Part II

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Concepts of Microeconomics

Most Essential Learning Outcomes

After reading this section, you should be able to:

1. Understand what a market is

2. Define demand
3. Categorize the forces/factors that affect the level of demand
4. Define supply
5. Classify forces/factors that affect the level of supply
6. Define equilibrium
7. Differentiate surplus from shortage
8. Understand price controls.

Indicative Contents (Weeks 2 & 3)

• The Market
• Demand
• Change in Quantity Demanded vs Change in Demand
• Forces that Cause the Demand Curve to Chang Supply
• Supply
• Change in Quantity Supplied vs Change in Supply
• Change in Supply

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The Market
A market is where the buyers and sellers meet. It is the place where they both trade or
exchange goods or services – in other words, it is where transaction takes place. There are
different kinds of markets such as wet and dry. A wet market is where people usually buy,
vegetables, fruits, meats, fish and etc. On the other hand, a dry market is where people buy
shoes, clothes and other dry goods.

Demand
Demand pertains to the quantity of a goods or services that people are ready to
buy/purchase at a given price within a given time period, when other factors besides price are
held constant (ceteris paribus).
Demand therefore implies three things:
• Desire to possess a thing
• The ability to pay for it or means of purchasing it; and
• Willingness to utilize it

Law of Demand
The Law of Demand states that if price goes UP, the quantity demanded will go DOWN.
Conversely, if the price goes DOWN, the quantity demanded will go UP ceteris paribus. The
reason for this is because consumer always tend to maximize SATISFACTION.

PD PD

Demand Schedule
A demand schedule is a table that shows the relationship of prices and the specific
quantities demanded are each of these prices.

Table 2.1
Hypothetical Demand Schedule for Rice Per Month
Situation Price (P) Quantity (kg)
A 5 8
B 4 13
C 3 20
D 2 30
E 1 45

ΔQ Q2 – Q1
QD = ------------ = -------------
ΔP P2 – P 1

Demand Curve
It is a graphical representation showing the relationship between the price and quantities
demanded per time period. A demand curved has a negative slope, thus it slopes downward
from left to right.

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 Demand Function
It shows the relationship between the demand for a commodity and the factors that
determine or influence this demand. Demand function expressed as a mathematical function.
Thus,

QD = f (own price, income, price related goods, etc.)

Change in Quantity Demanded vs. Change in Demand

Change in Quantity Demand – there is change in quantity demanded if the movement
is along the same demand curve. A change in quantity demanded is brought about by an
increase (decrease) in the product’s price. The direction movement is inverse considering the
Law of Demand.

Change in Demand
There is a change in demand if the entire curve shift to the ride side resulting in
increased demand. Therefore, goods and services that remain at the same price are demanded
in higher amounts by consumers. Conversely, demand decreases or falls if the entire demand
shift downward or to the left. Fewer amounts of goods or services at the same price are
demanded by consumers.

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Forces That Cause the Demand Curve to Change
Taste of Preference
This pertains to the personal likes or dislikes of consumers for certain goods and
services. If taste or preferences change so that people want to buy more of commodity at a
given price, then an increase in demand will result, and vice versa.
Changing Income
Increasing income of household raise the demand for certain goods and services, and
vice versa. This is because an increase in one’s income generally raises his capacity or power
to demand for goods and services which she/he cannot purchase at a lower income.
Occasional or Seasonal Products
The various events or seasons in a given year also result to a movement of the demand
curve, with reference to a particular goods. For example: During Christmas season demand for
Christmas trees, parols, and other Christmas decors increase.
Population Change
An increasing population leads to an increase in the demand for some types of goods
and services, and vice-versa. More people simply mean that more goods or services are to be
demanded. In particular, increase in population generally results to an increase demand for
basic goods, such as food and medicines. On the other hand, a decrease in population results in
a decline in demand.
Substitute Goods
Substitute goods are goods that are interchanged with another good. In a situation where
the price of particular good increases, a consumer will tend to look for closely related
commodities.
Expectations of Future Prices
If buyers expect the price of a good or service to rise or fall in the future, it may cause
the current demand to increase or decrease. Also, expectations about the future may alter
demand for a specific commodity.

Supply (Firms/Seller’s Side)

Supply is the quantity of goods or services that firms are ready and willing to sell at a
given price within a period of time, other factors being held constant. It is the quantity of goods
or services that a firm is willing to sell at a given time. Thus, supply is a product made available
for sale by firms.

ΔQ Q2 – Q1
QS = ------------- = ------------------
ΔP P2 – P1

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Law of Supply
The Law of Supply states that if the price of a good or service goes up, the quantity
supplied for such good or service will also go up; conversely, if the price goes down, the
quantity supplied also goes down, ceteris paribus.

Supply Schedule
A supply schedule is a schedule listing the various prices of a product and the specific
quantities supplied at each of these prices. Generally, the information provided by a supply
schedule can be used to construct a supply curve showing the price vs. quantity supplied
relationship.
Table 2.2
Hypothetical Supply Schedule for Rice Per Month
Situation Price (P) Quantity (kg)
A 5 48
B 4 41
C 3 30
D 2 17
E 1 5

Supply Curve
It is a graphical representation showing the relationship between the price of the
product/factor of production (e.g. labor) and the quantity supplied per time period. The typical
market supply curve for a product slope upward from left to right, indicating that as price rises
(fall), more (less) supplied. The upward slope indicates the positive relationship between price
and quantity supplied.

Supply Function
A supply function is a form of mathematical notation that links the dependent variable
(quantity supplied, QS), with various independent variables that determine quantity supplied.
Among the factors that influence the quantity supplied are the price of the product, number of
sellers in the market, price of factor inputs, technology, business goals, importations, weather
conditions, and government policies. Thus,

QS = f (own price, number of seller, price of factor inputs, technology, etc.)

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Change in Quantity Supplied vs. Change in Supply
Change in Quantity Supplied
There is a change in quantity supplied if the movement is along the same supply curve.
A change in quantity demand is brought about by an increase (decrease) in the product’s own
price. The direction of the movement is positive, considering the Law of Supply.

Change in Supply
There is change in supply when the entire demand-supply curve shifts upward or
downward. At the same price, producers or sellers are able to supply more amounts of good or
service. On the other hand, supply decreases if the entire supply curve shift upward. Producers
sell fewer amounts of a good or service at the same price. Increase (decrease) in supply is
caused by factors other than the price of the good itself, such as change in technology, business
goals, etc., resulting to the movement of the entire supply curve downward (upward).

Forces That Cause the Supply Curve to Change

Optimization in the use of Factors of Production
An optimization in the utilization of resources will increase supply, while a failure to
achieve such will result to a decrease in supply. Optimization refers to the process, or
methodology of making something as fully perfect, functional, or effective as possible.

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 Technological Change
The introduction of cost-reducing innovations in production technology increases
supply on one hand. On the other hand, this can also decrease supply by means of freezing the
production, through problem that the new technology might encounter, such as technical
trouble.
Future Expectations
This factor impact sellers as much as buyers. If sellers anticipate a rise in prices, they
may choose to hold back the current supply to take advantage of the future increase in price,
thus decreasing market supply. However, if sellers expect a decline in the price for their
products, they will increase present supply.
Number of Sellers
The number of sellers has a direct impact on quantity supplied. Simply put, the more
sellers there are in the market, the greater supply of goods and services will be available.
Weather Conditions
Bad weather conditions, such as typhoons, droughts, or other natural disasters, reduces
the supply of agricultural commodities, while good weather has an opposite impact.
Government Policy
Removing quotas and tariffs on imported product also affect supply. Lower trade
restrictions and lower quotas or tariffs boost imports, thereby adding more supply of goods in
the market.

Market Equilibrium
The meeting of supply and demand results to what is referred to as a “market
equilibrium”. As earlier said, that the market referred to here is a situation “where buyer and
sellers meet”, while equilibrium is generally understood as a “state of balance”.

Equilibrium
Equilibrium generally pertains to a balance that exist when the quantity demanded
equals quantity supplied. Equilibrium is the general agreement of the buyer and seller at a
particular price and a particular quantity.

Equilibrium Market Price

Is the price agreed by the seller to offer its good or service for sale and for the buyer to
pay for it. Specifically, it is the price at which quantity demanded for a good exactly equal to
the quantity supplied.

What happens when there is market disequilibrium?

When there is market disequilibrium, two conditions may occur; a surplus or a shortage.

Surplus
Surplus is a condition in the market where the quantity supplied is more the quantity
demanded. When there is surplus the tendency is for sellers to lower market prices in order for
the goods to be easily disposed from the market.

Shortage
Shortage is a condition in the market in which demand is higher than supply. When the
market is experiencing shortage, there is a possibility that consumers can be abused, while the
producers enjoy imposing higher prices for their own interest.

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Two Types of Price Controls

Floor Price
It is the legal minimum price imposed by the government. This is undertaken if a
surplus in the economy persists. In this case, the government may impose minimum price on
the producers’ commodities.

Price Ceiling
It is the legal maximum price imposed by the government. Price ceiling is utilized by
the government if there is persistent shortage of goods (e.g. basic commodities like food items
and oil products) in the economy.

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 Exercise 2: Demand, Supply, and Equilibrium

Name: _____________________________________________ Score: _______________

Course/Year/Section: _________________________________ Date: ________________

Part I. Matching Type (20points)

Direction: Match the items in Column A with Column B by writing the letter on the answer
sheet provided.
A B
_______1. Profit a. He demands for goods and services

_______2. Market b. Higher demand, less supply

_______3. Equilibrium c. The main goal of firms

_______4. Shortage d. A state of balance

_______5. Satisfaction e. The place where buyers and sellers trade

_______6. Increased in demand f. When the supply curve shifts to the left

_______7. Increased in supply g. When the demand curve shifts to the right

_______8. A fall in demand h. When the supply curve shifts to the right

_______9. Decrease in supply i. When the demand curve shifts to the left

_______10. If there is surplus? J. Price ceiling

_______11. Consumer k. Forces that affect the slope of demand

_______12. Changes in income l. Floor price

_______13. Technological change m. Forces that affect the slope of supply

_______14. Changes in expectation n. The main goal of consumers

_______15. Population change

_______16. Weather condition

_______17. If there is shortage?

_______18. Taste of preferences

_______19. Factors of production

_______20. Substitute goods

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Part II. Discuss the movement of demand and supply curve relative to the forces affect them.

1. What are the reasons why a demand curve increases or decreases? (5pts)

Discussion:

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2. What are the reasons why a supply curve increase or decrease? (5pts)

Discussion:

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=================================================================
Part II
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Concepts of Microeconomics

Most Essential Learning Outcomes

In this topic you will learn the meaning of elasticity. You will also learn why this
concept is very important to our everyday decision-making process as consumers. You may
have wondered why there are goods that you purchase more (less) when price become less
(more), while there are goods that you still purchase the same quantity of even if their prices
become high. If you have asked yourself why and tried to look for answer you are actually
applying of elasticity.

Indicative Contents (Weeks 4 & 5)

• Elasticity of Demand
• Elasticity of Supply
• Graphical Illustrations

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ELASTICITY OF DEMAND

You may have encountered the term elasticity in you Physics subjects, which refers to
the expansion or contraction of physical matter. In economics, however, elasticity means
responsiveness or reaction. In general, it is the ratio of the percent change in one variable to
the percent change in another variable. It is a tool used by economists for measuring the
reaction of function to changes in parameters in a relative way.
Demand elasticity is a measure of the degree of responsiveness of the quantity
demanded of a product to a given change in one of the independent variables that affect the
demand for that product.
Price elasticity of demand is the responsiveness of consumers’ demand to change in
price of the good sold.
Income elasticity of demand is the responsiveness of consumers’ demand to change
in their income.
Cross elasticity of demand is the responsiveness of demand for a certain good, in
relation to changes in price of other related goods.

Equation for Price Elasticity of Demand:

Δ Quantity demand
ED = ----------------------------
Δ Price
Where the symbol Δ (Greek letter delta) signifies an absolute change. You may have
observed that the most common method used by economics textbook in the measurement of
demand price elasticity is the arc elasticity. The formula for this indicator is:

The numerator of this coefficient (Q2-Q1)/[(Q1+Q2)/2], indicates the percentage change

in the quantity demanded. The denominator, (P2-P1)/[(P1+P2)/2], indicates the percentage
change in price.
We can illustrate the concept of elasticity through the following example:
Suppose we have the following price and quantity schedule for good X.

P Q
6 0
4 10
2 20
0 30

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 Assume that we want to determine how consumers would react if the price of good X
decreased. We can solve the elasticity coefficient by applying the formula, assuming that price
will decrease from Php 6.00 to Php 4.00, and quantity will increase from 0 to 10 units.

10 – 0 4-6
EP = --------------- ÷ --------------
(0+10)/2 (6+4)/2

10 (-2)
= --------------- ÷ --------------
5 5

50
= ----------------
(-10)

EP = -|5|

Now, try solving the elasticity coefficient for the other price and quantity combinations.
Do they have the same elasticity coefficient?
As you may have observed, price elasticity is always negative, although when we
analyze and interpret the coefficient, we ignore negative sign, thus only the absolute value is
interpreted. What could be the reason for this? It is always negative due to the very nature of
demand; if price increases, less quantity of good is demanded, there quantity change is negative
and leads to a negative price of elasticity of demand. Conversely, if price falls, this negative
value will lead to a negative (or positive) price elasticity of demand value.

Interpretation of the Elasticity Coefficient

For economists, solving the elasticity coefficient is only a tool rather and end itself.
What is important to them and to us is to understand the meaning of the computed elasticity.
Our concern now is how to analyze and interpret the elasticity coefficient. There are only
certain rules to remember in analyzing and interpreting the elasticity coefficient.
Demand for a product is said to be inelastic if consumers will pay almost any price for
the product, while demand for product may be elastic if consumer will only pay a certain price,
or narrow ranges of prices, for the product.
Inelastic demand means that a producer or seller can raise price without hurting
demand for its product.
Elastic demand means that consumers are sensitive to the price at which a product is
sold and will only buy it if the price rises by what they consider too much.
Unitary elastic demand is a type of demand which changes in the same proportion to
its price; this means that the percentage change in demand is exactly equal to the percentage
change in price
The demand for a good is inelastic when the change in quantity demand is less than
the change in price. Thus, we can say that demand is inelastic if the computed coefficient is
less than 1 (EP < 1). Conversely, the demand for a good is elastic if the change in quantity is
greater than the change in price. Therefore, we can say that demand is elastic if the computed
coefficient is greater than 1 (EP > 1). The demand for a good is unitary when the change in
quantity demand is equal to the change in price (EP = 1).

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GRAPHICAL ILLUSRATION

The price elasticity of demand can also be illustrated graphically. Figure 3.1 illustrates
an elastic demand curve while Figure 3.2 shows an inelastic demand curve, Take note of the
slope of the two demand curves.
We can observe in Figure 3.1 that the slope of an elastic demand curve is flatter. The
more the demand curve becomes horizontal, the greater its elasticity. This is because a small
change in price, say from P3.00 to P100, can result to a larger change in quantity demanded,
say from 5 units to 35 units. Take note of the broken line, ab, is shorter than broken line bc.
This means that more quantities of a good are demanded when price changes, even with a small
amount. In this case, we can say that consumers respond greatly to a small change in price.
On the other hand, we can see in Figure 3.2 that the slope of an inelastic demand curve
is steeper. In fact, the more the demand curve becomes vertical the greater it becomes inelastic.
This is so since a large change in price, say from P3.00 to P100 still only results in a small
change in quantity demanded, say from 15 units to 20 units. As illustrated in the graph, we can
observe that broken line ab is longer than broken line bc, implying that less quantities of a good
are purchased when there is a large change in price. Under this situation, consumers' response
in buying a good is lesser than the change in price.
At the extremes, demand can be perfectly price inelastic, that is, price changes have no
effect at all on quantity demanded. A perfectly inelastic demand curve is a straight vertical line
(See Figure 33a), On the other hand, demand can be perfectly price clastic, that is, straight
horizontal line (See Figure 3.3b).

Now that we have described what elasticity is, let us examine the reasons why demand
for some goods is elastic, whereas for others it is inelastic. The question therefore is: what
determines elasticity? However, before we look into these reasons, we have to remember that
the elasticity for a particular product may differ at different prices. For instance, although the
demand elasticity for rice is low at its current price, it may not be so inelastic at P70.00 to
P75.00 per kilo.
Going back to our question: what determines elasticity? Important factors that
influence demand elasticity include (a) ease of substitution, (b) proportion of total
expenditures, (c) durability of product which may include: (i) possibility of postponing
purchase, (ii) possibility of repair, and (iii) used product market, and (d) length of time period
(Keat and Young 2006).
Accordingly, the most important determinant of elasticity is ease of substitution. If there
are many good substitutes for the product sold in the market, elasticity for that product will be
high. Moreover, if the product itself is a good substitute for other goods, its demand elasticity

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will also be high. However, the broader the definition of a commodity, the lower its price
elasticity will tend to become, simply because there is less opportunity for substitutes.

Another major determinant of demand elasticity is the proportion of total expenditures

spent on the product. For example, if the current price of rice is P5.00 per kilo and it will
increase to P6.00 per kilo, we may shrug off the P1.00 increase since its effect on our total
expenditure is very negligible. However, for a product like appliances and other kinds of
technology, the situation may be entirely different. Thus, we can expect that the demand for an
air conditioning unit will be considerably high than that for rice. Another reason for the high
elasticity of this product is that an appliance purchase can be postponed because there is a
choice between buying and repairing. Faced with a higher purchase price, a consumer may
choose to repair instead of purchasing a brand-new product.
Lastly, as markets broaden, more and more product substitution become possible.
Advances in mode of transportation and communication accompanied by decreases in them
cost have increased the size of markets over time. Thus, the number of substitutes competing
for consumers' demand has increased. In fact, markets have not only widened on a national
scale; they have crossed national borders brought about by increase in international trade due
mainly to international agreements like the World Trade Organization (WTO) and other
regional trade blocks like the ASEAN Free Trade Agreement (AFTA) among ASEAN member
countries.

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ELASTICITY OF SUPPLY

Supply elasticity refers to the reaction or response of the sellers or producers to price
change in goods sold. In others words, it is a measure of the degree of responsiveness of supply
to a given change in price. Moreover, it is the percentage change in quantity supplied, given a
percentage change in price.

Equation for Price Elasticity of Demand:

Δ Quantity supplied
ES = ----------------------------
Δ Price

If a change in price results in a more than proportionate change in quantity supplied,

then supply is price elastic (See Figure 3.3). Take note that an increase in the price from P1.00
to P3.00 (represented by the broken line bc) resulted in a larger increase in quantity supplied
from 5 units to 25 units, represented by the broken line ab. This simply indicates that the
response of suppliers to a small change in price is to increase the quantity of goods supplied
more than the increase in price. Just like an elastic demand curve, the slope of an elastic supply
curve is also flatter compared to a normal supply curve. In fact, the more the supply curve tends
to horizontal, the more that it becomes highly elastic.

Conversely, if a change in price produces a less than proportionate change in the

quantity supplied, then supply is price inelastic (See Figure 3.4). Observe in the figure that an
increase in the price from P1.00 to P3.00 (represented by the broken line bc) resulted in a small
increase in quantity supplied from 7 units to 10 units represented by the broken line ab. The
small change in quantity supplied simply tells us that suppliers are not that responsive to price
changes under an inelastic supply condition. We can also see that inelastic supply curve is more
vertical than a normal supply curve. In fact, the more vertical the supply curve, the more it
becomes highly inelastic.
At the extremes, supply can be perfectly price inelastic, that is, price changes have no
effect at all on quantity supplied. A perfectly inelastic supply curve is illustrated by a straight
vertical line (See Figure 3.6a). On the other hand, supply can be perfectly price elastic, that is,
any amount will be supplied at the prevailing price. A perfectly elastic supply curve is a straight
horizontal line (See Figure 3.6b).

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 Just like demand elasticity, what determines supply elasticity? Two important factors
can be identified: (a) time, and (b) time horizon involved in which production can be increased.
Time is a determinant of supply elasticity as the producer responds to changes in prices
from time to time, given a certain period. Some producers change the number of supplies of
their commodities depending on the movement of prices, which shifts from time to time.
Also, the degree of responsiveness of supply to changes in price is affected by the time
horizon involved in the production process. In the short run, supply can only be increased (or
decreased) in response to an increase (or decrease) in demand/price by working a firms' existing
plant more intensively, but this usually adds only marginally to total market supply. Thus, in
the short run, the supply curve tends to be price inelastic. In the long run, firms are able to
enlarge their supply capacities by building additional plants and by extending existing ones so
that supply conditions in the long run tend to be more price elastic. However, in some cases,
like petrochemicals, the long-run supply responses can take around five years or more.

Now that you have a clear idea why some goods that you purchase are more (or less)
than the price changes, it is now time for you to apply the concept that you have learned in your
everyday activity as a consumer. It is expected that this concept will help you in your decision
making as a consumer (and maybe later on as a producer).

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 Exercise 3: Elasticity of Demand and Supply

Name: _____________________________________________ Score: _______________

Course/Year/Section: _________________________________ Date: ________________

Part I. Computation (Show you Solutions) (12points)

Direction: Determine the elasticity in the given situations and indicate whether the same is
elastic inelastic and unitary.

Demand Schedule

Situation Price (P) Quantity (Q)

A 929 71
B 489 91
C 365 112
D 239 145
E 86 178
F 39 316

1. Situations E & D
2. Situations A & C
3. Situations F & B

Supply Schedule

Situation Price (P) Quantity (Q)

G 898 922
H 745 856
I 623 649
J 577 521
K 369 273
L 208 125

1. Situations G & I
2. Situations L & K
3. Situations H & J

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Part II. Analysis (15pts)

Direction: Look for the price of the following products. Compare the estimated prices between
year 2019 and year 2020, and provided comment/s thereon.

Php Php
Goods (2019)/kilo (2020)/kilo Comment/s

PORK

CHICKEN

CARROTS

GINGER

RICE

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=================================================================
Part II
=================================================================
Concepts of Microeconomics

Most Essential Learning Outcomes

After reading this section, you should be able to:

1. Determine who is the consumers

2. Define goods and services
3. Identify consumer tastes and preferences
4. Discuss the importance of Maslow’s hierarchy of needs
5. Application of the economics of satisfaction
6. Consumer Surplus

Indicative Contents (Week 6-12)

• The Consumer
• Goods and Services
• Consumer tastes and preferences
• Maslow’s Hierarchy of needs
• The Economic Satisfaction
• Consumer Surplus

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 The Consumer
Who is the consumer? A consumer is one who demands goods and services. Without
consumption (households), there is no need for production (firms). The consumer is king in a
capitalist or free-market economy. Producers, for their own interests, have to satisfy the needs
and wants of consumers in orders to earn profits. In this perspective, all of us are consumers;
as we live our daily lives, we demand goods and services for the moment we wake in the
morning until we retire to our beds at nights.
Since we are the ultimate purchasers of goods and services, we have the power to
determine what is produced; this is referred to as consumer sovereignty. In general terms, if
we as consumers demand better, then more of it will be supplied vice-versa. The producers
simply obey the wishes and desires of consumers.

Goods and Services

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

Tangible goods can be classified according to, but not limited to, the following:

Consumers Goods
These are goods that yield satisfaction directly to any consumer. These goods are
primarily sold for consumption, and not to be used for further processing or as input/raw
materials needed in producing another good (e.g. soft drinks, bread, crackers, cellular phone
loads).
Essential or Necessity Goods vs Luxury Goods
Essential or necessity goods are goods that satisfy basic needs of man. In other words,
these are goods are necessary to our daily existence. These are goods that we cannot live
without such as food, water, shelter, clothing, electricity, medicine, etc.
Luxury goods are those that men may do without, but are sued to contribute to his
comfort and well-being. Examples of luxury good/s are private jet, yacht, luxury cars, perfume,
jewelry, etc.
Economic and Free Goods
An economic good is that which is both useful and scarce. It has value attached to it
and a price has to be paid for its use. If a good is so abundant that there is enough of it to satisfy
everyone’s needs without anybody paying for it, that good is free.
Water from our faucet is an economic good, because we are not utilizing it for free, we
have to pay its distributor. The air we breathe and the sunlight coming from the sun are
examples of free goods.

Consumer Tastes and Preferences

Consumers have various tastes and preferences. Generally, tastes and preferences are
determined by age, income, education, gender occupation, customs, and tradition, as well as
culture. Preferences are the choices made by consumers as to which products or services to
consume. The strength of our preferences will determine which product to buy, given our
limited disposable income and thus, the demand of products.

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 Brand is simply defined, the name, term, or symbol given to a product by a supplier in
order to distinguish his offering from that similar products supplied by competitors. Brand
names are used as a focal point of production differentiation between suppliers.

Maslow’s Hierarchy of Needs

It identifies the basic priorities of every consumer. Maslow saw human needs in the
form of hierarchy, ascending from the lowest to the highest. The basic human needs place by
Maslow in ascending order of importance (pyramid) are: (a) physiological needs, (b)
security/safety needs, (c) social needs, (d) esteem needs, and (e) self-actualization needs)

The Economics of Satisfaction

You might wonder by now how economics can explain the behavior of consumers in
order to attain a maximum level of satisfaction of the goods and services that they generally
consumer in this section, we try to explain how consumers attain maximum satisfaction level
on the many goods and services available to them for consumption. However, we have to
remember at this point of time that satisfaction is a relative term. We differ in the ways we are
satisfied, as well as the degree of our satisfaction. This section will discuss some of the theories
that economists have devised to explain how consumers are able to attain maximum level of
satisfaction when consuming particular good or service.

Utility Theory
Utility in economics refers to the satisfaction of pleasure that an individual or consumer
gets from the consumption of a good or service that he/she purchases. For purposes of
economic analysis, utility is also measured how much a consumer is willing to pay for a
good/service.

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 Marginal utility is defined as the additional satisfaction that an individual derives from
consuming extra unit of a good or service. Marginal means ‘additional’ or ‘extra’. In
economics, we use marginal analysis in the examination of the effects of adding one extra unit
to, or taking away one unit from, some economic variable.

Table 4.1 Hypothetical Demand Schedule for Siopao

Price (P) Quantity Demanded (QD)

15.00 1
12.75 2
10.50 3
8.25 4

This table shows that as you continue to buy siopao, your willingness to pay for it
continues to declines because your satisfaction from good declines as you consume more of it.
Total utility, on the other hand, is the total satisfaction that a consumer derives from
the consumption of a given quantity of a good or service in a particular time period. Our total
utility usually increases as we consume more and more of a good or service, but generally the
increase is at a slower or declining rate. This implies that each extra unit consumed adds less
marginal utility than the previous unit as we become satisfied with good or service we are
consuming.
This Law states that as a consumer gets more satisfaction in the long run, he
experiences a decline in his satisfaction for goods and services. This means consumption
of more successive units of the same good increases total utility, but at a decrease rate because
marginal utility diminishes. In other words, as we consume more and more of a good or service,
we like it less and less, and as we consume increasing amount of a good or service, we derive
diminishing utility, or satisfaction from each additional unit consumed.

Table 4.2 Hypothetical Utility Schedule for Siopao

Unit Purchased Total Utility Marginal Utility

1 40 40
2 90 50
3 170 80
4 270 100
5 350 80
The table shows the various units purchased, and the corresponding marginal utility.
The derivation of marginal is shown below.

Mathematical Derivation of Marginal Utility

How we derive marginal utility? Marginal utility is simply change in total utility
divided by the change in quantity. Thus,

ΔTU
MU = --------
ΔQ

Expanding our equation, we can solve for marginal utility using the following equation:

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 TU1 – TU2
MU = -------------------
Q2 – Q1
where:
TU2 = the new total utility
TU1 = the original utility
Q2 = the new quantity consumed
Q1 = the original quantity consumed

Applying the formula, we can derive the marginal utility for the total utility presented
in the Table 4.2. Thus, if we want to determine the marginal utility from the consumption of
two pieces of siopao to three pieces, we can simply apply the formulated presented above.

170 – 90
MU = -------------
3–2

MU = 80

Consumer Surplus

We have already encountered the term surplus in our discussion of price equilibrium in
the previous chapter. We have to remember that the term surplus is used in economics for
several related quantities. For this section, our interest is to understand what consumer plus is.
In general, consumer plus is a measure of welfare we gain from the consumption of
goods and services; it’s a measure of the benefits that we derive from the exchange of goods.
In specific terms consumer plus is the difference between the total amount that are willing and
able to pay for a good or service, and the total amount that we actually pay for that good or
service.

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 Exercise 4: Consumer Maximization of Utility

Name: _____________________________________________ Score: _______________

Course/Year/Section: _________________________________ Date: ________________

Essay (20points)

Directions: Answer the following question briefly but thoroughly.

1. Explain the following terms: Utility, Marginal Utility; Total utility; and the Law of
Diminishing Marginal Utility. Give examples, if necessary.

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2. Discuss the relationship between the utility and price.

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Chapter V – The Profit Maximizing Firm

Learning Objectives: At the end of this chapter, you should be able to: define
production, inputs and outputs; differentiate labor-intensive from capital intensive technology;
understand the law of diminishing returns; comprehend the concepts of return scales; explain
the theory of cost; and understand profit maximization.

Production, Inputs and Outputs

Production refers to any economic activity, which combine the four factors of
production (i.e. land, labor, capital and entrepreneurship) to form an output which will give
direct satisfaction to the consumer. It also includes materials goods or provision of any service
if it satisfies the wants of people. It is the act of combining the factors of production by firms
and institutions in order to produce goods and services. Simply stated, production is the process
of converting inputs into outputs.
Inputs are the commodities and services that are used to produced goods and services.
Inputs are generally classified into three broad categories: land, labor, and capital. Land or
more generally, natural resources, represents the gift of nature to our productive processes.
Labor is the combine mental and physical ability used in the production of goods and services.
Capital resources are the goods that are used in the production of other goods and services.
Capital goods include machines, equipment, buildings, factories, road, etc.
Outputs are the various useful goods and services that result from the production
process and are either consumed or employed in further production. Goods and services that
ultimately consumed are called final goods while those that are used to produce other goods
are referred to as intermediate goods. Examples of final goods are the clothes that we wear, the
notebooks and pens that we use, etc. Intermediate goods include the tire used in the production
of cars, the sugar in the making of cakes and candies, etc.

Technology: Labor Intensive or Capital Intensive

Technology is the body of knowledge applied to how goods are produced. In the other
words, technology is the production employed by firms in creating goods and services.
Technology can be classified into two broad categories: labor intensive and capital intensive,

Labor intensive technology utilizes more labor resources than capital resources. Labor
intensive technology is usually employed by economies where labor resources are abundant
and cheap. In the case of the Philippines, industries that are considered labor intensive include
the agriculture sector and some manufacturing sub-sectors like garments
Capital intensive technology utilizes more capital resources than labor resources in
the production process. Capital intensive technology is employed by industrialized economics
since capital resources are cheaper than labor. Countries such as Germany, Japan, Korea and
the United States are considered capital intensive economies.

Short Run Versus Long Run, Fixed Inputs and Variable Inputs
Before we proceed to our discussion on production cost, let us first distinguish between
short run and long run. When we distinguish between short run and long run, we should
remember that economists do not partition production decisions based on any specific number
of days, months, or years. Instead, distinction depends on the ability to vary the quantity inputs
or resources used in the production.

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Two types of inputs:
1. Fixed input is any resource whose quantity cannot readily be changed when market
conditions indicate that a change in output is desirable. Example of fixed inputs are plant and
buildings, machineries and equipment). These cannot easily change within a short period of
time thus they must remain as fixed amounts while managers decide to vary output.
2. Variable input on the other hand, is any economic resource whose quantity can readily
be changed in response to changes in output. For instance, managers can hire fewer or more
worker during a given period. They can also change the amount of materials used in
production.
Now we can link the concepts of fixed and variable inputs to the short run and long
run. The short run is a period of time so short that there is at least one fixed input, therefore
changes in outputs must be accomplished exclusively by changes which use variable inputs.
For example, the short run is period of time during which a firm can increase output by hiring
more workers or increasing the number of materials (variable inputs), while the size of the
firm’s plant or machinery and equipment (fixed inputs) remains unchanged. The long run is a
period of time so long that all inputs are considered variable. The long run therefore known as
the planning horizon. This is because in the long run, the firm can build new factories or
purchase a new machinery.

Production Function
Production function us the functional relationship between quantities of input sued in
production and the outputs to be produced. The production function specifies the maximum
output that can be produced with a given quantity of inputs, given the available technology.
For instance, making a dress, its production function may appear as follows:

ODRESS = f (Fabrics, Sewing Machine, Sewer, Thread, Buttons, etc.)

Total, Average, and Marginal Product

Starting from firm’s production function, we can determine three important concepts;
total, average, and marginal product.
Total product refers to the total output produced after utilizing the fixed and variable
inputs in the production process. Fixed inputs are components of production which do not
change, like machineries and equipment. On the other hand, variable inputs are changeable
resources in the production, such as raw materials and numbers of laborers. Total product is
designated in physical unit like cavans of rice or number of shoes.
Once we know the total product, it is easy to derive an equally important production
concept, the marginal product. Recall that the term ‘marginal’ means ‘extra’ or ‘additional’.
Thus, the marginal product of an input is the extra output produced by 1 additional unit of
input, with other input held constant.
For instance, assume that we are holding land, machinery, and all other inputs constant.
Labor’s marginal product will be the additional output obtain upon adding 1 unit of labor. We
can derive the marginal product using the following equation:

ΔTP TP
MP = AP =
ΔIL I

TP2 – TP1
MP =
IL2 – IL1

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 Table Hypothetical Production Schedule of Pencils
Input (Labor) TP MP AP
0 0 0 0
1 8 8 8
2 20 12 10
3 37 17 12
4 57 20 14
5 72 15 14
6 80 8 13
7 85 5 12
8 88 3 11
9 86 -2 10
10 82 -4 8

This table shows the total product that can be produced for different inputs of labor
when other inputs and the state of technical knowledge are held constant. From total product,
we can derive important concepts of marginal and average products.

The marginal product starts at 8 for the first unit of labor, increase to 12 units when
another unit of labor is added, and then falls to negative 4 units for the 10 th unit of labor.
Marginal product calculation such as this are crucial for understanding how wages and other
factor prices are determined. The final concept is the average product, which is equals total
product divided by total units of input used.

The Law of Diminishing Returns

Using production functions, we can understand one of the most famous economic laws,
the Law of Diminishing Returns:

The Law of Diminishing Returns holds that we will get less and less extra output when
we add additional doses of an input while holding other inputs fixed. In other words,
the marginal product of each unit of input will decline as the amount of that input
increases, holding all other input constant.

The Law of Diminishing Returns is an expression of a very basic relationship. As

successive units of variable resource (like labor) are added to a fixed set of resources (land, or
capital), beyond some point the extra or marginal product attribute to each additional unit of
the variable resource will decline.

Returns to Scale

Diminishing returns and marginal products refer to the response of output to an increase
of a single input when all other inputs are held constant. We noted that increasing farmers while
holding farmland constant would only increase rice production by ever smaller increments.
But sometimes we are interested in the effect of increasing all inputs. For example what
would happened to rice production if farmland, labor, irrigation, fertilizers, pesticides, and
other inputs were increase by same proportion? This question refers to the returns of scale, or
the effects of scale increases inputs on the quantity produced. Three important cases should be
distinguished from one another.
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 First is the constant return to scale indicate a case where a change in all inputs leads
to a proportional change in output. Second, increasing return scale (also called economies of
scale) happen when an increase in all inputs leads to a more-than-proportional increase in the
level of output. Last is the decreasing return to scale occur when a balanced increase in all
inputs leads to less-than-proportional increase in total output.

The Theory of Cost

In a business firm, costs are half the picture, the other half being sales or total revenue.
Cost refers to the all expenses acquired during the economic activity, or the production of
goods and/or services. It includes expenditures incurred for the utilization of the various factors
of production in the creation of goods.
The equation that every business person knows better that anything else in the world is:

Sales – Cost = Profit

or
Total Revenue – Total Costs = Profit

Explicit and Implicit Cost

Explicit cost are payments to the non-owners of a firm for their resources. These are
expenses made for the use of resources now owned by the firm itself. Examples of explicit
costs include: the wages paid to labor, the rental charges for plant or office building, the cost
of electricity and phone bills, the cost of raw of materials, among others.
Implicit costs are the opportunity cost of using resources by the firm. These are
opportunity cost of resources because the firm makes no actual payment to outsiders. For
instance, if you start your own business and acted as its general manager, you are giving the
opportunity of earning a salary as a manager of bank or manufacturing firm.

Fixed Costs and Variable Costs

Fixed cost, or overhead/supplementary cost are expense for the use of fixed factors of
production. Example of these are, rent, interest, and the expenses on machines, depreciation,
and salary/wages of employees under guaranteed contract. These expenses do not change
regardless of any change in quantity of output produced.
Variable cost, or prime/operating cost, on the other hand, are expenses which change
as a consequence of a change in quantity output produced. In other words, variable costs are
cost incurred for variable factors input. These include expenses on the labor inputs, raw
materials, electricity, fuel, etc., which are necessary for the efficiency of production

Total Fixed Cost, Total Variable Cost and Total Cost

As production expands in the short run, costs are divided into two basic categories –
total fixed cost and total variable cost. Total fixed cost (TFC) consists of costs that do not
vary as output varies and that must be paid even if output is zero (e.g. rent, property taxes, etc.).
As firm expands from zero, total variable cost is added to total fixed cost. Total
variable cost (TVC) consists of costs that are zero when output is zero, and varies as output
increases (decreases). These costs relate to the cost variable inputs (e.g. wages for daily
workers, raw materials, and electricity/fuel consumption).

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 Given total fixed cost and total variable cost, the firm can calculate total cost (TC).
Total cost is the sum of total fixed and total variable cost at each level of output. Thus,

TC = TFC + TVC

Average Cost: Average Fixed Cost, Average Variable Cost and Average Total Cost
In addition to total cost, firms are interested in the per-unit cost, or average cost. Thus
average cost is stated on a per-unit basis. Average cost includes average fixed cost (AFC),
average variable cost (AVC), and average total cost (ATC).
Average cost is total fixed cost divided by the quantity of output produced. Take note
that as output increases, average fixed cost falls continuously. This is because we are dividing
a larger and larger denominator into a numerator that stays the same.

AFC = FC / Q

Unlike average fixed cost, average variable cost rises with output. Average variable
costs is the total variable cost divided by the quantity of output produced. Usually it declines
for a while as output increases, but eventually it becomes level and then begin to rise, as more
output are produced.

AVC = VC / Q

Average total cost is total cost divided by the quantity of output produced. Average
total cost is sometimes referred to as per-unit cost. Like AVC, ATC declines with output for a
while but eventually levels out and then rises, as more outputs are produced. You will also
notice that ATC lags slightly behind AVC, leveling out when AVC begin to rise, and only
rising until after AVC is well on its way up.

ATC = TC / Q
or
ATC = AFC + AVC

Marginal Cost

Marginal cost (MC) is the cost of producing one additional unit of output. Marginal
analysis asks how much it costs to produce an additional unit of out. Thus, marginal cost is the
change in total cost when one additional unit of output is produced. Stated in another way,
marginal cost is the ratio of the change in total cost to a one-unit change in output.

ΔTC
MC =
ΔQ

TC2 - TC1
MC =
Q2 – Q1

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 Table for Short Run Cost Schedule
Q FC VC TC MC AFC AVC ATC
0 100 0 100 ---- ---- --- ----
1 100 40 140 40 100 40 140
2 100 68 168 28 50 34 84
3 100 90 190 22 33 30 63
4 100 115 215 25 25 29 54
5 100 148 248 33 20 30 50
6 100 195 295 47 17 33 50
7 100 260 360 65 14 37 51
8 100 350 450 90 13 44 57
9 100 460 560 110 11 51 62
10 100 600 700 140 10 60 70
This table illustrates a hypothetical short run cost schedule. The quantity of output is
shown in Column 1, while Columns 2, 3 and 4 show the FC, VC, and TC. Column 5 indicate
the MC while Columns 6, 7 and 8 are the AFC, AVC, and ATC, respectively.

The Concept of Profit Maximization

Profit maximization
Let us now look at the main objective of a business: profit maximization. Profit is
simply defined as the difference that arises when a firm’s total revenue is greater that its total
cost. This definition of economic profit differs from that used conventionally by businessmen
(accounting profit); accounting profit only takes explicit cost into account (refer to our
definition earlier). Economic profit can be viewed in terms of: (a) the return accruing to
enterprise owners (entrepreneurs) after the payment of all explicit (payment such as wages to
outside factor input suppliers) and all implicit costs (payment for the use of factor inputs like
capital and labor, supplier by the owners themselves, and (b) a residual return to the owner(s)
of a firm (an individual entrepreneur or group of shareholders) for providing capital and for
risk-bearing; (c) the reward to entrepreneurs for organizing productive activity, for innovating
new products, etc., and risk-taking, or (d) the prime mover of a private enterprise economy
serving to allocate resources between competing end uses in line with consumer demands.
In economics, profit maximization is the process by which a firm determines the price
and output level that returns the greatest profit. Why is this so? We have to remember the
objective of the firm in traditional theory of the firm and theory of markets is to maximize its
profit.
There are several approaches to this problem. The total revenue-total cost (TR-TC)
method relies on the fact that profit equals revenue minus cost, that is:

Profit = TR – TC
On the other hand, the marginal revenue-marginal cost (MR-MC) method is based on
the fact that total profit in a perfectly competitive market reaches its maximum profit when
marginal revenue equals marginal cost, that is:

MR = MC

The achievement of profit maximization can be depicted in two ways: when TR exceeds
TC by the greatest amount, and when profit maximization can be shown to occur, where MR
= MC.

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 Exercise 5: Profit Maximizing Firm

Name: _____________________________________________ Score: _______________

Course/Year/Section: _________________________________ Date: ________________

Crossword Puzzle (10points)

1. An economic activity which combines the factors of production like land, labor, capital
and entrepreneurship.
2. These are the expenses which a producer or firm incurs for the use of various factors of
production.
3. It refers to the physical quantity of a commodity produced by various inputs of factors
of production.
4. The amount of money a firm receives from the sale of its output.
5. It is a curve which shows various combination of labor and capital yielding the same or
equal output.
6. It is another term for fixed cost.
7. Refers to the reductions or fixed in average total cost as the output rises.
8. It is the reward for services of an entrepreneur.
9. It is a curve that shows combinations of two inputs have the same cost at a given price
of each unit.
10. It is another term for variable cost.

R E Q I C I S O C O

E C O S T A L C F S

V O D O Q U A N T T

E N U E D A M U R P

Z O P R H E P R O F

X M S E N T R Q T I

Y I V V U X I M E G

B E S O F S C A L E

P R O D U C T I O N

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Chapter VI – Market Structures

Learning Objectives: This chapter is all about markets. At the end, you will be able to
distinguish the following types of market structures. This chapter identifies types of market
structures. Market structure is a classification system using the key traits of markets, including
the number of firms, similarity of the product sold and by the ease of entry/exit from the market
structure.

Types of Market Structure

There are four major types of market structures, namely (1) perfection competition, (2)
monopoly, (3) monopolistic competition, and (4) oligopoly.

Perfect Competition

Perfect, or pure competition is a market structure characterized by:

• A large number of small firms,
• A homogeneous product, and
• A very easy entry/exit from the market.

Large number of small firms. One of the characteristics of a perfectly competitive

market are its many firms and buyers, that is, a large number of independent-acting firms and
buyers, with each firm and buyer being sufficiently small and so is unable to influence the price
of product transacted in the market.
Homogeneous product. The products offered by the competing firms are identical not
only in physical attributes but are also regarded as identical buyers who have no preference
between the products of various producers.
Very easy entry and exit. This means that there are no barriers to entry or impediments
to the exit of existing sellers. That is, new firms face no barriers such as licenses, patents, permit
copyrights, etc.

Monopoly

Monopoly is the opposite extreme of perfect competition. Under monopoly, the

consumer has only two choices – either buy the monopolist’s product, or none at all. Monopoly
is a market structure characterized by:
• A single seller or producer,
• A unique produce, and
• Impossible entry into the market.

Single seller or producer. A monopoly market is comprised of a single supplier selling

to a multitude of small, independently acting buyers. In other words, a monopoly means that a
single firm in the industry. One firm provide the total supply of a product in a given market.
Unique product. A unique product means that there are no close substitutes for the
monopolist’s product. As such, the monopolist faces little or no competition. In reality,
however, there are few, if any, product that have no close substitutes. For example, buying a
generator or using a gas lamp is a substitute for MERALCO. Similarly, putting a deep well can
be a substitute of Manila Water.
Impossible entry. Barriers to entry are so severe in a monopoly so that it is impossible
for new firms to enter the market. In other words, extremely high barriers make it very difficult

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of impossible for new firms to enter an industry. Barriers to entry include (1) sole ownership
of vital resource, (2) legal barriers like government franchises and licenses, and (3) economies
of scale.

Monopolistic Competition

Monopolistic competition is a type of market structure characterized by:

• Many small firms
• Differentiated products, and
• Easy market entry and exit

Many small sellers. Monopolistically competitive market is comprised of a large

number of independently acting firms and buyers. However, under monopolistic competition,
just like under perfect competition, the exact number for firms cannot be determine. We can
say therefore that the many-sellers condition is met when each firm is so small (relative to the
total market) that its pricing decisions have negligible effect on the market.
Differentiated product. The products offered by competing firms under
monopolistically competitive market are differentiated from each other in one or more
respects. In fact, this is the key feature of monopolistic. Product differentiation is the process
of creating real or apparent differences between goods and services sold in the market. A
differentiated product has close, but not perfect, substitutes.
Easy entry and exit. In monopolistically competitive market, there are no barriers to
entry preventing new firms from entering the market. Or obstacles in the way of existing firms
leaving the market. Thus, unlike a monopoly, firms in a monopolistically competitive market
face low barriers to entry. However, entry into monopolistically competitive market is not
quite easy as entry into a perfectly competitive market.

Oligopoly

An oligopoly is a market structure characterized by:

• Few sellers
• Either a homogeneous or a differentiated product, and
• Difficult market entry

Few sellers. Under oligopoly, the bulk of market supply is in the hands of a relatively
few large firms who sell too many small buyers. We can therefore say that oligopoly is
competition among the few. We are familiar with the Big Three oil companies in the
Philippines (Petron, Shell & Caltex), and of the fact that these three firms dominates the oil
industry in the country.

Homogeneous or differentiated products. The products offered by suppliers may be

identical, or more commonly, differentiated from each other in one or more respects. These
differences may be of physical nature (involving functional features) or may be purely
imaginary in the sense that artificial differences are created through advertising and sales
promotion.
Difficult entry. Similar to monopoly, there are formidable barriers of entry that make
it difficult for new firms to enter the market. High barriers to entry in an oligopoly protect firms
from new entrants. These barriers included exclusive financial requirements, control over the
essential resource, patent rights, and other legal barriers.

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Special Types of Market Structure
1. bilateral monopoly
2. bilateral oligopoly
3. duopsony
4. duopoly
5. monopsony

Bilateral monopoly is market situation comprising one seller (like monopoly) and only
one buyer (monopsony). Bilateral oligopoly is a market condition with a significant degree of
seller concentration (like oligopoly) and a significant degree of buyer concentration (like
oligopsony). Duopsony is a market situation in which there are only two buyers but many
sellers. Duopoly is a subset of oligopoly, describing a market situation in which there are only
two suppliers. Lastly, monopsony is a form of buyer concentration, that is, a market situation
in which a single buyer confronts many small suppliers. Monopsonists are often able to secure
(open-ended).

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 Exercise 6: Market Structures

Name: _____________________________________________ Score: _______________

Course/Year/Section: _________________________________ Date: ________________

Characteristics of different market structures: Complete the table. (25points)

Market Number of Product Imposition In and Out Example

Structures Sellers Differences of Prices in the
Industry

Pure
Competition

Monopolistic
Competition

Monopoly

Duopoly

Oligopoly

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Page | 37