We have a happy compromise!
IMO, 3 year old people and puppies typically share a few traits, one of them being an appreciation for open space. Put in a sofa, futon, loveseat, whathaveyou and the space will feel less open. I love how this three year old will run out into the room, dance around, ask for powwow music, spin to her heart's content, yadda yadda. I've decided that I can't spoil that for her.
So, we will keep the livingroom/sleeping room arrangement the same. No additions or changes -- just a recommittment to open spaces.
However, we are fortunate enough to have a small "office" room from where I am typing this message. It's already a pretty cramped space. We don't have a desk, but a table and shelf kind of pieced together to put computer stuff on. I've decided to put a (used) futon or loveseat next to the window in here. If we hook up a wireless keyboard/mouse we can type from our laps on the loveseat if we want. Tuck the keyboard/mouse away and cover up the monitor and we have a quiet space to curl up with books and journals. I think it's a good compromise, and good out-of-the-box thinking.
Thanks everyone for the input. To those of you contemplating ditching the sofa in favor of open space, if you have young ones I'd encourage you to just give it a try. Pay attention to what the kids do when you clear out the space and you might find it worthwhile. (In case you were wondering, for visitors who can't manage the floor (eg. grandparents), we have a couple of campchairs that we store in a closet.)
I've been reading about The Compact and I'm excited to try to make these changes w/o buying anything new. Thanks for the inspiration!