ECONOMICS

The study of scarcity

Economics - is the efficient allocation of the
scarce means of production toward the
satisfaction of human needs and wants.
• SCARCITY
Limited Resources Unlimited Wants
Scarcity
• ECONOMICS
Limited Resources Unlimited Wants
Allocation
• FACTORS OF PRODUCTION
• Labor
• Land
• Capital
• Entrepreneurship
CIRCULAR FLOW MODEL
Opportunity cost - foregone value of the next
best alternative.
• Basic Decision Problem • Positive Economics - economics as
• Consumption - members of society they are
• Production - producers
• Distribution - government • Normative Economics - what should
• Growth over time - nation be.

• Four Basic Economic Questions

• What to produce?
Ceteris paribus - all other things held
• How to produce?
constant
• How much to produce?
• For whom to produce?
• T
Microeconomics - deals with individuals
Macroeconomics - deals with the nation
• Types of Economics Systems • History
• Traditional economy - family • Adam Smith - Father of Economics,
consumption authored "Wealth of Nations"-
• Command economy - dictated by invisible hand
government
• Market economy - privately-owned • Neoclassical - market system
• Mixed economy - hybrid of command inefficiencies
and market economy.
• Socialism - key enterprises are owned • Keynes' General theory of
by government. unemployment, interest and money
Basic Analysis of Demand and Supply
• Demand - behavior of consumers

• Market - demand for a good or

service

• Methods of Demand Analysis

• Demand schedule
• Demand curve Law of Demand states that as the
price goes lower the qty. demanded
• Demand function goes higher and vice-versa,ceteris
paribus.
 • Change in Qty d vs Change in
• Function demand
• Qty demanded = a -bP

• Where:
change in price other factors
• Qd = qty demanded at a particular
price
aside from
change in price
• a= intercept of the demand curve
of that
• b=slope of the demand curve particular
• P=price of the good at a particular movement product
time period
along the curve

shift of demand
either upward -
positive or
downward-
negative
FORCES THAT CAUSE THE DEMAND CURVE TO
CHANGE
• 1. Taste or preferences
• 2. Changing incomes
• 3. Occasional or seasonal products
• 4. Population change
• 5. Substitute and complementary goods
• 6. Expectations of future prices
Supply - sellers/producers' behavior
• Can be analyzed:
1. supply schedule
2. supply curve
3. supply function
Function:
Qty s = a + bP
Where:
• Law of Supply - price is directly
Qty s = quantity supplied at a
related to quantity supplied,ceteris
particular price
paribus.
a = intercept of supply curve
b = slope of the supply curve
P = price of the good sold.
Change in Qty. Supplied vs. Change in Supply

Change in the price of that Other factors than the change in

particular good. price of the same good.

Movement along the supply

curve Leftward shift-negative, right-
ward shift-posititve
Forces that cause the supply curve to change
• A. Optimization in the use of factors of production
• B. Technological change
• C. Future expectations
• D. No. of sellers
• E. Weather conditions
• F. Government policy
Market Equilibrium - Qty. d = Qty. s
• Equation - Qty d. = Qty s.
• Shortage = Qty d > Qty s • Qty d. = a- bP
• Surplus = Qty d< Qty s • Qty s = a + bP

a-bP = a+bP
Market equilibrium graph Gov't intervention:
1. Price floor- happens, when there is a
surplus.This intervention is usually
implemented to protect sellers from getting
very low profits.(e.g. farmers).It causes
permanent surplus.
2. Price ceiling-happens during shortage,this is
to prevent the abuse of sellers to charge very
high prices especially during crisis.It results to
permanent shortage.
Concept of Elasticity - Responsiveness or
Sensitivity
• Demand Elasticity - response of • Income Elasticity
buyers Ei > 1 = normal good (income Qty d )
• A.) Price elasticity Ei< 1 = inferior good ( income Qtyd )
Ed = (% in Qtyd)/(% in Price)
Arc elasticity Ei = (% in Qty d)/% in income)
Ep = ((Q2-Q1/(Q1+Q2)/2))/ ((P2- Ei = (((Q2-Q1)/(Q1+Q2)/2)/(((I2-I1)/(I1+I2)/2)
P1)(P1+P2)/2)
Interpretation: Cross price elasticity of demand
% in Qtyd>% in Price = price Exy = (% in Qty d X) / (% in Price Y)
elastic or >1 If the result is positive = substitute, if not
complement
% in Qtyd<% in Price = price
inelastic or <1
Elasticity of Supply - response of the sellers
• Es = (% in Qty d)/ (% in Price) • Short-run supply - tends the price
if higher - elastic to be inelastic because of limited
capacity.

Extremes: both demand and supply

• Long-run supply - tends to be price
1.) Perfectly inelastic - e.g. medicine elastic because of additional capital.
for cancer patients.
2.) Perfectly elastic - e.g. trip to outer
space
Utility theory
• Utility - refers to satisfaction or • Law of Diminishing Marginal Utility -
pleasure that an individual or a decline in the satisfaction for
consumer gets from the goods and services.
consumption of a good or service Mu = ( Tu/ Q)
that they purchase.
• Consumer surplus = Expected price-
Actual price
• Marginal utility - additional • Indifference curve - Good A= Good
satisfaction B, equal satisfaction
• Total utility - total satisfaction Marginal rate of substitution - how
much of Good Y will be given up to
get Good X.
Production and Cost
• Short-run - inputs are variable and • The Law of Diminishing Returns
fixed the MP will get lower and
• Long-run - all inputs are variable lower as we put more inputs.

• Production Function Increasing returns to (economies of

• Qt-shirt = f(fabric,sewing scale) - increase in inputs is lower
machine,sewer, etc. than the outputs.
*Market Structures
MP = ( TP/ IL) 1.) Perfect Competition - many well-
informed sellers and buyers of an
AP = TP/ Input identical product and no barriers to
MP means marginal product entering or leaving the market.
AP means average product
• Characteristics: • 3. Oligopoly - few sellers,
a.) Large no. of small firms. homogeneous or differentiated
product, difficult entry, non-price
b.) Homogeneous product. competition
c.) Very easy entry and exit. • 4. Monopolistic competition - many
small sellers, differentiated product,
2. Monopoly - one seller, unique easy market entry and exit.
product, impossible entry, non- • 5. Monopsony - single buyer,many
competitive advertising sellers.
• Macroeconomics - of the study of how we can best increase our country's
wealth given the available resources we have like land, labor, and capital and
how these resources are transformed by entrepreneurs into final goods and
services which we ultimately consume to satisfy our needs and wants.

Production Possibilities Frontier - represents outcome or production

combination that can be product with a given amount of resources.

Complex Circular Flow Model (next slide)

The National Income Accounting
• The national income accounting is the system used to measure the aggregate income and
expenditures for a nation. It is measured by either Gross Domestic Product (GDP) or
Gross National Product (GNP)
• The most widely used measure is the GDP. It is the total market or money value of all final
goods and services produced in an economy over a period of one year.
• GDP excludes production abroad by Phl businesses and overseas Filipino workers. GNP,
on the other hand, is the total market value or money value of all final goods and services
produced by a nation's residents (e.g. Filipinos), no matter where they are located. Ex.
GNP includes SMC earnings on its foreign operations but GDP does not.
• Limitations:
• 1.) It is measured in market or money value.
• 2.) It only counts new domestic production.
• 3.) It only includes final goods and services.
• 4.) It excludes second-hand transactions and nonproductive financial transactions.
Approaches in Measuring GDP
• 1.) The Expenditure Approach - adding all the spending for final goods and
services during a period of one year.
GDP = Consumption + Investment + Gov't Expenditures + Net Exports (Exports -
Imports)
2.) The Income Approach - adding all the incomes earned by households in
exchange for the factors of production during a period of time.
GDP = Compensation of Employees + Rents + Profits + Net Interest + Indirect
Taxes + Depreciation
3.) The Industrial Origin or Gross Value Added Approach - the economy is
divided into three section composed of industries, as follows: 1. agriculture,
fishery and forestry sectors, 2. industry sector 3. service sector
Gross Value Added - is the domestic product of goods and services produced by
industries within the country.
GDP Shortcomings
• 1.Nonmarket Transactions • Consumption and Savings
• 2.Distribution, Kind and Quality of • Consumption means the
Products expenditures made by household
• 3. Neglect of Leisure Time
on goods and services.
• Y = Cb + C
• 4. The Underground Economy

• 5. Economic Bads - e.g. pollution

Where Y = factor income (for
consumption)
Nominal or Current GDP vs. Real GDP
Cb = borrowings from the economy's
• Real GDP = (Nominal GDP/GDP
stock of savings
Defactor) x 100) - removes the
effect of price increases or inflation C = change in consumption
• The Multiplier Concept
• "Multiplier Effect" - a phenomenon whereby some initial increase ( or decrease) in
the rate of spending will bring about a more than proportionate increase (or
decrease) in national income.

• The Value of Multiplier

k = ((1/(1-MPC)) + 1/MPS where: k = multiplier coefficient, MPC = marginal
MPS+MPC = 1 propensity to consume, MPS = marginal
propensity to save.
Factors of Consumption
1. Taste and Preference 4. Price Level
2. Population 5. Innovation and Promotion
3. Income 6. Advertising
• Investment - a capital spending mainly derived not from current income and
consumption but external to the circular flow. Refers to physical investment like fixed
assets.
Investment and the Multiplier - Y = C + I, Y=income, C= consumption, I =investments
• Savings = Income - Consumption

• Determinants of Savings

1. Price Level 2. Population Growth 3. Taxes

Investment Demand Determinants
1. Interest rate - the level of interest rate is determined by the forces of demand and
supply for finance in the money market.
As to Demand of Money, Lower Interest, Demand
As to Supply of Loanable Funds, Lower Interest, Supply

Acceleration Principle - states that the level of investment is a function of desired

changes in output.
• Multiplier Effect Between the Two • MPC = ( C/ Y)
• Income means Investment • 1-MPC = MPS

Income = Consumption + Investment

• 2. Innovations The Growth & Equilibrium Income
• 3. Profit Y=C+I+G
• 4. Expectations
• National Income Determinants Full employment equilibrium is an
• Aggregate Demand - Total Amount ideal objective because resources are
of expenditure (in nominal terms) not wasted. Full utilization of land,
on domestic goods and services labor, capital, and entrepreneurial
ability.
• AD = C + I + G + Xn
• AD = AS = Equilibrium level of
national income
Economic Fluctuations : The Business Cycle
• Business cycle = upswings and downswings in the level of real output or economic
fluctuations alternating between periods of depression and boom conditions.
• Four phases (insert graph four phases)

Unemployment - Generally, unemployed land, labor and capital. Strictly, labor

resource unemployment

Full employment - a macroeconomic goal.

• Unemployment rate = (No. of Unemployed/ Labor Force)
Types of unemployment
• 1. Frictional unemployment - people between jobs or freshly entering or re-entering
the labor market
• 2. Structural unemployment - mismatch of jobs offered by employees and potential
workers (unemployment and underemployment)
• 3. Cyclical unemployment - unemployment caused by changes in the business cycles
(e.g. depression)
• 4. Seasonal unemployment - unemployment due to season

• Demand side solution - Government-funded employment of the able-bodied poor.

• Supply side solution - Policies favorable to employers

• Inflation is defined as a broadly-based rise in the price level. In other words, inflation
is the rise in the general level of prices of goods and services in an economy over a
period of time.
• Consumer Price Index ( CPI)
• CPI is the cost of purchasing a hypothetic market basket of consumption goods bought
by a typical household consumer during a given period of time ( generally a month),
relative to the cost of purchasing the same market basket during the base year.

• Producer Price Index (PPI) - goods consumed by producers like energy and raw
materials. I
• Inflation rate = (CPI in current year - CPI in previous year/ CPI in previous year) x 100

• Theories of inflation - what causes inflation?

• 1.) Demand - pull inflation or "inflationary gap" inflation. Results if AD> AS

• 2.) Cost-push inflation - rise in prices due to increase in production costs.(e.g. gasoline)

Inflation and Purchasing Power of Money

General Price level = Purchasing Power of Money
• Three Major Reasons why Inflation will have a harmful effect on the economy.
• 1.) Because unanticipated inflation alters the outcomes of long-term projects, such as
the purchase of machine or an investment in a business it will increase the risk and
retard the level of such productive activities.
• 2.) Inflation distorts the information delivered by prices.
• 3.) People will respond to high and variable rates of inflation by spending less and
more time trying to protect themselves from inflation.

Core inflation - is a widely used measure of the underlying trend or movement in the
average consumer prices. (Stripping volatile price movements).Used as future indicator
of inflation.
Headline inflation - CPI rate of change
• Fiscal Policy = the use of government spending and taxes to influence the nation's
spending, employment and price level. It is also defined as the manipulation of the
national government budget to attain price stability, relatively full employment and a
satisfactory rate of economic growth.
• Fiscal Policy and the Crowding-Out Effect
• Crowding-out effect - squeezing out of private spending by a deficit-induced increase in
the real interest rate. It occurs when the gov't has large budget deficit. It will result to
higher interest rate. Thus, making borrowings more burdensome to private spenders
• Restrictive fiscal policy - increase taxes & reduce gov't spending will have as opposite
effect "crowding-in)
• Fiscal policy as a stabilization tool: A modern synthesis
• 1. Proper timing of discretionary fiscal policy is both difficult to achieve and of crucial
importance.
• 2. Automatic stabilizers reduce the fluctuation of aggregate demand and help to direct the
economy toward full employment.
• 3. Fiscal policy is much less potent than what early Keynesian view implied.
• Monetary Policy - a macroeconomic policy which involves the regulation of the
money supply, credit and interest rates in order to control the level of spending in
the economy. A tool used to achieve macroeconomic goals - price stability and
economic growth. It is promulgated by the Bangko Sentral ng Pilipinas.

• 1. Expansionary monetary policy - increase the inflation e.g. lowering of policy

interest rates and the reduction in reserve requirements.
• Problem solved: Recession and Unemployment
• Measures: BSP buys securities thru open market operations.
• BSP lowers bank rates, money supply increases,interest rate falls, investment
increases, aggregate demand increases, aggregate output increases by the increase
in investment, price level rises.
• 2. Contractionary/ Restrictive
• Problem: Inflation
• Measures:
• BSP sells securities thru open market operations.
• It raises bank rate, money supply decreases, interest rate rises, investment decreases,
aggregate demand decreases, aggregate output decreases by the investment decreases, price
level falls.

Money supply - anything that is generally accepted as payment for goods or services or in the
repayment of debts.
Functions of Money
1.) Money as the medium of exchange.
2.) Money as a unit of account.
3.) Money as a store of value.
• 1.) M1 or Narrow Money = consists of currency in circulation and peso demand
deposits.
• 2.) M2 or Broad Money = M1 + peso savings & time deposits
• 3.) M3 or Broad Money Liabilities = M2 + peso deposit substitutes, such as
promissory notes and commercial papers.
• 4.) M4 = M3 + transferrable and other deposits in foreign currency.

• Money market equilibrium, Ms=Md

• Inflation targeting-announcing target inflation and promises to achieve the said
inflation over a specified time period. This is the approach of BSP
• Reqs. For the successful adoption of inflation targeting
• 1. Firm commitment to price stability 4. Transparency
• 2. Central bank independence 5. Accountability
• 3. Good forecasting ability 6. Sound financial system