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1. How does it decide where to install apps when you download them? To the phone or to the memory card?
2. Are there any drawbacks to running an app from the card rather than directly on the device?
Anything that needs activity as the phone is booting probably shouldn't be on your sdcard. Launchers, widgets, and live wallpapers come to mind. There could be some exceptions to the rule here but in general those are the problematic ones. Most apps probably will say "Don't install on sdcard" or something along those lines in their market details.