APPLIED ECONOMICS REVIEWER

© angelica garcia

Economics
 a social science that seeks to allocate scarce resources in order to satisfy unlimited human
needs and wants
 comes from the Greek word “oekonomia”, which means management of the household

Two Branches of Economics

MICROECONOMICS
- It is concerned with the behavior of
individual entities such as the consumer,
the producer, and the resource owner.
- More concerned on how goods flow from
the business firm to the consumer and
how resources move from the resource
owner to the firm
MACROECONOMICS
- Concerned with the overall performance
of the entire economy.
- Focuses on the overall flow of goods and
resources and studies the cause of
change in the aggregate flow of money,
the aggregate movement of goods and
services, and the general employment of
resources.

Needs and Wants

 Needs – things we can’t live without. (e.g. food, water, shelter, clothing, etc.)
 Wants – things we can do without. (e.g. cars, laptops, jewelries, etc.)

The Economic Problem

 Although your wants or desires are virtually unlimited, the productive resources available to
help satisfy these needs are scarce.

Scarcity
 A condition where there are not enough productive resources to satisfy man’s unlimited needs
and wants.
 Considered as the key economic problem.
 Scarcity  Shortage
SCARCITY SHORTAGE
- Not enough resources available to use in - Consumers want more than producers
the way we would like are willing to supply at a given price.
- Implies finite limits - Relates to price
- Permanent

Economic Choices
 Resources are limited. Therefore, men cannot have all the goods and services they want,
consequently, they must choose some things and give up others.

Basic Economic Questions

In order to cope with restraints and limitations, these economic questions must be answered:
1. What to produce and how much?
 The society must decide what goods and services should be produced in the economy,
the quantity of these goods should also be decided on.

2. How to produce?
 A question on the production method that can be used to produce goods and services.

3. For whom to produce?

 About the market for the goods
Broad Categories of Productive Resources
1. Natural Resources – supplied by nature (land, water, etc.)
2. Capital Goods – human made materials needed to produce goods and services. (factories,
trucks, equipments, etc.)
3. Human Resources – physical and mental efforts given by individuals.

Factors of Production (Productive Resources)

1. Land – represents land and similar natural resources available such as farms and agricultural
land. (Natural Resources)
2. Labor – represents human capital such as workers and employees that transform raw material
and regulate equipment to produce goods and services. (Human Resources)
3. Capital – represents physical assets such as production facilities, warehouses, equipment, and
technology used in the production of goods and services. (Capital Goods)
4. Entrepreneurial Ability – represents the factor that decides how much of and in what way the
factors are to be used in the production. (Human Resource)

FACTORS OF PRODUCTION FACTOR PAYMENTS

Land Rent
Labor Salaries and Wages
Capital Interest
Entrepreneurial Ability Profit

Goods and Services

 Resources are combined in a variety of ways to produce goods and services.
GOODS SERVICES
- Tangible (something you can see, feel, - Intangible (not physical)
and touch) - Also uses scarce resources to satisfy
- Requires scarce resources to produce, human wants
and it satisfies human wants

The Economic Theory

 In order to simplify complex economic situations, economists develop economic theories or
economic model.
 The goal of economic theories and model is to make predictions about the real complex
world. (e.g. what happens to the enrolment of private universities/colleges when state
universities/colleges offer free tertiary education?)

Assumptions
 Statements that are pertinent to one’s study which is self-evident to have been the results of
past studies.
 The most common simplifying assumption in economics is the ceteris paribus assumption,
which means other things that are held constant.

Normative vs. Positive Statements

NORMATIVE POSITIVE
- Statements which make a resolution - Concerning what are, were, and will be
about what should be or ought to be - Based on scientific inquiry
- Based on value judgments
- Opinion
- Kahit sino pwede magsabi
Normative and Positive Statements Examples
1. Philippine GDP should be 15% this year. NORMATIVE
2. There are 7 billion humans living in the world. POSITIVE
3. Scarcity is considered the key economic problem. POSITIVE
4. There should be 5,000 Senior High School graduates this 2018. NORMATIVE

Marginal Analysis
 In economics, marginal means incremental, additional, extra, or one more; a change in an
economic variable
 Economic choice is based on the comparison of the expected marginal benefit and the
expected marginal cost of the action under consideration.
 Marginal Benefit – is the incremental increase in a benefit to a consumer caused by the
consumption of an additional unit of good.
 Marginal Cost – is the incremental increase in a consumer or firm’s input costs to produce one
additional unit of output.
 Marginal benefit normally declines as a consumer consumes one more additional unit of a
good. (e.g. remember the satisfaction of drinking another glass of water when you are thirsty is
less than your satisfaction on the first glass)
 Marginal Benefit > Marginal Cost

The Circular Flow Diagram

 Shows the connection between firms and
households in input and output markets.
 Markets – means by which buyers and
sellers carry out exchange (e.g.
supermarkets, department stores, stock
markets, internet, etc.)
 Households – are the resource owners
allowing the use of their resources by the
firms.
 Input Markets – the markets where
resources – labor, capital, and land are
used to produce products and are
Figure 1 The Circular Flow Diagram
exchanged
 Firms – are the producing units of outputs
 Output Markets – are the markets in which goods and services are exchanged
 In a market-based economy, households are consumers who make demand of goods and
services, while firms are producers which supply goods and services.
 Households earn money income (wages, rents, interests, and profit) as the resource owners.
 Firms earn money income from purchases of goods and services by the households.

Opportunity Cost
 The value of a best alternative you must pass up
 The benefit that you give up because you choose to take one alternative over the other one.
 Formula:

Trade-Offs
 A situation wherein something is given-up in return for another.

Computing for Opportunity Cost

1. Compute for the opportunity cost for each country given the table below:
Wine Coffee
 [Barrels] [Bags]
Country ABC 9 3
Country XYZ 8 2
a. Opportunity cost for each country in producing only coffee.

CoffeeABC =

CoffeeXYZ =

b. Opportunity cost for each country in producing only wine.

WineABC =

WineXYZ =

2. Assume you have the option between buying 3 laptops or buying 6 video cameras. Your
budget is scarce so you have to choose between these two options.
3 laptops
6 video cameras

a. Opportunity cost in buying laptops

Laptop =

b. Opportunity cost in buying video cameras

Video Cameras =

Choosing Among Alternatives

1. Calculate opportunity cost
 The moment you made your choice, you believed you were making the best use of all your
scarce resources. (Rational Self-interest)
 As long as you’re choosing the alternative where your marginal benefit exceeds your
marginal cost

2. Consider your time involved

 For some of us who can afford to buy whatever he/she wants, his/her time to enjoy these
goods and service is scarce. (Time scarcity)
 Each activity we undertake has an opportunity cost
 We all experience time constraint

3. Ignore sunk cost

 Sunk cost – a cost you have already incurred and cannot recover, regardless of what you
do know
 in making economic choices, one should ignore sunk cost
 “There’s no sense in crying over spilt milk.”

Economic Systems
 Economic Systems are the set of mechanisms and institutions that resolves the what, how, and
for whom questions for an economy.
  Economic systems can be distinguished through the following set of questions:
1. Who owns the resources?
2. What decision making process is used to allocate resources and products?
3. What types of incentives guide economic decision makers?

Types of Economy
1. Pure Market Economy
 Private firms account for all production
 There is private ownership of all resources
 The coordination of economic activities is based on the prices generated in free and
competitive markets
 Income from selling resources goes exclusively to the resource owners
 United Arab Emirates, Hong Kong, Singapore

ADAM SMITH INVISIBLE HAND THEORY

- 1723 – 1790
- Father of Economics
- Authored the Invisible Hand Theory (There is
an invisible hand governing the demand and
supply in a pure market economy.)
- Market forces coordinate production as if
by an invisible hand
- Smith argued that although each
individual pursues his/her own self-interest,
the invisible hand of market competition
promotes the general welfare

 Disadvantages of the Pure Market Economy

a. Difficulty Enforcing Property Rights – no government intervention so there is no central
authority to protect property rights, enforce contracts, and ensure that the rules of the
game are followed.
 There is no copyright because they are not the only ones selling the product.
b. Some people have few resources to sell – due to poor education, disability, discrimination,
the time demands of caregiving, or bad luck.
 Some people are only selling just to earn income.
c. Some firms try to monopolize markets – some producers may try to monopolize the market
by either unfairly driving out competitors or by conspiring with competitors to increase
prices.
 Monopolize – one powerful seller/institution
d. No public goods – firms cannot sell public goods profitably in a pure market economy,
therefore they are not producing public goods.
e. Externalities – private markets fail to account for externalities.
 Two types: Positive and Negative
 Example: In Divisoria
Negative Externalities – too much garbage and trash
Positive Externalities – you can bargain for lower prices
f. Economic fluctuation – market economies experience alternating periods of recession and
expansion, especially in employment and productions.

2. Pure Command Economy

 In this type of economy, all resources are government owned and government officials
coordinate production
 Ownership of resources is public (the reason why command economies are often termed
as communism)
 Central planners or officials answer the 3 economic question
 North Korea, Cuba
  Disadvantages of a Pure Command Economy
a. Consumers get low priority – central plans may reflect the preferences of central planners
rather than those of consumers
b. Little freedom of choice – central planners are responsible for the production so variety of
products tend to be narrower, also consumers have less freedom in other economic
decisions
c. Central planning can be inefficient – central planning is so complicated hence may end
up directing resources inefficiently because they are not usually after the general welfare
of the consumers
d. Resources owned by the central authority are sometimes wasted – since all resources are
all government owned, nobody has an incentive to see that resources are employed in
their highest-valued use.
e. Environmental damage – directors of government enterprises are often more concerned
with meeting production goals set by the central government
f. No role for Entrepreneurs – there is no private property, there are no private firms and profit.
With no profit incentive, no individual has a reason to develop new products. With no
entrepreneurs, pure command economies tend to be less innovative, less efficient, and
offers fewer consumer choices.

3. Mixed Economy
 Pure market and pure command economy
 Mixes central planning with competitive markets
 Market competition, government intervention, and ownership exists with varying degrees
 Philippines, United States, Japan, Sweden
 Example: In the Philippines, the Department of Trade and Industry (DTI) exists which is a
form of government intervention and they also protect the welfare of consumers. They also
implement a price ceiling during certain circumstances (i.e. calamities)

4. Transitional Economy
 An economic system which is in the process of shifting from central planning to competitive
markets.
 The transition involves converting government-owned enterprises into private enterprises (a
process called privatization.)
 Moscow, China, Hungary

5. Traditional Economy
 An economic system which is shaped largely by custom or religion
 Conservative type of economy
 For example, caste systems in India which restrict occupational choice, charging interest is
banned in Islamic countries.
 Tibet, Mongolia, India

Demand
 Indicates how much of a product consumers are both willing and able to buy at each price
during a given time period, ceteris paribus.

Effective Demand
 Entails willingness and ability of the consumers.
 Consumers might be able to buy a good or service because they can afford one, but they
may not be able to buy one because they don’t need it, or they are not interested.
 Law of Demand
 States that as price increases, quantity demanded decreases, ceteris paribus. As price
decreases, quantity demanded increases, ceteris paribus.
 There is a negative or inverse relationship between price and quantity demanded.

Demand Schedule
 Table showing how much of a given product a household would be willing to buy at different
prices.
 Example:
ANNA’S DEMAND SCHEDULE FOR TELEPHONE CALLS
PRICE (per call) QUANTITY DEMANDED (Calls per month)
0 30
0.50 25
3.50 7
7.00 3
10.00 1
15.00 0

Demand Curve
 A graph illustrating how much of a given Demand Curve

Price per call

product a household would be willing to buy 20
at different prices. 15
 X axis = demand; Y axis = price
10
 The demand curve slopes downward.
 Example: (See table above for reference) 5
0
Demand Schedule and Demand Curve (Plotting) 0 1 3 per month
Calls 7 25 30
Given the demand schedule below, plot the demand
curve.
A. Demand Schedule
Price of a Pizza (per slice in peso) Qd per week (million)
P150 8
P120 14
P90 20
P60 26
P30 32

B. Demand Curve

Demand Curve
Price per slice of pizza

200
150
100
50
0
8 14 20 26 32
Pizzas per week

Quantity Demanded (Qd)

 An individual point on the demand curve
Demand (D)
 Refers to the whole demand schedule or demand curve

Individual Demand vs Market Demand

 Individual Demand – the demand of an individual consumer
 Market Demand – the sum of individual demands of all consumers in the market

Substitution Effect
 Situation: Price of Product A declines while the prices of Products B,C, and D remain constant.
What happens?
 Substitution Effect – the higher opportunity cost causes some consumers to substitute other
goods for the now higher-priced product/service, so reducing the quantity demanded for
product

Income Effect
 Situation – Suppose you have a P200 daily allowance. Then you spend all your allowance on a
certain product, buying 4 at P50 each. What if the price falls at P40 per piece? You can now
afford to buy 5 pieces of the item.
 Real Income – income measured in terms of what it can buy.
 Income Effect – the price reduction, ceteris paribus, increases the purchasing power of your
income, therefore it also increases your ability to buy a certain product, and indirectly, other
goods.

Marginal Utility
 The change in total utility resulting from a one unit change in consumption of a good.

Total Utility
 The overall amount of satisfaction obtained from consuming several units of a good.
 Utils – standard unit of measurement for utility

Sample computation for Marginal and Total Utility

Rides Total Utility (in utils) Marginal Utility (in utils)
0 0 -
1 11 11
2 20 9
3 27 7
4 32 5
5 35 3
6 36 1
7 35 -1

Law of Diminishing Marginal Utility

 States that the more of a good an individual consumes per period, ceteris paribus, the smaller
the marginal utility of each additional unit consumed.

Elasticity of Demand
 A measurement of how responsive quantity demanded is to a price change; the percent
change in quantity demanded over the percent change in price.

or or
Elasticity Values in Demand
 Elastic – demand elasticity coefficient value is greater than 1
 Unit Elastic – demand elasticity coefficient value is equal to 1
 Inelastic – demand elasticity coefficient value is between 0 and 1

Sample Demand Elasticity Problems

Assume that the price of a slice of pizza falls from P120 to P90, so quantity demanded increases from
14 million to 20 million. What is the demand elasticity?

| |

Elastic

Determinants of Demand Elasticity

1. Availability of Substitutes
 The greater the availability of substitutes for a good and the more similar these are to the
good in question, the greater that good’s demand elasticity.
2. Share of Consumer’s budget spent on the goods
 The more the important the item is as share of the consumer’s budget, ceteris paribus, the
greater is the income effect of a change in price, so the more elastic is the demand for the
item.
3. Duration of the Adjustment Period
 The longer the adjustment period, the easier it is to find lower-priced substitutes
 The longer the period of adjustment, the more responsive the change in Qd is to a given
change in P.
4. Some Elasticity Estimates
 The elasticity of demand is greater than in the long run because consumers have more
time to adjust.
 Long run – consumers can more fully adjust to a price change.
 Short run – consumers have little time to adjust.

Movement along the Demand Curve

 Caused by changes in price, other things constant, changing the quantity demanded.

Shift in the Demand Curve

 Caused by a change in one of the determinants other than price, changing the demand.
Determinants of Demand
1. Changes in Consumer Income
 An increase in consumer’s income makes them more
willing and able to buy more units of a good at each price,
thereby increasing market demand.
 Normal Goods – the demand for normal goods increases
as money income increases
 Inferior Goods – the demand for inferior goods decreases
as money income increases (e.g. ukay-ukay clothes,
jeepney rides)
2. Changes in the Prices of Related Goods
 Substitutes – products that can be used in place of each other (e.g. beef and pork, coke
and pepsi)

 Complements – goods that are used in combination (e.g. bread and butter, spoon and
fork). If two goods are complements, a decrease in the price of one increases the demand
for the other.

3. Changes in the Size or Composition of the Population

 If the population grows, the number of consumers in the market increases, so demand
increases (e.g. if the population grows, the demand curve for rice shifts rightward, an
increase in the teenage population could shift mobile phone demand curve to the right)

4. Changes in Consumer Expectations

 e.g. your demand for business type clothing increases after getting a job offer
 e.g. if consumers expect an oil price hike they may fill their car tanks full, shifting the
demand curve of gasoline rightward
 e.g. if there will be a decrease in the price of iPhones, consumers may defer their purchase
of iPhones, shifting the demand curve of iPhones to the left

5. Changes in Consumer Tastes

 Change in tastes for a particular good would shift the demand curve (e.g. some people do
not like pizza, shifting the demand curve of pizza to the left; the use of jogger pants
becomes a fashion style for men, thus shifting the demand curve to the right)
 Tastes – likes and dislikes as a consumer

Supply
 Indicates how much of a good producers are willing and able to sell per period at each price,
other things constant

Law of Supply
 Says that the quantity supplied is directly or positively related to its price, other things constant.
thus, the lower the price, the smaller the quantity supplied; the higher the price, the greater
the quantity supplied
 Direct relationship
Supply Schedule
 A table showing how much of a product firms will supply at different prices.

The Supply Curve

 A curve or line, showing the quantities of a particular good supplied at various prices during a
given time period, other things constant
 With demand, consumers try to maximize their utility. With supply, producers try to maximize
profit.
 Think as if you are one of the producers like Jollibee, Petron, Samsung, and Apple. How
do you feel? Would you still like the feeling of being its consumers?
 Profit = Total Revenue – Total Cost
Profit (P)(Q) – Total Cost
 TR = TC : a firm breaks even
TR > TC : a firm continues operation
TR < TC : a firm fails; shut down

Sample Supply Schedule and Curve

ANNA’S SUPPLY SCHEDULE FOR PAPER
Price of Paper (per Quantity Supplied SUPPLY CURVE
piece) 6
2 0
1.75 10 4
2.25 20
2
3.00 30
4.00 45 0
5.00 45 0 10 20 30 45 45

Quantity Supplied (Qs)

 refers to the amount offered for sale at a specific price, as shown by a point on a given supply
curve

Supply (S)
 the entire relation between the price and quantity supplied, as shown by the entire supply
schedule or supply curve

Individual Supply vs Market Supply

 Individual Supply – The supply from an individual producer
 Market Supply – The supply from all producers in the market for that good
 Consider the table below:
Price per Pizza Quantity Supplied of Pizza per Producer
Yellow Cab Shakey’s
P90 400 300
P120 500 400
 Supply curves for each producer:
  Market curve for the producers:

Elasticity of Supply
 a measure of the responsiveness of quantity supplied to a price change; the percent change
in quantity supplied divided by the percent change in price

Formula: or or

 Sample problem:
a. If the market price increases from P90 to P120, the quantity of pizza supplied increases from
20 pieces to 24 pieces. Compute for the elasticity of supply of pizza.

Elasticity Values in Supply

 Elastic – supply elasticity coefficient value exceeds 1
 Unit Elastic –supply elasticity coefficient value is equal to 1
 Inelastic – supply elasticity coefficient value is less than 1

Determinants of Supply Elasticity

1. Length of the Adjustment Period
 the longer the adjustment period under consideration, the more easily producers can
adapt to price changes
 the elasticity of supply is typically greater in the longer period of adjustment

2. Number of Producers
 if there is an increase in the number of producers, the supply of the goods and services
can be increased more easily, thereby making supply more elastic

Movement along the Supply Curve

 Caused by changes in price, other things constant, changing the
quantity supplied

Shift of the Supply Curve

 Caused by a change in one of the determinants of supply other
than the price.
Determinants of Supply
1. Change in the Cost of Resources
 an increase in the cost of a resource will reduce the supply of a good; a decrease in the
cost of a resource will increase the supply of a good
 e.g. a decrease in the cost of cheese increases the supply of pizzas (rightward shift)

2. Change in the Prices of Other Goods

 A change in the price of other goods affects the opportunity cost of making the good (the
subject matter)
 e.g. if the price of spaghetti declines, the opportunity cost of making pizza declines, so
pizza production becomes relatively attractive (rightward shift of the supply curve of pizza)

3. Change in Technology
 Lowers the cost of producing goods, thus making markets more profitable
 e.g. a new model of oven which can bake pizzas in half the time as existing ovens could,
thereby shifts the supply curve of pizzas rightward

4. Change in Producer Expectations

 Any change that affects producer expectations about profitability can affect market
supply
 e.g. if rice producers expect the price to increase in the future, some may expand their
production capacity now
 e.g. expecting higher crude oil prices in the future might prompt some producers to
reduce their current supply while awaiting the higher price

5. Change in the Number of Sellers

 market environment can affect the number of suppliers in the market
 e.g. government strictly regulating the prices and entry of new firms in a variety of
industries, thereby limiting the production of goods by these firms
 e.g. taxation could also shift the supply curve

Market Equilibrium
 When the supply and demand intersects, the market is in equilibrium.
 In equilibrium, the quantity demanded and quantity supplied are equal. (Qd = Qs)
 The corresponding price is the equilibrium price or the market-clearing price, while the
quantity is the equilibrium quantity.

Equilibrium Price and Quantity

 In this illustration, demand and supply curves intersect at P = 8, and Q=
40.
 In this market, the equilibrium price is ₱ 8 per unit, while equilibrium
quantity is 40 units.
 Qd = Qs, therefore the market is clear.
Computing for Equilibrium Price and Quantity
 Example 1:

Solution:

Surplus and Shortage

 Surplus – If the market price is above the equilibrium
price, quantity supplied is greater than quantity
demanded.
 If a surplus happens, prices must fall to
increase quantity demanded and reduce
quantity supplied until the surplus is
eliminated.
 In the given figure:
 Market price of ₱12 is greater than the
equilibrium price of ₱8
 Qs (55) > Qd (25), there are excess Qs,
therefore the market is not clear
 The price will drop because of this surplus
 Shortage – If the market price is below the
equilibrium price, quantity supplied is less than
quantity demanded
 If a shortage occurs, prices must rise to
increase quantity supplied and reduce
quantity demanded until the shortage is
eliminated.
 In the given figure:
 Market price is lower than the equilibrium price
 Qs < Qd
 prices will rise because of shortage

Computation
 Problem:

Solution:

 What if the market price is equal to P12? (P = P12)

Qs > Qd = Surplus

 Problem:
 Solution:

 What if the market price is equal to P3? (P=P3)

Qs < Qd = Shortage

Price Ceiling
 Legally imposed maximum price on the market
 Transactions above this price is prohibited
 Government set ceiling price below the market equilibrium price
which they believed is too high
 Intends to keep stuff affordable for poor people
 e.g. rent control

Price Floor
 Legally imposed minimum price on the market
 Transactions below this price is prohibited
 Government set floor price above the market equilibrium price which
they believed is too low
 Placed on markets for goods that are an important source of income
for the sellers, e.g. labor market
 e.g. minimum wage

Change in Equilibrium Price and Quantity

 Change in supply, or demand, or both, will necessarily change the equilibrium price, quantity,
or both.
 Comparative Statics – comparing two equilibria
 Examples:
a. 10% decrease in producer’s subsidies; 25% increase in population (illustration at the side)

b. Increase in the price of a complement.

 c. An increase in the export of bananas from the Philippines to Florida

Cross Price Elasticity of Demand

Sample Problem: The original quantity demanded of good x is 400 and original price of good y is 24.
On the other hand, the quantity demanded for good x increased to 500, while price of good y
decreased to 15. Compute for elasticity.

Formula:

Solution:
= ÷

= ÷
=
= I-0.48I

Production Possibilities Frontier

 Combination of all output provided in the economy when
resources are maximized.
 The PPF is also known as the production possibility curve or
the transformation curve.
 Points B,A,C – attainable, efficient
 Points D,E – attainable, inefficient
 Point F – unattainable, inefficient
 Factors such as labor, capital and technology, among
others, will affect the resources available, which will dictate
where the production possibility frontier lies.
 Shift of PPF – technology, resources, quality
 Economic Growth
 Slopes downward. Variables move in opposite direction, illustrating opportunity cost.
 Law of Diminishing Returns – as you increase some of your inputs, the smaller and smaller will
be the return in production with other things kept constant.