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CHAPTER I Economic Way of Thinking SCARCITY

The basic and central economic problem confronting every society. It is the heart of the study of economics and the reason behind its establishment. Commodity or service being in a short supply.

Problem of Scarcity
Limited Resources Unlimited Wants

Scarcity

Economics

It is the science that deals with the management of scarce resources. Described as a scientific study on how individuals and the society generally make choices. Economics is simply scarcity and choices.

Economics
Limited Resources Unlimited Wants

Allocation

What is the relationship Between Economics and Scarcity?

The problem of scarcity gave birth to the study of economics. Their relationship is such that if there is no scarcity, there is no need for economics. The study of economics was essentially founded in order to address the issue of resource allocation and distribution, in response to scarcity.

Origin of the term Economics

The two Greek roots of the word economics are oikos- meaning household and nomus- meaning system or management. Oikonomia or Oikonomous therefore means the management of household.

Ceteris Paribus Assumption


Ceteris Paribus means all other thing held constant or all else equal. This assumption is used as a device to analyze the relationship between two variables while the other factors are held unchanged. It is widely used in economics as an exploratory technique as it allows economists to isolate the relationship between two variables.

Birth of Economic Theory: Classical Economics

Adam Smith(Scotland)Father of Economics. He was responsible for the recognition of economics as a separate body of knowledge. His book, Wealth of the nations, published in 1776, became known as the bible in economics for a hundred years.

Adam Smith The Father of Economics

John Stuart Mill- Developed the basic analysis of the political economy or the importance of a state's role in its national economy.

Karl Marx (German)- He is much influenced by the conditions brought about by the industrial revolution upon the working classes. His major work, Das Kapital, the centerpiece from which major socialist thought was to emerge.

Neoclassical Economics(1870's)
Alfred Marshall- The most influental economist during the neoclassical time because of his book Principles in Economics. He developed the analysis of equilibrium of a particular market and concept of marginalism.

Leon Walras- Introduced the general economic system. He developed the analysis of equilibrium in several markets.

Keynes' General Theory of Employment, Interest and Money


John Meynard Keynes (1883-1946)- Is an english economist who offered an explanation of mass unemployment and suggestions for government policy to cure unemployment in his influental book: The General Theory of Employment, Interest and Money(1936). Keynes' concern about the extent and duration of the worldwide interwar depression led him to look for other explanations of recession. (Pass & Lowes 1993)

Non-Walrasian Economics(1939)
John Hicks- He was recognized for his analysis of the IS-LM model, which is considered as an important macroeconomic model. IS refers to goods market for a given interest rate, while Lmmeans money market for a given value of aggregate output or income. The IS-LM model is a theoretical construct that integrates the real, IS (investment-saving, and the monetary, LM (demand for, and supply for money), sides of the economy simultaneously to present a determinate general equilibrium position for the economy as a whole (Pass & Lowes 1993).

Post-Keynesian Econimics(1940 and 1950's)


This period introduced major post-keynesian, neoclassical economists, whose views are known as the post-keynesian mainstream economics. This period welcomed various economists like: Paul A. Samuelson Kenneth J. Arrow James Tobin Lawrence Klein Joan Robinson Michael Kolechi

New Classical economics


New

classical economics highlighted the importance of adherence to national expectations hypothesis and analysis, which included various economic phenomena in formulating different kinds of studies and new theories in economics. This development in economics is applicable to concerns of developing countries, and was largely outcome of concerns of developing countries, and was largely an outcome of concern for the growth of developed countries. The great economist like Smith, Ricardo and Malthus addressed this problem.

Positive and Normative Economics


Positive Economics is an economic analysis

that considers economic conditions as they are, or considers economics as it is.


Normative Economics is economic analysis

which judges economic conditions as should be. It is that aspect of economics that is concerned with human welfare.

Four Basic Economic Question


What to produce?

An economy must identify what are the commodities needed to be produced for the utilization of society in everyday life. A society must also take into account the resources that it possesses before deciding what goods or services to produce.

H0w to produce?

There is no need to identify the different methods and techniques in order to produce commodities. The society must determine whether to employ labor intensive production or capital intensive inputs.

How much to Produce?

This identities the number of commodities needed to be produced in order to answer the demand of the society. The optimum amount of production must be approximated by producers. Underproduction will result to a failure to meet the needs and wants of the society. On the other hand, overproduction results to excess goods and services going waste.

For Whom to Produce?

This question identities the people or sectors who demand the commodities produced in a society. Economist must determine the target market of the goods and services which are to be produced to understand their consumption behaviors and patterns. An understanding of these result to higher sales of goods, and ultimately to increased profits.

Relationship of Economics to other Sciences


Economics is considered the queen of all

social sciences because it covers almost every activity of man in relation to the society. Because it covers almost every activity of man in relation to the society. Because of its multifarious applications, various sciences are closely related to the study of economics.

Business Management
Business

basically provides employment opportunities to members of the society, and is an important vehicle in the balance of economic activity. Its relation to study of economics is evident in analyzing microeconomic and macroeconomic behavior.

History- The history of economic ideas provides

information regarding theories that can be revisited in order to evaluate present and future economic issues.

Finance- Is defined as the management of

money, credit, banking and investment.

Physics- Innovations and output by physics

greatly affect the study of economics.

Sociology- Is the study of the behavior of

societies

Physiology- Is the study of the behavior of man

Importance of Studying Economics


To Understand the Society- Economic seek to analyze

transaction made by the society and its members, particularly with regard to details on their behavior and decision making (Case 2003). the internal operation and trade policies of countries. Its also measures the competitiveness of each country and identifies its comparative advantage in relation to other states (case 2003).

To understand Global Affairs-Economic seek to explain

To be an Informed Voter-An understanding of economic

develops individuals to be wise voters. Knowledge of economics provides individuals with an understanding of economic policies that are apt for the states current situation. With this in mind, voters have an informed choice in selecting leaders based on their economic, social , and political platform, rather than on their apparent popularity. (Case 2003)

Es in economic
Efficiency

Refers to productivity and proper allocation of economic resources. It also refers to the relationship between scare factor inputs and outputs of goods and services. This relationship can be measured in physical terms ( technological efficiency) or cost terms (economic efficiency). (Pass & Lowes 1993). Being efficient in the production and allocation of goods and services saves time, money, and increases a companys output. For instance, in the production of commodities, firms utilizing modern technology can improve the quantity and quality of products, which ultimately translates into an increase in revenue and profit

Equity

Means justice and fairness. Thus, while technological advancement may increase production, it can also bear disadvantages to employment of workers. Due to the presence of new equipment and machineries, manual labor may not be necessary, and this can result in the retrenchment or displacement of workers

Effectiveness

Means attainment of goals and objectives. Economic s is an important and functional tool that can be utilized by other fields. For instance, with the use of both productions (through manual labor or through technological advancements), whatever the output is, it will be useful for the consumption of the society and the rest of the world

Important Economic Terms


Wealth

Refers to anything that has a functional value(usually in money), which can be traded for goods and services. Wealth, therefore, is the stock of net assets owned by individuals or households. In aggregate terms, one widely used measure of the nations total stock of wealth is that of the marketable wealth, that is, physical and financial assets which are in the main relatively liquid. (Pass & Lowes 1993) Consumption This refers to the direct utilization or usage of the available goods and services by the buyer or the consumer sector. It is also the satisfaction obtained by consumers fir the use of goods and services (Pass & Lowes 1993)

Production

It is defined as the formation by firms of an output (products or services). It is the combination of land, labor and capital in order to produce outputs of goods and services Exchange This is the process of trading goods and/or services for money and/or its equivalent. It also includes the buying of goods and services either in the form of barter or through market. Distribution This is the process of allocating or apportioning scare resources to be utilized by the household, the business sector, and the rest of the world. In specific term, however, it refers to the process of storing and moving products to customers often through intermediaries such as wholesalers and retailers

Microeconomics and Macroeconomics


Microeconomics

This is the branch of economics which deals with the individual decisions of units of the economy-firms and households, and how their choices determine relative prices of goods and factors of production. The market is the central concept of microeconomics. It focuses on its two main players- the buyer and the seller, and their interact in with one another.

Macroeconomics

It is a branch of economics that studies the relationship among broad economic aggregates like national income, national output, money supply, bank deposits, total volumes of savings, investment, consumption, expenditure, general price level of commodities, government spending, inflation, recession, employment and money supply.

Concept of Opportunity Cost


Opportunity Cost

It refers to the foregone value next best alternative. It is the value of what is given-up when one makes a choice. The thing thus given-up called the opportunity cost of ones choice.

Opportunity Cost Illustration


Saving (Firm/Individual)

Credit (Interest)

Investment (Profit)

Factors of Production
Land

This broadly refers to all natural resources, which are given by, and found in nature, and are, therefore, not man made. It does not solely mean the soil or the ground surface, but refers to all things and powers that are given free to mankind by nature.

Labor

Any form of human effort exerted in the production of goods and services. Labor covers a wide range of skills, abilities and characteristics. It includes factory workers who are engaged in manual workers who are engaged in manual work. Capital Is man-made goods used in the production of other goods and services. It includes buildings, machinery and other physical facilities used in the production process. Entrepreneurship Is person who organizes, manages and assumes the risks of a firm, taking new idea or new product and turning it into successful businesses.

The Circular Flow Model


Economic Resources (Land, Labor, Capital)

HOUSEHOLDS

Firms (Producer)

Output of Goods and Services

Consumption

Basic Decision Problems

Members of society, with their individual wants, determine what type of goods or services they want to utilize or consume, and the corresponding amounts therefore that they should purchase and utilize. Production The problem of production is generally a concern of producers. They determine the needs, wants, and demands of consumers and decide how to allocate their resources to meet these demands.

Distribution

This problem is primarily addressed to the government. There must be proper allocation of all the resources for the benefit of the whole society. In market economy, though, absolute equality of every member, as to the distribution of resources, can never be achieved. Growth over Time This is the last basic decision problem that society or nation must deal with. Societies live on. They also grow in numbers. On the one hand, people have definite lives, but societies (or nations) have longer, if not infinite lives.

Types of Economic Systems


Traditional Economy

is basically a subsistence economy. A family produces goods only for its own consumption. The decisions on what, how, how much, and for whom to produce are made by the family head, in accordance with traditional means of production.
Command Economy

is a type of economy, wherein the manner of production is dedicated by the government. The government decides on what, how, how much, and for who, to produce. It is an economic system characterized by collective ownership of most resources.

Market Economy

Or capitalisms basic characteristic is that resources are privately owned, and that the people themselves make the decisions.
Socialism

Is an economic system wherein key enterprises are owned by the state. In this system, private ownership is recognized. However, the state has control over a large portion of capital assets, and is generally responsible for the production and distribution of important goods.
Mixed Economy

This economy is a mixture of market system and the command system. The Philippine economy is described as a mixed economy since it applies a mixture of three forms of decision-making. However, it is more marketoriented rather than command or traditional.

THE BASIC ANALYSIS OF DEMAND AND SUPPLY


Demand

is generally affected by the behavior of consumers, while supply is usually affected by the conduct of producers. The interplay between these two is the foundation of economic activity. Thus, the consumers identities his/her needs, wants, and demands, while producers address these by accordingly producing goods and services. In the end, the consumer gains satisfaction while the producer gains profit.

As the economy cannot operate without this

interaction between the consumer and the producer, it is essential, therefore, that students understand the different movements of the demand and supply curve, as well as the concept of market equilibrium.

Market

A market is where buyers and sellers meet. It is the place where they both trade or exchange goods or services- in other words, it is where their transaction takes place. There are different kind s of markets, such as wet and dry. Wet market is where people usually buy vegetables, meat etc. On the dry market , dry market is where people buy shoes, clothes, or dry goods.

Demand

Demand pertains as to the quantity of a good or service that people are ready to buy at given prices within a given time period, when other factors besides price are held constant. Simply put, the demand for a product is the quantity of a good or service that buyers are willing to buy given its price at the particular time. Demand therefore implies three things: -Desire to possess a thing; -The ability to pay for it means of purchasing it; and -Willingness in utilizing it.


Law of Demand

The law of demand states that if price goes UP, the quantity demanded will go DOWN. Conversely, if price goes DOWN, the quantity the quantity demanded will go UP ceteris paribus. The reason for this is because consumers always tend to MAXIMIZE SATISFACTION.

Demand schedule

A demand schedule is a table that shows the relationship of prices and the specific quantities demanded at each of these prices. The information provided by a demand schedule can be used to construct a demand curve showing the price- quantity demanded relationship in graphical form.

Demand schedule
Situation
Price (P) Quantity (kg)

A B C D E

5 4 3 2 1

8 13 20 30 45

Demand curve

It is a graphical representation showing the relationship between price and quantities demanded per time period. A demand curve has negative slope thus it slope downward from left to right. The down the downward slope indicates the inverse relationship between price and quantity demanded.

Demand Curve
P

Demand Function
A demand function shows the relationship between

demand for a commodity and the factors that determine or influence this demand. These factors are the price of commodity itself, prices of other related commodities, consumers level of incomes, taste and preferences, size and composition of level population, distribution of incomes, taste and preferences, size and composition of level population, distribution of income etc. Demand function is expressed as a mathematical function. Thus, Qd=f ( own price, income, price of related goods, etc.)

CHANGES IN QUANTITY DEMANDED VS. CHANGE IN DEMAND


Change in Quantity Demand

There is change in quantity demanded if the movement is along the same demand curve. A change in quantity demanded is brought about by an increase (decrease) in the products price. The direction of the movement however is inverse considering the Law of Demand

Change in Quantity Demand

Change in demand

There is a change in demand if the entire demand curve shifts to the right side resulting to an increase in demand. At the same price, therefore, more amount of a good or service are demanded by consumers.

Change in demand

a. Increase in Demand

b. Decrease in Demand

Forces that cause the demand curve to change


There are several

reasons why demand changes and thus cause the demand curve to change. The following are the more general reasons for the change in demand.

Taste or Preferences- Pertain to the personal like or

dislike of consumers for certain goods and services. If taste or preferences change so that the people want to buy more of a commodity at a given price, then an increase in demand will result or vice versa.
Changing Income- Increasing incomes of households

raise the demand for certain goods or services or vice versa. This is because an income in ones income generally raises his or her capacity or power to demand for goods or services which (s)he is not able to purchase at lower income. On the other hand, a decrease in ones income reduces his or her purchasing power, and consequently, his(her) demand for some goods or services ultimate declines.

Occasional or seasonal products- The various events or

seasons in a given year also result to a movement of the demand curve with reference to particular goods. For Example: during Christmas season, demand for Christmas trees , parols, and other Christmas decors increase. Moreover, demand for food items like ham and quezo de bola also increases. Similarly, as valentines Day approaches, the demand for red roses and chocolates also rises. It should be noted, however, that after these events, demand for these products returns back to the original level
Population Change- An increasing population leads to an

increase in the demand for some type of goods or services, and vice versa. More people simply mean that more goods and services are to be demanded. In particular, increase in population generally results to an increase in demand for basic goods, such as foods and medicines. On the other hand, a decrease in population results in a decline in demand.

Substitute Goods- Substitute goods are goods that are

interchanged with another good. In a situation where the price of a particular good increases a consumer will tend to look for closely related commodities. Substitute goods are generally offered at cheaper price, consequently making it more attractive for buyers to purchase.
Expectations of future prices- 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 9or decrease). Also, expectations about the future may alter demand for a specific commodity.

SUPPLY(Firms/Sellers side)
Supply is the quantity of goods or services that firms are

ready and willing to sell at a given price within a period of time, other factors being held constant.
Law of Supply- States that if price of good are service

goes up, the quantity supplied for such good or service will also go up; if the price goes down the quantity supplied also goes down, ceteris paribus. The law of supply implies that higher price is an incentive for business firms to produce more goods or services as this will maximize their profits.

Supply Schedule
Is a schedule listing the various prices of

a product and the specific quantities supplied at each of these prices. Generally, the information provided by a supply schedule can be used to construct a supply curve showing the price/quantity supplied relationship graphical form.

Supply Schedule
Situation A B C D E Price (P) 5 4 3 2 1 Quantity (Q) 48 41 30 17 5

Supply Curve
It is a graphical representation showing the

relationship between the price of the product or factor of production (e.g. labor) and the quantity supplied per time period. The typical market supply curve for a product slopes upward from left to right indicating that as price rise (falls) more (less) is supplied/ The upward slope indicates the positive relationship between price and quantity supplied.

Supply Curve

Supply Function
Is a form of mathematical notation that links the dependent variable, quantity supplied (Qs), with various independent variables which determine quantity supplied. Among the factors that influence the quantity supplied are price of the product, number of sellers in the market, price of factors inputs, technology, business goals, importations, weather conditions, and government policies. Qs=f (own price, number of sellers, price of factor inputs, technology, etc.)

Change in Quantity Supplied vs. Change in Supply


Change

in Quantity Supplied- If the movement is along the same supply curve. A change in quantity supplied is brought about by an increase (decrease) in the products own price. The direction of the movement however is positive considering the law of supply.

Change in Quantity Supplied

Change in Supply- When the entire demand supply

curve shifts rightward or leftward. At the same price, therefore, more amounts of a good or service are supplied by producers or sellers.

a. Increase in Supply

b. Decrease in Supply

Forces that Causes the Supply to Change


Just like demand, there are also forces that

cause the supply curve to change. Below are some of the reasons that cause the supply curve to change. Optimization in the use of factors of production- An optimization in the utilization of resources will increase in supply. Technological change- The introduction of cost-reducing innovations in production technology increases supply on one hand.

Future Expectations- This factor impacts

sellers as much as buyers. If sellers anticipate a rise in prices, they may choose to hold back the current supply to take advantage of the future increase in price, thus decreasing market supply. If sellers however expect a decline in the price for their products, they will increase present supply.
Number of Sellers- Has a direct impact on

quantity supplied. Simply put, the more sellers there are in the market the greater supply of goods and services will be available,

Weather Conditions- Bad weather, such as

typhoons, brought or other natural disasters, reduces supply of agricultural commodities while good weather has an opposite impact.
Government Policy- Removing quotas and

tariffs on imported products also affect supply. Lower trade restrictions and lower quotas or tariffs boost imports, thereby adding more supply of goods in market.

Market Equilibrium
From a separate discussion of demand and

supply, we now proceed with reconciling the two. The meeting of supply and demand results to what is referred to as market equilibrium. Equilibrium- Generally pertains to a balance that exists when quantity demanded equals quantity supplied. Equilibrium Market Price- Is the agreed by the seller to offer its good or services for sale and for the buyer to pay for it.

What happens when there is market disequilibrium?


When there is market disequilibrium, two conditions may happen: a surplus or a shortage. SURPLUS- is a condition in the market where the quantity supplied is more the quantity demanded. When there is a surplus, the tendency is for sellers to lower market prices in order for the goods to be easily disposed from the market.

Shortage- is a condition in the market in

which quantity demanded is higher than supplied. When the market is experiencing shortage, there is a possibility of consumers being abused, while the producers are enjoying imposing higher prices for their own interest. Shortage exists below the equilibrium point. When there is a shortage, there is an upward pressure to prices to restore equilibrium in the market

Price controls are classified into two types: floor price and price ceiling.
Floor Price

It is the legal minimum price imposed by the government. This is undertaken if a surplus in the economy persists.
Price Ceiling

Its is the maximum price imposed by the government. Price ceiling is utilized by the government if there is a persistent shortage goods in the economy.

THE CONCEPT OF ELASTICITY


Elasticity of Demand

You may encounter the term elasticity in your Physics subject which refers to expansion or contraction of physical matter. In economics however elasticity means responsiveness. In general, its is the ratio of the percent change in one variable to the percent change in another variable.

Price Elasticity of Demand

is the responsiveness of consumers demand to change in price of the good sold.

ARC Elasticity of Demand

(>1= Elastic) (<1= Inelastic) (1=Unitary)

Income Elasticity of Demand

is the responsiveness off consumers demand to a change in their income.

(+ = Normal Goods) (- = Inferior Goods)

Cross Elasticity of Demand

Is the responsiveness of demand for a certain good, in relation to changes in price of other related goods.

(+ = Complementary Goods) (- = Substitute Goods)

Consumer Behavior and Utility Maximization


Consumer

Is one who demands goods and services. Without consumption (households), there is no need for production (firm). The consumer is the king in a capitalist or free-market economy. Producers, for their own interests, have to satisfy the needs and wants of consumers in order to earn profits. In this perspective, all of us are consumers because as we live our daily lives we demand goods and services the moment we wake up in the morning until we retire to our bed at night.

Goods and Services

Goods refers to anything that provides satisfaction to the needs, wants and desires of the consumer. They can be any tangible economic products (like cars, books, clothes, etc.) that contribute directly (final goods) or indirectly (intermediate goods) to the satisfaction of human needs and wants. Services, on the other hand, are any intangible economic activities (such as hairdressing, catering, insurance, banking, telecommunication, etc.) that likewise contribute directly to the satisfaction of human wants.

Consumer Goods

These are the goods that yield satisfaction directly to any consumers. These goods are primarily sold for consumption, and not to be used for further processing or as an input/raw material needed in producing another good. Usually, these are goods that are easily accessible to consumers (e.g. soft drinks, bread, crackers, cellular phone loads.)

Essential or necessity goods vs. luxury

Goods Necessity goods are goods that satisfy the basic needs of man. In other words these are goods that are necessary in our daily existence as human beings. These are also goods that we cannot live without such as food, water, shelter, clothing, electricity, medicine etc. Conversely, luxury goods are those which men may do without, but which are used to contribute to his comfort and well being. Examples of luxury goods are private jet, yacht, luxury cars, perfumes, jewelry, etc.

Economic and Free Good

An economic good is that which both useful and scarce. It has value attached to it and price has to be paid for its use. If a good is so abundant that there is enough of it to satisfy everyones needs without anybody paying for it, that good is free. Water from our faucet is an economic good, because we are not utilizing it for free, we have to pay its distribution. The air that we breath and the sunlight coming from the sun are examples of free goods.

Taste and Preferences

Consumers have various tastes and preferences. Generally, tastes and preferences are determined by age, income, education, gender, occupation, customs and traditional as well as culture. Preference are the choices made by us consumers as to which products or services to consume. Brand the term or symbol given to a product by a supplier in order to distinguish his offering from that of similar products supplied by competitors.

Maslows Hierarchy of Needs


Physiological Needs

These are basic needs for sustaining human life itself, such as food, water, warmth, shelter, sex and sleep. According to Maslow, until these needs are satisfied to the degree necessary to maintain life, other higher needs will not stimulate people. Safety Needs These are the needs to be free of physical danger and the fear of losing ones work, property, food or shelter.

Social Needs

These needs cover the value of the sense of belongingness, love, care , acceptance and understanding of family, relatives and friends and to be accepted by others. Esteem Needs These needs explain the importance of self-esteem, recognition, status of an individual and the general acceptance of the society to an individual. This kind of need produces such satisfaction as power, prestige, status and self confidence. Self-Actualization Needs These needs explain the worth of a persons self development, growth and realization and achievement.

The Economic Satisfaction


You might wondering by now how economics can explain the behavior of consumers in order to attain maximum level of satisfaction on the goods and services that they generally consume. In this section we try to explain how consumers attain maximum satisfaction level on the many goods and services available to them for consumption. However, we have to remember at this point that satisfaction is a relative term. This is because we differ in the way we are satisfied as well as the degree of our satisfaction.

Utility Theory
Utility,

in economics, refers to the satisfaction or pleasure that an individual or consumer gets from the consumption of a good or services that (s)he purchases. For purposes of economic analysis, utility is also measured by how much a consumer is willing to pay for a good/services. Utility Theory simply tries to explain how our satisfaction or utility as consumers decline when we try to consume more and more of the same good at a particular point in time.

Marginal Utility is defined as the traditional

satisfaction that an individual derives from consuming an extra unit of a good or service. Marginal means additional or extra.
Total Utility on the other hand, is the total

satisfaction that a consumer derives from the consumption of a given quantity of good or service in a particular time period.
Law

of Diminishing Marginal Utility states that as a consumers gets more satisfaction in the long-run he experience a decline in his satisfaction for goods and services.

Mathematical Derivation of Marginal Utility


TU2= the new total utility TU1= the original utility Q2= the new quantity consume Q1= the original quantity consumed

Consumer Surplus

In general, consumer is a measure of the welfare we gain from the consumption of goods and services, or measure of the benefits that we derive from the exchange of goods. In specific term, consumer surplus is the difference between the total amount that we are willing and able to pay for a good or services and the total amount that we actually pay for that good or service.