Lesson 1: Basic Economic

Chapter 1: Economic Way of Thinking

Lesson Overview
Every society must provide goods and services for the welfare of its citizens. The
economy consists of all of the activities involved in the production and distribution of these
goods and services. Economics, as the study of the economy, seeks to address three
basic questions:
• Are there fundamental principles that help us understand how the economy works?
• How well does the economy perform in achieving social objectives?
• How would changes in laws or political institutions affect the performance of the
economy?

What is Economics?

Economics is essentially a study of the usage of resources under specific constraints,

all bound with an audacious hope that the subject under scrutiny is a rational entity which
seeks to improve its overall well-being. Social science concerned with the
efficient use of limited resources to achieve maximum satisfaction of economic wants. In
economics we will study the choices of individuals, firms, and governments. 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.

3 E'S IN ECONOMICS
Three E's in Economics have a vital role in the economic growth and development of a
certain country.
EFFICIENCY
➢ Efficiency refers to productivity and proper allocation of economic resources. It also
refers to the relationship between scarce factor inputs and outputs of goods and
services. This relationship can be measured in physical terms (technological
efficiency), or cost terms (economic efficiency) (Pass & Lowes, 1993). Being
efficient in the production and allocation of goods and services saves time and
money, and also increases a company's output. For instance, in the production of
commodities, firms utilizing modern technology can improve the quantity and
quality of products, which ultimately translates into an increase in revenue and
profit.

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

EFFECTIVENESS
➢ Effectiveness means attainment of goals and objectives. Economics is an
important and functional tool that can be utilized by other fields. For instance,
production with the use of both manual labor and technological advancements will
be useful for the consumption of the society and the rest of the world, regardless
of the output. In addition, produced goods
or services will be considered effective if they achieve the goals of both parties, that is;
satisfaction for the consumer and profit for business.

The Factors of Production

Land
This includes not only territory but all of the
natural resources, such as minerals and fossil
fuels, which the economy is endowed with.
Labor
This refers to the services of human beings
who bring not only their time and effort to the
economy but also their skills.
Capital
This consists of the human-made tools used in the economy: machinery, computers,
buildings, vehicles, and transportation systems. These tools of production are called
capital goods.
Entrepreneurship
This is the bringing together of land, labor, and capital into productive units. For example,
when Henry Ford organized the mass production of automobiles early in this century, he
brought labor and capital together in a new way on an assembly line, bringing the cost of
an automobile down to within the reach of the average.

How do we measure the success of an economy?

Standard of Living
By the standard of living we mean not only the goods and services we consume, but also
other aspects of the quality of life including health, leisure time, and environmental
amenities

FOUR BASIC ECONOMIC QUESTIONS

To address the problem of scarcity, the society must answer four basic economic
questions. These questions are as follows:
l. WHAT TO PRODUCE
An economy must identify the commodities that need to be produced for the
everyday uses of the society. A society must also take into account the resources it
possesses before deciding what goods or services to produce.
For example, an island nation, blessed with agricultural resources, and which does
not possess advanced technology, should not opt to produce space shuttles or satellites
because its resources are incapable of producing these outputs. However, it can take
advantage of its natural resources and it can produce agricultural goods and tourism
services.
In a market economy, prices drive what gets produced in the society. Resources
are allocated for the production of goods and services that have high prices and low input
prices, relative to one another.

2. HOW TO PRODUCE
There is a need to identify the different methods and techniques in order to produce
commodities. The society must determine whether to employ labor-intensive production
or capital-intensive production.
Labor-intensive production uses more human resources or manual labor in
producing goods and services than capital resources. This kind of production is advisable
for a society with a large population. In countries where labor resources are abundant, for
instance, the Philippines and Vietnam, the cost of labor is usually cheap. Goods are
produced thru the use of cheaper resources over more expensive inputs.
On the other hand, capital-intensive production employs more technology and
capital goods, like machinery and equipment in producing goods and services, over labor
resources. This type of production should be utilized in countries with high levels of capital
stock and technology, and scarce labor resources (i.e., Japan, Germany, and the USA).

3. HOW MUCH TO PRODUCE

This identifies the number of commodities that need to be produced in order to
answer the demands of the society. The optimum amount of production must be
approximated by producers. Underproduction will result in a failure to meet the needs and
wants of the society. On the other hand, overproduction results in the wastage of excess
goods and services.

4. FOR WHOM TO PRODUCE

This question identifies the people or sectors who demand the commodities
produced in a society. Economists must determine the "target market" for the goods and
services which are to be produced to understand their consumption behaviors and
patterns. An understanding of these results in the higher sale of goods and ultimately, in
increased profit. Goods and services are available to those who can pay the highest price.

BASIC DECISION PROBLEMS

Below are some decision problems that households, firms, governments, and societies
must think about in order to properly manage their resources.

CONSUMPTION
➢ Members of society, with their individual wants, determine what types of goods or
services they want to utilize or consume, and the corresponding amounts thereof
that they should purchase and utilize. The choices range from food, shelter,
clothing, etc. There is also a choice between privately-used goods or those
supplied by the government, such as security and defense, infrastructure, or
irrigation. Consumption is the basic decision problem that the consumers must
always deal with in their day-to-day activities.

PRODUCTION
➢ The problem of production is generally a concern of producers. They determine
the needs, wants, and demands of consumers, and decide how to allocate their
resources to meet these demands. Goods and services may be produced by
different methods of production, depending on the firm's technological state, and
on the available resources within the society.
DISTRIBUTION
➢ This problem is primarily addressed to the government. There must be proper
allocation of all the resources for the benefit of the whole society. In a market
economy though, absolute equality of every member can never be achieved when
it comes to the distribution 4 of resources.
GROWTH OVER TIME
➢ This is the last basic decision problem that a society, or rest of the world must deal
with. Societies continue to live on while they also grow in number. People have
definite lives but societies (or nations) have comparably longer, if not infinite lives.
All the problems of choice, consumption, production, and distribution have to be
seen in the context of how they will affect future events.

TYPES OF ECONOMIC SYSTEMS

To address economic problems, several
economic systems have been created and
applied throughout history Below is an
enumeration of these.

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

b. COMMAND ECONOMY
Communism or Command economy is a type of economy, wherein the manner of
production is dictated by the government. The government decides on what, how,
how much, and for whom to produce. It is an economic system characterized by
collective ownership of most resources, and the existence of a central planning
agency of the state. In this system, all productive enterprises are owned by the
people and administered by the state.
 c. MARKET ECONOMY
Market economy or capitalism's basic characteristic is that the resources are
privately owned, and that the people themselves make the decisions. It is an
economic system wherein most economic decisions and means of production are
made by the private owners. Under this economic system, factors of production
are owned and controlled by individuals, and people are free to produce goods
and services to meet the demand of consumers, who, in turn, are also free to
choose goods according to their own likes.

d. SOCIALIST ECONOMY
In Socialist economic systems, key enterprises are owned 'by the state. In this
system, private ownership is recognized however, the state has control over a
large portion of capital assets and is generally responsible for the production and
distribution of important goods. In a socialist economy, the main emphasis is on
the equitable distribution of income and wealth. As such, it is considered as an
economy bordering between capitalism and communism.

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

MICROECONOMICS AND MACROECONOMICS

Economics has two major branches of study: one concerned with individual decision
making; and the other, involved in understanding the behavior of the society as a whole

MICROECONOMICS
• This is the branch of economics that deals with the individual decisions of units of
the economy—firms and households, and how their choices determine the relative
 prices of goods and affect the different factors of production. The market is the
central concept of microeconomics.
It focuses on its two main players—the buyer/consumer and the seller/producer, and
their interactions.
Microeconomics operates on the level of the individual business firm, as well as that
of the individual consumer Its concerned with how a firm maximizes its profits, and how
a consumer maximizes his/her satisfaction.
Among the topics discussed in microeconomics are the theories of demand and
supply, elasticity of demand and supply, individual decision-making, theories of
production, output and cost of firms, a firm's profit maximization objective, different types
of business organizations, and kinds of market structures (Case 2003).

MACROECONOMICS
• It is the branch of economics that studies the relationship among broad economic
aggregates like national income, national output, money supply, bank deposits,
total volumes of savings, investment, consumption expenditure, general price level
of commodities, government spending, inflation, recession, employment, and
money supply (Kapur, 1997). The term macro, in contrast to micro, implies that it
seeks to understand the behavior of the economy as a whole.
• Macroeconomics focuses on the four specific sectors of the economy: the behavior
of the aggregate household (consumption) the decision making of the aggregate
business (investment), the policies and projects of the government (government
spending), and the behavior of externalities/foreign economic agents through
trading (export and import).
Moreover, macroeconomics also discusses the measurement of gross national
product and gross domestic product, the business cycle, the five macroeconomic goals
(sustained economic growth, price stability, reduced unemployment rate, trade balance
and redistribution of income), money and the economy, monetary and fiscal policies, and
economic growth and development.
THE CONCEPT OF OPPORTUNITY COST
Because people cannot have everything they
want, they are forced to make choices between
several options. Opportunity Cost refers to the
foregone value of the next best alternative. It
is the value of whatever is given-up when one
makes a choice. The thing thus given-up is
called the opportunity cost of one's choice.
When one makes choices, there is always an alternative that has to be given up,
A producer, who decides to produce shoes, gives up other goods that he could have
produced using the same resources. A student, who buys a book with his limited
allowance, gives up the chance of eating out or watching movie.
Opportunity cost is expressed in relative price. This means that the price of one
item should be relative to the price of another.