Lesson 1.1.

Introduction to Economics
Everybody goes through a day faced with constraints or limitations: motorists
complain of high gasoline prices, times when people suffer due to shortage Of
chicken in the market, or insufficient allowance for a student who needs to buy
books and school supplies. People always complain about not having enough—not
enough food on the table, not enough money to pay one's debts, or not enough
income to meet all the family's needs. This, in effect, is the existence of what we call
scarcity, that is, insufficiency Of resources to meet the wants of consumers and
insufficiency of resources for producers that hamper enough production of goods
and services.
Scarcity is the reason why people have to practice economics. Economics, as a
study, is the social science that involves the use of scarce resources to satisfy unlimited
wants. Part of human behavior is the tendency ofman to want to have as many goods and
services as he can. However, his ability to buy goods and services is limited by his
income and purchasing power. It is therefore in this context that man has to practice
eCOnomics.
Well-known economist Alfred Marshall described economics as a study Of
mankind in the ordinary business of life. It examines part of the individual and social
action that is most closely connected with the attainment and use of material requisites
of well-being.
Scarcity is a condition where there are insufficient resources to satisfy all the
needs and wants of a population. Scarcity may be relative or absolute. Relative scarcity is
when a good is scarce compared to its demand. For example, coconuts are abundant in
the Philippines since the plant easily grows in our soil and climate. However, coconuts
become scarce when the supply is not sufficient to meet the needs of the people. Relative
scarcity occurs not because the good is scarce per se and
is difficult to obtain but because of the circumstances that surround
the availability of the good. Bananas are abundant in the Philippines and are being grown
in a lot of regions around the country. But when a typhoon destroys banana plants and
the farmer has no bananas to harvest, then bananas become relatively scarce.
On the other hand, absolute scarcity is when supply is limited. Oil is absolutely
scarce in the country since we have no oil wells from which we
can source our petroleum needs, so we rely heavily on imports from oil-
producing countries like Iran and other Middle Eastern countries. Cherries
are absolutely scarce in our country since we do not have
the right climate to grow them and we have to rely on imports for our supply of
cherries. This explains why cherries are very expensive in the Philippines.
 CHOICE AND DECISION-MAKING

Because of the presence of scarcity, there is a need for man to make decisions
in choosing how to maximize the use of the scarce
resources to satisfy as many wants as possible. A homemaker
who has a monthly budget needs to decide on how to utilize it

to pay the rent, to buy food, to pay the children's tuition fees, and to buy new clothes
and shoes. If the budget is not enough, then the homemaker has to give up some of
these things. She needs to make a choice. If she decides not to buy new shoes for her
children at the start of the school year, then this is the choice she gave up.
Opportunity cost refers to the value of the best foregone alternative. When land
is devoted exclusively to the cultivation of rice, we give up an output of bananas or
mangoes that we could have planted on that land area. A producer who decides to
transform all his leather into shoes, gives up the chance to produce bags with that
leather. A school teacher who could have worked in a bank, gives up the salary that
she would have earned as a bank employee. A manager who quits his job in order to
take up a master's degree, gives up his salary as a manager. That salary is his
opportunity cost. Without scarcity, a person does not need to make choices since
he/she can have everything he/she wants.
The concept of opportunity cost holds true for individuals, businesses, and even a
society. In making a choice, trade-offs are involved. The opportunity cost of watching a
movie in a cinema is the value of other things that you could have bought with that
money such as a pint of ice cream, a combo meal in a fast food, or a simple t-shirt to be
used in a PE class. Another example is giving up work in favor of a recreational activity,
say you go on a week's stay in Boracay on a leave without pay. Then you are giving up
the income you would have earned had you not decided to go on that trip. Another
example would be a business proprietor that withdraws P 10,000 from his savings
account so he can buy materials to be used in his business. He gives up the interest the
savings would have earned but his goal is to earn more money that would be generated
by the business.

ECONOMIC RESOURCES

Economic resources, also known as factors of

production, are the resources used to produce goods and
services. These resources are, by nature, limited and
therefore, command a payment that becomes the income of
the resource owner.
1. Land - soil and natural resources that are found
in nature and are not manmade. Owners of lands
receive a payment known as rent.
2. Labor - physical and human effort exerted in production. It covers manual
workers like construction workers, machine operators, and production
workers, as well as professionals like nurses, lawyers, and doctors. The
term also includes jeepney drivers, farmers, and fishermen. The income
received by labors is referred to as wage.
3. Capital - man-made resources used in the
production of goods and services, which include
machineries and equipment. The owner of capital earns an income
called interest.
ECONOMICS A SOCIAL SCIENCE
Economics is a different science from bi0100' and
chemistry as these are physical sciences. Economics is
a social science because it studies human behavior just
like psych010U and soci010&t. A social science is,
broadly speaking the study of society and how people
behave and influence the world around them. AS a social
science, economics studies how individuals make choices
in allocating scarce resources to satisfy their unlimited
wants.

MACROECONOMICS AND MICROECONOMICS

There are two branches of economics. These are
macroeconomics and microeconomics.
Macroeconomics is a division of economics that is
concerned with the overall performance ofthe entire economy
It studies the economic system a' a whole rather than the
individual economic units that make up the economy. It
focuses on the overall flow of goods and resources and
studies the causes of changéin the aggregate flow of money,
the aggregate movement of goods and services, and the
general employment of resources. Macroeconomics is about
the nature of economic growth, the expansion of productive
capacity, and the growth of national income.
Microeconomics, on the other hand, is concerned with the
behavior of individual entities such as the consumer, the
producer, and the resource owner. It is more concerned on
how goods flow from the business firm to the consumer and
how resources move from the resource owner to the business
firm. It is also concerned with the process of setting
prices ofgoods that is also known as Price Theory.
Microeconomics studies the decisions and choices of the
individual units and how these decisions affect the prices
of goods in the market Likewise, it examines alternative
methods of using resources in order to alleviate scarcity.
It does not focus on aggregate levels of production,
employment, and income.
BASIC ECONOMIC PROBLEMS OF SOCIETY
All societies are faced with basic questions in the
economy that have to be answered in order to cope with
constraints and limitations. These are:
1. Whattoproduce and how much - society must decide
what goods and services should be produced in the
economy. Having decided on the nature ofgoods that
will be produced, the quantity of these goods
should also be decided on.
2. How to produce — is a question on the production
method that will be used to produce the goods and
services. This refers to the resource mix and
techn0100' that will be applied in production.
3. For whom to produce - is about the market for the
goods. For whom will the goods and services be produced? The
young or old, the male or female market, the low-income or the
high-income groups?
 How these questions are answered depends on the nature of the economic system
in place. The economic system is the means by which society answers the basic
economic problems.

ECONOMIC SYSTEMS
The economic system is the means through which society determines the answers
to the basic economic problems mentioned. A country may be under any of the
following types or even a combination of the three economic systems:

1. Traditional economy. Decisions are based on traditions and practices upheld

over the years and passed on from generation to generation. Methods are
stagnant and therefore not progressive. Traditional societies exist in primitive
and backward civilizations.
2. Command economy. This is the authoritative system wherein decision-
making is centralized in the government or a planning committee. Decisions
are imposed on the people who do not have a say in what goods are to be
produced. This economy holds true in dictatorial, socialist, and communist
nations.
3. Market economy. This is the most democratic form of economic system.
Based on the workings of demand and supply, decisions are made on what
goods and services to produce. People's preferences are reflected in the prices
they are willing to pay in the market and are therefore the basis of the
producers' decisions on what goods to produce.

WHY ECONOMICS IS IMPORTANT

Students may ask, "Why do we need to study economics?" To know how

important the subject is, all they need to do is read the front page of the newspapers
to see that the most important news are economic in nature. Watch the news on TV
and for sure, economic news always presents important
issues.

Economics will help the students understand why there is a need for
everybody, including the government, to budget and properly allocate
the use of whatever resources are available. It will help one understand how to
make more rational decisions in spending money, saving part of it, and even
investing some of it.
On the national level, economics will enable the students to take a look on how the
economy operates and to decide for themselves if the government officials and leaders
are effective in trying to shape up the economy and formulate policies for the good of
the nation.
 SCIENTIFIC APPROACH IN THE EMPIRICAL TESTING OF AN ECONOMIC THEORY

Economics is a study that attempts to explain how an economy operates and

how the consumer attempts to maximize his/her wants within limited means. Using
tools such as logic, mathematics, and statistics, the student needs to approach the
empirical testing of an economic theory in a scientific manner. This scientific
approach involves the following steps:
1. State the propositions or conditions that are taken as given and do not
need further investigation, as the basic starting point of investigation.
These propositions will serve as the premises upon which the theory is
established.
2. Observe facts in connection with the activity that we want to theorize.
3. Apply the rules of logic to the observed facts to determine causal
relationships between observed factors and to eliminate facts that are
unnecessary and irrelevant.
4. • Establish a set Of principles such that formulated hypotheses may be tested as to
whether they are valid or not.
5. Use statistics and econometrics as empirical proofin testing the hypotheses.
POSITIVE ECONOMICS VERSUS NORMATIVE ECONOMICS

Positive economics deals with what is—things that are actually happening such as
the current inflation rate, the number of employed labor, and the level of the Gross National
Product. Normative economics, on the other hand, refers to what should be—that which
embodies the ideal such as the ideal rate of population growth or the most effective tax
system. Positive economics is an overview of what is happening in the economy that is
possibly far from what is ideal. Normative economics focuses on policy formulation that will
help to attain the ideal situation.

MEASURING THE ECONOMY

We always get to read in the newspapers how our
economy has grown in recent years. Before we go into the essence of
applied economics, it is beneficial that students get to learn first how the growth
ofthe economy is actually measured. The national government is always happy to
inform the people that the country's Gross Domestic Product (GDP) has grown in
 rates, much higher than in the previous administration. We will now go into a short
discussion ofwhat the GDP is all about.
The government plans for a better economy from a perspective of what the
economy has been. Shaping the economy's future is changing past and present
perspectives extended to the future. In particular, looking ahead is grounded on past
and present performance and health of the economy. The heart of the economy is
production whose value measures both resource input and output of people. The
interplay of resources and outputs tells how well the economy has performed.
 Counting All through GNP
As the mirror of all products, Gross National Product
(GNP) is the market value of final products, both sold
and unsold, produced by the resources of the economy in a
given period. Market value is determined by supply and
demand while the economy's resources are those belonging
to Filipino citizens and corporations. Not all resources
belonging to the economy are in the economy, like the
capital and entrepreneurship that brought the SM mall to
China. Conversely, not all resources in the economy
belong to the economy like the capital and
entrepreneurship brought to the country by multinationals
like Nestlé and Procter and Gamble (P&G). In addition,
the value of final products already includes the values
of its components from the lower production stages. For
example, the price of your leather wallet already
includes the value of leather that in turn includes the
value of animal hide. In other words, counting the values
of products from the raw material to the intermediate and
on to the final production stages, double counts and
overstates the value of the economy's production.
Likewise, the value of any product in a certain period
should no longer be counted in succeeding periods to
avoid double counting and overstatement that can mislead
decision-making.
GNP/GDP: Expenditure Approach
One way to account GNP and classify its components is
by end-use expenditure. Products are final when they have
reached the highest levels of processing in the economy
for different uses in the given period. They are household
and individual consumption (C), and government expenditure
on goods and services including labor (G) and exports (X).
Products, regardless ofproduction stages, are also
considered final when basically stocked (unused) as
capital goods and inventories of raw materials and
intermediate products. Classified as investments (I), they
are stock of values for future use and therefore, have
reached the highest possible production stages for the
given period. On the other hand, their import components
(M) are excluded since import products are produced in
other economies. To restate the GNP equation:

GNP = C +1 + G + M)

Table 1.1 presents Philippine GNP statistics whose

components are classified by expenditure accounts. Capital
Formation is Investment (I) by both the private sector and
government that consists of fixed capital and inventory
changes. Fixed Capital includes capital goods (buildings,
machineries; equipment) while inventory changes are stocks
(unused) for future use from all stages produced in that
year. Net Factor Income from abroad is net export of factor
services equal to Factor Income from abroad less the factor
payments of other countries. Factor payments are for the
direct services of resources like the remittances of our
overseas contract workers for labor export. Likewise,
profit remittances to the home countries ofmultinational
companies like Nestle and Procter and Gamble (P&G)
represent our payments for importing their capital and
entrepreneurship. These factor payments to other countries
represent additional imports excluded from our GNP. On the
other hand, payments for non-factor services as part of
trade balance (XM) are for services using all factors
(resources) of production. Profit brought home by a
Filipino construction firm for construction services in
Saudi Arabia is an example of nonfactor service export
receipt.
 However, a better indicator of domestic employment
opportunities is Gross Domestic Product. Gross Domestic
Product (GDP) is defined as the market value of final and
products entrepreneurship produced within belonging the
country. to other The countries resources brought in the
to the economy domestic include economy capitalby

foreign businesses. In Table 1.1, GDP is net of GNP after

deducting Net Factor Income from abroad or by deducting
factor income from abroad and adding back Factor Payments
to other countries. In other words, a negative sign to Net
Factor Income from abroad changes the sign of Factor
Income from abroad from positive to negative and Factor
payments to other countries from negative to positive. The
table shows that Household consumption is the biggest GDP
expenditure (74%) followed by Capital Formation (19%) led
by the construction industry. In other words, our economy
mostly produces consumer goods and buildings and other
construction structures. The dominance of household
consumption reflects households' propensity to consume
more and save less. On the other hand, construction is
both private investments by the rich and public capital
spending by government largely financed by borrowings.

Net Inflow = Inflow - Outflow to - Net Inflow = -

Inflow + Outflow

GNP/GDP: Income Approach

 Another way to account GNP and classify its components
is by resource uses and contributions that make up the
production stages. As basic factors of production,
resources (land, labor capital, and entrepreneurship) add
value to products (e.g., leather) as processed into higher
forms (e.g., shoes). If all payments for resource
contributions (rent, wage, interest, and profit) went to
resource owners, GNP would simply be the sum of all factor
payments from the raw material to the final product stage.
In Figure 1.1, the value of, say, the final product (P700)
is equal to the intermediate product (P300) plus the factor
contributions (P400) that transformed the latter into its
final form. Following the arrow directions, the value of
the intermediate product (P300) is from the factor
contributions at the intermediate stage (P200) and the raw
material stage (PIOO). In other words, factor contributions
made the raw material (P 100) and the intermediate product
(P200) through the value added by factor contributions. The
same logic applies to the final product whose material
purchase is a product of factor contributions from the
lower stages. In conclusion, all products and their values
are the contributions of these essential (basic) factors of
production.
 Table 1.2 presents the Philippine GNP statistics whose
components are classified by factor contribution of the
economy's producing sectors. The biggest contributor of
GNP is the Service Sector (48%) serving all industries.
Next is the import-dependent Industrial Sector (44%)
providing industrial input across sectors. The smallest
sector is Agriculture, Fishery, and Forestry combined
(8%), needing im port complements to provide for the food
i
requirements of the population. Net Factor Income from
the rest of the world is factor income apart from the
factor contributions of the sectors. It includes the OFW
remittances and transfer payments from abroad.