Final Microeconomics Module1 18-Sep-2020 Updated PDF

San Beda University
College of Arts and Sciences

Department of Economics
Microeconomics:
Theory and Practice
MICROEC
Assistant Prof. C. B. Mendoza, Jr.

50 Years of Excellence in Economics
San Beda University
College of Arts and Sciences
Microeconomics:
Theory and Practice
Mr. C. B. Mendoza, Jr.
INTRODUCTION TO
MICROECONOMICS
Lecture 1
Nature and scope of
Economics
Definition of
ECONOMICS
❖ From on Greek word Oekonomia = management of HH
❖ Common problem:
• matching limited resources available to
HH with unlimited wants of HH members
❖ Philosophical Defn: Study of how men work to overcome
scarcity
❖ Specific Defn: Social science that studies and seeks the
efficient allocation of scarce resources to satisfy unlimited
human needs and wants
❖ Common questions re Production: what to produce? how
much? how to produce? for whom?
❖ Branches: micro, macro, etc.
Theories, Principles, and Models
• The scientific method
Accept, Continue to
Formulate a Test the reject or test the
Observe
Hypothesis Hypothesis modify the hypothesis,
Hypothesis if necessary
What Economics Is All About
❖ The word economy comes from the Greek word
oikonomos, which means “one who manages a
household.”
➢ A household faces many decisions. Like a
household, a society faces many decisions.
➢ The management of society’s resources is
important because resources are scarce
➢ Economics is the study of how society manages
its scarce resources.
What is Economics in General?
• Economics is the science of scarcity.
• Scarcity is the condition in which our wants
are greater than our limited resources.
• Since we are unable to have everything we
desire, we must make choices on how we will
use our resources.
• In economics we will study the choices of
individuals, firms, and governments.
choices
Economics is the study of _________.
Branches of ECONOMICS
❖ Objective: The efficient allocation of scarce resources to
satisfy human needs and wants
ECONOMICS:
MACROECONOMICS MICROECONOMICS
❖ Studies the behavior of aggregate ❖ Studies the behavior of individual
Micro
economic variables (national level) vseconomic
Macro units (HH, firms)
❖ Economics of the nation ❖ Economics of the firm
If the economy was a forest

Macroeconomics examines the Forest
Microeconomics
examines the trees
Microeconomics versus
Macroeconomics
MICROECONOMICS MACROECONOMICS
Scope Firm/Industry National Economy
Viewpoint Business Manager Govt Policymaker
What to Needs of customers Of buyers and sellers
produce?
How Max profit, utility, Max prodn, productivity,
much? quality employment, equity,
stability
How? Available resources + Devt objectives
For whom? Owners/Shareholders Society at large
Goal Competitiveness Sustained Eco Devt
Micro and Macro
• Microeconomics
• The study of the individual
consumer, firm, or market
• Macroeconomics
• The study of the entire economy or a
major aggregate of the economy
Microeconomic Agents
Firms
– Produce and sell goods and services
– Buy inputs (labor, capital & raw materials)
Consumers
– Buy goods and services
– Sell inputs (labor services, loanable funds)
Introduction slide 12
Analyzing Economic Problems
Why should managers/business
analyst study economics?
❖ To develop the economic insight necessary
to identify your business’ competitive
advantage.
➢ We draw on insights from both macroeconomic
(economy-wide concerns such as unemployment,
interest rates, currency exchange rates, inflation,
etc)
AND
➢ microeconomic (industry, markets, firm and
consumer-level) perspectives to identify market
opportunities, formulate strategies, gain
competitive advantage.
❖ To identify how the ups and downs in
economy-wide economic activity will
impact your business.
➢ Economics helps us identify how
movements in the economy can impact
our business and succeed and gain
advantage despite those.
❖ To improve your business’ profitability.
➢ Economics helps us understand market
variables that impact our businesses for
better or for worse and through the right
strategy respond to those variables.
Economics
• Economics
• A social science concerned with
making optimal choices under
conditions of scarcity
• Economic wants exceed society’s
productive capacity
Scarcity and Choice
• Resources are scarce

• Choices must be made
• Opportunity cost
• There’s no free lunch
Macroeconomics
❖ Managers need to understand the underlying the
macroeconomic environment where their
businesses operate to:
o Identify and create new opportunities for your
business
o Address the challenges that this environment
creates for your business
o Forecast and predict changes (through
macroeconomic models)
o Respond accordingly/strategically in ways that
will benefit the business
Economics is about deciding
• Economists do not restrict

themselves to considering only
decision problems involving money
and markets, though that is a big
part of economics.
The Economic Perspective
• Economic perspective
• Scarcity and choice
• Purposeful behavior to increase
utility
• Marginal analysis
Ten Principles of Economics
How People Make Decisions
❖ Principle 1: People Face Trade-offs
❖ Principle 2: The Cost of Something Is What You Give Up to Get It
❖ Principle 3: Rational People Think at the Margin
❖ Principle 4: People Respond to Incentives
How People Interact
❖ Principle 5: Trade Can Make Everyone Better Off
❖ Principle 6: Markets Are Usually a Good Way to Organize Economic
Activity
❖ Principle 7: Governments Can Sometimes Improve Market Outcomes
How the Economy as a Whole Works
❖ Principle 8: A Country’s Standard of Living Depends on Its Ability to
Produce Goods and Services
❖ Principle 9: Prices Rise When the Government Prints Too Much
Money
❖ Principle 10: Society Faces a Short-Run Trade-off between Inflation
and Unemployment
Factors in decision making
1. People face tradeoffs.

2. Opportunity cost.
3. Making decisions at the
margin.
4. People respond to incentives.
The principles of
HOW PEOPLE MAKE DECISIONS
Circular Flow Model
Production Resources Factor Four Factors
Income
Market Production Costs
And businesses
earn revenue.
Households Firms
Consumer Spending Revenue

Product
Purchased Goods and Services Market Goods and Services To Be Sold
Key Macroeconomic Indicators
Resources of the households
…. Description of how the HH and Firms behave: an

essential phenomena of the economy
Accumulatio
Wealth Production Distribution Consumption
n
PRINCIPLE 1
People Face Tradeoffs
• All decisions involve tradeoffs.
• Examples:
➢ Going to a party the night before your
DEADLINE for a reportorial requirement.
Leaves less time for analytical work
➢ Having more money to buy stuff requires
working longer hours, which leaves less time
for leisure.
➢ Protecting the environment requires resources
that could otherwise be used to produce
consumer goods.
Trade-offs
ALL decisions involve trade-offs.

Trade-offs are all the alternatives that we give up
whenever we choose one course of action over
others.
(Examples: going to the movies)
The most desirable alternative given up as a result of
a decision is known as opportunity cost.
What are trade-offs of deciding to go to college?

What is the opportunity cost of going to college?
PRINCIPLE 1
People Face Tradeoffs
• Society faces an important tradeoff:
efficiency vs. equality
❖ Efficiency: when society gets the most from its

scarce resources
❖ Equality: when prosperity is distributed
uniformly among society’s members
❖ Tradeoff: To achieve greater equality,
could redistribute income from wealthy to poor.
But this reduces incentive to work and
produce, shrinks the size of the economic “pie.”
PRINCIPLE 2
The Cost of Something Is
What You Give Up to Get It
• Making decisions requires comparing
the costs and benefits of alternative
choices.
❖ The opportunity cost of any item is whatever

must be given up to obtain it.
❖ It is the relevant cost for decision making.
PRINCIPLE 2
The Cost of Something Is
What You Give Up to Get It
• Examples:
The opportunity cost of…
➢ …going to college for a year is not just the tuition,
books, and fees, but also the foregone wages.
➢ …seeing a movie is not just the price of the ticket,
but the value of the time you spend in the theater.
Opportunity Costs
• Opportunity cost is the benefit that is

missed or given up when an investor,
individual or business chooses one
alternative over another.
PRINCIPLE 3
Rational People Think at the Margin
• Rational people
❖ Systematically and purposefully do the best they
can to achieve their objectives.
❖ Make decisions by evaluating costs and
benefits of marginal changes, incremental
adjustments to an existing plan.
Purposeful Behavior
• Rational self-interest
• Individuals and utility
• Firms and profit
• Desired outcome
PRINCIPLE 3
Rational People Think at the Margin
Examples:
➢ When a student considers whether to go to
college for an additional year, he compares the
fees & foregone wages to the extra income
he could earn with the extra year of education.
➢ When a manager considers whether to
increase output, she compares the cost of the
needed labor and materials to the extra
revenue.
Thinking at the Margin
# Times Benefit Cost
Watching Movie
1st $30 $10

2nd $15 $10
3rd $5 $10
Total $50 $30
Would you see the movie three times?
Notice that the total benefit is more than the
total cost but you would NOT watch the movie
the 3rd time.
Marginal Analysis
• Marginal benefit
• Marginal cost
• Marginal means “extra”
• Comparison between marginal benefit
and marginal cost
Marginal Analysis
In economics the term marginal = additional
“Thinking on the margin,” or MARGINAL
ANALYSIS involves making decisions based
on the additional benefit vs. the additional
cost.
For Example:
You have been shopping at the mall for a half hour; the additional
benefit of shopping for an additional half-hour might outweigh the
additional cost (the opportunity cost).
After three hours, the additional benefit from staying an additional
half-hour would likely be less than the additional cost.
PRINCIPLE 4
People Respond to Incentives
• Incentive:
❖ Something that induces a person to act, i.E.
The prospect of a reward or punishment.
❖ Rational people respond to incentives.
o Rational people make statements, decisions,
or judgments using reasoned thinking, based
on facts, and applying rules.
PRINCIPLE 4
People Respond to Incentives
• Examples:
➢ When gas prices rise, consumers buy more
hybrid cars and fewer gas guzzling SUVs.
➢ When cigarette taxes increase, teen smoking
falls.
ACTIVE LEARNING 1
Applying the principles
o You are selling your 2015 Audi R8. You have

already spent $1000 on repairs. At the last
minute, the transmission dies. You can pay
$600 to have it repaired, or sell the car “as is.”
o In each of the following scenarios, should you
have the transmission repaired? Explain.
• A. Blue book value (what you could get
for the car) is $6500 if transmission works,
$5700 if it doesn’t
• B. Blue book value is $6000 if
transmission works,
ACTIVE LEARNING 1
Answers
Cost of fixing transmission = $600
A. Blue book value is $6500 if transmission
works,
• Benefit of fixing transmission = $800
($6500 – 5700).
• Get the transmission fixed.
B. Blue book value is $6000 if transmission
works,
• Benefit of fixing the transmission is only $500.
• Do not pay $600 to fix it.
ACTIVE LEARNING 1
Observations
✓The $1000 you previously spent on repairs

is irrelevant. What matters is the cost and
benefit of the marginal repair (the
transmission).
✓The change in incentives from scenario A

to scenario B caused your decision to
change.
How individual decisions affect
others
1. Trade (exchange) can benefit
everyone.
2. Markets are often a good way to
organize exchange.
3. Government can sometimes
improve on markets.
The principles of
HOW PEOPLE INTERACT
The Circular Flow
Income($)
Labor
Households Firms
Goods(bread)
Expenditure
($)
PRINCIPLE 5
Trade Can Make Everyone Better Off
❖ Rather than being self-sufficient, people

can specialize in producing one good or
service and exchange it for other goods.
❖ Countries also benefit from trade and

specialization:
➢ Get a better price abroad for goods they produce
➢ Buy other goods more cheaply from abroad than could
be produced at home
PRINCIPLE 6
Markets Are Usually A Good Way to
Organize Economic Activity
❖ Market: a group of buyers and sellers
(need not be in a single location)
❖ “Organize economic activity” means
determining
➢ What goods to produce
➢ How to produce them
➢ How much of each to produce
➢ Who gets them
PRINCIPLE 6
❖ A market economy allocates resources
through the decentralized decisions of many
households and firms as they interact in
markets.
❖ Famous insight by Adam Smith in The Wealth

of Nations (1776):
➢ Each of these households and firms acts as if “led by an
invisible hand” to promote general economic well-being.
PRINCIPLE 6
❖ The invisible hand works through the price
system:
➢ The interaction of buyers and sellers determines prices.
➢ Each price reflects the good’s value to buyers and the
cost of producing the good.
➢ Prices guide self-interested households and firms to make
decisions that, in many cases, maximize society’s
economic well-being.
PRINCIPLE 7
Governments Can Sometimes
Improve Market Outcomes
• Important role for govt:
• ENFORCE PROPERTY RIGHTS (with police,
courts)
➢ People are less inclined to work, produce, invest, or

purchase if large risk of their property being stolen.
PRINCIPLE 7
❖ Market failure: when the market fails to
allocate society’s resources efficiently
❖ Causes of market failure:
➢ Externalities, when the production or consumption
of a good affects bystanders (e.g. pollution)
➢ Market power, a single buyer or seller has substantial
influence on market price
(e.g. monopoly)
❖ Public policy may promote efficiency.
PRINCIPLE 7
❖ Government may alter market outcome to
promote equity.
❖ If the market’s distribution of economic well-

being is not desirable, tax or welfare policies
can change how the economic “pie” is
divided.
o Price Stability
o Increase Output of
Production
o Full Employment
PRINCIPLE 7
Economic Goals
1. Economic Freedom
2. Economic Equity
3. Economic Efficiency
4. Economic Security
5. Economic Stability
6. Economic Growth
Economic Freedom
❖ This goal is about the amount of choice
people have in where they work and live,
the type of career they have, what they do
with their income and what they buy or
sell.
❖ Economic freedom is restricted in some
cases to protect the rights of others, for
example there are laws prohibiting the
production, sale and purchase of illegal
drugs.
Economic Equity
❖ Means what is fair. This can be seen as an
equality of opportunity or an equality of
outcome
❖ This goal centers on fairness. People's beliefs
around what is right or wrong determine
how this goal is achieved.
❖ Issues that involve Economic Equity
certainly deal with redistribution of income.
Economic Efficiency
❖ An economic principle holding that
businesses and individuals should fulfill
as many of society’s needs as possible
while maximizing the provided resources.
❖ When a society achieves economic
efficiency, goods and services are
produced without a lot of waste and those
goods and services are what the
consumers want and or need the most.
Economic Security
❖ Protecting consumers, producers, and

resource owners from risks that exist in
society. Each society must decide from
which uncertainties individuals can and
should be protected
Economic Stability
❖ This goal involves three aspects: sustained

growth without large swings in output or
consumption; stable rate of employment;
and a stable level of prices without dramatic
inflation or deflation. Most nations with
economic freedom allow for some
unemployment and inflation.
Economic Stability
Full Employment
❖ Full employment does not mean that no one is jobless in a
country; rather full employment refers to the situation
when there is no voluntary unemployment in the country.
❖ There is always a certain level of unemployment in the
country due to economic instabilities and imperfections.
Such level of unemployment is called the natural rate of
unemployment.
❖ But the government tries its best to reduce the level of
unemployment in a country as much as it can. It is one of
the most important responsibilities of the government of a
country to create job opportunities for its people.
Economic Stability
Price Stability
❖ Inflation means a general increase in price level. Increase in
price level results in an unequal and unfavorable
distribution of wealth in an economy.
❖ Due to inflation the growth rate also decreases. It reduces
purchasing power and it also causes a deficit in the balance
of payment which effects the international repute of the
country.
❖ Therefore, the government of a country takes a serious and
effective step to overcome inflation and to keep the prices of
commodities stable.
Economic Stability
The balance of payment
❖ A balance of payment is the statistical record of economic
transactions with the rest of the world.
❖ Economic transactions refer to international trade that includes
the import and export of goods and services. Where imports
increase the exports the balance of payment becomes
unfavorable.
❖ If the value of imports is greater than the value of exports, then
the balance of payment is in deficit.
❖ On contrary, if the value of export is greater than the value of
imports than the balance of payment is in surplus.
❖ A balance of payment deficit in disadvantageous to the country.
It affects the credibility, repute, and ranking of the country.
❖ In order to keep the balance of payment favorable, the
government imposed duties on imports and provides subsidies
on exports.
Economic Growth
❖ Economic growth is the sustained increase in the
production of goods and services. It is measured
by Gross Domestic Product (the total value of all
final goods and services produced in a nation in a
year).
❖ A nation's standard of living can only improve if
GDP increases.
❖ To achieve economic growth a country must
invest in education, technology and capital goods.
This goal is closely related to a country's long
term ability to use resources to achieve the other
goals.
ACTIVE LEARNING 2
Discussion Question
o In each of the following situations, what is

the government’s role?
o Does the government’s intervention improve
the outcome?
• a. Public schools for K-12
• b. Workplace safety regulations
• c. Public highways
• d. Patent laws, which allow drug
companies to charge high prices for life-
saving drugs
The principles of
HOW THE ECONOMY AS A WHOLE
WORKS
0.20 Asian Financial
POST war Era Martial Law Crisis World Financial
years Crisis
EDSA People
0.15 Power
0.10
% Growth
0.05
0.00
(0.05)
(0.10)
2000
58
72
86
48
50
52
54
56
60
62
64
66
68
70
74
76
78
80
82
84
88
90
92
94
96
98
02
04
06
08
10
12
14
16
% Growth Expon. (% Growth) Poly. (% Growth)
Resources of the Country
Macroeconomic Aggregates
SNA describes the essential phenomena of the economy
Accumulatio
Wealth Production Distribution Consumption
n
How the economy will behave?
Movie Factory Household
Macroeconomics involves the study of aggregate

factors such as employment, inflation, and gross
domestic product, and evaluating how they influence
the economy as a whole.
Summary of the Movie’s Plot
At the core: OUTFLOWS:
❖ Savings
Interdependent economic
❖ Taxes
activities….. ❖ Imports
HOUSEHOLDS
FIRMS
Income
Prodn Factors
Consumer Goods
Purchases
INFLOWS: … That can be

❖ Investments
❖ Gov’t Spending influenced by the
❖ Exports balance between
inflows and outflows
Summary of the Movie’s Plot
If Inflows are greater than OUTFLOWS:
❖ Savings
outflows
❖ Taxes
.. Then income increases ❖ Imports
HOUSEHOLDS
FIRMS
Income
Prodn Factors
Consumer Goods
Purchases
INFLOWS: Question:
❖ Investments
❖ Gov’t Spending
Should inflows be
❖ Exports always greater than
outflows?
The Economy As A Factory
❖ Production has a rated
capacity subject to
technological constraints as
well as the scarcest
resource/input
❖ Overproduction is possible but
only for limited period as costs
eventually increase (Why?)
❖ The scarcest resource for
developed countries is labor
❖ The sign that the economy is
overheating is a low
unemployment rate below the
4-6 natural rate
The Economy As A Household
o Traditional farm-
based HH produces
output for itself and
possibly other HH as
exports
o Excess output of
other HH is
exchanged or bought
as imports
How the economy will behave?
The Economy ❖ Role of Key Actors
as a Movie ❖ Interdependence of economic activities
The Economy ❖ Capacity Limits

as a Factory ❖ Operating beyond limits causes
overheating
The Economy ❖ Availability of foreign currencies as the
as a Household limit
❖ Need to keep watch of dollar
transactions, i.e.
o Cash position
o Income-spending balance
o Access to other people’ money
Who are the main characters?
Government Banks Workers/Families
Traders Investors Business Firms
Who are the main characters?
Income (Rent, Wage and Interest)
Resources (Land, Labor and Capital)
How do the Main

Characters Interact?
HOUSEHOLDS BUSINESS FIRMS
Output of Consumer Goods and Services
Consumer Spending
Circular Flow and Policy Areas
P. Savings Taxes Imports
HOUSEHOLDS Banks Government World

FIRMS
Income
Prodn
Factors
Consumer
Goods
Purchases Investments Gov’t Exports

Spending
The Circular Flow
GDP in Circular Flow
GDP in Circular Flow
Circular Flow and Policy Areas
P. Savings Taxes Imports
HOUSEHOLDS Banks Government World

FIRMS
Income
Prodn
Factors
Consumer
Goods
Purchases Investments Gov’t Exports

Spending
Key Takeaway:
Why expenditure = income
In every transaction,
the buyer’s expenditure
becomes the seller’s income.
Thus, the sum of all
expenditure equals
the sum of all income.
Economy is Measured by Gross
Domestic Product
Two definitions:
1. Total expenditure on domestically-
produced final goods and services
2. Total income earned by domestically-
located factors of production
Gross Regional Domestic Product
PRINCIPLE 8
A Country’s Standard of Living Depends on
Its Ability to Produce Goods & Services
❖ Huge variation in living standards across
countries and over time:
➢ Average income in rich countries is more than ten times
average income in poor countries.
➢ The Advance economies standard of living today is about
eight times larger than 100 years ago.
PRINCIPLE 8
A Country’s Standard of Living Depends on
Its Ability to Produce Goods & Services
❖ The most important determinant of living
standards:
• Productivity- the amount of goods and services produced
per unit of labor.
❖ Productivity depends on the equipment, skills,
and technology available to workers.
❖ Other factors (e.g., labor unions, competition from
abroad) have far less impact on living standards.
Incomes and Growth Around the
World
FACT 1: There are vast difference in living standards around the world
Growth
Gross Value Added (In Million pesos at 2000 constant prices) CAGR
Country (2018 vs
(2000-18)
1980 1990 2000 2010 2017 2018 2017)
Qatar 35,009 15,454 29,976 67,403 61,264 68,794 12.3% 1.8%
Singapore 4,928 11,862 23,852 47,237 60,298 64,582 7.1% 7.0%
United States 12,575 23,889 36,335 48,467 59,928 62,795 4.8% 4.3%
Australia 10,194 18,211 21,679 52,022 54,066 57,374 6.1% 4.7%
Hong Kong SAR, 5,700 13,486 25,757 32,550 46,226 48,676 5.3% 5.8%
China
Canada 11,171 21,448 24,190 47,450 45,070 46,233 2.6% 3.8%
Germany 12,138 22,304 23,636 41,532 44,240 47,603 7.6% 3.7%
United Kingdom 10,032 19,095 28,150 39,436 40,361 42,944 6.4% 3.9%
United Arab Emirates 42,764 27,729 33,291 33,893 39,812 43,005 8.0% 0.0%
France 12,713 21,794 22,364 40,638 38,679 41,464 7.2% 3.2%
Japan 9,465 25,359 38,532 44,508 38,332 39,290 2.5% 3.8%
European Union 8,385 15,989 18,262 33,741 33,908 36,570 7.8% 4.0%
Italy 8,457 20,826 20,088 36,001 32,327 34,483 6.7% 3.8%
Brunei Darussalam 25,422 13,608 18,013 35,270 28,572 31,628 10.7% 0.6%
Mexico 3,027 3,112 7,158 9,271 9,278 9,673 4.3% 3.1%
China 195 318 959 4,550 8,759 9,771 11.6% 10.9%
Thailand 683 1,509 2,008 5,076 6,578 7,274 10.6% 6.4%
South Africa 2,906 3,140 3,032 7,329 6,132 6,374 3.9% 2.1%
Philippines 685 716 1,039 2,124 2,982 3,103 4.1% 4.1%
Lao PDR 0 203 325 1,141 2,424 2,542 4.9%
Vietnam 0 95 390 1,318 2,366 2,567 8.5%
India 267 368 443 1,358 1,981 2,010 1.4% 5.5%
Burundi 221 208 136 234 293 272 -7.3% 0.5%
PHI Gross National Income, in billions pesos at 2000 constant prices
14,000 Asian Financial 40.0
Crisis
World COVID-19
12,000 Financial 30.0
Martial Law Crisis
years
10,000POST war Era
EDSA People 20.0
Power
PERCENT CHANGE
IN BILLION PESOS
8,000
10.0
6,000
0.0
4,000
-10.0
2,000
0 -20.0
Actual % Growth Expon. (Actual)
Real GDP Growth Momentum, (1950-2019)
0.20 Asian Financial
POST war Era Martial Law Crisis World Financial
years Crisis
EDSA People
0.15 Power
Years AAGR
1948-2014 4.6
0.10
50s 7.0
60s 5.1
Growth
0.05
70s 6.0
80s 1.5
0.00 90s 2.7
2000s 4.4 UPWARD MOMENTUM
(0.05) 2010s 6.1

BEFORE 2010s WE ARE IN A GROWTH MOMENTUM WHEREIN 5 IS A NO BRAINER
(0.10)
% Growth Expon. (% Growth) Poly. (% Growth)

Average Economic Growth (2010-2017), PH vs Asia
9.0
CHN, 7.9LAO, 7.7

8.0
KHM, 7.5
7.0 MMR, 6.6

PHL, 6.4 BGD, 6.0
VNM, 6.1
6.0 IDN, 5.6MYS, 5.5
5.0 SGP, 4.8
4.0
THA, 3.5TPE, 3.4KOR, 3.4
HKG, 3.0
3.0
2.0 BRN, 1.7
1.0
0.0
CAGR
Economic Structure of the Philippines
10,000
9,000
EXPENDITURES ITEM % Contribution
8,000
1980 1990 2000 2018
7,000
HFCE 59.2 65.5 72.2 68.5
6,000
GOVERNMENT SPENDING 13.7 12.8 11.4 11.1
5,000
CAPITAL FORMATION 27.3 24.3 18.4 30.8
4,000
NET EXPORTS -0.2 -2.6 -2.0 -10.4
3,000
2,000
1,000
0
80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17
HFCE Govt Investment Net Exports
10,000,000
9,000,000
SECTOR % Contribution
8,000,000 1980 1990 2000 2018
7,000,000 AFF 16.4 15.4 14.0 8.1
6,000,000 INDUSTRY 41.6 35.9 34.5 34.1
5,000,000 SERVICES 42.0 48.7 51.6 57.8
4,000,000
3,000,000
2,000,000
1,000,000
0
80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17
AFF Industry Services
10,000.0
9,000.0 1998 2005 2008 2018
8,000.0 AFF 13.3 13.3 12.8 8.1
INDUSTRY
7,000.0
Mining 0.7 1.0 1.0 0.9
6,000.0 Manufacturing 24.5 23.7 22.8 23.3
Construction 6.5 4.4 5.1 6.7
5,000.0
EGWS 3.6 3.6 3.6 3.2
4,000.0
SERVICES
3,000.0 TSC 5.8 8.1 8.1 7.3
Trade 14.6 16.5 16.5 16.9
2,000.0
Finance 5.3 5.7 6.2 7.4
1,000.0 Real Estate 9.9 9.4 10.0 11.4
Public Admin 5.6 4.7 4.3 4.3
0.0
98 99 00 Other
01 Services
02 03 04 05 06 07 0810.2 09 10 9.6 11 1210.1 13 14
10.5 15 16 17
AFF Mining MFG CONS EGWS TSC Trade Finance Real Estate Public Admin Other Services
Economic Structure of the Philippines vs ASEAN
PH ID MY TH SG
AFF 8.1 13.7 8.9 8.7 0.0
INDUSTRY 34.1 41.0 39.4 35.1 24.8
Manufacturing 23.3 21.2 23.0 27.6 18.8
SERVICES 57.8 45.4 51.7 56.3 75.2
HFCE 68.5 56.1 55.4 47.8 35.6
GOVERNMENT SPENDING 11.1 9.1 12.2 16.4 10.9
CAPITAL FORMATION 30.8 33.4 25.5 22.8 27.6
NET EXPORTS -10.4 1.3 7.0 13.5 24.3
GDP Per Capita
Manufacturing Resurgence
GROWTH IN MANUFACTURING LEADS TO

JOB CREATIONS
PRINCIPLE 9
Prices Rise When the Government Prints
Too Much Money
❖ Inflation: increases in the general level of
prices.
❖ In the long run, inflation is almost always
caused by excessive growth in the quantity of
money, which causes the value of money to fall.
(Purchasing power)
❖ The faster the govt creates money, the greater
the inflation rate.
Money and How it is Being Measured
What is Money: Descriptive Definitions
❖ Mainly focus on the functions of money and

not what the money is.
➢ “Anything that is generally acceptable as a
means of exchange and that at the same time
acts as a measure and store of value”.
➢ “Money is anything that is widely used as mean
of Payments and is generally acceptable in
settlement of debts”.
Money and How it is Being Measured
What is Money: General Acceptability Definitions
❖ Money is anything which is commonly used

and generally accepted as a medium of
exchange or as standard of value.
❖ As anything which is widely accepted in
payment for goods or in discharge of other
kinds of business obligations.
❖ Money is anything that is generally accepted
in payment for goods and services or in the
repayment of debts.
The Quantity Theory of Money
Supply of money
• Money Supply
• The amount of money in circulation
• Economists use two basic approaches to define
and measure money.
• The transactions approach
• The liquidity approach
The Monetary System
Supply of money
• Transactions Approach (M1)

• A method of measuring the money
supply by looking at money as a medium
of exchange
• Liquidity Approach (M2)

• A method of measuring the money supply
by looking at money as a temporary store
of value
Department of Economics 15-98

The Monetary System
Measuring the Quantity of Money
M1, M2, M3 are all measures of money supply, the
amount of money in circulation at a given time.
❖ M1, also called narrow money, normally include
coins and notes in circulation and other money
equivalents that are easily convertible into cash.
❖ M2 is somewhat broader measure of the supply of
money, which includes all of M1 plus savings and
time deposits held at banks.
❖ M3 is an even broader measure of the money
supply, which includes all of M2 plus large
denomination, long-term time
Money and Inflation: Conceptual framework
• A simple theory linking the inflation rate to

the growth rate of the money supply.
• Begins with the concept of velocity…
PHI M3 Growth and Inflation, 1960-2019
70% M3 Growth CPI Inflation
60%
50%
40%
30%
20%
10%
0%
-10%
Jan-66 Jan-71 Jan-76 Jan-81 Jan-86 Jan-91 Jan-96 Jan-01 Jan-06 Jan-11 Jan-16
The demand for money
o The demand for money is affected by several
factors,
➢ The level of income
➢ Interest rates
➢ Inflation
➢ Uncertainty about the future.
o The way in which these factors affect money
demand is usually explained in terms of the
three motives for demanding money:
➢ The transactions
➢ The precautionary
➢ The speculative motives
Inflation and Money Supply (M1)
25.0% 45.0%
PRICE INDICATORS 40.0%
20.0%
35.0%
30.0%
15.0%
25.0%
10.0% 20.0%
15.0%
5.0%
10.0%
5.0%
0.0%
0.0%
-5.0% -5.0%
86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17
M1 GDP Growth Inflation
Inflation and GDP Growth
25.0% 120.0%
PRICE INDICATORS
20.0% 100.0%
15.0% 80.0%
10.0% 60.0%
5.0% 40.0%
0.0% 20.0%
-5.0% 0.0%
86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17
GDP Growth Inflation
PRINCIPLE 10
Society Faces a Short-run Tradeoff
Between Inflation and Unemployment
❖ In the short-run (1–2 years), many

economic policies push inflation and
unemployment in opposite directions.
❖ Other factors can make this tradeoff more
or less favorable, but the tradeoff is
always present.
Two measures of inflation vs GDP Growth
25.0% 9.0%

20.0%
7.0%
6.0%
15.0%
5.0%
10.0% 4.0%
3.0%
5.0%
2.0%
1.0%
0.0%
0.0%
-5.0% -1.0%
86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 18 19
GDP Growth GDP Inflation Inflation

Inflation and Unemployment
25.0% 45.0%
20.0%
35.0%
30.0%
15.0%
25.0%
10.0% 20.0%
15.0%
5.0%
10.0%
5.0%
0.0%
0.0%
-5.0% -5.0%
86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17
MS GDP Growth Unemployment Rate Inflation
Summary
❖ The principles of interactions among

people are:
✓ Trade can be mutually beneficial.
✓ Markets are usually a good way of
coordinating trade.
✓ Govt can potentially improve market
outcomes if there is a market failure or if
the market outcome is inequitable.
Summary
❖ The principles of the economy as a

whole are:
✓ Productivity is the ultimate source of living
standards.
✓ Money growth is the ultimate source of
inflation.
✓ Society faces a short-run tradeoff between
inflation and unemployment.
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Thinking Like and Economist:
Economic Theories and Models
Thinking Like an Economist
The Economist as Scientist: Assumptions & Models
• Economists play two roles:

1.Scientists: try to explain the world
2.Policy advisors: try to improve it
The Economist as Scientist
o The Scientific Method: Observation,

Theory, and More Observation
o The Role of Assumptions
o Economic Models
• First Model: The Circular-Flow Diagram
• Second Model: The Production
Possibilities Frontier
The Scientific Method
The Econimist as a Scientist
The Economist as Scientist: Deduction vs. Induction
Deduction Process
Theory Hypothesis Observation Confirmation
The Economist as Scientist: Deduction vs. Induction
Induction Process
Observation Pattern Hypothesis Theory
The Economist as Scientist: Empiricism
❖ Acquiring information and facts

through the observation of our world
o Pragmatic observations
o Developing theory through experience
and observation
o Non-scientific
o Quick and practical solution to a
problem
o With little interest in explaining when,
how, or why
The Economist as Scientist: Quantitative vs. Qualitative
❖ Quantitative ❖Qualitative
o Numerical, measurable
data o Generally non-
o Traditional or positivist numerical data
approach o Typically
• Clearly stated anthropological and
questions
sociological research
• Rational hypotheses
• Developed research methods
procedures o Observations of a
• Extraneous variable “natural” setting
controls
o In-depth descriptions of
• Large samples
• Traditional, situations
statistical analyses o Interpretive and
descriptive
The Role of Assumptions
The Economist as a
Scientist
The Economist as Scientist: Assumptions & Models
❖ Assumptions simplify the complex world,
make it easier to understand.
- Example: To study international trade,
assume two countries and two goods.
- Unrealistic, but simple to learn and
gives useful insights about the real
world.
❖ Model: a highly simplified representation
of a more complicated reality. Economists
use models to study economic issues.
The Economist as Scientist: Theory vs. Hypothesis
❖ Hypothesis Hypotheses
o A belief or prediction of the
eventual outcome of the research
o A concrete, specific statement
about the relationships between
phenomena
o Based on deductive reasoning
❖ Theory In an ideal Theories
o A belief or assumption about how world…
things relate to each other
o A theory establishes a cause-and-
effect relationship between
variables with a purpose of
explaining and predicting
phenomena
o Based on inductive reasoning
Laws
Models and theories
• Model -- a hypothesis about the relationships
among variables.
• Everyone uses models.
• Because a model abstracts from reality it makes
mistakes.
• Models can contain two kinds of errors or
mistakes:
• the wrong explanatory variables may be
included.
• the functional form may be incorrect.
Modeling System
• Model
• An abstraction or an approximation that is used to
represent reality
• Types of models
• Narrative (aka descriptive)
• Physical
• Schematic
• Mathematical
Contents of models
• List of variables, especially a clear statement of

what is to be explained
• Dependent v. independent variables
• Hypothesized relationships among the variables.
• Using tables of values, graphs, or equations.
A model of heights
H
height A H = a + b(A)
a b = H/A
age in years
A better (nonlinear) model of
heights
• naive
(linear)
fancy
height
age in years
A better model?
• Height = f(age, gender, parents’

heights, nutrition, ...)
Gender effects in the better model
• Height = f(age, gender, parents’

heights, nutrition, ...)
men
women
height
age
MODEL SUMMARY
• Three ways to describe models

• Graphs
• Tables of values
• Mathematical functions (equations)
• Important concepts
• Dependent and independent variables
• Linear function, intercept and slope

THE PPF MODEL
The Economist as a
Scientist
AN ECONOMIC MODEL
The Production Possibility Curve
• Purposes of model
• Show scarcity constraint
• Illustrate economic efficiency
• Introduce opportunity cost concept
• Variables
• Quantities of goods that may be produced
• Givens
• Total amounts of inputs available
• Technology of production
PPF DEFINED
• The Production Possibility Curve (or

frontier) shows the maximum amount
of a good you can produce given the
amounts of other goods produced, and
given the total amounts of inputs
available, and given the technology of
production.
PPC EXAMPLE
• Assumptions:
• There are only two goods, Puto and Pansit.
• There are limited inputs and given technology of
production.
• Definition:
• The PPC shows the maximum amount of Puto
you can produce, given the amount of Pansit to
be produced.
PRODUCTION POSSIBILITY
CURVE
Pansit
400
Which points are attainable
300 and which points are unattainable?
200
100
0
0 10 20 30 40 50 60
Puto
Go to hidden slide
CURVE
Pansit
What’s the effect of an improvement
400 in the technology for producing
Pansit?
300
200
100
0
0 10 20 30 40 50 60
Puto
Go to hidden slide
CURVE
Pansit
What’s the effect of an increase in
400 total resources (inputs)?
300
200
100
0
0 10 20 30 40 50 60
Puto
Go to hidden slide
CURVE
• Points “inside” the PPC are inefficient.

• For any point “inside” there
corresponds some point that
represents more production of both
goods.
• Note that while points on the PPC are
efficient, we cannot say at this time
whether some are better for society
than others.
OPPORTUNITY COST DEFINED
• The opportunity cost of doing something is what
you must give up in order to do it.
• The cost of a Puto is what you must give up to
consume it, which in this case is easily computed in
money.
• The cost of a college education includes both money
and other foregone alternatives. For example, the cost
of a year at MSU includes not only tuition and books,
but the income you could have earned working on a
full time job.
• The cost of attending a Lugnuts baseball game
includes the value of the time you could have spent
studying economics.
The PPC can show opportunity
cost
• Suppose you are at some point on a PPC.
• Then suppose you want to consume one
more Puto.
• The opportunity cost of one more Puto is
the amount of Pansit you must give up in
order to get it.
• Note that this opportunity cost is equal to
minus the slope of the PPC.
CURVE
Pansit
400
300 More Puto means less Pansit
200
100
0
0 10 20 30 40 50 60
Puto
OPPORTUNITY COST INCREASES AS
MORE OF A GOOD IS PRODUCED
• Not only does more Puto mean less

Pansit, but each additional Puto costs
more than the one before it.
• This idea shows up as the PPC being

concave to the origin. (The curve
bows out.)

CURVE
Pansit
400
Opportunity cost of more Puto is
300 constant.
200
100
0
0 10 20 30 40 50 60
Puto
CURVE
• We will use Production Possibilities

Curves that are straight lines (i.e.,
that have constant opportunity cost)
to illustrate some important economic
principles.

The Circular Flow of
Economic Activity
The Economist as a
Scientist
The Circular Flow of Economic
Activity
The Circular Flow
❖ Our economy is an enormous, constant cycle in
which Goods, Services, Resources, and money flow
back and forth.
❖ Economists refer to this as the Circular Flow of
Economic Activity
❖ Economic Interdependence
Businesses (Producers), households (Individuals), and the
government depend on each other in order for the economy to
run smoothly.
Circular Flow Model
Households
are where you find
regular people who
work and consume in
our economy
Households own and control resources and
sell them to businesses.
Capital
H B
O
U
U Natural S
S
I
E N
H
Human E
O S
L S
D
S
Circular Flow Model
Households Firms
are the businesses that
produce, employ us,
and purchase in our
economy
Businesses use the resources to
make finished products.
B
U
S
I
N
E
S
S
3. Businesses take finished
products and sell them to
households.
H
B O
U U
S S
I E
N H
E O
S L
S D
S
Economic Activity
Circular Flow Model
Factor
Market
The factor market

is where the four
factors of
production are
bought and sold.
Households Firms
The Factor Market
Production Resources Factor
Market
Households
contribute their
land, labor, skills,
and capital to the
factor marker.
Households Firms
Circular Flow Model
Market
Those things are

put to use in firms.
Households Firms
The Product Market
Market
The product
market is where
firms sell their
goods and
services and
people buy them.
Households Firms
Product
Market
Circular Flow Model
Market
Firms send those

goods and
services into the
Households market.
Firms
Product
Market Goods and Services To Be Sold
Circular Flow Model
Market
Goods & services

purchased by
households.
Households Firms
Product
Circular Flow Model
Firms put money back into

the factor market in the form
of capital, wages, salaries,
and other costs of
Households production resources Firms
Product
Circular Flow Model
Income
money paid to
individuals by
businesses
becomes
Households household income Firms
Product
Circular Flow Model
Income
When households spend

this money on goods and
services it is known as
consumer spending
Households Firms
Consumer Spending
Product
Circular Flow Model
Income
And businesses
earn revenue.
Households Firms

Product
Circular Flow Model
Income
Production Resources Govt Spending
Transfer
Payments Govt Subsidies
Taxes Taxes
Govt Services Govt Services
Households Firms
Goods & Services Govt Spending

Product
Circular Flow Model
A Simplified Version
RESOURCES
WAGES AND SALARIES
Households Businesses
EXPENDITURES
FINISHED GOODS
The Circular Flow
Describe how you
have been involved
in the flow over the
last week of your
life.
Economic Activity
❖ The flow of payments in an economy
is a circular flow.
❖ Individuals--people living in
households--work for businesses,
rent their property (or their capital)
to businesses, and manage and own
the businesses.
Economic Activity
❖ All these activities generate incomes--
flows of payments from businesses to
households.
❖ But households then spend their
incomes--on consumption goods, in
taxes paid to governments, and on
assets like stock certificates and
bank CDs that flow through the
financial sector.
Economic Activity
❖ The two flows--of incomes and of
expenditures--are equal: all
expenditures on products are
ultimately someone's income, and
every piece of total income is also
expended in some way
REFLECTION
❖ What is economic interdependence?
❖ What three elements depend on one another
for economic interdependence?
❖ What role do households play in the
economy?
❖ What role do firms play in the economy?
❖ What role does the government play in the
economy?
The Economist as a
Policy Advisor
The Economist as Policy Advisor
❖ As scientists, economists make
positive statements,
which attempt to describe the world as it is.
❖ As policy advisors, economists make
normative statements,
which attempt to prescribe how the world
should be.
❖ Positive statements can be confirmed or refuted,
normative statements cannot.
❖ Govt employs many economists for policy
advice. E.g., the Phil. President has a Council of
Economic Advisors.
Methodology: Positive v.
Normative Economics
❖ Positive econ. -- Studies the way the
world is.
• How much will a new gasoline tax raise the price of
gasoline?
• Will an increase in the minimum wage increase
unemployment?
• Why is the price of corn Php4.20 per bushel?
• How much will a drought in the corn belt raise the
price of corn? Of Rice?
• What will be the effect on Byron Brown’s Puto
consumption if we take Php1000 away from Tom Izzo
and give it to Brown?
Methodology: Positive v.
Normative Economics
❖ Normative econ. -- Studies the way the
world should be.
• Should there be a new tax on gasoline?
• Should there be an increase in the minimum
wage?
• Should Php1000 be taken from M. Peter
McPherson and given to Byron Brown?
• What should the price of corn be?
Introduction
Three pillars of economic analysis:
scarcity, choice and coordination
Economics
• Economics
• A social science concerned with
making optimal choices under
conditions of scarcity
• Economic wants exceed society’s
productive capacity
5 Key Economic Assumptions
1. Society’s wants are unlimited, but ALL resources are
limited (scarcity).
2. Due to scarcity, choices must be made. Every choice
has a cost (a trade-off).
3. Everyone’s goal is to make choices that maximize their
satisfaction. Everyone acts in their own “self-interest.”
4. Everyone acts rationally by comparing the marginal
costs and marginal benefits of every choice
5. Real-life situations can be explained and analyzed
through simplified models and graphs.
Economics is about deciding
• Economists do not restrict

themselves to considering only
decision problems involving
money and markets, though that
is a big part of economics.
Factors in decision making
1. People face tradeoffs.
2. Opportunity cost.
3. Making decisions at the margin.
4. People respond to incentives.
How individual decisions affect
others
1. Trade (exchange) can benefit
everyone.
2. Markets are often a good way to
organize exchange.
3. Government can sometimes
improve on markets.
The Economic Perspective
• Economic perspective
• Scarcity and choice
• Purposeful behavior to increase
utility
• Marginal analysis
Scarcity and Choice
• Resources are scarce

• Choices must be made
• There’s no free lunch
Purposeful Behavior
• Rational self-interest
• Individuals and utility
• Firms and profit
• Desired outcome
Marginal Analysis
• Marginal benefit
• Marginal cost
• Marginal means “extra”
• Comparison between marginal benefit
and marginal cost
Theories, Principles, and Models
• The scientific method
Accept, Continue to
Formulate a Test the reject or test the
Observe
Hypothesis Hypothesis modify the hypothesis,
Hypothesis if necessary
2 Perspectives: Macro vs Micro
Economics
• What is microeconomics?
• What is macroeconomics?
Micro and Macro
• Microeconomics
• The study of the individual
consumer, firm, or market
• Macroeconomics
• The study of the entire economy or a
major aggregate of the economy
MICROECONOMIC AGENTS
Firms
– Produce and sell goods and services
– Buy inputs (labor, capital & raw materials)
Consumers
– Buy goods and services
– Sell inputs (labor services, loanable funds)

Microeconomics
• Microeconomics
➢ Is the branch of economics that analyzes
the decisions that individual consumers,
firms, and industries make as they
produce, buy, sell goods and services
➢ When applied to business decision-
making, it’s called managerial economics
Microeconomics
• Microeconomics
➢ Is the branch of economics that analyzes
the decisions that individual consumers,
firms, and industries make as they
produce, buy, sell goods and services
➢ When applied to business decision-
making, it’s called managerial
economics
Pricing/Prices
• Pricing/Prices
➢ the key element in any market system
• Prices –
➢ the amounts of money that are charged
for different goods and services in a
market economy
➢ Act as signals that influence the
behavior of both consumers and
producers of goods and services
Pricing/Prices
• Prices can be output prices or

input prices
➢ Output prices – prices of final products
sold by a firm
➢ Input prices – prices of inputs,
resources used to produce final
products or output (e.g. land cost,
building rental cost, raw material, labor
cost/wages, etc.)
Pricing/Prices
Why is price/pricing important?

➢ Price/pricing is important in determining a
firm’s profitability
➢ Output price has impact on revenues a firm
➢ Input price has impact on costs/cost of
production
➢ Taken together, Revenue – Cost = Profitability
➢ Managerial actions, decisions are thus based on
responses to changes in prices and on the
ability to influence these prices
Other Microeconomic Influences
on Managers
❖ Decisions about – demand, supply,
production, and market structure
❖ Factors that affect consumer
behavior/demand and the willingness of
consumers to buy your product vs the
competition
❖ Relative prices – price of one good over
another similar good or another alternative
on Managers
❖ A firm/company’s production technology
❖ Prices paid for resources
❖ Basically all demand and cost decisions
➢ these are all the focus of
microeconomics
on Managers
❖ In sum,
➢ How consumer behavior affects their revenue.
➢ How production technology and input prices
affect their costs.
➢ How the market and regulatory environment in
which managers operate influences their ability
to set prices and to respond to the strategies of
their competitors.
➢ These microeconomic factors exert influence on
how managers make decisions
Macroeconomics
❖ Macroeconomics
➢ Managerial decisions are also influenced
by events in the larger economic
environment where businesses operate
Macroeconomics
❖ Macroeconomics is the branch of economics

that focuses on the overall level of economic
activity, changes in the price level, and the
amount of unemployment by analyzing
group or aggregate behavior in different
sectors of the economy
Macroeconomics
❖ Macroeconomics is concerned with

o Economic Activity
o Price Level
o Unemployment
o Interest rates
o Currency exchange rates
o WHY?
Macroeconomics
❖ Specifically, macroeconomics is concerned

with changes in the ff:
o Overall level of economic activity (GNI, GDP)
o Interest rates (price of capital)
o Inflation (CPI, WPI—affects people’s capacity to
buy)
o Unemployment rates (indicator if people have
jobs, generate income, and hence capacity to
purchase/buy)
o Currency exchange rates (price of imports and
exports)
The Economizing Problem
• The economizing problem

• Limited income and unlimited wants
• The budget line
• Attainable and unattainable
combinations
• Trade-offs and opportunity costs
Society’s Economizing Problem
• 4 categories of economic resources

• Land
• Labor
• Capital
• Investment
• Entrepreneurial ability
Production Possibilities Model
• Economic model that shows different
combinations of two goods that an
economy can produce
• Full employment
• Fixed resources
• Fixed technology
• 2-good economy
• Consumer goods and capital goods
Increasing Opportunity Costs
• Law of increasing opportunity costs

• As more of a particular good is
produced, its marginal opportunity
costs increase
• Production possibilities curve
• Concave shape
• Economic rationale
Unemployment, Growth, & the
Future
Economic
A’
growth
14
13
B’
12
11
A Unattainable
10
B C’
Industrial robots
9
8
C
7
6
D’
5
D
4
3 Now attainable
2 Attainable
1 E E’
0 1 2 3 4 5 6 7 8 9
Puto
Present Choices, Future
Possibilities
Future Future
Goods for the future
Goods for the future

Curve Curve
F
Current P Current
curve curve
Goods for the present Goods for the present
Presentville Futureville
Pitfalls to Sound Economic
Reasoning
• Biases
• Loaded terminology
• Fallacy of composition
• Post hoc fallacy
• Correlation not causation
LECTURE 1A
Graphs and Their Meaning
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2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
in Economics
Construction of a Graph
• Graph
• A visual representation of the
relationship between two variables
• Horizontal axis
• Vertical axis
• Independent variable
• Dependent variable
• Ceteris paribus
Direct and Inverse Relationships
• Direct relationship
• Both variables move in the same direction
Direct and Inverse Relationships
• Inverse relationship
• Variables move in opposite directions
Slope of a Line
• Slope
• Slopes and measurement units
• Slopes and marginal analysis
• Infinite and zero slopes
• Vertical intercept
Positive Slope of a Line
vertical change +50 1
Slope = = = = 0.5
horizontal change +100 2
Php400
Consumption (C)
300
200
100 50 Vertical
change
100
0
Horizontal change
Income (Y)
Negative Slope of a Line
vertical change -10 1

Slope =
horizontal change
=
+4
= -2 2
= -2.5
50
40
Ticket Price Php
30
Vertical
-10
change
20
4
Horizontal change
10
4 8 12 16 20
Attendance
Slope of a Line
Slope = zero
Price of Bananas
Slope =
Consumption
infinite
Purchases of watches Divorce rate
Equation of a Linear Relationship
• y = a + bx, where
• y is the dependent variable
• a is the vertical intercept
• b is the slope of the line
• x is the independent variable
Equation of a Line
Y = 50 + .5C
Php40
Consumption (C)
300
200
100
0
Php100 200 300 400
Income (Y)
Slope of a Nonlinear Curve
• Slope always changes

• Use a line tangent to the curve to find
slope at that point
Slope of a Nonlinear Curve
20
15
10
0
5 10 15 20
Lecture 2
The Market System and the
Circular Flow
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2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
in Economics
Main alternative economic systems in
the world
ADAM SMITH
• It is an account of
economics at the dawn of
the Industrial Revolution,
as well as a rhetorical
piece written for the
generally educated
individual of the 18th
century - advocating a
free market economy as
more productive and
more beneficial to
society.
ADAM SMITH
“Invisible Hand of the Market”
• The self-
regulating
nature of the
market-
place.
• "It is not from the benevolence of the

butcher, the brewer or the baker that we
expect our dinner, but from their regard to
their own self-interest... Every individual
intends only his own security, only his own
gain. And he is in this led by an invisible
hand to promote an end which was no part
of his intention. By pursuing his own
interest, he frequently promotes that of
society more effectually than when he really
intends to promote it."
• The natural force that guides free market

capitalism through competition for scarce
resources. According to Adam Smith, in a
free market each participant will try to
maximize self-interest, and the interaction
of market participants, leading to exchange
of goods and services, enables each
participant to be better off than when
simply producing for himself/herself.
• Another misconception is that the

invisible hand is a form of
individualism. It would be hard to
call the actions of a baker who
spends all day baking bread for
strangers "individualism."
• It is simply untrue that personal greed will

always result in society's best interest:
crime is a devastating counter-example.
• The very reason we have police and criminal
justice systems is to prevent the harm
caused to society by individuals seeking to
enrich themselves at the expense of the
group.
Understanding Economic Systems
Communism, Socialism,
Capitalism
Warm Up Question #1
• What standard of living do you hope

to attain in life? How do you plan to
accomplish this goal?
Main Idea
• Economies vary when it comes to government
involvement. The relationship between
government and the economy has been debated
since historical beginnings.
Essential Question
I. Understanding Economic Systems
• Economics – the social science that analyzes the

production, distribution, and consumption of
goods and services.
• Many different economic systems in the world
• Helps formulate our understanding of Modern
Philippine History
Economies of the World - 2018
According to this map, which are amongst the world’s wealthiest nations?
Economic Systems
• Economic systems
o Set of institutionalized arrangements
o Coordinating mechanism
• Differences in systems exist by
o Degree of decentralized use of markets and
prices in decision-making
o Degree of centralized government control
4 Different Economic Systems
• Traditional
• Command/Socialism
• Capitalism/Market
• Mixed
Traditional Economic System
• Economic system is based on customs
and traditions (handed down from 1
generation to another).
• Allocation of scarce resources stems
from ritual, habit, or customs
• BARTER!! Means trade! No money!
• Examples: Africa, parts of India, the
Australian Aborigines
Examples of Traditional
Economies
Aborigines
Inuits
Advantages Disadvantages
• Economic roles are • Discourages new

set ideas
• Stable, predictable, • Lack of progress
and continuous • Lower standard of
living
Does a traditional economy answer
the big three questions?
• What will be produced?

– Whatever tradition, values, and rituals dictate
• How will it be produced?
– However tradition, values, and rituals dictate
• For whom will it be produced?
– Whomever tradition, values and rituals dictate
Economic Systems:
Capitalism
A. An economic system in which factories,
equipment, or other means of
production are privately owned rather
than controlled by the government.
B. Example – the Philippines, United
States of America, European Union,
Japan
Economic Systems:
Capitalism
Laissez-Faire
❖ The idea that the free market,
through supply and demand,
will regulate itself if government
does not interfere
❖ Government should be “hands
off” with big business
❖ Highest form of capitalism
❖ Ex. Rise of Industry in America John D.
in 19th Century Rockefeller
founder of
Standard Oil
had a net
worth of
$668 Billion
Economic Systems:
Capitalism
Supply and Demand
A. The way a market regulates itself in a capitalist society
B. In your Social Studies Journal add the following
visualization.
C. So how does this work?
Laissez-Faire Capitalism
• Ideal economy
• “Keep the government from interfering with
the economy”
• Power of government just needed to
o Protect private property from theft
o Provide a legal environment for contract
enforcement
• People interact in markets to buy and sell
The Command System
• The command system is known as

socialism or communism
• Government ownership of resources
• Decisions made by a central planning
board
• North Korea, Cuba, Myanmar
Economic Systems:
Command System
Socialism
A. A political and economic theory
that advocates ownership of the
means of production, such as
factories and farms, by the
people rather than by capitalists
and land owners.
B. Power belongs to the working
class
C. Ex – China, Yugoslavia (parts of
U.S.S.R.)
The symbol of the Soviet
Union featured the hammer
and sickle symbols of laborers
50 Years of Excellence in Economics for centuries
Economic Systems:
Command System
Communism
A. An economic or political system in which the
state or the community owns all property and
the means of production, and all citizens
share the wealth.
B. Creates a classless society (theoretically
C. Ex – Vietnam, Cuba, U.S.S.R.
Command Economy
• A central authority
(government) has to answer
the big three questions
• Government decides the

needs of the people, the best
way to produce it and for
everyone!
Command Economy
• There is very little if any input from the
people.
• Examples: North Korea, Cuba, China
Advantages
Disadvantages
• Basic Needs taken care • Doesn’t meet wants
of • No incentives
• Education, public • Requires a large
health, other services bureaucracy
cost very little if • New and different ideas
anything are discouraged
• Very little • No room for
unemployment individuality
Does a command economy answer
the big three questions?
• What is being produced?

– Whatever the government decides
• How is it being produced?
– The government will tell someone to make it
• For whom is it being produced?
– Whomever the government decides needs it
The Market System
• The market system is a mix of

decentralized decision making with
some government control
• Systems found in much of the world
• Private markets are dominant force
• Private ownership of resources
• Self-interested behavior
Technology and Capital Goods
• Advanced technology and capital

goods are encouraged
• Specialization
• Division of labor
• Geographic specialization
Use of Money
• Money makes trade easier

• Medium of exchange
• Without money, people would have to
barter
Active, but Limited Government
• Government may be needed to

alleviate market failures
• Government can increase effectiveness
of a market system
• Possible government failure
The Five Fundamental Questions
• What goods and services will be produced?

• How will the goods and services be
produced?
• Who will get the goods and services?
• How will the system accommodate change?
• How will the system promote progress?
What Will Be Produced?
• Goods and services that create a profit

• Consumer sovereignty
• “Dollar votes”
• Method for consumers to determine
which goods will be produced
• Determines which products and
industries survive or fail
How Will the Goods Be
Produced?
• Minimize the cost per unit by using
the most efficient techniques
• Technology
• Prices of the necessary resources
Who Will Get the Output?
• Consumers with the ability and

willingness to pay will get the product
• Ability to pay depends on income
How Will the System Change?
• Changes in consumer tastes

• Changes in technology
• Changes in resource prices
How Will the System Progress?
• Technological advance
• Creative destruction
• Capital accumulation
The Invisible Hand
• The “invisible hand”

• 1776 Wealth of Nations by Adam Smith
• Unity of private and social interest
• Virtues of the market system
• Efficiency
• Incentives
• Freedom
The Demise of Command
Systems
• Command system was a failure
• Soviet Union, Eastern Europe, and China
• The coordination problem
• Set output targets for all goods
• The incentive problem
• No adjustments for surplus or shortage
Capitalism Socialism Communism
(Market (mixed economy) (Command
economy) economy)
•Basic means of
Ownership •Individuals control Government owns means
production owned and
and control means of production of production
•Market determines managed by
Government determines
what goods will be government
what goods will be sold at
sold at what price •Private ownership,
what price
with regulation, of
businesses
Competition •Competition keeps
prices low and Cooperation stressed No competition, lower
quality high over competition quality goods
•high standard of •high standard of living

Standard of living and economic Goal is equality for
and economic security
Living security everybody, enforced by
•High taxes provide
•Individuals free to the government
free health care and
earn profits, but may education
risk losses
Economic Scenarios
• Work with your table groups to
demonstrate your understanding of
economies.
• Analyze the following scenarios and then
identify the type of economy that is being
described in the statement.
Scenario #1
• In this economy
manufactures of
automobiles control
the number of
vehicles produced
each month in a effort
to avoid surpluses
that would minimize
their profits.
Scenario #2
• In this economy, the
government produces it’s
signature crab flavored
soft drink and determines
that it will be sold for
$1.25 in all stores.
Scenario #3
• In this economy, investors
can make millions investing
in the construction of new
homes, but it is just as
likely that the value of these
properties could decrease
by 40% and they will lose
millions of dollars.
Scenario #4
• In this economy,
unemployment is around
3% and although taxes are
high, all members of the
society have access to
good schools and
hospitals.
Scenario #5
• In this economy, there

are only 3 types of
automobiles to choose
from. They often
break down and they
are all painted a light
brown color.
Scenario #6
• In this economy, you

are the owner of
construction
company, but all your
materials to build
houses is regulated
by the government to
ensure safe housing
for all.
Scenario #7
• In this economy, the value
of goods fluctuates greatly
and as a company you must
continue to produce quality
goods, or risk being out of
business.
Creating a Visual Reminder – Supply & Demand
• These concepts are complex, yet understanding

them is essential to our discourse this year.
Supply $ Price $
Supply $ Price $
Demand $ Price $
Demand $ Price $
• With the time remaining in class, I am asking you to create a

visual reminder, with your table group for supply & demand.
The function and working parts of the
nation’s economy
The Circular Flow Model
• The circular flow diagram

• Households
• Businesses
• Sole proprietorship
• Partnership
• Corporation
• Product market and the resource market
• The real flow and the money flow
How the System Deals with Risk
• Business owners and investors face risk

• Losses due to input shortages
• Changes in consumer tastes
• Natural disasters that affect the supply
chain
• Employees and suppliers have security
• Paid whether the firm makes a profit or
not
How the System Deals with Risk
• Business risks are restricted to owners

• Attracts needed inputs
• Inputs easier to obtain since many dislike risk
• Focuses attention
• Owners personally responsible for outcome
• Will encourage prudent decisions
• Manage risk well and the owners will prosper

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San Beda University

College of Arts and Sciences

Assistant Prof. C. B. Mendoza, Jr.

• The scientific method

❖ Economics of the nation ❖ Economics of the firm

If the economy was a forest

Goal Competitiveness Sustained Eco Devt

• Resources are scarce

• Economists do not restrict

1. People face tradeoffs.

Consumer Spending Revenue

…. Description of how the HH and Firms behave: an

ALL decisions involve trade-offs.

What are trade-offs of deciding to go to college?

❖ Efficiency: when society gets the most from its

❖ The opportunity cost of any item is whatever

❖ It is the relevant cost for decision making.

• Opportunity cost is the benefit that is

1st $30 $10

o You are selling your 2015 Audi R8. You have

✓The $1000 you previously spent on repairs

✓The change in incentives from scenario A

❖ Rather than being self-sufficient, people

❖ Countries also benefit from trade and

❖ Famous insight by Adam Smith in The Wealth

➢ People are less inclined to work, produce, invest, or

❖ If the market’s distribution of economic well-

❖ Protecting consumers, producers, and

❖ This goal involves three aspects: sustained

o In each of the following situations, what is

SNA describes the essential phenomena of the economy

Movie Factory Household

Macroeconomics involves the study of aggregate

INFLOWS: … That can be

The Economy ❖ Capacity Limits

Government Banks Workers/Families

Traders Investors Business Firms

Resources (Land, Labor and Capital)

How do the Main

Output of Consumer Goods and Services

HOUSEHOLDS Banks Government World

Purchases Investments Gov’t Exports

HOUSEHOLDS Banks Government World

Purchases Investments Gov’t Exports

Actual % Growth Expon. (Actual)

(0.05) 2010s 6.1

% Growth Expon. (% Growth) Poly. (% Growth)

CHN, 7.9LAO, 7.7

7.0 MMR, 6.6

5.0 SGP, 4.8

2.0 BRN, 1.7

GROWTH IN MANUFACTURING LEADS TO

❖ Mainly focus on the functions of money and

❖ Money is anything which is commonly used

• Transactions Approach (M1)

• Liquidity Approach (M2)

Department of Economics 15-98

• A simple theory linking the inflation rate to