Aspects of Economic Problem 1

GOALS OF ECONOMIC STUDY AND ANALYSIS

Economists develop theories, or models, to help explain economic behavior an economic theory,
or economic model, is a simplification of economic reality used to make predictions about the
real world. Thus, the goal of economic theory is to make predictions about the real world, such as
what happens to the consumption of a certain soft-drink brand when its price increases.
Simplify the Problem
A theory captures the important elements of the problem under study. It need not spell out every
detail and relationship. In fact, the more detailed a theory gets, the more confusing it becomes,
and the less useful it may be. The world is so complex that simplifying often is necessary to make
sense of things. For example, a wristwatch is a model that tells time. A watch loaded with extra
features and dials, however, is harder to read a glance and is therefore less useful as a time-telling
model. Store mannequins simplify the human form (some even lack arms and heads). Some comic-
strip and cartoon characters are simplified, for example, by omitting their claws (in the case of
Winnie the Pooh and Tigger) or even teeth (in the case of Snoopy). You might think of economic
theory as a stripped-down, or streamlined, version of economic reality. One way to strip down
reality is with simplifying assumptions.
Simplifying Assumptions
To help develop a theory, economists make simplifying assumptions. One category of assumptions
is the other things-constant assumption. The idea is to identify the variables of interest and then
focus exclusively on the relations among them, assuming that nothing else of importance changes
that other things remain constant.
Rational Self-Interest
A key assumption about behavior is that, in making choices, you rationally select alternatives you
perceive to be in your best interests. By rational, economists mean that you try to make the best
choices you can, given the information available. In general, rational self-interest means that you
try to maximize the expected benefit achieved with a given cost or to minimize the expected cost
of achieving a given benefit.

ASPECT OF ECONOMIC STUDY AND ANALYSIS

Positive and Normative Economics

Positive Economics is a principle in economic analysis which describes what exists and how it
works. It strives to give an objective description of the state of things. Normative Economics,
meanwhile, focuses on the outcome of economic behavior, evaluates and makes judgments, and
proposes courses of action.

Example of Positive and Normative statements:

Positive: “Taxes enable the government to provide services to the people.”

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 Aspects of Economic Problem 2

Normative: “The government should levy more taxes so it can provide more services to the
people.”

These two principles are vital tools in studying Economics. Economists apply them to come up
with conclusions that will be used to design economic policies and theories.

Microeconomics and Macroeconomics

Microeconomics is the branch of economics that deals with human behavior and choices they
relate to relatively small units: an individual, a firm, an industry, a single market. Macroeconomics
is the branch of economics that deals with human behavior and choices as they relate to an entire
economy. In microeconomics, economists discuss a single price; in macroeconomics, they discuss
the price level. Microeconomics deals with the demand for a particular good or service;
macroeconomics deals with aggregate, or total, demand for goods and services Microeconomics
examines how a tax change affects a single firm's output; macroeconomics looks at how a tax
change affects an entire economy's output.

Economic Systems

It is necessary to properly allocate these resources to meet people’s unlimited wants. This process
of allocation answers three economic questions: What to produce? How to produce? For whom
to produce?

1. What to produce?
A society determines the kind and quantity of products it will produce depending on what
the consumers want to buy or are willing to pay for.

2. How to produce?
A society decides who will produce goods and what process of production will be used.
Goods may be produced by corporation, small business-owners, or the government itself.
The process of producing goods may be addressed depending on the costs and the
availability of resources needed.

3. For whom to produce?

The question revolves around the issue of who will benefit from the goods and services
produced. This depends on the distribution of wealth in a particular society. Therefore, a
consumer who has a capacity to pay for certain goods and services is more likely to benefit
than one who cannot afford them.

The answers for what, how, and for whom to produce are influenced by the structure of a society’s
economic system. An economic system is characterized by the type of institution responsible
for the management and allocation of resources used in the production of goods and services.
Generally, there are three known economic systems, namely, market economic system, command
economic system, and mixed economic system.

A market economic system is where all economic resources are owned by private entities.
This system proposes the following answer to the three economic questions: (1) produce goods

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 Aspects of Economic Problem 3

that yield high profits; (2) produce at maximum efficiency with minimum costs; and (3) distribute
the goods to those who can afford to buy them.

A command economic system is where all resources are owned by the government. The
question “What to produce?” is answered by producing more public goods like roads, public
schools, and public hospitals. The question “How to produce?” is answered by employing all
possible laborers and using all available machinery and equipment. The government answers the
final question by producing for the public.

Lastly, the mixed economic system is where all three questions are answered by both the
government and private entities in consideration of their mutual benefit. Economic resources are
owned by both. Today, most countries apply this type of economy but in different proportions –
some countries employ an economic system which is more command-oriented that market-
oriented, while others have more market-oriented economic system.

Market Participants
There are four types of decision makers in the economy: households, firms, governments, and
the rest of the world. Their interaction determines how an economy's resources get allocated.
Four Types of Participants
Households play the leading role in the economy. As consumers, households demand the goods
and services produced. As resource owners, households supply the resources used to produce
goods and services.
Firms governments, and the rest of the world demand the resources that households supply. They
then use these resources to supply the goods and services that households demand. The rest of
the world includes foreign households, foreign firms, and foreign governments that supply
resources and products to Philippine markets and demand resources and products from Philippine
markets.
Markets
Markets are the means by which buyers and sellers carry out exchange. By bringing together the
two sides of exchange, demand and supply, markets determine price and quantity. Markets may
be physical places, such as supermarkets, department stores, or shopping malls. Markets also
involve other ways for buyers and sellers to communicate, such as the stock market, telephones,
bulletin boards, classified ads, the Internet, and face-to-face bargaining
Markets provide information about the quantity, quality, and products offered for sale. Goods and
services are bought and sold in product price of markets. Resources are bought and sold in
resource markets. Many economists believe that the most important resource market is the labor,
or job, market.

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 Aspects of Economic Problem 4

The Circular-Flow Model

Image Source : https://wiki.ubc.ca/The_Circular_Flow_Diagram

Households supplies the factors of production to the firms through the markets for factors of
production. The firms will then utilize factors of production to create goods and services to be sold
in the markets for goods and services. The households will then buy for consumption these goods
and services from the firms through the market for goods and services.
The Economic Indicators
Gross Domestic Product (GDP) is the total value of final goods and services produced during
a given period within the geographic boundaries of a country regardless of by whom. The goods
and services are produced domestically
Gross National Product (GNP) is the total value of final goods and services produced during a
given period by the citizens of a country no matter where they live. The goods and services are
produced by the nationals" of the country.
Calculating GNP
GNP = GDP + Net Factor Income (Net income inflow from abroad – Net income outflow to foreign
countries)

Net Factor Income

Difference between the factor income earned from abroad by normal residents of a country and
the factor income earned by non-residents (foreigners) in the domestic territory of that country.

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 Aspects of Economic Problem 5

Example:
Compute the GNP of the Philippines with a GDP of Php 400M in 2012-2013, with an attribute of
net income from American employees of Php 100M in the country and Php 250M net income of
Filipinos working in America.
GNP= GDP+ Net Factor Income
= Php 400 million + (Php 250 million + (-Php 100 million) )
GNP= Php 550 million

Calculating GDP

1. Expenditure Approach

GDP= C + G + I + (X - M)
GDP = C + G + I + (X - M)
GDP = $304 + $156 + $124 + $18
GDP = $602

2. Income Approach

GDP = NI + Indirect Business Taxes + Depreciation

find the value of NI,

NI = W + R + i + PR
NI = $67 + $75 + $150 + $200
NI = $492

GDP = $492 + $74 + $36

GDP = $602

References:
Arnold R. (2012). Principle of Economics. Pasig City, Cengage Learning Asia Pte Ltd.
McEachern W. (2013). Applied Economics. Quezon City. Abiva Publishing House, Inc.
https://wiki.ubc.ca/The_Circular_Flow_Diagram
http://www.econport.org/content/handbook/NatIncAccount/CalculatingGDP/Examples.html

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