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Chapter 19 The Firm The

Chapter 19 The Firm The basic economic problem is scarcity. Human wants are unlimited. Resources are limited. The basic goal in dealing with the problem of scarcity is to produce as much consumer satisfaction as possible with the limited resources available. To produce as much consumer satisfaction as possible with the limited resources available, society must use its limited resources as efficiently as possible. Whatever is produced must be produced with as few resources as possible (at the lowest opportunity cost). Most production in a developed economy takes place through firms; either business firms or nonprofit firms. Firm – an entity that employs resources to produce goods and services. Most resources (labor, land, capital, entrepreneurship) are owned by households. For instance, each person owns his or her own labor. Potentially, all production could take place at the household level. A great deal of production does take place at the household level; e.g. child care, food preparation, clothes washing, etc. But most production takes place through firms. Why does most production take place through firms? Firms and Efficiency Firms are often the best way to organize the limited resources for production. For many types of production, firms can produce more efficiently (at lower cost) than households. Example 1: Juanita produces some of the goods and services that she consumes using her own resources. She cooks her own meals, cleans her own house, washes her own hair, etc. But Juanita also purchases goods and services from firms. She pays a stylist to cut her hair rather than cutting it herself. She buys food (e.g. fruits and vegetables) at the supermarket rather than growing her own garden. She buys various manufactured goods (e.g. a new refrigerator) rather than making them herself. Most of the goods and services that she consumes are produced by firms, because she finds it cheaper to buy the goods than to produce them herself. Firms and Reduced Transaction Costs The efficiency advantage that firms have over household production may occur because firms can reduce transaction costs. Transaction costs – the costs of bringing buyers and sellers together for exchanges. When two parties voluntarily engage in a trade, both parties expect to benefit from the trade. But if the transaction costs of carrying out the trade are large, the transaction costs may outweigh the benefit of the trade. A firm may be able to reduce transaction costs, creating more opportunities for mutually beneficial exchanges. Example 2A: Juanita, who lives in Tulsa, Oklahoma wants three pounds of bananas and is willing to pay 80¢ per pound. Lucio, a banana farmer in Ecuador, is willing to sell bananas for 20¢ per pound. But the transaction costs of carrying out the exchange directly between Juanita and Lucio would outweigh the benefit of the trade. Firms, such as wholesale distributors and supermarkets, can reduce transaction costs and make it possible for Juanita to purchase bananas grown by Lucio. Example 2B: The transaction costs of buying groceries would be very high if the consumer tried to buy directly from each producer. This might involve a drive to the nearest dairy farm to purchase milk, a drive to the nearest bakery to purchase bread, a drive to the nearest orchard to purchase apples, a flight to Ecuador to purchase bananas, etc. Instead, supermarkets make a variety of groceries available at low transaction costs. FOR REVIEW ONLY - NOT FOR DISTRIBUTION 19 - 1 The Firm

Wal-Mart Corporation, the largest retailer in the world, exists primarily because it is able to reduce transaction costs. Wal-Mart uses its efficient distribution system to make products from all over the world conveniently (and inexpensively) available to the local consumer. Firms and Team Production The efficiency advantage that firms have over household production may occur because team production is more productive than individual production. Productivity is measured by output per unit of input. Example 3: One worker can produce 3 widgets in an hour. The productivity of the one worker is 3 widgets per labor/hour. A team of 10 workers can produce 100 widgets in an hour. The productivity of the team is 10 widgets per labor/hour. In this example, team production is more productive than individual production. Team production allows for two advantages over individual production: 1. Specialization of labor. In individual production, the individual must attempt to master every step in the production process. In team production, each worker may be able to specialize in a specific task. Each worker may become very skilled and productive at his or her specific task. Example 4: Jeff is hired to work in a refrigerator assembly plant. Jeff’s job on the assembly line is installing the back wheels on each refrigerator. Jeff doesn’t have to learn how to assemble an entire refrigerator, and can quickly learn to do his specific task very efficiently. Adam Smith discussed the importance of specialization (division) of labor in Book 1 of “The Wealth of Nations”. See the appendix at the end of this chapter. 2. Extensive use of capital. Team production may allow for the use of large amounts of highly specialized and highly productive capital. A large assembly plant may include hundreds of millions of dollars worth of capital, making the team of workers employed at the plant highly productive. Example 5: Juanita is planning a formal dinner party for 40 people. Though Juanita normally does her own cooking, she decides that her kitchen is not equipped for the preparation of such a large and elaborate meal. So Juanita hires a catering firm to prepare the meal. The catering firm has a very large, well-equipped kitchen. Shirking in Team Production In individual production, if an individual is less productive than he or she could be, that individual suffers the consequences. Thus, the individual producer is motivated to be as productive as possible. But individuals employed as part of a team don’t always have this motivation. Individuals employed as part of a team may be motivated to avoid their obligations as part of the team. Example 6: Meg is assigned an individual research report for her Economics class. She works diligently on the report (an analysis of the causes of high textbook prices) and earns a grade of A. Meg is also assigned to a team to prepare a group research project in her Sociology class. Meg calculates that the rest of the team will prepare an adequate report, even if she doesn’t participate in preparing the report. Meg devotes her time to her other classes. The team (including Meg) receives a grade of B for the report. Meg has engaged in shirking. FOR REVIEW ONLY - NOT FOR DISTRIBUTION Shirking – avoiding the performance of an obligation. An employee who engages in shirking may still benefit from the other team members’ production. The shirking employee may be motivated to engage in activities beneficial to themselves rather The Firm 19 - 2

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    PRINCIPLES OF ECONOMICS JEFF HOLT S

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    Principles of Economics, 6th Editio

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    16. Study Guide for Chapter 7 17. C

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    11. Appendix: Book Review - “The

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    20. Appendix: The NCAA Cartel 21. S

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    Introduction: A Brief History of U.

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    In the twentieth century, per capit

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    Appendix: The 35 Largest National E

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    Multiple Choice: ___ 1. The Jamesto

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    2. Describe the economic cost of th

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    Chapter 1 Scarcity and Choices The

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    Example 5B: At the end of 1982, the

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    Example 11: When Cindy quits her jo

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    consequences may result in failure

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    An upward sloping curve (as in Exam

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    In making decisions, humans tend to

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    5. ______________________ _________

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    ___ 13. If the value of one variabl

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    Y Point X Y A 0 1 B 3 3 C 6 5 D 9 7

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    Chapter 2 Trade and Economic System

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    Example 4B: The following quantitie

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    1. An increase in the quantity of r

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    3. For whom to produce? This is det

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    The graph below illustrates the shi

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    The two primary economic systems ar

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    ___ 12. The capitalist vision sees

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    ___ 25. According to the book “Ca

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    Chapter 3 Demand, Supply, and Equil

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    . For inferior goods, income and de

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    The same information can be placed

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    Not only does a free market elimina

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    $7 - 6 - 5 - S 3 S1 S 2 Price 4 - 3

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    Example 17: The graph below illustr

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    Questions for Chapter 3 Fill-in-the

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    ___ 12. Assuming a market originall

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    $8 - 7 - 6 - 5 - Price 4 - 3 - 2 -

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    Chapter 4 Inflation and Unemploymen

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    Computing the Rate of Inflation The

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    Full Employment Though unemployment

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    3. Cyclical unemployment - due to d

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    During the Great Depression, the ec

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    Appendix: Think Like an Economist -

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    Answer questions 8. and 9. based on

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    ___ 25. The extension of unemployme

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    Chapter 5 Measuring Total Output: G

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    5. Leisure. Leisure time is by defi

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    The U.S. is a high per capita GDP c

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    Example 17: In “An International

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    The simple circular flow diagram be

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    ___ 3. Which of the following would

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    2. Explain what nonproduction trans

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    Chapter 6 The Aggregate Market The

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    Example 2C: Assume the same facts a

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    Example 5B: The price of crude oil

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    Price Level Real GDP SRAS AD 2 AD 1

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    Appendix: Why the Aggregate Demand

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    ___ 3. DEF Company can invest in ne

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    2. List and explain the two factors

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    Chapter 7 Classical Economic Theory

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    Notice that the investment demand c

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    Long-Run Equilibrium If Real GDP is

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    Example 6B: When the economy is in

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    Laissez-faire If the economy is sel

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    ___ 5. According to Say’s Law: a.

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    3. On the graph below, draw an aggr

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    Chapter 8 Keynesian Economic Theory

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    Example 2B: The graph below illustr

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    Example 5: Assume that the table be

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    Notice on the graph on the previous

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    According to Keynesian theory, a ch

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    “The General Theory” also inclu

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    ___ 8. If the consumption function

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    3. If the MPC is .667, and investme

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    Chapter 9 Fiscal Policy The basic e

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    Keynesian Fiscal Policy Theory and

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    Example 5A: The federal government

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    The Laffer Curve What will happen t

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    Appendix: The Importance of Incenti

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    ___ 4. A decrease in government exp

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    2. Explain what automatic stabilize

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    Chapter 10 Money, Money Creation, a

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    Example 4B: The castaways on Gillig

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    Looking at the balance sheet below,

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    Demand-side One-shot Inflation Exam

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    4. Inflation increases uncertainty

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    life; it came into existence not by

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    calculated by using the potential d

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    ___ 12. If the required-reserve rat

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    4. Referring to the balance sheet f

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    Chapter 11 The Federal Reserve Syst

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    5. After Bank X sells the $300,000

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    Low Mortgage Interest Rates Mortgag

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    Relaxed Standards for Mortgage Loan

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    The Bursting of the Housing Bubble

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    On February 17, 2009, the federal g

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    Fed policies caused short-term inte

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    ___ 10. The Fed’s most important

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    ___ 25. In response to the recessio

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    Chapter 12 Monetary Policy The basi

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    2. A change in aggregate demand (AD

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    Monetarist Transmission Mechanism C

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    3. Borrowers do not have to seek ou

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    Appendix: Book Review - “The Age

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    Questions for Chapter 12 Fill-in-th

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    ___ 16. The primary source of incom

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    7. According to Alan Greenspan, wha

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    Chapter 13 Taxes, Deficits, and the

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    Example 5: In 2015, Taxpayer A had

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    of $5 and a quantity of 10 units. T

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    The complexity of the tax law also

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    the current government spending and

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    cut of 1964. The top rate was lower

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    ___ 6. Federal excise taxes: a. are

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    3. How would eliminating the loopho

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    Chapter 14 Economic Growth The basi

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    2. Labor. Labor can contribute to e

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    estricting international trade (e.g

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    An improvement in technology (e.g.

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    The table below shows the economic

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    will increase both Real GDP and per

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    ___ 8. Which of the following is co

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    ___ 26. The opinion that economic g

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    Chapter 15 Less Developed Countries

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    Example 8: Countries A, B, C, and D

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    Obstacles to Economic Development f

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    c. Restrictions on international tr

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    Appendix: Book Review - “The Powe

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    Example 25: In Brazil, about half t

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    Study Guide for Chapter 15 Chapter

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    ___ 13. Among the counterproductive

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    4. List four ways that governments

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    3. Exclusive ownership of an essent

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    maximizing quantity (4 units) creat

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    $22 - 20 - 18 - 16 - 14 - Deadweigh

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    2. Negotiating, beginning at a high

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    Legal barriers are created by gover

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    ___ 8. The slope of the demand curv

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    Price Quantity 3. List some of the

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    Chapter 23 Monopolistic Competition

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    For Percomp (the perfect competitor

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    Example 7A: The graph below represe

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    Example 9: The Organization of the

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    Example 12 illustrates the dilemma

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    its current price and quantity. The

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    ___ 14. Game theory: a. is a method

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    Answers for Chapter 23 Fill-in-the-

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    Chapter 24 Factor Markets The basic

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    $ $240 - 200 - 160 - 120 - 80 - 40

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    Since producers will attempt to equ

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    2. Differences in nonmoney aspects

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    were his strikeouts, walks, and hom

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    ___ 3. To maximize profits, a produ

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    ___ 19. According to the book, “M

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    Multiple Choice: 1. a. 8. c. 15. d.

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    Chapter 25 Labor Unions The primary

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    The elasticity of demand for union

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    Example 4A: Assume that the graph b

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    Notice from the graph in Example 6

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    Wage Factory A Quantity of Labor S

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    As a cartel, a labor union faces a

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    ___ 10. For a monopsony: a. there i

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    Chapter 26 Interest, Present Value,

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    An increase in expected rates of re

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    An asset is valuable because we exp

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    Example 13B: General Ordnance prove

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    Appendix: Present Value Table One f

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    ___ 4. An increase in expected rate

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    Problems: 1. List and explain the t

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    Chapter 27 Market Failure The basic

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    External Benefit If a market genera

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    Example 2: To encourage the consump

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    $100 - 90 - 80 - MSC 70 - $ 60 - 50

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    A common good is nonexcludable. Non

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    Study Guide for Chapter 27 Chapter

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    ___ 5. What government policy would

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    4. Based on the information on the

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    Chapter 28 Public Choice and Govern

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    Candidates and the Median Voter Mod

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    Example 8: According to State and F

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    Example 10: When Elvis Presley was

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    4. Pessimistic bias. This is the te

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    ___ 5. An elected official will: a.

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    2. If a certain policy will yield s

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    Chapter 29 Government Regulation of

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    underproduction is the amount that

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    micromanagement results in business

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    market. They may agree with their c

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    Questions for Chapter 29 Fill-in-th

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    ___ 10. The public interest theory

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    4. List the four types of costs imp

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    Chapter 30 Agriculture and Health C

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    weather may cause bumper crops. Bad

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    Security and Rural Investment Act o

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    Example 12: From 1960 to 2013, the

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    1. NHI would provide universal heal

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    d. Insurance providers are not allo

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    Study Guide for Chapter 30 Chapter

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    Answer questions 7. through 10. by

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    ___ 21. If there were no individual

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    Chapter 31 Income Distribution and

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    Income is more equally distributed

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    over a typical career is the accumu

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    Ideal Income Redistribution The ide

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    Poverty - a family whose income fal

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    Appendix: Income Inequality around

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    How is this story an analogy for th

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    ___ 2. In 2013, the Lowest Income 6

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    Problems: 1. Explain the two primar

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    Absolute advantage - when one natio

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    Fiat money - money by government de

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    Nonrivalrous good - a good for whic

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    Absolute advantage, 16-9 Absolute e

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    “Company town”, 25-6 Comparativ

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    Eli Lilly and Company, 22-1 Emergen

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    Houston, Texas, 15-10 Human capital

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    Market, 3-1, 3-8-9 Market basket, 4

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    Political bias, 9-4, 12-7 Political

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    Short run production, 20-2-3 Short-

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    Upturns, 9-4 USDA, 27-9, 30-1-2, 30

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