ASSUMPTION COLLEGE OF NABUNTURAN

Nabunturan, Compostela Valley

Basic Microeconomics

Principles of Microeconomics.

Part I – Economics: an overview

- Economics deals with the allocation of scarce resources to satisfy the unlimited wants and needs
of people.
- is a social science that studies the production, distribution, consumption, and exchange of goods
and services.
- The word economy or economics comes from the two Greek words “oikos”, which means
household, and “nomos” which means to manage or to rule. Thus, economics is about managing
a household, or the bigger household which is the economy of a country.

Economics as a field of study integrates the knowledge on knowing:

Scarcity – an economic concept that disposes of the reality of “Lack”.
Trade-off – an encounter of man where two or more options are of equal importance.
Rational Choice – man’s attitude to choosing an option that generates the highest utility among
options. Theoretically, the benefits received is greater than the cost incurred.
Opportunity cost – in choosing one option, the option not chosen is known as the opportunity
cost.

Example: In management, challenged on how to allocate its scarce resources (money). Options: Hire
technical people or acquire updated machinery. Send its people to training or renovation of the building.

Common terminologies in economics:

Assumption – principle that economists use to simplify reality and make the world easier to understand.
One important assumption used in economics is “ceteris paribus” or “all other things should remain
constant”. It helps us simplify reality to the relationship we are interested in.

Variable – a measure that can change from time to time and from observation to observation. E.g. price,
income, inflation, GNP, GDP.

Theory is a statement or a set of related statements about cause and effect, action and reaction.

Model – a formal statement of theory. Usually, a mathematical statement of a presumed relationship

between two or more variables

USES OF ECONOMICS

To learn a new way of thinking – the cost and benefit thinking

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 a. Scarcity is the natural limitation of resources that nature and previous generations have
provided.
b. Opportunity cost, the cost or value of the next best alternative or choice.
- That which we forego or give up when we make a decision or a choice
- No such thing as a free meal
c. Marginalism – in weighing the cost and benefit of a decision, it is important to weigh only
the cost and benefit that arises from the decision.

1. Having a basic knowledge of economics, individual canto;

- Manage personal lives

- Design better government policies
- Manage personal and family finances
- Comes up with sound business policies and decision
- Gives understanding on key national issues and how to deal with it

Two distinct roles of economics in promoting and understanding national issues – central to the field of
economics

1. It helps describe, explain, and predict economic behavior. Example, it helps people understand
the causes of poverty. This descriptive aspect is known as positive economics which describes
facts and behavior of the economy. It is concerned with “the way things are”.
2. Prescribes or offers value judgment for economic problems. This prescriptive aspect is known as
normative economics. It considers deeply held values or moral judgment. There are no correct
or wrong answers to this approach and can only be resolved by a political decision. It is
concerned with “what ought to be”.

Division of Economics

Microeconomics – an economic behavior that deals on the individual units of the society. Firms,
consumers, and owners of the factors of production are some of examplesmple. Microeconomic
fundamentals are base the market and price theories.

Macroeconomics – an economic behavior that deals with the whole economy or the aggregates
such as the government, busine,ss and household. The aggregate is composed of individual units; it
provides a profile of the economy. Macroeconomic Fundamentals are balance inflation, harmonious
institution, and strong infrastructure development.

The basic economic problems

1. What to produce and how much – it is the determination of the goods and services needed by
the people, and in deciding what goods to produce that will compromise with the society’s
inputs of production.
2. How to produce – it deals on the efficiency of one’s technology, that is, technology refers to the
very method of production.

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 3. For whom – it is all about on the mechanisms of distribution and identify who in the economy
should benefit with the goods and services produce by the economy.

The Economic systems

Plans and decisions among countries varies, this mechanism is based on the present economic
system employed among these countries.

An economic system is a set of economic institutions that dominate a given economy. Designed
to provide goods and services to the people in a most efficient and equitable manner.

1. Capitalism – known also as a market economy, and laissez – faire. Individuals and firms pursue
their self - interest without intervention from the government.
2. Communism – known also as a command economy and a system with the presence of central
planning, where the mechanism of allocation is performed by the government or planning
agency. With the combination of government ownership of enterprises and central planning the
government dictates the direction of the economy.
3. Socialism – a combination of capitalism and socialism where the major or strategic industries are
owned by the government while minor industries are owned and managed by private
individuals and firms.
4. Mixed economy – a regulated market economy. The government plays a vital role in the
economy while allowing the market mechanism to govern the economy. The Philippines is an
example of a mixed type system, known as a socialist – capitalist economy.

What is an Effective Economic System?

Economic systems are basically intended for the good of the people and society, however, there
are vital indicators that determines an effective economic system;

Abundance – how much of the available goods and services is received by the members of the society,
and enjoyed.

Growth – Tangible is nature, refers to the physical development of a society.

Stability - absence of inflation and absence of unemployment

Security – refers to the protection a system can extend to its people.

Efficiency – simply means productivity. How cost is minimized with the manipulation on the inputs of
production.

Justice and equity – how vital is equity in the society? Conforming with the absence of gap between the
rich and the poor. Justice reflects fairness.

Economic freedom

Social Justice – the Ultimate Goal of Economics

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THE MARKET MECHANISM

- Market is a mechanism by which the buyers and sellers interact to determine both price and
quantity of goods and services

Demand, supply and price determination

Demand is a market expression, presented as a schedule of various quantities where buyers are willing
to purchase goods and services in a given price, time, and place.

Demand schedule – is a table that shows the relationship between price and quantity.

Demand schedule for Balut

Price Quantity
demanded
5 6
10 4
15 2

Demand Curve – a graphical representation of the demand schedule. It shows the mathematical
relationship between price and quantity demanded which is inversely proportional.

Price 15

10

2 4 8 qd

The law of Demand

- With all other things remains constant (ceteris paribus), when price increases, quantity
demanded decreases, when price decreases, quantity demanded increases.
- Demand function – is a mathematical expression of the law of demand; Qd = a – bp

Exemptions to the law of demand:

1. Giffen goods – a theoretical good, when price increases demand also increases.
2. Snob goods – when lot of people buy the good, its demand dies down

Factors of demand

- Change in income
- Population
- Taste and preferences

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 - Prices of related goods
- Price expectation

Application of the law of demand:

1. Price – it leads to the change in quantity demanded, causes a movement along the curve.
2. Non price – leads to the change in demand, causes a change in the whole demand schedule and
curve. As the demand curve shift to the right, demand increases and as the curve shifts to the
left, demand decreases due to the change created by the factors of demand.

Supply – is a market expression among sellers, a schedule of various quantities where sellers are more
willing to offer goods and services given the price, time, and place.

Supply schedule – is a table that shows the relationship between price and quantity supplied.

Price Quantity
supplied
5 8
10 4
15 2

Supply curve – is a graphical representation that shows the quantity suppliers are willing to offer given
the price of the said quantity, all other things should remain constant (ceteris paribus)

Price 15

10

2 4 8 Qs

Law of supply
- Ceteris paribus, as price increases quantity supplied increases and as price decreases quantity
supplied decreases, price and quantity supplied is directly proportional.

Supply function is a mathematical expression of the law of supply; Qs = a + bp.

Factors of supply
- Technology
- Cost of production
- Price expectation
- Prices of other goods

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 - Taxes and subsidies
- Number of sellers

Application to the law of supply

- Price – leads to the change in quantity supplied, causes a movement along the supply curve
- Non – price – leads to the change in supply, causes a shift in the supply curve. Right shift means
an increase in supply, left shift means a decrease in supply.

Market Equilibrium
- Is market condition where there is agreement between and among buyers and sellers.
- It is the point of intersection between the demand curve and the supply curve.
- Market disequilibrium happens when;
1. When quantity demanded is higher than the quantity supplied, known as shortage.
2. When quantity demanded is lesser than the quantity supplied, known as surplus

Price determination
- In the market mechanism, price is determined by the interplay of supply and demand.
- The behavior of the household (demand) and the firm (supply) depends on the price.
Thus:

Price is high when there is more demand than supply;

Price is low when there is more supply than demand;
Price is constant (equilibrium) when demand equals supply.
Ceteris paribus

Elasticity and Consumer Behavior

GENERAL ELABORATION

- The law of demand states that “buyers are more willing to purchase goods and services when
prices are low and tends to decrease it purchases when price goes up”. These are natural
reactions or inclinations of buyers given all things are held constant.
- However, these inclinations vary depending on the importance and availability of the goods and
services.
- This varying reaction of buyers is known as the demand elasticity.
- On the suppliers side “they are more willing to produce goods and services when prices are high
and tends to minimize production when prices go down”
- This reaction among sellers is known as Supply elasticity.

DEMAND ELASTICITY

- Refers to the reaction of buyers to the change in price of goods and services.
- This reaction is based on the very nature of the product or service (important / not so
important) and its availability (substitutes / complements).

Types of Demand Elasticity

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 Types On reaction to price Degree of importance Mathematical
change coefficient
ELASTIC DEMAND - Changes in price
results to a
greater change in
the quantity Though it can give >1 (greater than 1)
demanded comfort and pleasure, - Buyer’s reaction
- Buyers are very it is not that very is high compared
sensitive to price important among to the change in
change and are buyers. Example; the price.
easily television set, - A 5% increase in
discourage, branded clothing the price may
though the lines, etc. result to 50%
product can decrease on the
directly give quantity
comfort and demanded and
pleasure vice versa.
- Buyers can easily
find a substitute
of the said
commodity.
INELASTIC DEMAND - Changes in price
results into a
minimal reaction
among buyers in <1 (less than 1)
the purchase of - A 25% increase
commodities Very important. These in the price will
- These are are products that result to a 5%
products that buyers can’t live decrease in
buyers still without. Example; rice quantity
purchase even if and other market demanded and
price increases commodities that we vice versa.
but when price consume every day.
decreases,
buyer’s
purchases little
quantity since
they cannot take
advantage
because most of
the inelastic
products are
perishable.
UNITARY DEMAND - There is an equal
change in price
and quantity Either important or =1
demanded. not so important - A 25% increase

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 - This type of in price results
demand into a 25%
elasticity can be decrease in
traced based on quantity
market incidents. demanded
PERFECTLY ELASTIC - Without change
DEMAND in price, there is Product of this type
an infinite
change in the
falls in the category
under a purely
∞
- This shows that
quantity competitive market.
even without
demanded
the change in
the price
commodity,
quantity
purchases
changes
infinitely.

PERFECTLY INELASTIC A change in price will

DEMAND result to a no change in Extreme importance 0
quantity demanded for this involve life - No reaction
and death among buyers
even price
changes.
A cancer patient
who needs
chemotherapy will
demand an exact
amount even if its
price increases by as
much as 1 million
per session or 1
peso.

DETERMINANTS OF DEMAND ELASTICITY

1. Number of Goods Substitute - commodities are highly elastic when it has many goods
substitute and Inelastic if it has no substitute or minimal.
2. Price Increase in proportion to income – any changes in price based on how consumers respond.
A minimal increase of price and yet buyers are sensitive enough not have it is elastic, and those
commodity that increases large amount and still buyers purchase the commodity, then it is
inelastic

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 3. Importance of the product to the commodity – refer to the table.

ECONOMIC SIGNIFICANCE OF DEMAND ELASTICITY

- Demand elasticity concept is not just a theoretical exercise but has a bearing of understanding
towards business and government, via the formulation policies.
- With good knowledge of the concept will help businessmen in planning pricing strategies and
the government in terms of formulating appropriate tax measures.
- The market price of a product influences wages, rents, interests, and profits.

With the right pricing strategy, businessmen may attain the following goals;

1. Achieve target return on investment

2. Maintain or improve a share in the market
3. Meet or prevent competition
4. Maximize profit

Economic Significance of demand elasticity: practical examples

1. Wage determination
2. Farm Production Guide
3. Maximize profits
4. Imposition of sales tax

ELASTICITY OF SUPPLY

- Refers to the reaction of sellers to price change.

- The ability of producers to respond to price change depends on the very nature of the product
in itself, for example manufactured products can easily be produce based on the increases of
price and holds its production if the price goes down. On the one hand, producers of agricultural
products find it difficult to respond to price changes due to the cropping season. A copra farmer
cannot harvest its young coconut due to an increase in the price of copra and cannot hold it if
the price decreases.

Types of Supply Elasticity

1. Elastic Supply – a change in price results to a greater change in quantity supplied. 5% increase in
the price may lead to a 30% increase in the quantity supplied. This explains as to how responsive
the sellers are towards price change. Products under this type are those which can be produce
overtime by manufacturing firms.
2. Inelastic Supply – A change in price results to a lesser change in the quantity supplied. 25%
increase in the price will only yield to a 10% increase in the quantity supplied. Products under
this are seasonal crops that yields in a long period of time
3. Unitary Supply – a change in price results to an equal change in the quantity supplied.

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 4. Perfectly Elastic Supply – without change in price, there is an infinite change in quantity
supplied. This occur when economic players are given with no other choice, example, the supply
of labor increases every year this situation happens almost every year yet the price of labor
(salary / wages) stays virtually the same.
5. Perfectly Inelastic Supply – a change in price result to a no change in the quantity supplied. This
category involves commodities that are fixed such as, Land, and other commodities sold in a
fixed volume or weight.

Determinant of Supply Elasticity

Time is considered as the only determinant of the concept but being sub divided into three ideas;

1. Storage Life
2. Season / Weather
3. Ability to respond among producers

Elasticity Concept: An Application

Formula; (change in quantity / based quantity) / (change in price / based price)

(Q2 – Q1/Q) / (P2 – P1 / P) note: normally your based quantity and price is the Q 1 and P1, respectively.

Example:

2010 2011
Price 15.25 18.75

Quantity 1260 1195

Other forms of elasticity:

1. Income Elasticity – this measure the responsiveness of buyers to change in income.

Category of Income elasticity:

Normal Goods – buyers tend to increase its purchases as income increases and vice versa.
Inferior Goods – these are those goods that even the income of the buyer increases, the quantity
purchases are low or none at all.

2. Cross elasticity – this refer to the commodities that can be used in exchange over the other
(substitute) or the utility of one commodity is based on the presence of the other (complement).

Category of Cross Elasticity:

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Substitute – these are commodities of which as price of good 1 increases, the quantity demanded for
good 2 increases also, and vice versa

Complement – these are commodities of which as price of good 1 increases, the quantity demanded for
good 2 decreases, and vice versa.

Consumption Economics

The fundamental notion that consumers must make choices due to scarcity is the epitome of analyzing
how economics work. Thus, consumption economics is a discipline where consumers maximize utility
given the constraint.

There are two approaches of which economists employ in examining consumption economics;

1. Traditional approach – utility Analysis

Utility – means a “measured satisfaction”. The existing law governing utility is the Law of diminishing
Marginal Utility. Technically, utility is a term used by economists to refer on the satisfaction consumer
gets in the consumption of goods and services.

The Law of diminishing marginal utility

- This theory of utility states that “as an individual consumes more of the same good total utility
increases, but at a decreasing rate because marginal utility diminishes.
- It shows the fundamental assumption that as Juan eats a cone of ice cream his satisfaction
increases, as more ice cream is consumed Juan’s total utility increases, but every additional ice
cream consumed by Juan may likely to decrease its utils.

Assumption affecting thereto;

Total Utility – is the total satisfaction consumers get from consuming any given quantity of a good.

Marginal utility – is the additional satisfaction an individual gets from consuming an additional unit or
additional quantity of a good or service.

Utils – is the arbitrary unit used to measure satisfaction.

Modern Approach: indifference curve

The approach in analyzing consumer behavior in choosing a combination of two goods in order
to attain maximum utility is referred to as indifference curve analysis. An indifference curve is a graph of
various combinations of goods which yield exactly the same level of satisfaction.
Indifference curves are negatively slope because for a consumer to be indifferent, all points on
the curve must represent equal amounts of utility. If more of a good is added to the combination, some
of the other good must be given, termed as the Marginal Rate of Substitution, the percentage of the
goods given up over the goods gained.
A series of indifference curve is the indifference map, as the curve is placed at the right the
higher the utility and as the indifference curve goes to the left, the lower the utility.

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The budget line and the equilibrium of the consumer

The budget line is the combination of goods and services an individual is willing to have given
the budget or income.

When the indifference curve is placed outside the budget line, consumers cannot choose it for it
is not within the constraint, or is beyond the budget. And as the indifference curve is placed inside the
budget line, consumer can purchase the combination of goods but with a lower utility.

Thus, the point of which the budget line is tangent to the indifference curve is known as the
equilibrium of the consumer.

Production Economics

Production is defined as the transformation of inputs into output. Inputs refer to the factors of
production; Land, Labor, Capital, and the Entrepreneur. Outputs are the goods and services produced
over a given period of time.

Production function is a relationship between the amount of inputs required and the amount of
output that can be obtained or produced using such input. Important to the concept of the production
function are the fixed input and variable input.

- Fixed input – are factors of production that cannot be varied or do not change whether there is
production or none. E.g. Land and Capital.
- Variable Input – are factors of production that varies or can change regardless on the volume of
production. E.g. Labor and entrepreneur.

The consistent idea on the study of production is the theory known as the law of diminishing returns
that states “as more variable input is added to a fixed input, total productivity increases but at a
decreasing rate because marginal productivity diminishes.

Assumptions that support the theory:

- Space
- Capital capability
- Behavior

Market Structures and the Price – output determination

Market structures are theoretical frameworks for existing firms and industries in the real world.

Models:
1. Pure Competition – there are many independent sellers, selling identical or similar commodity,
free – enterprise thus, nobody controls the price. Sellers are said to be price takers

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 2. Monopoly – there is only one seller offering unique commodity, price is determined by the
seller.
3. Oligopoly – is a market where few sellers are offering identical or differentiated products but
dominates the economy. Firms under these can either collude/collusive and/or non – collusive.
4. Monopolistic competition – involves few sellers supplying the market with different types of
brands of the same product and capturing specific group of buyers for a particular brand of
product.
5. Monopsony – is the reverse of monopoly. There is only one buyer for a particular good or
service.

Macroeconomics

Circular flow diagram of economic activities – a visual mode of how the economy works as a whole

Measuring growth: national income account

Gross National Product (GNP)

- The total market value of all the goods and services produced by a nation in a given period of
time (quarter, semestral, annual)

Gross domestic product

- Measures the total market value of all the goods and services produced in a country

Approaches to measuring the GDP

1. Expenditures Approach – adding up all the value of all final goods and services spent during a
given period

Consumption (C) + Investment (I) + Government Spending (GS) + Net Export (x-m) = National Income (NI)

National Income – total earnings of the factors of production owned by its citizens or by the total market
value of all final goods and services produced by its citizens.

NI + Indirect Taxes + Depreciation = GNP

2. Product or Expenditures Approach

Household consumption expenditures

+ Government purchases of goods and services
+ Gross domestic investment of business firms
+ net exports
______________________________

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Gross National Product
- Depreciation (capital consumption allowance)
- Net National Product
- Indirect Business Taxes
_________________________________
National Income

3. Industry Origin Approach

Agriculture, fishery, and forestry

+ Industry (mining, manufacturing, construction, electricity, gas and water)
+ Service sector (transportation, trade, finance, service)
________________________________
Gross Domestic Product
+ Factor income from the rest of the world = Gross National Product

The Business Cycle, inflation and unemployment

- Refers to the fluctuations in the economy.

1. Prosperity – peak of the business cycle

2. Recession – Both production and consumption fall
3. Depression – Both production and consumption are at their lowest levels
4. Recovery – both production and consumption rises towards full employment

Inflation – is the general rising of the price level.

Types of Inflation
1. Demand – pull Inflation
2. Cost – Push Inflation
3. Structural Inflation

Effect of Inflation
1. Decrease in the value of money
2. Inflation losers; fixed salary and retirees, creditors and savers
3. Inflation gainers; speculators, people with flexible income, debtors

Government role in combating inflation and unemployment;

1. Fiscal policy – refers to the revenue and expenditure measures of the public budget. Fiscal policy
can either be Investment based, this is when the government decreases the tax and increases
government spending known as Pump priming or Savings based, where the government
increases the tax and decreases government spending.
2. Monetary Policy – consist of action from the central bank to influence money supply or interest
rates in an attempt to stabilize the economy. Expansionary Monetary Policy is applied when CB
increases the volume of money or decreases the interest rate to promote spending and
investment, Contractionary monetary policy puts decreases the volume of money by increasing
the interest rate to promote savings.

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Unemployment
Types of unemployment
1. Frictional unemployment
2. Structural unemployment
3. Cyclical unemployment
4. Seasonal unemployment

Taxation
- It is an inherent power of the state to impose and collect revenues to defray the necessary
expenses of the government.
- It is compulsory contribution imposed by a public authority irrespective of the amount of
services rendered to the payer in return.
- It is compulsory level on private individuals and organization by the government to rise revenue
to finance expenditure on public goods and services.
Purposes of taxation
- Collect revenue for the government - create a sense of identity
- Redistribute income - reallocate resources
- Correct an adverse balance of payment - check consumption considered undesirable
- Protect local / infant industry - influence population trend
Sources and Origin of taxation
- Statutes or presidential decree
- BIR regulation
- Provincial, Municipal and Barangay ordinances
- Observance of international agreement
- Administrative ruling and opinion
- The constitution
- Judicial Decisions
Object of Taxation
- Persons – whether natural or judicial - property of any kind
- Transactions, interests, and privileges
Classification of tax system
- Progressive – the higher the income the higher the tax
- Proportional – the tax rate is constant and unaffected by the level of income
- Regressive tax – the higher the income the lower the tax rate
Classification of taxes
As to who bears the burden
- Direct tax
The burden cannot be shifted
Based on income and wealth

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