Business Environment

Every business organization has an internal and external environment. For the
organization to be successful, it is important to study its environment regularly. This is
to assess any developments and understand factors that can contribute to its success.

Environmental scanning is a process used by organizations to monitor their

external and internal environments. The purpose of the scan is to identify the
opportunities and threats affecting the business. As a part of the environmental
scanning process, the organization collects the information regarding its environment
and analyzes the impact of changes in the market. Environmental analysis is a
strategic tool in assessing the level of threats or opportunities that might affect the
business. This eventually helps the management team to make better decisions.

Internal Environment

The internal environment of the organization consists of factors that are

controllable by the management. As the figure above shows, the internal environment of
an organization consists of various elements like the value system,
mission/vision/goals/objectives of the organization, structure, culture, quality of
employees, labor unions, technological capabilities, etc. These elements lie within the
organization and any changes to them can affect the overall success of the business.

External Environment

There are two elements in the external environment: micro and macro. These
environmental factors are beyond the control of the business but they still minimize the
impact if the business has an effective strategic plan.

Micro Environment Factors

1. Suppliers

Suppliers can control the success of the business when they hold power. The
supplier holds the power when they are the only or the largest supplier of the goods in
the market.

1
2. Resellers

Market intermediaries, middleman, or resellers have a great contribution to the

delivery of products to the ultimate consumers. For example, if the reseller has a
reputable name then this reputation can be leveraged in marketing the product.

3. Customers

A customer is an individual or business that purchases goods or services.

Customers are important because they drive revenues. Without them, businesses have
nothing to offer. Most public-facing businesses compete with other companies to
attract customers, either by aggressively advertising their products or by lowering
prices to expand their customer bases.

4. Competition

Those who sell the same or similar products and services as your organization is
called competitors. The presence of one or more competitors can reduce the prices of
goods and services as the companies attempt to gain a larger market share.

Macro Environment Factors

1. Political factors

These are about how and to what degree a government intervenes in the economy.
It includes government policy, political stability or instability in overseas markets, foreign
trade policy, tax policy, labor law, environmental law, and trade restrictions.

2. Economic factors

Economic factors have a significant impact on how an organization does business

and also how it is profitable. These factors include economic growth, interest rates,
exchange rates, inflation, disposable income of consumers and businesses.

3. Social Factors

These include the shared belief and attitudes of the population. These factors
are population growth, age distribution, health consciousness, career, attitudes and so
on.

4. Technological Factors

Technological factors affect the management and marketing in three ways: new
ways of producing goods and services, new ways of distributing goods and services, and
new ways of communicating with target markets.

5. Environmental Factors

These factors have become important due to the increasing scarcity of raw
materials, pollution targets, doing business as an ethical and sustainable company.

6. Legal Factors

It includes health and safety, equal opportunities, advertising standards,

consumer rights and laws, product labeling, and product safety. It is clear that
companies need to know what is and what is not legal in order to trade successfully
 ACTIVITIES

Activity: Environmental Scanning

Directions: Think of one (1) business establishment nearby. Identify the micro
and macro environment factors that affect the business
establishment.

Micro Environment Factors

1. Suppliers

2. Resellers

3. Customers

4. Competitors

Macro Environment Factors

1. Political

2. Economic

3. Social

4. Technological

5. Environmental

6. Legal
SWOT Analysis

 SWOT (strengths, weaknesses, opportunities, and threats) analysis is a framework used to

evaluate a company's competitive position and to develop strategic planning. SWOT analysis
assesses internal and external factors, as well as current and future potential (Grant, 2020).

 A SWOT analysis is designed to facilitate a realistic, fact-based, data-driven look at the strengths
and weaknesses of an organization or an industry. The organization needs to keep the accuracy of
the analysis by avoiding pre-conceived beliefs or gray areas and instead focusing on real-life
contexts. Companies should use it as a guide and not necessarily as a prescription.

 SWOT analysis is a technique for assessing the performance, competition, risk, and potential of a
business, as well as part of a business such as a product line or division, an industry, or other
entity.

Internal Factors: Strengths (S) and Weaknesses (W)

 These are the resources and experiences readily available to the business proponents. These
factors include:
1. financial resources such as money and source of funds for investment;
2. physical resources such as the company’s location, facilities, machinery,
and equipment;
3. human resources consisting of employees;
4. access to natural resources, trademarks, patents, and copyrights; and
5. current processes, such as employee programs, sales, and distribution capabilities, marketing
programs, etc.

 Strengths describe what an organization excels at and what separates it from the competition: a
strong brand, loyal customer base, a strong balance sheet, unique technology, and more.

 Weaknesses stop an organization from performing at its optimum level. There are areas where the
business needs to improve: lack of raw materials, personnel attitude, poor location, and lack of
budget for product promotion, among others.
External Factors: Opportunities (O) and Threats (T)

 These are factors that affect a company, an organization, an individual, and those outside their
control. These factors include:
1. economic trends such as stock market, economic performance, and the like;
2. market trends such as new products or technology, changes in tastes and lifestyle of society;
3. national and local laws and regulations;
4. relationship with suppliers; and
5. competitive threats.

 Opportunities refer to favorable external factors that could give an organization a competitive
advantage. Examples include larger market, company expansion, and new customer trends,
among others.

 Threats refer to factors that have the potential to harm an organization. For example, changes in
government policy, changes in consumer tastes and preferences, inflation, and recession, among others.

+ -

Internal Factors
S W

External Factors
O T
 ACTIVITIES

Activity: SWOT Analysis

Directions: Identify if the following situations are under STRENGTHS,
WEAKNESSES, OPPORTUNITY, and THREATS. Write the
number of the corresponding market situation in the SWOT
Analysis Matrix.

Business: Barbecue Stand

1. The City Council of LGU in Pasig passed a new bill requiring small
businesses to register in the Business and Licensing Department of the
City which is costly.

2. More customers are beginning to like the sauces used by the barbecue
business.

3. The carinderia in front of the barbecue stand added grilled meals in their
menu.

4. Customers are asking if they can order ahead of time by texting the owner.

5. There is a steady supply of meals in the market.

6. Poor sanitation practices by the helpers.

7. A new building is under construction near the barbecue stand.

8. Only 2 helpers are attending to the needs of growing customers.

S W

O T
 Porter’s Five Forces Analysis
 The five forces model was originally developed by Michael E. Porter of Harvard Business
School. Porter’s Five Forces Analysis is a framework or a guide for assessing and
evaluating the competitive strength and position of a business organization.

 Porter’s theory identifies the five forces that determine the competitiveness and attractiveness
of a market and which seek to locate the power in a business situation, its current
competitive position, and the strength of a position that an organization may enter into.

 According to Porter, the origin of profitability is identical regardless of industry. In that

light, the industry structure is what ultimately drives the competition and profitability and
not on whether an industry produces a product or service, is emerging or mature, high-tech or
low-tech, regulated or unregulated.

Porter’s Five Forces:

1. Competitive Rivalry

 This force examines how intense the competition currently is in the market, which is
determined by the number of existing competitors and what each is capable of doing. Rivalry
competition is high when consumers can easily switch to a competitor offering for little
cost.

2. Bargaining Power of Suppliers

 This force analyzes how much power a business’ suppliers have and how much control it
has over the potential to raise its prices, which, in turn, would lower a business’s
profitability. Also, it looks at the number of suppliers available. The fewer there are, the
more power they have.

3. Bargaining Power of Buyers

 This force looks at the power of the consumer to affect pricing and quality. Consumers have
power when there aren’t many of them, but lots of sellers, as when it is easy to switch from
one business’s products or services to another. Buying power is low when consumers
purchase products are small amounts and the seller’s product is very different from any of its
competitors.

4. Threat of New Entrants

 This force examines how easy or difficult it is for the competition to join the marketplace in
the industry being examined. The easier it is a competitor to join the marketplace, the greater
the risk of a business’s market share being depleted.
 5. Threat of Substitute Products or Services

 This force studies how easy it is for consumers to switch from a business’s product or
service to that of a competitor. It looks at how many competitors there are, how
their prices and quality compare to the business being examined, and how much of a
profit those competitors are earning, which would determine if they can lower their costs
even more.
 ACTIVITIES

Activity: Porter’s Five Forces Analysis

Directions: Analyze if the following forces below are under SUPPLIERS BUYERS, NEW
ENTRANTS, SUBSTITUTE PRODUCTS and INTENSITYO RIVALRY. Write the number of
the corresponding market force in each box.

Industry growth Customer’s information

Government policy Capital requirements
Differentiation of inputs Diversity of competitors
The relative price performance of the other Exit barriers
products Buyer propensity to switch to other
Price Sensitivity products

NEW ENTRANTS INTENSITY OF RIVALRY

POWER OF SUPPLIERS POWER OF BUYERS

SUBSTITUTES
 MANUFACTURNG INDUSTRY
Manufacturing Business

 A manufacturing business is any business that uses components, parts, or raw materials to
make a finished good.

 These finished goods can be sold directly to consumers or other manufacturing businesses for
making a different product. Manufacturing businesses in today's world are normally
comprised of machines, robots, computers, and humans that all work in a specific manner to
create a product (Hill, 2020).

 Large-scale manufacturing allows for the mass production of goods using assembly line
processes and advanced technologies as core assets.

 Efficient manufacturing techniques enable manufacturers to take advantage of economies

of scale, producing more units at a lower cost.

Economies of Scale refer to the cost advantage experienced by a firm when it increases its level
of output. The advantage arises due to the inverse relationship between the “per-unit fixed
cost” and “quantity produced”.

The greater quantity of the output produced, the lower the per-unit fixed cost.
Economies of scale would also result in a fall in the average variable costs (average non-
fixed costs) as output increases. This is brought about by operational efficiencies as a
result of an increase in the scale of production.

Economies of scale can be implemented by a firm at any stage of the production process. In this
case, production refers to the economic concept of manufacture and involves all activities
related to a commodity. Thus, a business can decide to implement economies of scale in its
marketing division by hiring a large number of marketing professionals.

A business can also adopt the same in its input sourcing division by moving from human
labor to machine labor.

These are the effects of economies of scale on production costs:

1. It reduces the per-unit fixed cost. As a result of the increased production, the fixed cost gets
spread over more output than before.

2. It reduces per-unit variable costs. This occurs as the expanded scale of production increases
the efficiency of the production process.
Manufacturing Industry in the Philippines

 According to the Board of Investment, the Philippine manufacturing industry remains

to be the most important sector for long-term productive employment, value- added
generation, and innovation.

 It has the highest multiplier effect on the economy compared to other sectors.
Manufacturing is called the engine of the economy. Many services exist because of
manufacturing, hence many service jobs will disappear if manufacturing disappears.
Manufacturing creates more quality and gainful employment, as it has extensive linkages not
only among its sub-sectors but also with other industries, not to mention that it can further
make the services and logistics sectors more active.
Increasing manufacturing activities also have spillover effects of inducing additional demand
from the agriculture and resource-based industries.

The latest Annual Survey of Philippine Business and Industry (ASPBI) showed a total of
24,200 manufacturing establishments in 2017. This represents a 13.6% decrease from the
28,003 manufacturing establishments recorded in 2016.

 Among industry groups, the manufacture of other food products accounts for 7,880
establishments or 32.6% of the total. Manufacture of beverages followed by 2,407
(9.9%) establishments. Printing and service activities related to printing ranked third
with 1,581 (6.5%) establishments. The total employment generated by manufacturing
establishments reached 1.3 million in 2017.

In the recent data about the Philippine economy, the Gross Domestic Product (GDP) growth
rate dropped by 16.5 percent in the second quarter of 2020.

The main contributors to the decline were:

1. Manufacturing with -21.3%;

2. Construction with 33.5%;

3. Transportation and Storage with -59.2 percent%.

 E-Commerce
 Electronic Commerce (e-commerce, eCommerce) is the exchange of information
or business transactions using any form of electronic communication.
 E-commerce operates in all four of the following major market segments: (1)
business to business; (2) business to consumer; (3) consumer to consumer; and (4)
consumer to business.

E-commerce is facilitated through the use of electronic devices such as computers,

tablets, and smartphones which may be thought of like a digital version of mail-order
catalog shopping. With e-commerce, businesses may establish a wider market presence by
providing cheaper and more efficient distribution channels for their products or services.

Advantages of E-Commerce
1. Convenience. E-commerce can operate 24 hours a day, seven days a week.
2. Increased selection. Many stores offer a wider array of products online than they
carry in their brick-and-mortar counterparts.

Disadvantages of E-Commerce
1. Limited customer service. If you are going to buy a computer online, you cannot
simply ask an employee to demonstrate a particular model's features in person.

2. Lack of instant gratification. When you buy an item online, you must wait for it
to be shipped to your home or office.

3. Inability to touch the products. Online images do not necessarily convey the
whole story about an item, and so e-commerce purchases can be unsatisfying when
the products received do not match consumer expectations.

E-Commerce in the Philippines

E-Commerce accounts for USD 1. 3 trillion of the world’s economy.

eCommerce allows local businesses to broaden their markets well beyond Philippine
shores. Personal e-commerce can easily be achieved by Filipinos through any of the
numerous buys and sell sites currently available. While businesses can set up their e-
commerce facility using their websites.
With the global pandemic, there is an increase in the demand for e-commerce
in the Philippines. While the younger population embraced online shopping, the
need for social distancing has pushed the cash-centric and face to face shopping
culture towards a more digital one, and this is expected to continue.
 What is lacking is the proper digital and logistics infrastructure to truly enable
a digital economy. There is a need to upgrade the bandwidth capacity to service the
online market.

Filipinos are prolific users of social media. Estimates this year show that there
are 76 million active social media users from the Philippines. Of this number, 75
million are on Facebook, 12 million on Twitter, and 4 million are LinkedIn users
There is good reason to be optimistic about e-commerce growth in the Philippines.

Kemp and Moey (2019) released a study about e-commerce in the Philippines.
According to their report, Filipinos spent a total of USD 4.7 billion on online
purchases in 2018, with more than three-quarters of this amount – USD 3.5 billion
– going to online travel purchases. Online consumer goods purchases totaled just
USD 840 million in 2018, with electronics and physical media accounting for the
greatest share within this total.

The market for digital media products in the Philippines is particularly small,
with the country’s internet users spending just USD 286 million across video games,
video-on-demand services like Netflix, digital music streaming and downloads, and
subscriptions to digital news and magazines.

The average Filipino e-commerce shopper spent USD 18 on online consumer

goods purchases in 2018, although it’s worth stressing that this figure doesn’t
include travel-related p ases or spend on digital media
 Micro, Small and Medium Enterprises (MSMEs)
According to the Magna Carta for MSMEs, micro, small, and medium enterprises are classified based on
the worth of the business assets. The micro- enterprises have a total asset up to ₱3,000,000. The total
assets for small enterprises should range from ₱3,000,001 – ₱15,000,000. For medium enterprises, the
total assets are from ₱15,000,0001 – ₱100,000,000. MSMEs help to promote a competitive economic
activity, provide employment and it can reduce poverty in the country.

Number of MSMEs in the Philippines

The 2018 List of Establishments of the Philippine Statistics Authority (PSA) recorded a total of 1,003,111
business enterprises operating in the country. Of these, 998,342 (99.52%) are MSMEs and 4,769
(0.48%) are large enterprises. Micro enterprises constitute 88.45% (887,272) of total MSME
establishments, followed by small enterprises at 10.58% (106,175) and medium enterprises at 0.49%
(4,895). The majority of the MSMEs can be found in the National Capital Region (NCR) with 203,312
(20.36%) business establishments.

The top five (5) industry sectors according to the number of MSMEs in 2018 were:

1. Wholesale and Retail Trade with 461,765 establishments;

2. Accommodation and Food Service Activities with 144,535 establishments;

4. Manufacturing with 116,335 establishments;

5. Other Service Activities with 66,162 establishments; and

6. Financial and Insurance Activities with 46,033 establishments.

Contribution of MSMEs on the Philippine Economy

1. Employment Opportunities

These MSMEs generated a total of 5,714,262 jobs or 63.19% of the country’s total employment in 2018.
The micro-enterprises produced the biggest share (28.86%) closely followed by small enterprises
(27.04%) while medium enterprises were far behind at 7.29%. Meanwhile, large enterprises generated a
total of 3,328,801 jobs or 36.81% of the country’s overall employment.

2. Exports Contribution of MSMEs

MSMEs account for 25% of the country’s total export revenue. It is also estimated that 60% of all
exporters in the country belong to the MSME category. MSMEs can contribute in exports through a
 subcontracting arrangement with large firms, or as suppliers to exporting companies.

Government Programs to Support MSMEs

1. Barangay Micro Business Enterprise (BMBE) Act or R.A. 9178

It encourages the formation and growth of BMBEs (or micro-enterprises) by granting them incentives and
other benefits (i.e., exemption from income tax, exemption from minimum wage). As defined in the
article, Barangay Micro Business Enterprise refers to any business entity or enterprise engaged in the
production, processing or manufacturing of products or commodities, including agro-processing,
trading, and services, whose total assets including those arising from loans but exclusive of the land on
which the particular business entity's office, plant and equipment are situated, shall not be more than
Three Million Pesos (P3,000,000.00). It includes also the enterprise engaged in services, excluding
those rendered by anyone, who is duly licensed by the government after having passed a government
licensure exam, in connection with the exercise of one’s profession (e.g., accountant, lawyer, doctor,
etc.)

According to Section 7-8 of the article: “All BMBEs shall be exempt from tax for income arising from the
operations of the enterprise”. “The BMBEs shall be exempt from the coverage of the Minimum
Wage Law, provided, that all employees covered under this Act shall be entitled to the same benefits
given to any regular employee such as social security and healthcare benefits.”

2. Go Negosyo Act or R.A. 10644

The law seeks to promote “job generation and inclusive growth through the development of MSMEs”
in the country. It promotes “ease of doing business and facilitates access to services for MSMEs within
its jurisdiction” by establishing of Negosyo Centers in all provinces, cities, and municipalities to
promote. Business advisory services through technology transfer, production and management training,
and marketing assistance for MSMEs. Business registration assistance through the Philippine Business
Registry Databank under the Department of Trade and Industry (DTI). Go Negosyo Act will provide
financial assistance for the development and promotion of MSMEs in priority sectors of the economy
to be sourced from the MSME Development Fund and BMBE Fund.
 Consumer Theory

Consumer theory is the study of how people decide to spend their money based on their
individual preferences, and budget constraints. Consumer theory shows how individuals
make choices, subject to how much available income they have to spend, and the prices
of products. Consumption refers to the use of goods and services to satisfy human
wants.

Individuals have the freedom to choose between different bundles of goods and
services. Consumer theory seeks to predict their purchasing patterns by making the
following three basic assumptions about human behavior:

1. Utility maximization - Individuals are said to make calculated decisions

when shopping, purchasing products that bring them the greatest benefit known as a
maximum utility.

2. Nonsatiation - People are seldom satisfied with one trip to the shops and
always want to consume more.

3. Decreasing marginal utility - Consumers lose satisfaction in a product the

more they consume it.

The Utility Function

A consumer aims to maximize the satisfaction he/she derives from the use of a good or
service. The utility is a term in economics that refers to the total satisfaction received
from consuming a good or service. Economic theories based on rational choice usually
assume that consumers will strive to maximize their utility. The economic utility of a
good or service is important to understand, because it directly influences the demand,
and therefore price, of that good or service. In practice, a consumer's utility is
impossible to measure and quantify. In order easily understand the concept of utility, we
shall assume that it is measurable in units, which is called util. Util is one unit of
satisfaction.

The utility function shows the relationship between utility and consumption. In the
 equation form, it is U = f(C), which is simply stated as: utility is a function of
consumption. Also, the utility for the consumption of goods X and Y can be expressed
as U = f(X,Y). The important measures of utility are Total Utility and Marginal Utility.

Total Utility refers to the combined utility derived from consuming an additional unit of a good.
Marginal Utility refers to the additional utility derived from consuming an additional unit of a
good.

Law of Diminishing Marginal Utility

The Law of Diminishing Marginal Utility states that, as additional units of goods are
consumed, the additional utility derived from each additional unit tends to diminish. In
other words, as a consumer takes more units of a good, the extra utility or satisfaction
that he derives from an extra unit of the good goes on falling. It should be carefully
noted that the marginal utility, and not the total utility, that declines as the consumption
of good increases. The law of diminishing marginal utility means that the total utility
increases but at a decreasing rate.

The law is based upon the fact that the total wants of humans are virtually unlimited,
each single want is satiable. Therefore, as an individual consumes more and more units
of goods, the intensity of his want for that goods declines, to the point that he no longer
wants to consume more goods. When the saturation point is reached, the marginal utility
of goods becomes zero. The zero marginal utility of goods implies that the individual has
reached his/her satisfaction.
Table 1. Hypothetical Utility Schedule for Milk tea
Cups of Milk
Tea Total Marginal
Consumption Utility utility
per day
1 12 12
2 22 10
3 30 8
4 36 6
5 40 4
6 41 1
7 39 -2
8 34 -5
 Consider Table 1 in which we have presented the total and marginal utilities derived by
a person who consumes milk tea per day. When one cup of milk tea is taken per day, the
total utility derived is 12 units. And because this is the first cup its marginal utility is
also 12 utils. With the consumption of 2nd cup per day, the total utility rises to 22 but
the marginal utility falls to 10 utils. It will be seen from the table that as the
consumption of milk tea increases to six cups per day, the marginal utility from the
additional cups diminishes (the total utility is increasing at a diminishing rate).

However, when the cups of tea consumed per day increased to 7, then instead of giving
positive marginal utility, the 7th cup gives negative marginal utility which is equal to -2.
Too many cups of milk tea consumed per day (say more than six for an individual) can
cause acidity and gas trouble. Thus, the extra cups of milk tea beyond 6 cups to a person
gives him disutility, instead of positive satisfaction.

The figure represents the data taken from

the above table. We have to put the utility on the
y-axis and the number of cups of milk tea
consumed per day are on the x-axis. As the figure

shows, the curve increases up to the 6th cup of

milk tea, and beyond that the curve declines. This
indicates that the utility reaches its maximum

satisfaction up to 6th cups, and beyond that, the

marginal satisfaction declines.

APPLIED ECONOMICS- GLACI-SHS SY. 2021-2022 Page 19

 ACTIVITIES

Activity 1: My Utility!
Directions: Explain and graph the utility schedule below. Use the space below
for your answer.

Hypothetical Schedule of Chocolate Candy

Quantity
of Consumption Total Marginal
Utility Utility
1 7 7
2 16 9
3 22 6
4 26 4
5 28 2
6 28 0
Activity 2: I am Important
Directions: As a student-consumer, explain your importance to the businesses.

1. .

2. .

3. .

4. .

5. .

WRAP-UP

To summarize what you have learned in the lesson, answer the following questions:

1. What is consumer theory?

APPLIED ECONOMICS- GLACI-SHS SY. 2021-2022 Page 20

 2. What are the factors affecting business and industry in terms of consumers?

Production is a process of combining various inputs to produce an output for consumption. It is the act
of creating output in the form of a commodity or a service that contributes to the utility of individuals. The
term input refers to the resources used to produce goods and services. Output refers to the product created as a
result of the combination of input in the production process.

Production Theory

In economics, production theory explains the principles in which the business has to take decisions on
how much of each commodity it sells, how much it produces, and how much of raw material ie., fixed capital
and labor it employs. It defines the relationships between the price of the commodities and productive factors
on one hand, and the quantities of these commodities and productive factors that are produced on the other
hand.
The Production Function is an equation showing the maximum output of a commodity that a firm can
produce per time with each set of inputs.
Q = f(i)
Where: Q = output and i = input
To be more specific, output depends on the quantity of land, labor, and capital available. Thus, Q =
f(Ld,Lb,C).
Basically, production analysis is concerned with the analysis in which resources such as land, labor, and
capital are employed to produce a firm’s final product. To produce goods, the basic inputs are classified
into two divisions: fixed inputs and variable inputs. Fixed inputs are resources that remain constant in the
short-run. Variable inputs are resources which can be changed in the short-run or long-run.

The short-run is the period in which at least one factor of production is considered fixed. Usually, the
capital is considered constant in the short-run. In the long-run, all factors of production are variable, while in
the very long-run all factors of production are variable and research and development are possible. Economic
models and theories are not dynamic, but they are fixed to a period. So, economists based their models on the
short-run or long-run. The difference in these periods is the ability to change the factors of production given
the time. For example, in the short run, it is impossible to set up a new factory, but more plausible to hire new
workers. It shows that in a period, the current output can change with one factor, while in the long run, you
can make any changes.

Law of Diminishing Marginal Returns

If more variable factors of production are used in a combination with a fixed factor of production, the

APPLIED ECONOMICS- GLACI-SHS SY. 2021-2022 Page 21

 marginal product, and then the average product will eventually decline. The law of diminishing marginal
returns determines the behavior of output in the short-run.

The law of diminishing marginal returns is a theory in economics that predicts when the optimal level of
capacity is reached, adding a factor of production will actually result in a smaller increase in output.

Output produced is measured in three forms:

1. Total Product (TP) - is the combined production of several units of a given input.

Think of a pizza restaurant, with tables, chairs, and ovens (fixed factor of production). With no workers,
the output is zero, with one worker the output is ‘x’ units. The worker takes orders, makes pizzas, cleans
tables, and serves the bill. If there are two workers, the second worker can do the same work as the first,
and the output will be 2x units. They can specialize and further increase the outputs.

2. Marginal Product - is the additional output produced by an additional unit of the input and is equal to
change in total product/change in input.
For example, when one more chef has added the production increases to x units, and when the second
worker has hired the output increases by more than 2x units. In the above figure, the output will increase at an
increasing rate till L1, hence the marginal product is rising till L1. Given a fixed input, as the manager of the
pizza restaurant adds extra workers, the total output increases however at a decreasing rate. When the
manager of the store hires more workers, each new worker adding less to the output, and the marginal product
begins to fall from L1 to L2. After the L2, the contribution of newly hired workers is negative. If a fixed
capital, which has a limited capacity, can cater up to 5 workers, hiring more than 5 workers will be useless.
No firms will hire beyond L2, where there is too much of labor to a fixed capital.

3. Average Product – refers to the average contribution per unit of input and is equal to TP/i.
Take note take that if the marginal product is greater than the average product, then the average product
will rise. If the marginal product is less than the average product, then the average product will drop. If the
marginal product is equal to the average product, then the average product will be at its maximum.

Significance of Production Theory in Business

As we already learned, a business is engaged in providing goods and services to customers to make
profits. Although some businesses are engaged in retailing goods that they bought from producers, many
businesses produce the goods that they sell. It is therefore important for the business proprietors to be aware
of the production behavior that will maximize output within limited quantities of inputs available. This in turn

APPLIED ECONOMICS- GLACI-SHS SY. 2021-2022 Page 22

 will help maximize profits for the enterprise.

APPLIED ECONOMICS- GLACI-SHS SY. 2021-2022 Page 23

 Fiscal Policy

 Fiscal policy is a tool by which a government adjusts its spending levels and tax rates to
monitor and influence the nation’s economy.
 Fiscal policy is based on the theories of British economist John Maynard Keynes, known as
Keynesian Economics. This theory states that the government can influence macroeconomic
productivity levels by increasing or decreasing the tax levels and public spending. VAT –
VALUE ADDED TAX
 This can influence the curbs of inflation, increases employment, and maintains a healthy value
of money. Fiscal policy plays a very important role in managing the country’s economy.
The enactment of Tax Reform for Acceleration and Inclusion (TRAIN) is one of the
examples of fiscal policy.
The TRAIN Law aims to make the country’s tax system simpler, fairer, and more
efficient to promote investments, create jobs, and reduce poverty.
The reform includes amendments on the personal income tax, passive income for both
individuals and corporations, estate tax, donor’s tax, value-added tax (VAT), excise tax,
documentary stamp tax, and tax administration, among others.

The idea is to find a balance between tax rates and public spending. For example, stimulating a stagnant
economy by increasing spending or lowering taxes, also known as expansionary fiscal policy, runs the
risk of causing inflation to rise.
This is because an increase in the amount of money in the economy, followed by an increase in
consumer demand, will result in a decrease in the value of money. It means that it would take
more money to buy something that has not changed in value.

Let's say an economy has slowed down, the unemployment levels are up, the consumer spending is
down, and the businesses are not making substantial profits.
The government may decide to fuel the economy's engine by decreasing taxation, which signals
the consumers to spend more while the government increases also their spending in the form
of buying services from the market such as building roads or schools. By paying for such
services, the government creates jobs and wages that are in turn pumped into the economy.
Pumping money into the economy by decreasing taxes and increasing government spending is
known as pump priming.

With more money in the economy and fewer taxes to pay, consumer demand for goods and services
increases. This, in turn, rekindles businesses and turns the cycle from stagnant to active. If there are no
reins on this process, the increase in economic productivity can cross over a very fine line and lead to
too much money in the market. This excess in supply decreases the value of money while pushing up

APPLIED ECONOMICS- GLACI-SHS SY. 2021-2022 Page 24

prices (because of the increase in demand for consumer products). Hence, inflation exceeds the
reasonable level. For this reason, fine-tuning the economy through fiscal policy alone can be a difficult,
if not improbable, means to reach economic goals.

Monetary Policy
 Monetary policy refers to the actions undertaken by a nation's central bank to control the
money supply to achieve macroeconomic goals that promote sustainable economic growth.
Monetary policy consists of the process of drafting, announcing, and implementing the plan of
actions taken by the central bank, currency board, or other competent monetary authority of a
country that controls the quantity of money in an economy and the channels by which new
money is supplied.
 Monetary policy consists of management of money supply and interest rates, aimed at achieving
macroeconomic objectives such as controlling inflation, consumption, growth, and liquidity.
 These are achieved by actions such as modifying the interest rate, buying or selling government
bonds, regulating foreign exchange rates, and changing the amount of money in the banks are
required to maintain as reserves.

Economists, analysts, investors, and financial experts across the globe eagerly await the monetary policy
reports and outcome of the meetings involving monetary policy decision-making. Such developments
have a long-lasting impact on the overall economy, as well as on specific industry sector or market.

Monetary policy is formulated based on the inputs gathered from various sources. For instance,
the monetary authority may look at macroeconomic numbers like GDP and inflation,
industry/sector-specific growth rates and associated figures, geopolitical developments in the
international markets (like oil embargo or trade tariffs), concerns raised by groups representing
industries and businesses, survey results from organizations of repute, and inputs from the
government and other credible sources.

Broadly speaking, monetary policies can be categorized as expansionary or contractionary. If a country

is facing a high unemployment rate during a slowdown or a recession, the monetary authority can opt for
an expansionary policy aimed to increase economic performance and expanding economic activity.
As a part of expansionary monetary policy, the monetary authority often lowers the interest rates
through various measures that make money-saving relatively unfavorable and promotes
spending.
It leads to increased money supply in the market, with the hope of boosting investment and
consumer spending.
Lower interest rates mean that businesses and individuals can take loans on convenient terms to

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 expand productive activities and spend more on big-ticket consumer goods. An example of this
expansionary approach is low to zero interest rates maintained by many leading economies
across the globe since the 2008 financial crisis.

However, the increased money supply can lead to higher inflation, raising the cost of living and the cost
of doing business. Contractionary monetary policy, by increasing interest rates and slowing the growth
of the money supply, aims to bring down inflation. This can slow economic growth and increase
unemployment but is often required to tame inflation.

Significance of the Government Policies in Business and Industry

Both fiscal and monetary policy plays a large role in managing the economy and both have direct
and indirect impacts on household finances and business operation.
Fiscal policy involves tax and spending decisions set by the government and will impact
individuals and businesses. If the government wants to spend more, they will hire people and
also tap businesses to carry out the projects. Moreover, if the government spends more on
infrastructure, specifically in paving roads, transportation of goods can be fast and on time.
Monetary policy is set by the central bank and can boost consumer spending through lower
interest rates that make borrowing cheaper on everything from credit cards to mortgages. It also
helps businesses to lend money for business expansion or additional capital for business
operations.

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 Impact of Business on the Community: Efficiency in Perfectly Competitive
Markets

Efficiency in Perfectly Competitive Markets

 In economics, the marginal cost of production is the change in the total production cost that
comes from making or producing one additional unit. Meanwhile, a marginal benefit is the
maximum amount for a consumer is willing to pay for an additional good or service.
 It is also the additional satisfaction or utility that a consumer receives when the additional good
or service is purchased.
 The marginal benefit for a consumer tends to decrease as consumption of the good or service
increases. When profit-maximizing firms in perfectly competitive markets combine with utility-
maximizing consumers, something remarkable happens: the results of the quantities of outputs of
goods and services demonstrate both productive and allocative efficiency.

Productive efficiency means producing at the lowest cost possible without any waste. The
quantity of output supplied is within the production possibilities frontier. In the long-run of a
perfectly competitive market, the price in the market is equal to the minimum of the long-run
average cost curve. Hence, the goods are being produced and sold at the lowest possible
average cost.

Allocative efficiency means that among the points on the production possibility frontier, the
point that is chosen is socially preferred. It means that businesses supply what people
demanded. In a perfectly competitive market, the price is equal to the marginal cost of
production.

Think about the price that is paid for a good as a measure of the social benefit received for that
good, after all, willingness to pay takes what the good is worth to a buyer. Then think about the
marginal cost of producing the good as representing not just the cost for the firm, but more
broadly as the social cost of producing that good. When perfectly competitive firms follow the
rule that profits are maximized by producing at the quantity where the price is equal to marginal
cost, thus they are ensuring that the social benefits received from producing a good are in line
with the social costs of production.
To explore what is meant by an allocative efficiency, it is useful to walk through an example. First by
assuming that the market for wholesale flowers is perfectly competitive, so P = MC. Now, consider what
it would mean if the firms in that market produced a lesser quantity of flowers. At a lesser quantity,

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marginal costs will not yet have increased as much, so that price will exceed marginal cost; that is, P
> MC.
In that situation, the benefit to society as a whole of producing additional goods, as measured by the
willingness of consumers to pay for marginal units of a good, would be higher than the cost of the
inputs of labor and physical capital needed to produce the marginal good.
In other words, these gains to society as a whole from producing additional marginal units will
be greater than the costs.

Conversely, consider what it would mean if, compared to the level of output at the allocatively efficient
choice when P = MC, firms produced a greater quantity of flowers. At a greater quantity, marginal costs
of production will have increased so that P < MC.
In that case, the marginal costs of producing additional flowers are greater than the benefit to
society as measured by what people are willing to pay. For society as a whole, since the costs are
outstripping the benefits, it will make sense to produce a lower quantity of such goods.

When perfectly competitive firms maximize their profits by producing the quantity where P =
MC, they also assure that the benefits to consumers of what they are buying, as measured by the
price they are willing to pay, is equal to the costs to society of producing the marginal units, as
measured by the marginal costs the firm must pay—and thus that allocative efficiency holds.

Impact of Efficiency in Perfectly Competitive Markets

 The statements that a perfectly competitive market, in the long run, will feature both productive
and allocative efficiency do need to be taken with a few grains of salt.
 Remember, economists are using the concept of “efficiency” in a particular and specific sense,
not as a synonym for “desirable in every way.” For one thing, consumers’ ability to pay reflects
the income distribution in a particular society. Thus, a homeless person may have no ability to
pay for housing because they have insufficient income.

Perfect competition, in the long run, is a hypothetical benchmark. For market structures such as
monopoly, monopolistic competition, and oligopoly, which are more frequently observed in the real
world than perfect competition, firms will not always produce at the minimum of average cost, nor will
they always set price equal to marginal cost. Thus, these other competitive situations will not produce
productive and allocative efficiency.

 Real-world markets include many issues that are assumed away in the model of perfect
competition, including pollution, inventions of new technology, poverty which may make some
people unable to pay for basic necessities of life, government programs like national defense or

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 education, discrimination in labor markets, and buyers and sellers who must deal with imperfect
and unclear information.

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