Applied Economics

Module 6
ANALYZE THE EFFECTS OF CONTEMPORARY ECONOMIC ISSUES AFFECTING THE FILIPINO ENTREPRENEUR

Contemporary Economic Issues Facing the Filipino Entrepreneur

1. Investment and interest rate

2. Rentals
3. Minimum wage
4. Taxes

INVESTMENT: A DETERMINANT OF INCOME

INVESTMENT
- Is a process of building up capital stock, or the expenditure which determines the income and production in the
economy.
- Is the capital expenditure on the purchase of physical assets such as plant, machinery, and equipment (also known
as fixed investment) and stocks (also known as inventory investments ) .
- Refers to the value of machinery, plants, and buildings that are bought by firms for production purposes (Piana
2001).
INVESTMENT EXPENDITURE
- Investment expenditure means capital spending.
- It is mainly derived from accumulated savings and other sources external to the circular flow; it does not come
from current income and consumption.
WHY IS INVESTMENT ESSENTIAL TO THE ECONOMY?
- Current business income serves current business needs.
- The surplus may not be sufficient to finance even a fraction of investment spending. Instead, a business may
borrow the savings of the economy, which households likewise do, e.g., for housing construction.
- Investment, therefore, requires that a portion of current consumption be foregone (i.e., saved) to free up
resources which can be used to finance investment.
INVESTMENT IS CLASSIFIED INTO TWO TYPES:
1. FIXED INCOME INVESTMENT
- Investors are aware that there are risky investment options. For investors who are averse to risk, fixed income
investments are the best option since these investments are guaranteed to have a lower risk of losses.
- Are investments that provide fixed periodic sources of income over a certain period of time.
Examples:
1. government securities like treasury bonds, treasury bills and notes
2. corporate bonds (which have higher interests compared to government securities)
3. special deposit accounts offered by the Bangko Sentral ng Pilipinas (BSP)
4. foreign currency time deposits.
2. VARIABLE INCOME INVESTMENT
- Are forms of investment that are suitable for risk tolerant individuals.
- Returns are not fully guaranteed and money or resources invested may also not be fully recovered. The reason
for this is that the returns from variable income investments are strongly influenced by economic situations and
the behavior of financial markets.
Examples:
1. business ownerships in the form of equities
2. company stocks
3. investment fund shares that have a high level of liquidity since they can be easily converted to cash.

1. INVESTMENT AND ITEREST RATES

- Interest rates play a key role in increasing capital stock, which in turn affect investments.
- There is a negative or inverse relationship between investment and interest rate.
❖ the higher the interest rate, the lower the quantity of investment;
the lower the interest rate, the higher the quantity of investments
WHAT IS INTEREST RATE? WHAT IS IT’S ROLE IN INVESTMENTS?
▪ In economics, interest is used in two ways.
1. It can be the price of the credit, which is often referred to as loanable funds.
2. It can also be the return that the capital earns as an input in the production process.
▪ Interest rate represents the cost of using or borrowing money.
▪ Loanable funds refer to the amount of money lent out by a lender to a borrower, for which the borrower will pay
an interest rate to the lender for the use of that fund.
▪ Interest as the return on capital can be illustrated in the case of a printing press owner who decides to buy
additional equipment which costs P10,000.
 After a year, he earns P 1,000 for using the equipment in his business. The P 1,000 is equivalent to a 10 percent
interest rate on the capital which is the equipment.
In this case, interest is the return earned by the capital as an input in the production process.

MARKET FOR LOANABLE FUNDS

▪ Figure 5.1 shows the market for loanable funds where the demand is the amount of funds that firms and
individuals will borrow at a given interest rate.
▪ A downward sloping demand curve indicates low interest rates, which means that borrowing money is quite
cheap. When the cost of borrowing is low; more people are encouraged to avail of loans.
▪ Th supply curve is the amount the individuals wish to save. It is upward sloping since individuals get a higher return
on their money when interest rates are high, and they are thus willing to save more.

INVESTMENT DEMAND CURVE

▪ Interest rates affect the level of production of investment goods. A change in interest rates results in a change in
investment demand.
▪ The rate at which a borrower pays for the money that is borrowed is usually influenced by macroeconomic
conditions such as inflation-which reduces the purchasing power of capital-and money supply. This relationship is
best described by the investment demand curve.
▪ A change in the interest rate causes a movement along the investment demand curve as shown in Figure 5.2

DETERMINANTS OF INVESTMENT
▪ Fluctuations and changes in interest rates have a significant influence on investments
▪ Determinants of Investments
1. Future expectations – reflect plans to change production capacity. As expectations change, anticipating future
returns from investments, the investment demand curve shifts to the right. On the other hand, if there are
expectations of lower profits, the investment demand curve shifts to the left.
2. Level of Economic Activity – When GDP is high, the level of production increases. This boosts demand for capital
and encourages higher investment. When household income increase, consumption also goes up, which further
leads to a rise in aggregate demand.
3. Technological Change – with changes in technology, demand for capital will have to increase in order to keep
up with these important developments.
4. Public Policy – public policy in the form of granting incentives to firms can significantly affect the demand for
capital, thereby increasing investments. Investment tax credits and tax holidays can encourage investments in a
country.

2. RENTALS
▪ Rent
- Typically refers to the use of property for a certain amount
 - It is the price paid for the use of land and other natural resources or factors of production that is in fixed
supply.
- Rent has been traditionally associated with land, which is a fixed factor of production.
▪ The concept of economic rent applies to economic factors, not just land.
▪ Economic rent is a payment in excess of opportunity costs. According to David Ricardo, an influential British
classical economist in early 1800s, rent is a surplus of revenue over cost, which arises due to differences in the
level of usability of the land.
▪ The scarcity of land becomes the concept of rent.
Rent on Land
- Land is one of the most common type of investments aside from owning shares, cash and securities.
- In order to analyze how the price for the use of land is determined, we must look at the supply of land and its level
of demand.
- Since the supply of land is perfectly inelastic, the level of demand is what determines the rent on land.
- Aside from renting the land out, the owner of the land can also opt to sell the land at a higher price to earn a
profit.
HOW IS THE DEMAND FOR LAND DETERMINED?
▪ Economic rent also relies on productivity differences.
▪ Several determinants indicate the productiveness of the land:
a. Products grown on the land
The location attribute of the land can also be considered for its demand
b. Prices of other resources which are combined with the land
City areas have higher land rents than remote areas with difficult access to transportation and communication.
Note:
A person keen on investing on land must realize that there are also risks to watch out for. For one, it takes a long
time to sell such property , which means money is not easily realized.

3. WAGES
DETERMINANTS OF MARKET WAGE RATES
▪ A basic principle of economics is the notion that the price or value of goods, services and even resources, such as
labor, is determined by the behavior of demand and supply.
▪ Labor Demand
- The demand for labor is similar to the demand for a good, and thus generally follows the law of demand.
- The wage, which is the price of labor, is plotted in the y-axis of the graph, and the quantity of labor, which
can be expressed by the number of employment available in the market, is plotted in the x-axis.
- Similar to the law of demand , when the price of labor increases, the related quantity of labor decreases,
which makes the price of labor inversely related to the quantity of labor. This means that employers will
hire more people when wages go down.
▪ Labor Supply
- It follows the principle of the law of supply, which says that if the price of labor increases, then the supply
of labor also increases and vice versa.
- As wages increases, more people will enter the labor market and compete for higher-paying jobs. But if
wages decline, there will be fewer people looking for jobs and competing for these lower wages.
WHAT IS MARKET CLEARING?
▪ When the labor demand and supply meet at a certain wage and quantity of workers, an equilibrium is reached.
This point of equilibrium is called the market clearing.
▪ It is where firms may hire an employee at the existing wage rate and people who would like to have that wage
rate would be able to do so.
▪ However, as this is a competitive labor market, even though there is an identified market clearing, employers and
employees may leave the labor market, as firms may want to pay lower wages or workers may wish to earn higher
wages.
EQUILIBRIUM WAGES
▪ When jobs are safe and easy, we can assume that the wages they pay are average. Most people want to have such
jobs.
▪ As the job becomes more difficult and dangerous, workers naturally require a higher wage to do such work.
▪ Compensating Differential is the difference in wages that arise to offset the nonmonetary characteristics of
different jobs.
People who work in coal mines or on night shifts usually receive a compensating differential to make up for the
unpleasant nature of the job.
EQUILIBRIUM IN A COMPETITIVE LABOR MARKET
▪ In a perfect competitive labor market, firms and workers are free to enter and exit the market. This makes the
equilibrium allocation of workers to firms efficient.
▪ How the workers fit the firm maximizes the total gains that workers and firms accumulate by trading with each
other.
▪ A competitive equilibrium leads to an efficient allocation of resources.
 ▪ Figure 5.3 shows the intersection of the labor supply and the labor demand in a competitive market.
▪ The x-axis represents the employee hours while the y-axis represents the wage level.
▪ The demand curve gives the total number of employee hours that firms in the market demand at the wage, while
the supply curve shows the total number of work hours that agents in the economy allocate to the market at any
given wage level.

MINIMUM WAGE
▪ Minimum wage is the lowest allowed wage paid to workers by virtue of legislation and government policies.
▪ This is a form of government intervention to alleviate poverty and income inequality in terms of rendering job
services.
▪ The effects of minimum wages may in principle differ between industries in which employers do and do not have
control over the wage rates they pay for the labor of a given skill and application
▪ Minimum wage is set primarily to protect workers from abusive employment practices.
▪ A decent minimum wage is actually a useful tool in addressing wide disparities in wage distribution.

4. TAXES
▪ Taxes are the lifeblood of the government.
- Without taxes, the government will not be able to provide services to its people, such as public works,
health, education, defense and police protection, and social services.
- Hence, taxation is necessary for the government to be able to finance its expenditure.
▪ Taxation is the act of levying tax so that the sovereign, through its law-making body, can raise income to defray
the necessary expenses of the government.
- It is an inherent power of the state to demand enforced contributions from the people for public purposes.
- Hence, tax is a levy imposed by the government on the income, wealth and capital gains of persons or
businesses, on spending on goods and services, and on properties.
▪ Taxes are used by the government for a variety of purposes
a) raising revenue to cover government expenditures on the provision of social services such as education,
health and public infrastructure as well as the salaries and benefits of public servants;
b) as an instrument of fiscal policy in regulating the level of total spending (or aggregate demand) to stabilize
the economy;
c) altering the distribution of income and wealth;
 d) controlling the volume of imports into, and sometimes exports of certain goods out of, the country.
TYPES OF TAXES
1. Direct taxes are taxes levied by government on the income and wealth received by households and businesses to
raise government revenue and to act as an instrument of fiscal policy.
a) Individual income taxes are taxes that are levied on households. These are taxes on particular persons
b) Corporate income taxes are taxes on businesses. Take note that corporations are legal entities that
assume an independent personality. Thus, if a corporation earns a profit, it must pay a corporate income
tax. This is considered direct tax.
2. Indirect taxes are taxes levied by government on goods and services to raise revenue and to act as an instrument
of fiscal policy. Observe that these are not taxes on people but on goods and services that people purchase and
consume.
a) Value-added tax (VAT) are taxes included on goods and services
b) Excise taxes are taxes included on certain products.
3. Progressive taxes are taxes that place greater burden on those best able to pay and put little to no burden on the
poor.
• The best example is the individual income tax.
• For most taxpayers today, the more they earn, the higher percentage they pay for tax
• In terms of the average tax rate, people in higher income brackets pay a substantially higher average tax
rate than those in the lower brackets.
4. Proportional taxes are taxes that place an equal burden on the rich, the middle class, and the poor. In other words,
taxes are levied at a constant rate as income rises.
5. Regressive taxes are taxes that fall more heavily on the poor than on the rich. Under this taxation structure, taxes
are levied at a decreasing rate as income rises.
• This form of taxation takes a greater proportion of tax from a low-income taxpayer than from a high-
income taxpayer.
• Indirect taxes such as the VAT or excise taxes on certain products are regressive when taken as a
proportion of total net income.

BASIC PRINCIPLES OF TAXATION

▪ The basic principles of taxation refer to key concepts that guide governments in designing and implementing an
equitable taxation regime. These basic principles are generally referred to as Adam Smith’s Canons of Taxation.
1. Adequacy. Taxes should be just enough to generate revenue required for the provision of essential public
services like health, education, and national defense and police protection.
2. Broad basing. Taxes should be spread over as wide as possible to all sectors of the population or economy
to minimize individual tax burden.
3. Compatibility. Taxes should be coordinated to ensure tax neutrality and meet the overall objectives of
good governance.
4. Convenience. Taxes should be enforced in a manner that facilitates voluntary compliance to the maximum
extent possible.
5. Earmarking. Tax revenue from a specific source should be dedicated to a specific purpose only when there
is a direct cost-and-benefit link between the tax source and the expenditure, such as the allocation of
motor users’ tax for road maintenance.
6. Efficiency. Tax collection efforts of the government should not cost an inordinately high percentage of tax
revenues.
7. Equity. Taxes should equally burden all individuals and entities in similar economic circumstances.
8. Neutrality. Taxes should not favor any one group or sector over another and should not be designed to
interfere with or influence individual decision-making.
9. Predictability. The collection of taxes should reinforce their inevitability and regularity.
10. Restricted exemptions. Tax exemptions must only be done for specific purposes (e.g., to encourage
investment) and within a limited period.
11. Simplicity. Tax assessment and determination should be easily understood by an average taxpayer.

Compiled by:
ANITA G. AGUIRRE
DVRMNHS-SHS
Discussion Questions: Choose 2 questions to answer.
1. If there is an increase in taxes, what happens to investment?
2. What is labor market equilibrium in a competitive market?
3. Why do governments impose minimum wages?
4. What will happen if there is an increase in the level of economic activity?
5. Discuss why employment is created when minimum wages are imposed.
 ASSESSMENT
Test 1. Multiple Choice
Directions: Encircle the letter that corresponds to the correct answer.
1. It is a process of building up capital stock, or the expenditure which determines the income and production in the
economy.
a. Income b. Consumption c. Investments d. Savings e. Capital
2. Fixed income investments are said to be:
a. Investments that provide fixed periodic sources of income over a certain period of time.
b. Investments that are suitable for risk-tolerant individuals.
c. Investments where returns are not fully guaranteed and money or resources invested may also not be fully recovered.
d. All of the above
e. None of the above
3. It represents the cost of using or borrowing money.
a. Income b. Interest rate c. Loanable funds d. Production e. Consumer
4. The amount of money lent by a lender to a borrower, for which the borrower would pay an interest rate to the lender
for the use of that fund.
a. Income b. Interest rate c. Loanable funds d. Production e. Consumer
5. Future __________ reflect the plans to change production capacity.
a. Level of economic activity c. Public policy e. None of the above
b. Technological change d. Expectations
6. This form of granting incentives to firms can significantly affect the demand for capital, thereby increasing investments.
a. Level of economic activity c. Public policy e. None of the above
b. Technological change d. Expectations
7. The price paid for the use of land and other natural resources or factors of production that is in fixed supply is called
a. Level of economic activity c. Wages e. None of the above
b. Technological change d. Expectations
8. This point of equilibrium is called the _________ , where firms may hire an employee at the existing wage rate and
people who would like to have that wage rate would be able to do so.
a. Market clearing c. Labor demand e. Rent
b. Labor supply d. Wages
9. It is known as the lifeblood of the government.
a. Direct taxes b. taxes c. indirect taxes d. Proportional taxes e. Regressive taxes
10. Progressive taxes are:
a. Taxes that place an equal burden on the rich, the middle class and the poor.
b. Taxes that fall more heavily on the poor than on the rich.
c. Taxes levied by government on the income and wealth received by households and businesses to raise revenue and to
act as an instrument of fiscal policy.
d. Taxes levied by government on goods and services to raise revenue and to act as an instrument of fiscal policy.
e. Taxes that place a greater burden on those best able to pay and little or no burden on the poor.
Test II. Identification
Directions: Fill in the blanks with the correct words provided below.
GDP Investment demand Lender
Labor Stock of capital Opportunity cost
Employees Loanable funds Inflation
Investors Risky Purchasing power
Borrower Minimum wages Expectations
Tax credits Interest rates Money
Economic rent Good
1. __________ are aware that there are investment options that are __________.
2. __________ play a key role when increasing the ________, which in turn affect investments.
3. __________ are the amount of ________ lent by a lender to a borrower, for which the borrower pays an interest rate
to the ____________ for the use of that fund.
4. The rate at which a _________ pays for the money that is borrowed, is usually influenced by macroeconomic conditions
such as ___________, which reduces the ___________ of capital and money supply.
5. As __________ change by anticipating future returns from investments, the _________ curve shifts to the right.
6. When _________ is high, the level of production increases, boosting demand for capital, which leads to higher
investments.
7. Investment _________ and tax holidays, can encourage investments in a country.
8. The concept of _________ applies to economic factors, not just land. Economic rent is payment in excess of _________.
9. The demand for __________ is simply like the demand for a __________, so it generally follows the law of demand.
10. As governments impose __________, companies must comply with this and should not be paying __________ less
than the set minimum wage.
Reference:
Viray, E. B., and J. A. Bato. Applied Economics. Mandaluyong City: Anvil Publishing, Inc., 2018