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than contributing to

than contributing to team production. Shirking activities might include arriving late for work, taking long breaks, leaving work early, making personal phone calls, surfing the internet, etc. Most of the harm of this shirking may fall on the other members of the team. Firms often employ managers to oversee teams of employees. One of a manager’s duties is to limit shirking behavior and to promote productive behavior. But what is to keep a manager from shirking his or her own duties? One way to encourage a manager to be diligent to limit the shirking behavior of employees is to make the manager a residual claimant (e.g. with a profitsharing plan or a bonus based on firm profitability or team productivity). Residual claimants of a firm receive a share of the firm’s profits. Some firms take the additional step of making all employees residual claimants. The Principal-Agent Problem The problem of shirking by employees is a specific example of a common problem called the principal-agent problem. An agent is a person who agrees to act for the benefit of another, the principal. In an employment situation, the employee is an agent of the firm. The employee agrees to work for the benefit of the firm. But humans are by nature self-interested. Any agent who finds a conflict between his or her selfinterest and the principal’s interest will tend to pursue self-interest. This is the principal-agent problem. Thus, managers try to compel employees to pursue the firm’s interest. And business firms sometimes make employees residual claimants so that the employees will have a selfinterest in pursuing the firm’s goal of profit-maximization. Business Firms Firms are either business firms or nonprofit firms. Business firms are owned by individuals; proprietors, partners, or stockholders. These owners are the residual claimants of the business firm. Business firms come in different legal types, and vary widely in size. The most common legal type of business firm is the proprietorship, but in terms of total sales, corporations are the most important type of business firm. Example 7A: According to the “Statistical Abstract of the United States: 2012”, proprietorships make up 72% of business firms, and have 4% of total sales, partnerships make up 10% of business firms, and have 15% of total sales, and corporations make up 18% of business firms and have 81% of total sales. Most corporations are small businesses. But the small percentage of corporations that are large provide the majority of total corporate sales. Example 7B: According to the “Statistical Abstract of the United States: 2012”, over 80% of corporations have annual sales of under $1 million. The fewer than 20% of corporations with annual sales of over $1 million have over 96% of total corporate sales. The Chief Goal of Business Firms All types of business firms are assumed to pursue profit-maximization as their chief goal. It is in the best interest of the residual claimants of a business firm for the firm to achieve maximum profits. But is it in the best interest of society that business firms seek to maximize profits? Generally, yes. In a competitive market, the goal of profit-maximization will compel a business firm to do two things that serve the best interest of society: FOR REVIEW ONLY - NOT FOR DISTRIBUTION 1. The firm will use its resources to produce in response to consumer demand. Competition forces a profit-seeking firm to be responsive to consumer demand. In a competitive market, a firm that is not responsive to consumer demand will lose customers to its competitors. Producing in response to consumer demand contributes to society’s goal (in 19 - 3 The Firm

dealing with the basic economic problem of scarcity) of producing as much consumer satisfaction as possible with the limited resources available. Example 8A: Darla opens a donut shop featuring tofu-based donuts. But consumers find the donuts unappealing. If Darla wants to stay in business and have a chance to earn a profit, she will have to change her donuts in response to consumer demand. 2. The firm will use its resources as efficiently as possible. The firm must use its resources efficiently in order to minimize production costs and thus maximize profits. Using resources efficiently also contributes to society’s goal of producing as much consumer satisfaction as possible with the limited resources available. Example 8B: Darla employs a large number of her relatives as employees at her donut shop. She has the employees place the sprinkles on the donuts one sprinkle at a time. This production technique justifies her large number of employees. Unfortunately, this inefficient use of labor causes the donuts to be so costly that they are not competitive. If Darla wants to stay in business and have a chance to earn a profit, she will have to use her resources more efficiently. Legal Types of Business Firms One of the key characteristics of a business firm is its legal type. Most business firms are proprietorships, partnerships, or corporations. Each of these legal types of business firm is discussed over the next few pages: Proprietorship – a firm owned and operated by one individual. Proprietorships are the most common type of business firm. As mentioned previously, proprietorships make up over 70 percent of business firms. One reason proprietorships are so common is that they are easy to form and to dissolve. In many cases, all that is required to form a proprietorship is for the proprietor to bring the necessary resources together and begin conducting business. Certain regulatory requirements may have to be met as well. To dissolve a proprietorship, the proprietor fulfills any remaining obligations of the firm and then stops conducting business. Example 9: A huge snowstorm hits Springfield. Homer sees an opportunity to make a profit. He invests $10,000 in a used snowplow and starts a driveway clearing business. Homer can form his proprietorship by simply bringing the necessary resources together and offering his services to the public. If Homer decides to dissolve his proprietorship, he will simply fulfill any remaining obligations and then stop offering his services to the public. Another advantage of the proprietorship is the direct connection between ownership and control. The owner controls the business and can quickly make decisions in pursuit of self-interest without the need to consult others. A major disadvantage of the proprietorship is that the proprietor has unlimited liability. Unlimited liability means that the proprietor is personally liable for the debts of the proprietorship. The proprietor’s personal assets are subject to the business debts. Thus, a person who invests $10,000 to start a proprietorship is putting at risk the $10,000 invested in the business and all the proprietor’s other assets. Example 10: Homer invests $10,000 in a used snowplow to start a driveway clearing business. Homer carelessly plows into a parked Rolls Royce. Homer offers the car’s owner (a Mr. Burns) the snowplow as compensation for the destroyed car. Mr. Burns sues Homer’s business and wins a $150,000 judgment. Homer will have to pay the business debt out of his personal assets. FOR REVIEW ONLY - NOT FOR DISTRIBUTION Other disadvantages of the proprietorship include: The Firm 19 - 4

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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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    Chapter 16 International Trade The

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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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    3. The graph below represents a lab

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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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