpayer receives from the activities financed by the tax.
The rest of the world is also populated by households, firms, and governments. International trade creates
gains that arise from comparative advantage. The balance of payments summarizes transactions between
the residents of one country and the residents of the rest of the world. Although consumers gain from
comparative advantage, nearly all countries impose trade restrictions to protect specific domestic
industries.
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted
in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Chapter 3
Economic Decision Makers
40
TEACHING POINTS
1. This chapter discusses the principal players in the economy and also reviews the historical
development of the institutions of the economy. For example, the evolution of the firm and the
household are discussed, and both are integrated with the concepts of specialization and
comparative advantage from Chapter 2.
2. Students should be familiar with the idea of household production. A common example would be
fixing the evening meal rather than dining out. Fixing the auto, painting the house, and cultivating
a garden are all examples of household production.
3. It might be instructive to point out how certain inventions, such as the vacuum cleaner, have
expanded the degree of household production. An interesting question to raise is whether such
changes were supply induced or demand induced. That is, did the need for vacuum cleaners appear
in the market and give rise to the invention, or did the invention give rise to the market and thus
the increased household production of cleaning?
3. Many students will not know the basic structure of corporate finance. It is therefore advisable to
discuss the difference between corporate stocks and corporate bonds, one implying ownership and
the other implying debt. The stock financing of corporations is an interesting application of
specialization. The owners of the corporation may know little about the actual production of the
firm’s product but are able to supply capital and earn a return.
4. In discussing the section on the rationale for government, you may wish to emphasize the basic
ideas of public goods and externalities. It is interesting to note that while pollution abatement
equipment may be produced and sold by private business, it is government that creates demand for
the goods. Private sellers of such equipment would have a hard time finding customers in the
absence of government mandates.
5. It is important to stress externalities as examples of situations where the market outcome may not
be optimal. Externalities can be negative or positive. Cigarette smoking, for example, is an activity
that generates a negative externality with possibly harmful medical side effects. As a result, all
domestic air travel is now smoke free and many states have passed legislation outlawing smoking
in public places. This subject will be of interest to almost everyone whether or not they smoke.
Positive externalities may flow from public education, immunizations, and government funded
research.
6. Although students are probably aware of the recent large U.S. trade deficits, they probably do not
know what these deficits mean or why the foreign sector is of increasing importance to the U.S.
economy. While detailed discussion of these topics is deferred to later chapters, it is useful to link
briefly the notions of trade and comparative advantage (a world PPF) and to tie into this discussion
the relevance of exchange rates and trade restrictions to the operation of international markets.
You might even wish to bring in the recent volatility in world capital markets as a possible byproduct of the increasing importance of international trade.
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted
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Chapter 3
Economic Decision Makers
41
ANSWERS TO END-OF-BOOK QUESTIONS AND PROBLEMS
1.1. (Evolution of the Household) Determine whether each of the following would increase or decrease the
opportunity costs for mothers who choose not to work outside the home. Explain your answers.
a. Higher levels of education for women.
b. Higher unemployment rates for women.
c. Higher average pay levels for women.
d. Lower demand for labor in industries that traditionally employ large numbers of women.
a. Opportunity costs rise as higher levels of education increase the level of earnings available to
women working outside the home.
b. Opportunity costs fall as there are fewer chances for working outside the home.
c. Opportunity costs rise as women forgo higher earnings if they do not work outside the home.
d. Opportunity costs fall as there are fewer employment opportunities for women in these
traditional industries.
1.2. (Household Production) Many households supplement their food budget by cultivating small
vegetable gardens. Explain how each of the following might influence this kind of household
production:
a. Both husband and wife are professionals who earn high salaries.
b. The household is located in a city rather than in a rural area.
c. The household is located in a region where there is a high sales tax on food.
d. The household is located in a region that has a high property tax rate.
a. This would reduce the amount of household production.
b. This would reduce household production because of the high price of land as well as other
opportunity costs.
c. This would increase household production.
d. This would reduce the amount of household production of food, since it raises the cost of
owning land
1.3. (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.
1.4. (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 not-for-profit 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.
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Chapter 3
Economic Decision Makers
42
2.1. (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.
2.2. (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.
2.3. (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 and, in that way, maximize the profit of each
member.
2.4. (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.
3.1. (Government) Complete each of the following sentences:
a. When the private operation of a market leads to overproduction or underproduction of some
good, this is known as a(n) _________________.
b. Goods that are nonrival and nonexcludable are known as __________________.
c. ________________ are cash or in-kind benefits given to individuals as outright grants from the
government.
d. A(n) ________________ confers an external benefit on third parties that are not directly
involved in a market transaction.
e. ________________ refers to the government’s pursuit of full employment and price stability
through variations in taxes and government spending.
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Chapter 3
a.
b.
c.
d.
e.
Economic Decision Makers
43
Market failure
Public goods
Transfer payments
Positive externality
Fiscal policy
3.2. (Tax Rates) Suppose taxes are related to income level as follows:
Income
$1,000
$2,000
$3,000
Tax
$200
$350
$450
a. What percentage of income is paid in taxes at each level?
b. Is the tax rate progressive, proportional, or regressive?
c. What is the marginal tax rate on the first $1,000 of income? The second $1,000? The third
$1,000?
a. The percentages for income levels of $1,000, $2,000, and $3,000 are 20 percent, 17.5 percent,
and 15 percent, respectively.
b. The tax system is regressive.
c. The marginal tax rates are 20 percent, 15 percent, and 10 percent, respectively.
Income
$1,000
$2,000
$3,000
Tax
$200
$350
$450
Marginal Tax Rate
(200/1,000) 0.20
(350/1,000) 0.35 − 0.20 = 0.15
(450/1,000) 0.45 − 0.35 = 0.10
3.3. (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 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
(43 percent) and payroll taxes (35 percent).
3.4. (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.
4.1. (International Trade) Why does international trade occur? What does it mean to run a deficit in the
merchandise trade balance?
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted
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Chapter 3
Economic Decision Makers
44
International trade occurs because of comparative advantage and specialization. Countries specialize
in the production of those goods and services in which they have a comparative advantage and then
trade those goods with countries that have comparative advantages in the production of other goods
and services. The level of economic transaction between one country and the rest of the world is
recorded in the country’s balance of payments. The merchandise trade balance is one part of the
balance of payments. A deficit indicates that the country is buying more goods from other countries
than it is selling to other countries. Such a deficit must be covered by a surplus in another account of
the balance of payments.
4.2. (International Trade) Distinguish between a tariff and a quota. Who benefits from and who is harmed
by such restrictions on imports?
Tariffs are trade restrictions in the form of taxes on imports. They affect sales by changing the price of
the good, but they do not directly limit the quantity. Quotas directly limit the quantity of the good that
can be imported from a country, but price effects are only indirect. Domestic producers and their employees benefit from trade restrictions on imports as both the price and quantity sold of domestic production increase. Domestic consumers are harmed as they face higher prices. Domestic exporters and
their employees also suffer as the overall volume of trade is reduced. The government can benefit from
revenues generated by the tariffs and the selling of import licenses under a quota.
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted
in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Chapter 3
Economic Decision Makers
45
SUPPLEMENTAL CASES, EXERCISES, AND PROBLEMS
Case Studies
These cases are available to students online at www.cengagebrain.com.
User-Generated Products
In a market economy, new products and processes are usually developed by profit-seeking entrepreneurs,
but sometimes sheer curiosity and the challenge of solving difficult problems lead to new and better ways
of doing things. For example, loose communities of computer programmers have been collaborating for
decades. By the early 1990s, they formed a grass roots movement known as “open source,” which was
fueled by the Internet. In 1991, Linus Torvalds, a student at the University of Helsinki in Finland, wrote
the core program for what would become known as the Linux operating system. He posted his program
online and invited anyone to tinker with the coding. Word spread, and computer aficionados around the
world began spending their free time making Linux better. Other software has developed in the opensource arena. For example, from the University of Illinois came web server software named Apache, and
Swedish researchers developed database software called MySQL. The Free Software Directory lists more
than 5,000 free software packages. The term free refers not only to the dollar cost of the software, which is
zero, but to what you can do with the software—you can examine it, modify it, and redistribute it to
anyone. Free user-generated software now includes the most widely used web server (Apache) and the
second most popular desktop operating system (Linux), web browser (Firefox), and office suite
(OpenOffice).
Other user-generated products include some familiar names—Wikipedia, MySpace, Facebook,
YouTube, and Twitter. Wikipedia is a free online encyclopedia written and edited by volunteers. The idea
is that collaboration over time will improve content much the way that open-source software has evolved.
Wikipedia claims to be one of the most visited online sites. Founder Jimmy Wales says he spent a half
million dollars getting Wikipedia going, but now the project relies on volunteers and donations.
MySpace and Facebook are social networking sites that allow users to post personal profiles, blogs,
photos, music, videos, and more. The main attraction of these sites is material provided by users. The
companies simply provide the software and hardware backbone to support the network. MySpace, founded
in July 2003, was sold in July 2005 for about $330 million. Its value, however, was eroded by competition
and the site was sold again in 2011for an estimated $35 million. Facebook was started by a college
sophomore in 2004; the company had 500 million users by 2010 and an estimated market value of $10
billion.
YouTube is an online site that allows users to post their own videos and view those posted by others.
Searching is easy. For example, “comparative advantage” turned up more than 150 videos, including
“Econ Concepts in 60 Seconds.” When sold to Google in 2006, YouTube had only 67 employees and no
profit. Still, because visitors were viewing more than 100 million videos a day, all those eyeballs offered
tremendous advertising potential. Google paid $1.7 billion for a company with no profit.
Finally, Twitter is a social networking and microblogging service that allows users to send and receive
“tweets,” which are messages limited to 140 characters. Delivery can be online via the Twitter Web site,
by cell phones, or by using other applications. The company had about 100 million users in 2010, but
projects one billion users by 2013.
User-generated products are not new. Radio call-in shows have been making money off callers for
decades. But the Internet has increased opportunities for users to create new products and to improve
existing products. Most of the users are just having fun. The more users involved, the more attractive that
product is to each user. That’s why networking and video sites try to dominate their markets.
Sources: Jaron Lanier, You Are Not a Gadget, (Knopf, 2010); “A World of Connections,” The Economist,
5 February 2010; and Jessica Vascellaro, “Facebook CEO in No Rush to ‘Friend’ Wall Street,” Wall Street
Journal, 3 March 2010. The Free Software Directory is found at http://directory.fsf.org/.
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted
in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Chapter 3
Economic Decision Makers
46
The Electronic Cottage
The Industrial Revolution shifted production from rural cottages to urban factories. But the Information
Revolution spawned by the microchip and the Internet has decentralized the acquisition, analysis, and
transmission of information. These days, someone who claims to work at a home office is not necessarily
referring to corporate headquarters but to a spare bedroom. According to a recent survey, the number of
telecommuters, or “remote workers,” has more than doubled in the last decade. Pushing the trend are
worsening traffic, higher gas prices, wider access to broadband, growing self-employment resulting from
layoffs during the recession of 2008–2009, and even the threat of terrorism. The average commute is 23
miles, and eliminating that can save about $1,000 a year in gas and can avoid putting more than 6,000
pounds of carbon dioxide into the atmosphere. What’s more, it often makes sense to try a new business at
home before moving to a separate, more costly, location. Most small businesses are home-based, at least at
the start.
From home, people can write a document with coworkers scattered throughout the world, then discuss
the project online in real time or have a videoconference on Skype (McDonald’s saves millions in travel
costs by videoconferencing). Software allows thousands of employees to share electronic files. A 2010
survey found the majority of those who use computers for most of their work believe they could work at
home. When Accenture moved headquarters from Boston to a suburb, the company replaced 120 tons of
paper records with an online database accessible anytime from anywhere in the world.
To support those who work at home, an entire industry has sprung up, with magazines, newsletters,
Web sites, and national conferences. In fact, an office need not even be in a specific place. Some people
now work in virtual offices, which have no permanent locations. With iPhones, BlackBerries, or other
links, remote workers, can conduct business on the road—literally, “deals on wheels.”
Chip technology is decentralizing production, shifting work from a central office either back to the
household or to no place in particular. More generally, the Internet has reduced transaction costs, whether
it’s a market report authored jointly by researchers from around the world or a new computer system
assembled from parts ordered over the Internet. Easier communication has even increased contact among
distant research scholars. For example, economists living in distant cities are four times more likely to
collaborate now than they were two decades ago.
Sources: Betty Beard, “Survey: Most Could Work from Home,” Arizona Republic, 6 March 2010; Colleen
DeBaise, “For More Workers, Home is Where the Office Is,” Wall Street Journal, 3 January 2010; and
Daniel Hamermesh and Sharon Oster, “Tools or Toys? The Impact of High Technology on Scholarly
Productivity,” Economic Inquiry, 40 (October 2002): 539–555. For information about how to run a
business from home, go to http://www.ows.doleta.gov/unemploy/self.asp.
Experiential Exercises
1. Have students get a library copy of The Wealth and Poverty of Nations, by David Landes, and read
pages 207–210. Ask them how they would interpret Landes’s story about mechanization using the ideas
developed in this chapter?
2. The Contracting and Organizations Research Institute at the University of Missouri maintains lots of
interesting information about the evolution of the firm. Students can visit the Institute’s Web site at
http://cori.missouri.edu/index.htm to familiarize themselves with the kinds of issues economists are
studying.
3. The household is the most important decision-making unit in our economy. Have students look through
the rotating columns (e.g., “Work and Family” and “Personal Technology”) in the Wall Street Journal
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted
in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Chapter 3
Economic Decision Makers
47
this week, and find a description of some technological change that might affect household production.
Ask them to explain how production would be affected.
4. (Global Economic Watch) Go to the Global Economic Crisis Resource Center. Select Global Issues in
Context. In the Basic Search box at the top of the page, enter the phrase "Not-So-Free Ride." On the
Results page, scroll down to the Magazines section. Click on the link for the April 20, 2008, article
"Not-So-Free Ride." Can you list negative externalities of driving in addition to the ones described in
the article?
The article listed congestion, carbon emissions, and traffic accidents. Other possible negative
externalities are pollution byproducts other than carbon, high noise levels, and road rage.
5. (Global Economic Watch) Go to the Global Economic Crisis Resource Center. Select Global Issues in
Context. In the Basic Search box at the top of the page, enter the terms "tax rate" and/or "tax rates." Find
resources that are no more than three years old that describe tax rates in two foreign countries. Write an
analysis of these tax rates in your own words.
Student answers will vary, but should exhibit understanding of the great international variability in tax
rates.
Additional Questions and Problems
(From student Web site at www.cengagebrain.com)
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 DVD Player
d.
A manicure
e.
A pair of shoes
f.
An eye exam
g.
A personal computer
h.
A neighborhood teenager mowing a lawn
a.
b.
c.
d.
e.
f.
g.
h.
Nondurable
Durable
Durable
Service
Nondurable
Service
Durable
Service
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted
in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Chapter 3
Economic Decision Makers
48
2. (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.
ANSWERS TO ONLINE CASE STUDIES
1. (CaseStudy: 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.
2. (CaseStudy: The Electronic Cottage) How has the development of personal computer hardware
and software reversed some of the trends brought on by the Industrial Revolution?
The Industrial Revolution led to centralized production in large urban facilities. The personal
computer revolution has reintroduced some elements of the cottage industry into our economy.
Computers, modems, fax machines, electronic mail, and the Internet allow more and more people
to work in their homes—as in the cottage industry system. This has greatly decentralized the
acquisition, analysis, and transmission of information. Direct supervision of production is more
difficult if many employees work mainly at home or on the road. However, the computer revolution
has contributed to the trends of a more efficient division of labor and lower transportation costs.
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted
in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.