Microeconomics Chapter 3: Economic Decision Makers

1) The Evolution of the Household
2) Households Maximize Utility
3) Households as Resource Suppliers

a farm household was largely self-sufficient
- each family member often specialized in a specific farm task
- produced what they consumed and consumed what they produced
- many workers moved from farms to urban factories, where they became more specialized but less self-sufficient

a) Utility = the satisfaction received from consumption; sense of well-being
- households act in their best interests and do not deliberately try to make themselves less happy
- subjective goals

households use their limited resources (labor, capital, natural resources, and entrepreneurial ability) in an attempt to satisfy their unlimited wants
- most valuable resource sold by most households is LABOR
a) Transfer Payments = cash or in-kind benefits given to individuals as outright grants from the government
- Cash Transfers: welfare benefits, Social Security, unemployment compensation, disability benefits
- In-Kind Transfers: provide for specific goods and services, such as food, health care, and housing

Personal Consumption
1) Durable Goods = goods expected to last three or more years (automobile or a refrigerator)
- 9% of income
2) Nondurable Goods = food, clothing, gasoline
- 19% of income
3) Services = haircuts, air travel, and medical care
- 54% of income

Taxes (11%)
Savings (7%)

1) The Evolution of the Firm
2) Types of Firms
3) Cooperatives
4) Not-for-Profit Organizations
5) Why Does Household Production Still Exist?

Specialization and Comparative Advantage explain why households are no longer self-sufficient
- Problem = transaction costs (if the consumer had to visit each of these specialists and reach an agreement)
- Solution = an entrepreneur (the consumer can pay someone to do the bargaining, who hires all the resources necessary to make the sweater, an is able to reduce the transaction costs per sweater)

a) Industrial Revolution = development of large-scale factory production that began in Great Britain around 1750 and spread to the rest of Europe, North America, and Australia
- Factores
1) promoted a more efficient division of labor
2) allowed for the direct supervision of production
3) reduced transportation costs
4) facilitated the use of machines far bigger than anything used in home

b) Firms = economic units formed by profit-seeing entrepreneurs who employ resources to produce goods and services for sale
- maximize profit
- Profit = Revenue - Cost

a) Sole Proprietorship
b) Partnerships
c) Corporations

a firm with a single owner who has the right to all profits but who also bears unlimited liability for the firm's losses and debts
- complete control
- raising enough money can be challenging
- usually goes out of business when the proprietor dies or leaves the business
*most common type of business (71% of all U.S. businesses and 4% of all business sales)

a firm with multiple owners who share the profits and bear unlimited liability for the firm's losses and debts
- easier than sole proprietors to raise enough funds to get the business going
- partners may not always agree
- both partners face unlimited liability for any debts or claims against the partnership
- death or departure of one partner can disrupt the firm's continuity
*least common form of U.S. business (10% of all firms and 15% of all business sales)

a legal entity owned by stockholders whose liability is limited to the value of their stock ownership
- many investors can pool their funds, which is the easiest way to amass large sums to finance the business
- limited liability = stockholders' liability for any loss is limited to the value of their stock
- has a life apart from its owners (survives even if ownership changes hands)
- taxed, sued, and even charged with a crime
- influence is limited to voting for a board of directors (stockholders own a tiny fraction of the shares and thus has little say)
- Double Taxation
a) corporate profits
b) stockholder income (corporate dividends or realized capital gains)
*make up 19% of all U.S. business and 81% of all business sales)

a hybrid corporation takes advantage of the limited liability feature of the corporate structure while reducing the impact of double taxation
- profits are taxed only once
- no more than 100 stockholders and no foreign stockholders

a) Cooperative = an organization consisting of people who pool their resources to buy and sell more efficiently than they could individually
- minimize costs and operate with limited liability of members

Two Types
1) Consumer Cooperatives
2) Producer Cooperatives

a retail business owned and operated by some or all of its customers in order to reduce costs

producers join forces to buy supplies and equipment and to market their output
- reduce costs and increase profits

a) Not-for-Profit Organizations = groups that do not pursue profit as a goal; they engage in charitable, educational, humanitarian, cultural, professional, or other activities, often with a social purpose
- government agencies are not included in not-for-profit organizations even though they do not have profit as a goal either

if a household's opportunity cost of performing a task is below the market price, then the household usually performs that task
a) No Skills or Special Resources Are Required
b) Household Production Avoids Taxes
c) Household Production Reduces Transaction Costs
d) Technological Advances Increase Household Productivity

households usually perform domestic chores that demand neither expertise nor special machinery

if you paint the house yourself, no taxes are involved
- do-it-yourself activities favors household production over market transactions

doing the job yourself allows for more personal control over the final product

a) Information Revolution = technological change spawned by the microchip and the Internet that enhanced the acquisition, analysis, and transmission of information
- more people can work from their homes

1) The Role of Government
2) Government's Structure and Objectives
3) The Size and Growth of Government
4) Sources and Government Revenue
6) Tax Principles and Tax Incidence

Market Failure = a condition that arises when the unregulated operation of markets yields socially undesirable results

a) Establishing and Enforcing the Rules of the Game
b) Promoting Competition
c) Regulating Natural Monopolies
d) Providing Public Goods
e) Dealing With Externalities
f) A More Equal Distribution of Income

governments safeguard private property through police protection and enforce contracts through a judicial system
- make sure market participants abide by the rules of the game

a) Collusion = an agreement among firms to divide the market and fix the price (to avoid competition)
b) Antitrust Laws = prohibitions against price fixing and other anticompetitive practices

a) Monopoly = a sole supplier of a product with no close substitutes
b) Natural Monopoly = one firm that can supply the entire market at a lower per unit cost than could two or more firms
- faces no competition
- maximizes profit by charging a higher price
- government then regulates a natural monopoly, forcing it to lower its price and increase outputs

a) Private Goods = a good, such as pizza, that is both rival (amount consumed by one person is unavailable for others to consume) in consumption and exclusive
b) Public Goods = a good that, one produced, is available for all to consume, regardless of who pays and who doesn't; such a good is non-rival and nonexclusive, such as a safer community

a) Externalities = a cost or a benefit that affects neither the buyer nor seller, but instead affects people not involved in the market transaction
- negative externality: factory pollution, auto emissions, or traffic congestion
- positive externality: good education, inoculated against a disease, driving carefully
*governments often use taxes, subsidies, and regulations to discourage negative externalities and encourage positive externalities

transfer payments reflect society's willingness to provide a basic standard of living to all households
- redistribute income to the poor
- normative statements (opinions differ about who should receive benefits)

government attempts to promote:
- full employment
- price stability
- economic growth
a) Fiscal Policy = the use of government purchases, transfer payments, taxes, and borrowing to influence economy-wide variables such as inflation, employment, and economic growth
b) Monetary Policy = regulation of the money supply to influence economy-wide variables such as inflation, employment, and economic growth (interest)

a) Federal Government = primary responsibility for national security, economic stability, and market competition
b) State Governments = fund public higher education, prisons, and highways and welfare
c) Local Governments = provide primary and secondary education with aid from the state, plus police and fire protection

1) Difficulty in Defining Government Objectives
2) The Size and Growth of Government
3) Sources of Government Revenue
4) Tax Principles and Tax Incidence

a) Voluntary Exchange Versus Coercion
- market exchange relies on the voluntary behavior of buyers and sellers
- however, any voting rule except unanimous consent must involve some government coercion
b) No Market Prices
- revenue side of the government budget is usually separate from the expenditure side (no necessary link between the cost of a program and a benefit)

a) Gross Domestic Product (GDP) = a way of tracking the impact of government over time; total value of all final goods and services produced in the US

a) Federal Government relies on individual income tax
b) State Government relies on income and sales taxes
c) Local Government relies on the property taxes

d) Payroll Taxes = deducted from paychecks to support Social Security and Medicare (fund retirement income and medical care for the elderly)

...

those with a greater ability to pay, such as those earning higher incomes are those owning more property, should pay more taxes

those who get more benefits from the government program should pay more taxes

the distribution of tax burden among taxpayers; who ultimately pays the tax

the tax as a percentage of income remains constant as income increases; also called a flat tax

the tax as a percentage of income increases as income increases

the percentage of each additional dollar of income that goes to the tax

the tax as a percentage of income decreases as income increases

1) International Trade
2) Exchange Rates
3) Trade Restrictions

International trade occurs because the opportunity cost of producing specific goods differs across countries
- trade between the U.S. and the rest of the world has increased in recent decades
a) Merchandise Trade Balance = the value during a given period of a country's exported goods minus the value of its imported goods
b) Balance of Payments = a record of all economic transactions during a given period between residents of one country and residents of the rest of the world

a) Foreign Exchange = foreign money needed to carry out international transactions
- exchange rate = measures the price of one currency in terms of another

a) Tariffs = a tax on imports
b) Quota = a legal limit on the quantity of a particular product that can be imported or exported

Disadvantage = interfere with the free flow of products across borders and tend to hurt the overall economy