MICROECONOMICS

CHAPTER I
INTRODUCTION

Lesson 1
BASIC ECONOMIC CONCEPTS

OBJECTIVES:
1. To define economics.
2. To discuss the importance of economics.
3. To discuss why we study economics.
4. To identify the fundamental economic activities and factors of production.
5. To compare the divisions of economics.

A. Nature and Scope of Economics and Microeconomics

Introductory Part
Economics is everywhere. When you turn on the TV, you will be faced with a variety of news
headlines concerning economic activities. The same goes with reading a printed newspaper or
online news, topics are mainly about economics—price fluctuations, healthcare, environmental
issues, employment, trade, globalization, and so on. In real-life situations, consumers are buying
a plethora of goods or services. Companies are always busy doing business. The government
makes so many decisions pertaining to issues and the state of the economy. Countries across the
world trade with one another to sustain every nation’s needs. These members of the economy
have something in common—economics affects their interactions. In fact, economics dictates
how they live and function. They face economic problems and they make economic decisions.

B. Basic Terms
● Needs – basic requirements for survival like food, water, and shelter. In recent years, we
have seen a shift of certain items from wants to needs like telephone services, motor
vehicles, and education.
● Moslow’s Hierarchy of Needs

● Wants – the various desires of man that must be satisfied with goods and services. Wants
are defined as something that a person would like to possess; either immediately or at later
time. Wants are not as important as needs, because a person can live without wants.
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Goods versus
● Goods – things (tangible or intangible) that are produced, sold, bought, and utilized which
satisfy a person’s needs and wants.
● Services – the efforts rendered by someone for a price such as haircuts, doctor’s visits, legal
consulting, etc. which also satisfy human needs and wants. Non-physical, intangible parts of
the economy, as opposed to goods which we can touch or handle.
● Consumer Goods – goods that are intended for final use by the consumer like milk, soft
drinks, and food.
● Capital Goods – goods that are used in the creation or production of other goods like
buildings, machinery, and equipment.
● Essential or Necessity Goods – goods that are used to satisfy the basic needs of man such as
food, clothing, shelter, and medicine.
● Luxury Goods – goods that man may do without but are used to contribute to his comfort
and well-being, such as chocolates, perfumes, and expensive cars.
● Superior goods- expensive(branded)

● Imperior Goods-

● Durable Goods – goods that last more than 3 years when used on a regular basis.

● Non-durable Goods – goods that last less than 3 years when used on a regular basis.

C. Four Core Principles of Economic Way of Thinking

People are engaged in various activities—selling, distributing, exchanging, consuming, and
so on. These activities, at any rate, involve individual choice.
According to Krugman (2008), four economic principles describe the economic way of
thinking and underlie the economics of individual choice. These are:
1. Rational choice. Choices are necessary because resources are scarce
2. Opportunity cost. The true value of something is its opportunity cost.
3. Choosing at the margin. “How much” decisions require making trade-offs at the margin:
comparing the costs and benefits of doing a little bit more of activity versus doing a little bit less
4. Responding to incentives. People usually respond to incentives, exploiting opportunities
to make themselves better off. These four principles will be more covered in detail in the
following topics.

D. Scarcity and Choice

● Scarce – means very small in amount.

● Scarcity – a situation that arises from the assumption of unlimited needs and wants and the
fact that resources to obtain goods and services are limited.
o It implies that we cannot have all that we want; hence, we need to make the best
use of scarce resources to satisfy our wants as much as possible.
o It limits our options and forces us to make hard choices which mean that in order to
get something, we must give up something else. There is always a trade-off to be
able to satisfy unlimited wants with limited resources.
o Scarcity is the reason why people must “economize”.
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● Economics is a study of decision-making. It studies what choices people make, how they are
made, and what happens as a result. The choice is the ability of an individual to make a
decision. Thus, choice always involves decision making.
● An old adage that can sum up somehow the matter of choice in economics is “There is no
such thing as a free lunch.”. It means that whatever goods and services are given, they must
be paid for by someone— that is, one cannot get something for nothing. This also implies
that every choice entails costs. These costs may take in the form of time, money, or
something that is valued.
● Since resources are scarce and a choice has to be made, one has to give up something he
already has to get something he desires. In economics literature, the act of giving up one
thing in order to get something else is called trade-off. It is the alternative a person gives up
when he makes a decision.

E. Opportunity Cost
● The concept of opportunity cost is one of the core ideas in the economic way of thinking and
is vital to understanding individual choice. If an individual chooses something, he gives up
the other thing.
● This is the opportunity cost of a decision. Boyes (2008) defined opportunity cost as the
highest-valued alternative that must be forgone when a choice is made.
● For example, a student chooses to review his lessons in Economics today. This means he
gives up doing other activities—he chooses not to watch a series, do household chores, or
surf the internet. If reviewing lessons in Economics is his best alternative to a full day of
other activities, then the opportunity cost of doing activities like watching a series or surfing
the internet is the value of reviewing his Economics lessons. It’s the cost of the lost
opportunity.

F. Marginal Analysis
● Choices are not instantly made. Rational people always decide by carefully analyzing the
benefits they would get and the cost they would incur from their decisions. To put it another
way, they compare their marginal benefits and marginal costs. Marginal cost is the extra
cost of using one more unit of a good or service. In comparison, a marginal benefit is an
additional satisfaction derived from consuming one more unit of a good or service. The
study of weighing the benefits and costs usually for decision making is called cost-benefit or
marginal analysis.

G. Incentives
● Scarcity requires everyone to choose and one thing that drives one person to make a
decision involves incentives. In the most general terms, incentive is a benefit or reward that
encourages someone to behave in certain ways. Salary increase and bonuses paid to
workers, recognition awards for students, price discounts given to customers, and tax
deductions to businesses are all forms of incentives.
● Krugman (2008) points out that people usually respond to incentives, exploiting
opportunities to make themselves better off.
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H. Economics as a Social Science

The discipline of Economics is social science as it seeks to explain the relationships between
people and societies. As a matter of fact, it is the “queen of the social sciences,” as cited by Paul
Samuelson. Like other social sciences such as sociology, psychology, and political science,
economics is also concerned about human behavior.
Although economics has similarities with other fields, it is viewed from a different
perspective. Economics is unique in analyzing various areas of human behavior. Economists
answer different questions and solve problems using tools and methodologies, which are far-
reaching that other social scientists find overwhelming.

I. Economics: Defined
Etymologically, the word economics comes from the ancient Greek word ‘oikonomia’—
which literally means the management of a family or a household. A household has inadequate
resources, and managing these resources will require certain decision-making skills.
There are numerous definitions of economics. Different economists have advanced more or
less the meaning of the term. Some of the commonly used specific and general definitions are as
follows:
1. Wealth definition. Adam Smith, a Scottish economist, regarded as the father of
economics, laid out in his magnum opus, “Wealth of Nations,” the definition of economics
focused on wealth creation. Smith defined economics as an inquiry into the nature and causes of
the wealth of the nation.
2. Welfare definition. This definition of Economics was explained in the influential book of
Alfred Marshall, “Principles of Economics,” which focused on welfare and human activities
instead of wealth accumulation. To Marshall, economics is the study of mankind in the ordinary
business
of life; it examines that part of individual and social action which is most closely connected
with the attainment and with the use of material required for well-being.
3. Scarcity definition. This definition is credited to Lionel Robbins, a British Economist, and
emphasized scarcity, which is central in the definition of economics. According to his book, “An
Essay on the Nature and Significance of Economic Science,” economics is the science which
studies human behavior as a relationship between ends and scarce means which have
alternative uses. His famous definition was the most accepted definition of economics and still
generally used today.
4. Growth-Oriented Definition. The definition was credited to Paul Samuelson, called by the
New York Times as the "foremost academic economist of the 20th century". According to him,
“economics is a study of how people and society choose, with or without the use of money to
employ scarce productive resources which could have alternative uses, to produce various
commodities over time and distribute them for consumption now and in the future among
various persons and groups of society.”
The meaning of the word economics has developed over time. Today, many books and other
reference materials define economics in similar ways—a science that deals with the allocation of
limited resources to satisfy unlimited human wants. Mankiw (2010) defined economics as a
science that studies how society manages its scarce resources. Krugman (2008) defined
economics as the study of the production, distribution, and consumption of goods and services.

J. Reasons for Studying Economics

Economics governs many aspects of life. Individuals whether rich or poor are always faced with
making choices because scarcity indeed exists. It is where proper knowledge in Economics is of
greater importance. Studying economics will not only help us become wiser in making everyday
life decisions but will also make us aware of our interconnectedness with other people,
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organizations, and the environment we live in to contribute to society and the economy.
Basically, the following are the reasons why there is a need to study Economics.
1. Understand how goods or resources are produced and properly allocated to society.
2. Understand the behavior and roles of the different individual decision-makers: the
households, firms, and the government.
3. Explain how the national or global economy operates.
4. Know the forces that affect the dynamics of any market.
5. Understand economic issues and trends.

K. Fundamental Economic Activities

1. Production – the process of transforming raw materials to a finished product.
2. Distribution – the physical apportionment of goods and services from the producers to the
consumers; it is simply called marketing distribution or trade.
3. Exchange – the transfer of ownership over goods and services from one person to another
and this is usually accomplished using money or credit.
4. Consumption – the process of using goods and services in the direct satisfaction of human
needs and wants; it is regarded as the most important function in economics because it is
the ultimate end of economic activity; without consumption, there would be no need for
production and distribution.

L. Factors of Production
1. Land – includes all the natural resources, including mineral deposits, water, air, trees,
poultry, livestock, and all other forms of these raw materials used in production of goods
and services.
2. Labor – any form of human effort like physical or mental, which is exerted in the production
of goods and services.
3. Capital – refers to the machinery, tools, equipment, and structures used in the production of
goods and services.
Human Capital-
Physical Capital
4. Entrepreneurship – the ability of an individual to provide the right kind of good or service at
the right place and time, to the right people at the right price.
● Entrepreneur – the person who puts together or organizes the other factors of
production (land, labor, capital) to create goods and services which can satisfy the
needs and wants of man. He is innovative and a risk taker.

M. Divisions of Economics
Economists develop economic principles and models at two levels. These two levels are the
branches of Economics: Microeconomics and Macroeconomics. Microeconomics is concerned
with the behavior and decision-making of the individual players in the economy, such as the
consumers, businesses, and the government. Microeconomics studies the prices, markets,
buying decisions of consumers, selling decisions of firms, costs of production, profit
maximization, market failure, etc. On the contrary, macroeconomics is focused on the overall
structure and performance of the national or global economy. It is concerned with the analysis
of aggregates. Macroeconomics studies the determination of national income, price level,
employment, economic growth, money, economic policies, international trade, among others.
The comparison of topics of interest for microeconomics and macroeconomics is depicted in
Table 1.1.

Table 1.1 – Matrix of Comparison of Topics between Microeconomics and Macroeconomics

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Microeconomics (Topics of Interest) Macroeconomics (Topics of Interest)

Supply and demand for goods and services in Aggregate demand and aggregate supply
the market

Worker’s decision, employment in an Employment and unemployment

industry

Price of a product General price level and inflation

Commodity market, labor market, etc. Financial market, Stock exchange

Domestic trade International trade

Firm’s profit, household income National Income, GDP

Mortgage loan interest General Interest rate

Government regulations, government failure Government economic policies – fiscal

monetary policies

CHAPTER I

Lesson 2
FUNDAMENTAL ECONOMIC PROBLEMS AND ECONOMIC SYSTEMS

OBJECTIVES:
1. To identify and briefly discuss the four fundamental economic problems.
2. To define economic systems.
3. To identify and describe the types of economic system.

Introductory Part
People are now living in a complex world that takes place in a wide range of institutions with
interrelated economic activities. All countries have something in particular – they all face economic
problems and they nevertheless handle them in different ways. In some countries, the government
plays a big part in making economic decisions, while in others, decisions are left much more to the
private sector. Even though this is the case, the different economic actors, including people, business
organizations, and the government still carry out their respective roles in ensuring that resources
properly allocated and economic goals are being achieved in a society.

A. Economy Defined
Every country, regardless of its level of development, has an economy. The economy plays a
crucial role in determining how limited resources will be allocated to fulfill all the wants and
needs of different economic agents in a society. The economy refers to the structure in which
various economic activities are organized by economic players, including individuals, business
organizations, or governments.
B. National Economy versus Global Economy
The national economy encompasses all the economic activities related to production,
distribution, trade, and consumption of goods and services that take place locally or
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domestically. These inter-related activities take place in a country to fulfill the wants and needs
of those living and operating within the economy. The Philippines is an example of a national
economy. Presently, the economy of the Philippines is the 36th largest economy in the world by
nominal GDP, according to IMF data. It’s now a newly industrialized country and one of Asia's
fastest-growing economies with an estimated GDP of $356 billion in 2019.
On the other hand, the global economy covers all collective worldwide economic activities.
It is characterized by globalization, international trade, finance, and global investment. Currently,
193 economies make up the global economy. United States, China, Japan, Germany, and India
are the world’s top five largest economies. The world’s total GDP as of 2019 is valued at $86
trillion.

C. Sectors of the Economy

The production of goods and services in the economy is going on at different levels. An economy
may be analyzed in terms of its parts, referred to as economic sectors to determine who are
engaged in different activities. The three sectors of the economy are:
1. Primary Sector. The agricultural sector of the economy that is concerned with the
production of raw materials and includes activities directly related to agriculture and the use of
natural resources. Farming, fishing, forestry, mining, oil extraction, and raw processing are
activities that lie within this sector.
2. Secondary Sector. The industrial sector of the economy which covers the production of
finished
goods, including the processing of materials produced by the primary sector. Manufacturing,
fastmoving consumer goods, energy utilities, construction, and heavy industries are the activities
associated with this sector.
3. Tertiary Sector. The service sector that covers the production and provision of intangible
commodities to consumers and businesses. Activities under this sector include transportation,
distribution, retail, banking and finance, information technology, tourism, education, healthcare,
etc.
D. Players of Economy
A huge number of people and organizations are involved in a modern economy. These people
and organizations are players of the economy who interact with one another and decide how an
economy’s resources are efficiently allocated. These economic players fall into four sectors as
follows:
1. Households. These are individuals or groups of people living together and considered the
consuming-unit of the economy. They demand and consume the goods and services produced
by the economy. As resource owners, they provide and supply land, labor, and capital to firms,
governments, and the rest of the world. A family who buys and consumes food regularly is a
representation of a household.
2. Firms. They represent the business sector of the economy responsible for transforming
inputs to outputs. These are the business organizations within which land, labor, and capital are
organized for the production of goods or services. They supply economic goods and services to
services to different markets for consumption by households, governments, and the foreign
sector. A furniture company selling its products to a department store is a representation of a
firm.
3. Government. The public sector of the economy responsible for the formulation and
implementation of economic policies. When it comes to the economy, the government functions
to provide public goods and services, maintain competition, correct externalities, stabilize the
economy, and redistribute the income. The Philippine government, which collects excise taxes
from businesses, represents the public sector.
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4. Rest-of-the-World. This sector makes up foreign households, foreign firms, and foreign
governments that supply resources and commodities to a domestic economy and demand
resources or commodities from a local economy. The trading of the Philippines to other
countries like the US and Japan, which sell domestic goods and buy imported goods, is a
representation of the rest-of-the-world.

E. Why Economic Problems Exist?

1. Economic problems exist because of two fundamental facts:
1. resources are limited; and
2. human wants are unlimited.
2. Human wants cannot all be possibly satisfied because resources are scarce.

F. The Four Fundamental Economic Problems

All nations, big or small, developed or underdeveloped, must find answers to the following
fundamental economic problems:
1. What goods or services are to be produced?
● Explanation:
▪ This refers to the choice of goods or services that the economy should
produce.
▪ Will a country produce rice, coconuts, bananas, or manufacture bags, shoes,
and garments? Or if a country is preparing for war, should it concentrate on
the manufacture of ammunitions, rocket ships, nuclear weapons, and the
like?
▪ Since resources are scarce, no economy can produce every product desired
by the members of society.
▪ Basic needs of the people are given top priority.
▪ The decision of what goods and services are to be produced would depend on
what is needed and what is wanted. It also depends on culture, availability
of resources, and climate.
2. How many goods or services are to be produced?
● Explanation:
▪ This refers to the quantity of each good or service that the economy will have
to produce to make up the total output.
▪ Suppose that a country has decided to manufacture shoes. How many pairs
should be manufactures? Or, if rice production is decided on, how much
should be the total output?
▪ No economy can produce goods and services enough to satisfy all members of
the economy.
3. How are the goods or services produced?
● Explanation:
▪ This refers to the choice of technique of production and the manner of
combining resources to come up with the desired output.
▪ Since a good can be produced with different techniques, the problem is which
of these to use.
▪ The economy that decides on the production of shoes will also have to come
up with the decision on how the shoes will be manufactured. What
materials will be used? Will production involve the use of more labor or the
use of more machinery? How will the available resources be combined to
come up with the most efficient output of shoes?
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▪ The least costly but efficient method must be chosen in order to save
resources. This means maximum output with minimum input without
sacrificing quality of the goods and services.
▪ A labor-intensive technology makes use of more labor than capital while a
capital-intensive technology makes use of more capital than labor.
4. For whom are the goods or services produced?
● Explanation:
▪ This refers to the choice of who will benefit from the production of goods and
services.
▪ In other words, this refers to the target market which the producers will sell
their products.
▪ Will the shoes be sold to high income buyers or to low income buyers? Will
the target market be males, females, or children? Will
the shoes manufactured be sold to domestic consumers or to the
foreign markets?
G. The Economic Systems
● Economic System – comprised of the various processes of organizing and motivating labor,
producing, distributing, and circulating of the fruits of human labor, including products and
services, consumer goods, machines, tools, and other technology used as inputs to future
production, and the infrastructure within and through which production, distribution, and
circulation occurs in a particular society; OR SIMPLY, this is the framework in which society
decides on its economic problems.
● The principal objective of an economic system is to solve the fundamental economic
problems. It has varied concepts, strategies, and ways of improving the living conditions of
people. However, all economic systems have one common goal: a high standard of living for
all the citizens.

H. The Types of Economic System

1. Traditional Economy – an economic system that answers the four fundamental economic
problems based on social customs and on how the society has dealt with these questions in
the past.
● Decisions on what, how, and for whom to produce are made by referring to the
traditional manner of doing things.
● Production is carried in the methods used by the forefathers and is therefore very
primitive. Example: A farmer engaged in the production of rice does exactly what his
father did when he planted rice more than 50 years ago.
● This type of economic system is very backward since it does not allow for change.
● This is usually practiced in underdeveloped regions and in mountainous areas where
transportation and communication are practically non-existent.
● A country’s customs can differ greatly from that of a neighboring country so
traditional economies vary from one another.
2. Command Economy – an economic system where the means of production are owned and
controlled by the government and the answers to the four fundamental economic problems
are dictated by the government through the head of the nation or a group of men
designated by the head to make decisions.
● Its decisions are arrived at by planners or government men who dictate what, how,
and for whom to produce.
● This system works under the principle that “the interests of the society should
prevail over that of the individuals.”
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● The government decides how to answer the four fundamental economic problems
for the country rather than by giving individuals the chance to decide what they
want or need.
● The government plans what to produce and how resources should be allocated.
Individual preferences are not considered at all. Consumers buy what is available
and may have to do without what they want or what they need.
● The consumer’s freedom of choice is curtailed, and the system does not enable him
to participate in the decision-making process regarding the answers to the society’s
fundamental economic problems.
● This type of economy is difficult for the individual because it is impossible for the
government to know exactly what is best for every citizen.
3. Market Economy – an economic system wherein the means of production are privately-
owned and answers the fundamental economic problems by considering consumer’s choice.
● The four fundamental economic problems are answered in the marketplace by the
interaction of buyers and sellers. For example, the question of what to produce may
be based on what trend is popular right now. The producer would create a product
that he thinks would sell well to the public in hopes of making a profit. The question
of how to produce is usually based on the producer’s choice. A product may be
produced with more workers or more machines and computers to save on labor
costs. For whom to produce is based on the buyers who decide what they want or
need and what price they are willing to pay for the products.
● Competition is supreme, there is consumer sovereignty, and the price of the goods is
the guiding factor for producers to know what and how much to produce.
● The market prices serve as signals to the producers about what goods to produce
and how much of these goods should be produced. High prices indicate that goods
are in demand and serve as go signals for production. However, prices tend to fall
when goods are not in good demand and serve as a red light to decrease or limit
production. The problem of production is therefore solved by the price mechanism.
4. Mixed Economy – a blend of the different types of economic system.
● It is seldom that an economic system exists in its pure form.
● While the economy of United States is basically market-oriented, there exist forms of
government regulation and control. On the other hand, the People’s Republic of
China’s economy is basically command-oriented in nature, yet it cannot be said that
it does not use the price system at all.
● The Philippine economy is a mixture of the three forms of economic systems
discussed above. In the mountains and isolated barrios, most farmers are still
traditional in their production methods. While most buyers and sellers are
influenced by the price system, it cannot be denied that the government plays a
significant role in decision-making with regards to production, business, and
industry. The existence of price control, strict government regulations, government
support, and subsidy programs are proofs of the importance of government
participation in decision-making in the country’s production activities.
● In a mixed economy like ours, the questions of what to produce and how to
produce, answered predominantly through the price mechanism, are modified
through government intervention in the form of direct controls, taxes, and subsidies.
● The problem of for whom to produce is also solved by the price mechanism coupled
with different forms of government regulation. The economy will produce those
goods or services that will satisfy the wants of those people who have the money to
pay for them.
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● Predominantly, the Philippine economy is market economy in nature but the best
way to describe its economic system is mixed economy.

I. Economic Goals
All countries in the world have particular objectives and they struggle to attain such goals. These
goals are pivotal to ensuring long-term stable economic success. Economic efficiency, economic
equity, economic security, and economic freedom include the goals at the micro-level. In
contrast, economic growth, full employment, economic stability, and a favorable balance of trade
are the goals at the macro level of the economy.
1. Economic efficiency. It ensures the utilization and allocation of the economy’s scarce
resources.
This goal is achieved when available resources are efficiently produced at its optimum level
preventing any wastes.
2. Economic equity. This pertains to the fair or equitable distribution of income and wealth
within a society. A fair distribution of income means that the gap between the rich and the poor
is too narrow.
3. Economic security. This involves protection against economic risks where people in the
economy have a stable income for a decent living.
4. Economic freedom. This goal is achieved when every member of a society can make a choice
or take economic decisions. People are free to buy goods, own a property, prefer an employment
or establish a business within the economy not constrained by the government and others.
5. Economic growth. This is the economy’s ability to produce goods and services within a
specific period. Gross Domestic Product measures the productive capacity of the economy that
takes into account the entire economic real output.
6. Full employment. It occurs when all available resources are utilized to capacity to produce
goods and services. This is expressed by the employment of the members of the labor force
measured by the employment or unemployment rate.
7. Economic stability. It enables the economy to reduce excessive fluctuations in people’s
standard of living. There is neither inflation nor inflation. In other words, the economy has stable
prices of goods and services.
8. Reasonable balance of trade. This goal is achieved when the value of a nation's exports is
more than the value of its imports.

CHAPTER I

Lesson 3
THE CIRCULAR FLOW MODEL

OBJECTIVES:
1. To explain the economic activities that take place within the economy.
2. To define and explain the circular flow model.
3. To describe the interaction between the household and the firm.

Introduction
There are two basic activities undertaken in any economy: production and
consumption. The firms perform the production function while households undertake
consumption. To be able to produce, firms need the economic resources consisting of land,
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labor, and capital. The individuals comprising the households own these resources. When
the economic resources are used in the production of goods and services, employment of
these resources occurs.
A price is paid to resource owners whenever these resources are used in production.
Rent is paid to the land owner, interest to the capitalist and wage to labor. The goods and
services produced by these firms are consumed by households. The interaction between
households and firms regarding production, consumption, employment and income
generation results to the circular flow of goods and services in the economy.

A. Definition
• The Circular Flow Model is a model that is used to show the flow of resources and
income through an economy.

• It is a simple economic model showing the relationship between money income and
spending for the economy.

• The circular flow model is only a model, a simplification of a complex reality.

However, it is necessary to be understood in order to have a clear understanding of
the complexities that are encountered in the economic activities of a nation.

In other words, it offers a simple way of organizing all of the economic transactions
occur between household and firms in the economy. To see the circular in its simplest form,
we will begin with an economy in which there is no government, no financial markets, and
imports or exports.

B. The Interrelationship Between the Household Sector and Business Sector

In Simple economy, there are two players, basically these are the households and
the firms, industries or businesses.
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Economic activities take place through the interrelationship that exists between two
economic units:

1. the household, which is the basic consuming unit; and

2. the business firm, which is the basic producing unit.

C. The Circular Flow Model

The Factor Market or Resource Market which appears at the top or upper part of
the diagram in which firms obtain the labor, services, capital, and natural resources that
they need from the household. It is the place where resources or the services or resource
suppliers are bought and sold.

The Goods and Services Market, which appears at the bottom of the diagram in
which households buy goods and services that firms produce. The place where goods and
services produced by businesses are bought by and sold to the households.

Firms-produce goods and service using inputs such as land, labor, capital and
entrepreneurship.

Household-owns the factors of production and consumes all the goods and services
produced by the firm.

In the Factor Market (Resource Market) household are sellers and firms are buyers.
Household provides firms the inputs that the firms use to produce goods and services.
Households own all economic resources either directly as workers or entrepreneurs or
indirectly through their ownership of business corporations. They sell their resources to
businesses that will need them in order to produce goods and services. This is represented
by the outer arrow from the household going to the business sector.

In return, the firm pays the household, wages for the labor, rent for the land, profit
for the capital of household sector. So firms make factor payment-wages, interest
payments, rents, royalties and all of that in exchange for the factors services they buy, in
short, costs of the business firm. But these payments made by the firm are considered as
flows of income in the form of wages etc. to the household. This represented by the inner
arrow from the business sector going to the household sector.

In other words, the upper portion of the circular flow diagram shows the movement
of resources such as land, labor, capital, to be used by the firm in producing goods and
services. Productive resources, therefore flow from the household to businesses, and
money flows from businesses to the household.
 MICROECONOMICS

In the Goods and Services Market (Product market) household are buyers and
firms are sellers. Households buy the output of Goods and services that firms produce. In
the product market, businesses combine the resources owned by the households (i.e., land,
labor, capital) in order to produce and sell goods and services (e.g., cellular phone, signature
shirt, pizza, etc.) This is represented by the outer arrow from the business sector going to
the household sector. In return, the households receive income from selling their resources
to the businesses. Consequently, the households use the (limited) income they received
from sale of resources the sale of resources in order to buy goods and services that the
businesses produced in the form of consumption expenditure or payments for goods and
services. The payments represent the income received by the firm. Households make
payments for the things they buy in product markets. This is represented by the inner arrow
from the household sector going to the business sector.

The monetary flow of consumer (household) spending on goods and services yields
sales revenues for businesses. Businesses compare those revenues to their costs in
determining the profitability and on whether or not a particular good or service should
continue to be produced and sold. In simplest manner, In the Lower portion of the diagram,
presents the movement of goods and services provided by the firm to the household.

By Convention, when firms use labor, capital or natural resources that they
themselves own, they are counted as “buying” those factors from the households that are
ultimate owner firm owners. All production costs or expenses incurred by the firms can be
viewed or called as factor payments.

In this simple economy, households spend their income on consumer goods as soon
as they receive it and firms sell their output to households as soon as they produce it.
According to Doland Lindsey, “The fluid that the economy’s plumbing working is not water
but money” Because money is what we use as means of payment for buying goods and
services, May it be in a form of coins, paper currency, bank account balances on which
checks can be written.

In a nutshell, as shown in the circular flow there is a clockwise real flow of economic
resources and finished goods and services (represented by the outer arrows in circular)and
a counterclockwise money flow of income(wages, salaries etc.) and consumption
expenditures or payment for goods and services (represented by the inner arrows in
circular).

CHAPTER 2
MICROECONOMICS
LESSON 1
The Concept of Demand
 MICROECONOMICS

OBJECTIVES:
4. To define the concepts of demand, demand schedule, demand curve, the law of demand
and the demand function.
5. To identify the different factors affecting demand.
6. To analyze changes in the demand schedule and movements along the demand curve.

Introduction
The fundamental economic problem calls for making definite decisions on what goods to
produce, how much to be produced, how they shall be produced and for whom they shall be
produced. To address the problem, the market is used as the principal mechanism.

A. The Market

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 Generally, a market is defined as an institution or mechanism that brings together buyers

(demanders) and sellers (suppliers) of goods and services. A place where buyers and sellers
can meet to facilitate the exchange or transaction of goods and services.
 A market exists when “buyers wishing to exchange money for a good or service are in
contact with sellers wishing to exchange goods and services for money.” These happens
because it is through the market where “buyers make known their decisions to buy or not to
buy and on what terms, and sellers make known their willingness and ability to sell or not to
sell and on what terms.”
 There are different kinds of markets such as wet and dry. Wet market is where people
usually buy vegetables, meat, fish, etc. On the other hand, dry market is where people
buy clothes, shoes, or other dry goods.
 How a Market functions?
Market are strictly made up of buyers and sellers. The actions and decisions of
buyers constitute demand for a product or service, while the sellers’ decisions and
actions constitute supply. Markets are important because they act as the
mechanism by which resources are allocated. For instance when a buyer decides on
purchasing a certain commodity on a regular basis, he is sending a signal to the
seller to produce the wanted commodity on regular basis. The collective desires of
buyers to purchase a commodity constitute the demand for the commodity. If the
sellers accede to the demand, economic resources will be required and
subsequently, a demand for them will be forwarded to the resources owners. The
higher the demand is for product and services, the higher will be the demand for
economic resources.
 MICROECONOMICS

B. The Theory of Demand and Supply

 Theory of Supply and Demand – this theory shows how consumer preferences determine
consumer demand for goods and services and how business costs determine supply of the
product in the market. It is a basic and important tool in explaining changes in a
predominantly market economy like the Philippine economy.

C. Demand (Consumer’s side)

 The demand for a product (or simply, demand) is the amount of the good or services that
buyers in a specific market are willing and able to buy per unit of time, ceteris paribus or
“other things held constant”.
 Demand is the desire of households for goods and services in the particular product market
and this desire must be supported by their capacity and willingness to pay for such goods
and services
 Demand can be analyzed in several ways. However the most common way of analyzing
demand is through a demand schedule or a demand curve and demand function:

A. Demand Schedule – shows, in tabular form, the various quantities of the product
that will be bought at various prices at a specific time and place. It may reflect an
individual schedule for one buyer or a market schedule for a group of buyers.
Example: Table 1 presents a hypothetical demand schedule for banana per month.
Table 1
Vigan City Individual Demand Schedule for Banana per Week
Price of Banana Quantity Demanded
Situation
(per kilo) (in kilo)
A P 45 5
B P 40 10
C P 35 15
D P 30 20
E P 25 25
F P 20 30
The table shows the various prices and quantities for the demand for
banana per month. For instance, at given price of P 45.00 the buyer is willing to
purchase only 5 kilos of banana (situation A); however, at a price of P 20.00, he is
willing to buy 30 kilos of banana (situation F).
Take note that as the price goes up the quantity of banana being purchased
by the consumer goes down. On the other hand, as the price goes down the
quantity of banana being purchased by the consumer goes up. This implies that the
quantity demanded is inversely related with price. In other words, consumer are not
willing to purchase more banana at higher prices but will consume more if are low.

B. Demand Curve – it is a graphical representation of the demand schedule. Example:

Figure 1 presents the hypothetical demand curve for banana per month.
 MICROECONOMICS

Figure 1
Vigan City Individual Demand Curve for Banana per Week

50
A
45 B
40
C
35
D
Price of Banana

30
E
(per kilo)

25
F
20
15
10
5
0
0 5 10 15 20 25 30 35
Quantity Demand (in kilo)

Figure 1 illustrates a normal demand curve. A demand curve has negative slope thus
it slopes downward from left to right. The downward slope indicates the inverse relationship
between price and quantity demanded. The figure illustrates a typical demand curve. The Y-
axis represents price (P), while the X-axis represents the quantity demanded (Q d). The
demand curve is negatively sloped or downward sloping. The (negative) slope measures the
change in quantity demanded for a unit change in price. This indicates that the price of
commodities decreases (increases), more (less) goods will be bought by the consumer.

 Law of Demand – When the price of a product is increased, and the “other things” are kept
constant, buyers tend to buy less of the product. On the other hand, when the price
decreases, buyers tend to buy more of the product.
 Hence, the law of demand explains the inverse relationship of price and quantity demanded,
quantity demanded goes down as price goes up, and vice versa.
 The two factors below explain why a consumer tends to buy more of a product or service if
its price falls.
1. Income Effect – as price falls, the purchasing power of the consumers is enhanced
because they can buy more of a product.
2. Substitution Effect – as price falls, the product becomes less expensive compared to
similar products so that the consumers tend to buy more of that product and less of
the similar product.

C. Demand Function - is expressed as a mathematical equation or function that shows

the relationship between a demand for a commodity and the factors that influence or
determine this demand. These factors are – the price of the commodity itself, prices of
other related commodities, level of incomes, taste and preferences, sizes and
 MICROECONOMICS

composition of level of population, distribution of income, etc. Thus, we can show our
mathematical function for demand as:

Qd = f(x)

Qd = f (product’s own price, income of consumers, price of related goods, etc.)

 We can therefore come-up with the demand equation as:

Qd = a-bP
Where

Qd = quantity demanded at a particular price

a = intercept of the demand curve
Intercept (a) = the price when no quantity demanded
b = slope of the demand curve
Slope (b) = Change in Quantity Demanded / Change in Price
P = price of the good at a particular time period

 Example:
Table 2
Demand Schedule for Candy
Situation Price (P) Quantity Demanded (Qd)
A P5 10
B P4 20
C P? 30
D P2 ?
E P1 50
F P0 60

Situation D
Given:
Qd = ?
a = 60
b = 10
P=2
Solution:
Qd = a – bP
Qd = 60 – 10(2)
Qd = 60 – 20
Qd = 40

Situation C
Given:
Qd = 30
a = 60
b = 10
P=?
Solution:
Qd = a – bP
 MICROECONOMICS

30 = 60 – 10P
10P = 60 – 30 (Transpose)
10P = 30
10 = 10
P=3

C. Change in Quantity Demanded vs. Change in Demand

 Change in Quantity Demanded
We can say that there is change in quantity demanded (symbolized as Q d) if there
is a movement from one point to another – or from one price-quantity combination to
another – along the same demand curve. A change in quantity demanded is mainly brought
about by an increase or decrease in the product’s own price. The direction of the movement
however is inverse considering the Law of Demand.
We can explain change in quantity demand through a demand curve. Figure 2
illustrates the concept of change in quantity demanded. We can see in this figure the
original price is at Po and at this price level the quantity demanded Q O. The point of
interaction between Po and QO is at point a along the demand curve. Now let us assume that
price decreases to P1. As a result, quantity demanded will increase to Q 1 because of the
change in the product’s price. As a result the quantity demanded will move to point b along
the same demand curve because of the decrease in price as shown in the arrow. The reverse
will happen if price will increase.

Figure 2. Change in Quantity Demanded

 Change in Demand
There is a change in demand if the entire demand curve shifts to the right (left)
resulting to an increase (decrease) in demand due to other factors other than the price of
the good sold. At the same price, there price more or less amounts of a good or service are
demanded by the customers. Figure 3.1 illustrates and increase in demand. In the figure, we
can observe that the entire demand curve shifts upward or to the right (indicated by the
arrow) from D to D’. We can also observe that at the same price P o more goods will be
demanded by consumers (from Qo to Q1).

Figure 3.2
 MICROECONOMICS

A. Increase in Demand

Conversely, demand decreases or falls if the entire demand curve shifts downward or to the
left. Thus, at the same price level, less amounts of a good or service are demanded by consumers. A
decrease in demand illustrated in Figure 3.2. We can observe in the figure that the entire demand
curve shifts downward or to the left (indicated by the arrow) from D to D’. If price remains at the
same level demand for the product or service will decrease (from Qo to Q1).

Figure 3.2

B. Decrease in Demand

Increase or decrease in demand brought about by factors other than the price of the good is
brought about by factors other than the price of the good itself such as taste and preferences, price
of substitute goods etc. resulting in the shift of the entire demand curve either upward (right) or
downward (left).

D. Non-Price Determinants of Demand

In the discussions above, price is assumed as the most important factor affecting
demand. Observations show however that there are other factors that can and do affect
demand. The “other factors” that influence demand, known as Non-Price Determinants of
Demand, are as follows:
1. Tastes and Preferences.
 Explanation: Tastes and preferences pertain to the personal likes or dislikes of
consumers for a certain goods and services. A favorable change in consumer tastes
and preferences – a change that makes the good or service more desirable – would
increase demand
 Examples:
 Consumers prefer appliances that have higher electrical consumption
efficiency, thus, increasing demand for these appliances.
 MICROECONOMICS

 Conversely, the fashion craze for the green color may soon pass, so the
demand for green clothes will decrease.

Source: https://www.apple.com/uk/newsroom/2022/05/the-music-lives-on/
Since 2001 when the first Apple iPod was released, many other models in the series where
launched on the market: iPod Classic, iPod Touch, iPod Shuffle, iPod Mini and iPod Namo.

 As an illustration: Remember the craze for Ipods? This came about in the
Philippines sometime in in 2006, and everyone just wanted to have one. At
that time, there were quite a number of MP3 player brands being sold in the
market. However, for some reasons, consumers were just so engrossed with
the thought of having an Ipod MP3 player, to the point that some shops had
all their stocks sold out. This is a clear example of consumer preferences
when it came to MP3 players during that time. Consumers preferred a
certain brand (Apple) because at that time, it was “in” to have an iPod.
Consumer preferred towards a certain product increases the demand for
that product. However, products which consumers do not prefer, suffer a
decrease in demand.

2. Number of Buyers or Population Change

 Explanation: An increase in the number of buyers in a specific market results in
greater demand, and vice versa. This simply means that more goods and services are
to be demanded because of rising population. On the other hand, a decrease in
population results in a decline in demand.
 Examples:
 Concern for health has increased the number of consumers who prefer
organically grown fruits and vegetables and thus increased their demand.
 Conversely, education on the benefits of breastfeeding has decreased the
number of mothers buying infant milk formula for babies and thus
decreased the demand for the milk formula.
3. Changing Income
 Explanation: For most products, an increase in income causes increase in demand.
This is because an increase in one’s income generally raises his/her capacity or
power to demand for goods and services which he/she is not be able to purchase at
lower income. On the other hand, a decrease in one’s income reduces his
purchasing power, and consequently, his demand for some goods and services
ultimately declines.
 Take for instance, Juan who is receiving a monthly salary of P10k. He loves to buy
shirts during payday. With his income, he could only buy 3 shirts per month. After a
year, however, he was promoted to a higher position. Due to his promotion his
salary increased to P20k per month. Because of the increase in Juan’s salary he can
now afford to buy more shirts, let say 6 shirts per month. His capacity to buy more
 MICROECONOMICS

shirts (and other goods or services for that matter) is simply the result of the
increase in his monthly salary.
 Example:
 As consumers earn more, they tend to buy more beef, clothes, and
electronic equipment.
 Additional Discussion:
 Products whose demand varies directly with income are called normal or
superior goods. Like steak, name-brand clothing, Laptop, sit-down
restaurant meals)
 On the other hand, there are products whose demand decline as money
income rise and are called inferior goods. Inferior goods are the types of
products people typically purchase when their income is low.
 Example of inferior goods: canned goods, ramen and second-hand
clothing.

4. Occasional or Seasonal Products

 Explanation: the various events or seasons in a given year also result to a movement
of the demand curve with reference to a particular goods.
 Example:
 During the Christmas season, demand for Christmas trees, lanterns, and
other Christmas decors increases. Moreover, demand for food items like
ham and quezo de bola also increases.
 Similarly, as Valentine’s Day approaches, the demand for flowers am
chocolates also rises. It should be noted, however, that after these events,
demand for these products returns back to the original level.

5. Prices of Related Goods

 Explanation: Changes in prices and availability of related goods may increase or
decrease the demand for a product or service depend on whether the good is a
substitute or a complement:
 Example:
 Tea is a substitute for coffee while creamer is a complement of coffee.
 If the price of coffee rises, consumers will tend to buy less coffee,
and switch to buying tea which becomes relatively cheaper.
 On the other hand, if the price of the coffee rises, the demand for
coffee decreases as well as that of the creamer.

 Substitute Good – something that can be used in place of another good. In a
situation where the price of a particular good increases a consumer will tend
to look for closely related commodities.
 Example: For instance, Juan wants to buy a pair of Nike rubber shoes. But
the price of the shoes that he wanted was worth P 5,000.00. Considering the
price and his lower budget of P 3,000.00 he opted for an alternative brand
of shoes with a lower price, say Converse shoes. In this situation, Nike and
Converse are substitutes.
 Complementary Good – something which is used together with another
good.
 Example: For instance, your pen cannot if there is no in in it or your
cellphone cannot function if you do not have SIM card or load in it.
6. Expectations of future prices
 MICROECONOMICS

 Explanation: If buyers expect the price of a good or service to rise (or fall) in the
future, it may cause the current demand to increase (or decrease). Also,
expectations about the future may alter demand for a specific commodity.
 Example:
 If consumers expect that the price of fruit cocktail will rise during the
Christmas season, they will buy the product early, thus increasing current
demand for fruit cocktail.
 Take for another example the fluctuating prices of rice. If households expect
that a drastic increase in the price of rice will happen after a week, their
natural behavior is to purchase and stock-up rice before the price goes up.

B. Changes in the Demand Schedule and Movements Along the Demand Curve

Table 3
Change in the Demand Schedule
(i.e. consumer’s income increased)
Price of Mangoes Initial/Original Demand Increase in Demand
(per kilo) (Do) (D1)
P 45 100 150
P 40 150 200
P 35 200 250
P 30 250 300
P 25 300 350
P 20 350 400
Legend: Do = original demand | D1 = new demand after the increase in income

Figure 4
Movement along the Demand Curve
(i.e. consumer’s income increased)
50
45
40
35
Price of Mangoes

30
(per kilo)

25
20
D1
15
Do
10
5
0
50 100 150 200 250 300 350 400 450
Quantity Demand (in kilo)

Legend: Do = original demand | D1 = new demand after the increase in income

MICROECONOMICS