Chapter 1

ECONOMIC
WAY OF
THINKING
Teacher
Welcome,
students!
ECONOMIC WAY OF THINKING
WEALTH OF THE
SC
NATIONS RE AR
SO CE
UR
CE
S
ECONOMICS:
ADAM
SCARCITY
SMITH
SCARCITY

- is the basic and central economic problem confronting every

society. It is the heart of the study of economics and the reason
behind its establishment.
 Authours have defined scarcity in various ways- some of which are complexly stated.
One author defines scarcity as a commodity or service being in short supply, relative to
its demand. (Kapur 1997) which implies a constant availability of a commodity or
economic resource relstive to the demand for them.

In quantitative terms, scarcity is said to exist when at a zero price there is a unit of
demand, which exceeds the available supply (Kapur 1997). Simply put scarcity pertains to
the limited availability of economic resources relative to society's unlimited demand for
goods and services.
 Since human wants and needs are unlimited and the available resources are finite, scarcity
naturally result leaving the socirty with the problem of resource allocation

Figure 1.1: Problem of Scarcity

Limited Resources Unlimited Wants

SCARCITY

This figure illustrates the interaction of limited resources available and the inlimited wants of the society. If
limited resources fall short to meet the unlimited wants of the society, it will eventually create a problem ,
which is called, "scarcity".
 ECONOMICS
Economics is a science that deals with the management of scarce resources. It is also describe as
a scientific study on how individuals and the society generally make choices (Fajardo 1977).
Specifically, It is the study of the problem of using available economic resources as efficiently as
possible so as to attain the maximum fulfillment of society's unlimited demand for goods and
series. As Slavin (2005) puts it, economics is simply scarcity and choice.

It should be noted that individuals and groups within the society have innumerable wants, and
to satisfy this wants, there are available resources that can be utilized. However, since these
resources are finite, they are not freely available. Economics steps in to assist individuals and
societies in making proper choices - that is, the allocation and itilization of economic resources,
with the end in view of satisfying human wants for goods and services.
Figure 1.2: Economics

Limited Resources Unlimited Wants

Allocation

This figure depicts the relationship between available limited resurces and the unlimited wants of the
society. This shows that when limited resources fail to meet the unlimited wants of the society,
economics comes into play in order to effectively and efficiently allocate resources.
 What is the relationship between
Economics and Scarcity?
The problem of scarcity gave birth to the
study of economics. Their relationship is
such thet if there is no scarcity, there is
no need for economics. The study of
economics was essentially founded in
order to address the issue of resource
allocation and distribution, in response
to scarcity.
Origin of the term "economics"
The two Greek roots of the word
economics are oikos - meaning
household - and nomus - meaning
system or management. Oikonomia or
oikonomus therefore means the
"management of household."
 With the groeth of the Greek society until its developement into city-
states, the word became known or was reffered to as "state management".
Consequently, the term, "management of household" now pertains to the
microeconomic branch of economics, while the phrase "state
management" presently refers to the macroeconomics branch of
economics (Fajardo 1977). Because of its far reaching significance, in the
early years, economics covered other scholarly fields, such as religion,
philosophy, and political science.
 Ceteris Paribus Assumption
The assumption of "Ceteris Paribus" is important in studying
ecoomics. Ceteris Paribus means "all other things held constant
or else equal." This assumption is used as a device to analyze the
relationship between two (2) variables while the other factors are
held unchanged. It is widely used in economics as an exploratory
technique as it allows economists to isolate the relationship
bwetween two (2) variables.
BRIEF HISTORY: The
Classical, Keynesian, and
Modern Economics
 Birth of Economic Theory: Classical
Economics
Economic theory saw its birth during the mid 1700s and 1800s. During this era, two important
economists emerged. First is Adam Smitb of Scotland. He is considered the most important
personality in the history of economics-being regarded as the "Father of Economics He was
responsible for the recognition of economics as a separate body of knowledge. His book, wealth of
the Nations published in 1776. became known as the role in economics for a hundred years (Fajardo
1977 contributions was his analysis of the relationshine consumers and producers through de ears
(Fajardo 1977). One of his major Adam Smith, 1723-1790 producers through demand and supply, tely
explained how the market works through the invisible hand.
 Birth of Economic Theory: Classical
Economics
John Stuart Mill was the heir to David Ricardo, who developed the basic analysis of
the politicat economy or the importance of a state's role in its national economy.
The term political economy is an older English term that applies management to an
entire polis (state). Moreover, Karl Marx, a German, also emerged during this
period. He is much influenced by the conditions brought about by the industrial
revolution upon the working classes. His major work, Das Kapital, is the
centerpiece from which major socialist thought was to emerge (Sicat 1983).
 NEOCLASSICAL (1870s)

Neoclassical Economics was believed to have transpered around the year 1870. Its
main concern was market system efficiencies. It brought recognition to the
economists Leon Walras, who introduced the general economic system, and Alfred
Marshall, who became the most influential economist during that time because of his
book Principles in Economics. Leon Walras developed the analysis of equilibrium in
several markets. On the other hand, Alfred Marshall developed the analysis of
equilibrium of a particular market and the concept of "marginalism" (Sical 1983)
 Keynes' General Theory of Employment,
Interest and Money
John Maynard Keynes is in English economist who offered an explanation of
mass unemployment and suggestions for government policy to cure
unemployment in his influential book: The General Theory of Employment
Interest and Money (1936). Keynes concern about the extent and duration of the
worldwide interwar depression led him to look for other explanations of
recession. (Pass & Lowes 1993). Keynes argued that classical political economists
were concerned with the relative shares in national output of the different factors
of production, rather than the forces which determine the level of general
economic activity, so that their theories of value and distribution related only to
the special case of full employment.
John Maynard Keynes, 1883-1946
 Keynes' General Theory of Employment,
Interest and Money
Concentrating upon the economic aggregates of National Income, Consumption, Savings, and
Investment, Keynes provided a general theory for explaining the level of economic activity. He argued
that there is no assurance that savings would accumulate during a depression and depress interest rates,
since John Maynard Keynes savings depend on income and with high unemployment 1883-1946 incomes
are low. Furthermore, he argues that investment depends primarily on busine confidence which would
be low during a depression so the investment would be unlikely to rise even if interest rate fell. Finally,
he argues that the wa rate would be unlikely to fall much during a depression given its 'stickinese and
even if it did fall, this would merely exacerbate the depression by reducing consumption
 Non-Warlasian Economics (1939)

During the Non-Walrasian Era, John Hicks was recognized for his analysis of the IS-
LM model, which is considered as an important macroeconomic model. Is refers to
the goods market for a given interest rate, while LM means money market for a given
value of aggregate output or income. The IS-LM model is a theoretical construct that
integrates the real, IS (Investmentsaving), and the monetary, LM (demand for, and
supply for money), sides of the economy simultaneously to present a determinate
general equilibrium position for the economy as a whole (Pass & Lowes 1993).
Post-Keynesian Economics (1940 and 1950s)

After World War II, the Post-Keynesian Period saw the development of rules and regulations of
different private and public institutions. This period introduced major post-Keynesian,
neoclassical economists, whose views are known as the post-Keynesian "mainstream
economics". This period welcomed various economists like Paul A. Samuelson, Kenneth J.
Arrow, James Tobin and Lawrence Klein, to mention some recognized leaders and others are
Joan Robinson; and Michael Kolechi. Another stream of thought was introduced by liberal
market post-Keynesians, mainly the monetarists, led by Milton Friedman. (Sicat 1983)
 New Classical Economics

New Classical Economics highlighted the importance of

adherence to national expectations hypothesis and analysis,
which included various economic phenomena in formulating
different kinds of studies and new theories in economics. This
development in economics is applicable to concerns of
developing countries, and was largely an outcome of concern
for the growth of developed.
David Ricardo, 1772-1823
POSITIVE AND
NORMATIVE
ECONOMICS
 Positive economics is an economic
Positive
analysis that considers economic
Economics condition "as they are", or considers
economic "as it is". It uses objective
or scientific explanation in
analyzing the different transactions
in the economy. It simply answer
the question 'what is'.
Examples of positive statements:
The economy is The economy is now on a slowdown
now experiencing a because the world is experiencing a
slowdown because financial and economic crisis. Other
of too much reasons are also due to the financial
politicking and problem of the US, increase on the
corruption in the prices of crude oil and lack of
governent. investors or capital deficiency.
 On the other hand, normative economics is
Normative economic analysis which judges economic
conditions "as it should be". It is that aspect of
Economics economics that is concerned with human welfare.
It deals with ethics, personal value judgements,
and obligations analyzing economic phenomena
(Kapur 1997). It answers the question "what
should be". It is also referred to as policy
economics because it deals with the formulation
of policies to regulate economic activities.
Examples of normative statements:
The Philippine
In order to minimize the lash of
government should
global recession, the Philippine
initiate political reforms
government should release a
in order to regain investor
stimulus package geared towards
confidence, and
encouraging economic
consequently uplift the
productivity.
economy.
Four Basic Ecnomic Questions

What to How to
produce? produce?

How much to For whom to

produce? produce?
 An economy must identify what are the commodities needed
to be produced for the utilization of the society in everyday
life. A society must also take into account the resources that it
possesses before deciding what goods or services to produce.

For example, an island nation, blessed with agricultural

What to resources, and which does not possess advanced technology

should not opt to produce space shuttles or satellites because
its resources are incapable of producing these outputs.

produce? However, it can take advantage of its natural resources and it

can produce agricultural goods and tourism services.

In a market economy, what gets produced in the society is

driven by prices. Resources are allocated to the production of
goods and services that have high prices and low input prices
relative to one another.
 There is a need to identify the different methods and techniques in
order to produce commodities. The society must determin whether
to employ labor intensive production or capital intensive production.

Labor intensive production uses more of te human resource or

manual labor in producing goods and services than capital resources.
This kind of production is advisable to a society with large poulation.
In countries where labor resources are abundant, the cost of labor is
usually cheap, for instance the Philippines an Vietnam. Goods are
How to
product by employing more of cheaper resources and less of more
expensive inputs.
produce?
On the other hand, capital intensive production employs more
technology and capital goods like machineries and equipment in
produsing goods and services than labor resources. This type of
production should be utilized by countries with high level of capital
stock and technology , and with scarce labor resources, like Japan,
Germany, and the USA.
 This identifies the number of commodities
needed to be produced in order to answer
the demand of the society. The optimum
How much amount of production must be
approximated by producers.
to produce? Underproduction will result to a failure to
meet the needs and wants of the society. On
the other hand, overproduction results to
excess goods and services going to waste.
This question identifies the people or sectors
who demand the commodities produced in a
society. Economists must determine the
"target market" of the goods and services
which are to be produced to understand For whom to
their consumption behaviors and patterns.
An understanding of these result to higher
sales of goods, and ultimately to increased
produce?
profits. For those who can pay the highest
price is for whom goods and services are
produced.
 RELATIONSHIP OF ECONOMICS TO
OTHER SCIENCES
Economics is considered he "queen" of all socia;l sciences because it covers almost
every activity of man in relation to the society. Because of its multifarious
applications, various sciences are closely related to the study of economics.
 BUSINESS MANAGEMENT
Business basically provides employment opportunities to member
of the society, and is an imprtnat vehicle in the balance of economic
activity. Its relation to the study of economics is evident in
analyzing microeconomic and macroeconomic behavior.
 HISTORY
The history of economic ieas provides information regarding
theories that can be revisited in order to evaluate present and future
economic issues.
 FINANCE
Finance is defined as the management of
money credit banking and investment. It
is a system that includes the circulation
of money, the granting of credits, making
investments, and the provision of
banking facilities. Money and Finance
are important in the study of economics.
PHYSICS
Innovations and output brought about by
physics greatly affect the study of
economics. A country's economic activity
speeds up through inventions and
Technological advancements in energy,
transportation, and communication. These
new creations and discoveries help society
to make day-to-day activity easier and
more accessible.
 SOCIOLOGY
Sociology is the study of the behavior of
societies. In relation to sociology,
economics essentially deals with the
behavior of economic subjects. For
instance, macroeconomics examines the
behavior of the aggregates of the
economy.
PSYCHOLOGY
Psychology is the study of the behavior
of man. Psychology is primarily useful
in the study of microeconomics, which
scrutinizes and focuses on the smallest
units of the economy. Microeconomics
also seeks to understand the decision-
making of individuals.
 IMPORTANCE OF STUDYING
ECONOMICS
In order to fully understand economics, its importance and
practical use in everyday life must be appreciated.
 TO UNDERSTAND THE SOCIETY

Economics seeks to analyze transactions made by the society and its

members, particularly with regard to details on the behavior and
decision making (Case, 2003)
 TO UNDERSTAND GLOBAL AFFAIRS
Economics seeks to explain the internal operation and trade
policies of countries. It also measures the competitiveness of each
country and identifies its comparative advantage in relation to other
states (Case 2003).
 TO BE AN INFORMED VOTER
An understanding of economics develops individuals to be wise voters.
Knowledge of economics provides individuals with an understanding
of economic policies that are apt for the state's current situation. With
this in mind, voters have an informed choice in selecting leaders based
on their economic, social and political platform, rather than on their
apparent popularity. (Case 2003)
 Efficiency refers to productivity and proper
allocation of economic resources. It also refers to
the relationship between scarce factor inputs and
outputs of goods and services. This relationship can
be measured in physical terms (technological
efficiency) or cost terms (economic efficiency).
3 Es IN (Pass & Lowes 1993) Being efficient in the
production and allocation of goods and services
ECONOMICS saves time, money, and increases a company's
output. For instance, in the production of
commodities, firms utilizing modern technology can
improve the quantity and quality of products, which
ultimately translates into an increase in revenue and
profit.
 Equity means justice and fairness. Thus,
while technological advancement may
increase production, it can also bear
disadvantages to the employment of 3 Es IN
workers. Due to the presence of new
equipment and machinery, manual labor ECONOMICS
may not be necessary, and this can result in
the retrenchment or displacement of
workers.
 Effectiveness means the attainment of goals
and objectives. Economics is an important
and functional tool that can be utilized by
3 Es IN other fields. For instance, with the use of
both productions (through manual labor or
ECONOMICS through technological advancements)
whatever the output is, it will be useful for
the consumption of society and the rest of
the world.
IMPORTANT ECONOMIC TERMS

Economics has its own unique language. Thus, for a

student to truly understand the different concepts
and theories in economics, an understanding of these
terms should first be achieved.
 WEALTH

Refers to anything that has a functional value (usually in money),

which can be traded for goods and services. Wealth, therefore. is the
stock of net assets owned by individuals or households. In aggregate
terms, one widely used measure of the nation's total stock of wealth is
that of the 'marketable wealth,' that is, physical and financial assets
which are in the main relatively liquid. (Pass &Lowes, 1993)
 CONSUMPTION

This refers to the direct utilization or usage of the available goods and
services by the buyer or the consumer sector. It is also the satisfaction
obtained by consumers for the use of goods and services. (Pass &
Lowes 1993)
 PRODUCTION

It is defined as the formation by firms of an output (products or

services). It is the combination of land, labor, and capital in order to
produce outputs of goods and services.
 EXCHANGE

This is the process of trading goods and/or their equivalents. It also

includes the buying of goods and services either in the form of barter or
through the market.
 DISTRIBUTION

This is the process of allocating or apportioning scarce resources to be

utilized by the household, the business sector, and the rest of the
world. In specific terms, however, it refers to the process of storing and
moving products to customers often through intermediaries such as
wholesalers and retailers. (Pass & Lowes, 1993)
 DISTRIBUTION

This is the process of allocating or apportioning scarce resources to be

utilized by the household, the business sector, and the rest of the
world. In specific terms, however, it refers to the process of storing and
moving products to customers often through intermediaries such as
wholesalers and retailers. (Pass & Lowes, 1993)
 MICROECONOMICS AND
MACROECONOMICS

Economics has two major branches of study: one is concerned with

individual decision making: and the other is involved in understanding
the behavior of the society as a whole.
 MICROECONOMICS

This is the branch of economics which deals with the individual

decisions of unites of the economy--firms and households, and how
their choices determine relative prices of goods and factors of
production. The market is the central concept of microeconomics. It
focuses on its two main players--the buyer and the seller, and their
interaction with one another.
 Microeconomics operates on the level of the
individual business firm, as well as that of
MICRO- the individual consumer. It concerns how a
firm maximizes its profits, and how a
ECONOMICS consumer maximizes his/her satisfaction.
 MICROECONOMICS

Among the topics disucssed in microeconomics are the theories of

demand and supply, elasticity of demand and supply, individual
decision making, theories of production, output and cost of firms, a
firms profit maximization objective, different types of business
organizations, and kinds of market structures. (Case 2003)
 It is the branch of economics that studeis the
relationship among broad economic aggregates
like national income, national output, money
supply, bank deposits, total volumes of saving,
MACRO- investment, consupmtionm, expenditure,
general price level of commodities, government
ECONOMICS spending, inflation, recession, employment,
and money supply (Kapur 1997). The term
macro, in contrast to micro, implies that it
seeks to understand the behavior of the
economy as a whole.
 MACROECONOMICS

Macroeconomics focuses on the four specific sectors of the economy:

the behavior of the aggregate business (investment): the policies and
projects of the government (government spending); and the behavior of
external/foreign economic, agents, through trading (export and
import).
 MACROECONOMICS

Moreover. macroeconmics also discusses the measurement of gross

national product and gross domestic product, the business cycle, the
five macroeconmic goals. money and the economy, moentary and fiscal
policies, and economic growth and development.
The Concept of Opportunity Cost
Because people cannot have everything they want, they are forced to
make choices between several options. Oppurtunity cost refers to the
foregone value of the next althernative. It is the value of what is given-
up when one makes a choice. The thing thus given-up is called the
opportunity cost of one's choice.
The Concept of Opportunity Cost
When one makes choices, there is always an alternative that has to be given
up. A producer, who decides to produce shoes, gives up another goods that
he could have produced using the same resources. A student, who buys a
book with his limited allowance, gives up the chance of eating out or
watching movie.

Opportunity cost is expressed in relative price. This means that the price of
one item should be relative to the price of another.
 EXAMPLE

If the price of the Coke is P20.00 per bottle and one piece of cupcake is
P10.00 then the relative price of Coke is 2 pieces of cupcake. If a
consumer only has P20.00 and chooses to buy a bottle of Coke with it,
then we can say that the opportunity cost of that bottle of Coke was the
2 pieces of cupcake, assuming that the cupcake was the next best
alternative.
Figure 1.3 Opportunity Cost
Saving (Firm Individual)

Credit (Interest) Investment (Profit)

This figure illustrate the concept of opportunity cost. The savings of the
firm/individual is subject to two choices between credit and investment. If the savings
of the individual will be put on credit, there is possibility of earning interest or a bad
debt (not getting the money back), on the other hand, when savings of an individual is
invested, it may earn profit or may be subject to loss. With this in mind, what do you
think is the best choice or next best alternative?
 FACTORS OF PRODUCTION

There are four factors which serve as inputs in the production

processes. Specifically, there are: land, labor, capital, and
entrepreneurship. Below is a more comprehensive discussion of each
factor.
 LAND
The broadly refers to all natural resources, which are given by, and
found in nature, and are, therefore, not man made. It does not solely
mean the soil or the ground surface, but refers to all things and powers
that are given free to mankind by nature. In this sense, land comprises
all materials and things, tains, rivers, oceans, minerals, air, and
sunshine, light, etc. Land can sometimes be classified as fixed
resource. The compensation for use of land is called rent.
 LABOR
Labor is any form of human effort exerted in the production of goods
and services. Labor covers a wide range of skills, abilities, and
characteristics. It includes factory workers who are enganged in
manual work. It can also refer to an accountant, economist, nurse,
typrist, and other workers and proffesionals.

The supply of labor in country is a dependet on its population, and on

the percentage of the population that is willing to join the labor force.
Naturally, a country with a high population growth rate is expected to
come up with a bigger labor supply. The reward for labor rendered is
salary or wage
 CAPITAL
Capital is man-made goods used in the production of other goods and
services. It includes building, machinery, and other physical facilities
used in the production process.
A nation's capital stock is dependent on its level of saving. Saving refers
to that part of a person's income, which is not spent on consumptiuon.
The reduction of productive capacity of capital is called depreciation.
Then reward for the use of capital is called interest.
Money is not actually considered as capital in economics as it does not
produce a good or service but it is rather a form of asset that is used as
a medium of exchange.
 ENTREPRENEURSHIP
An entrepreneur is a person who organizes, manages and assumes the

risk of a firm, taking a new idea or a new product and turning it into a

successful business. Often times, the entrepreneur is not presented as a

separate factor of production, but is classified as part of labor.

However, since an entrepreneur performs a special type of work, it

should not be considered as part of labor.

 ENTREPRENEURSHIP

Etrepreneurs possess mangerial skills needed in building, operating

and expanding a business. He/she decides what combinations of land,

labor and capital are to be used in the production process.

Entrepreneurship is an economic good that commands a price

refferedt as profit or loss.

BASIC DECISION
PROBLEMS
 CONSUMPTION

Consumption is the basic decision problem that the consumers must

always deal with their day to day activities

 GROWTH OVER TIME
This is the last basic decision problem that a society or nation must

deal with, Societies continue to live on, They also grow in numbers. On

the one hard people have definite lives, but societies (or nations) have

longer, if not indefinite lives. All the problems of choice, consumption,

production, and distribution have to be the seen in the context of how

they will affect future events.

 PRODUCTION
The problem of production is generally a concern of producers. They

determine the needs, wants and demands of consumers, and decide

how to allocate their resources to meet these demands. Goods and

services may be produced by different methods of production,

depending on the firm's technological state, and on the available

resources within the society.

 DISTRIBUTION

The problem is primarily addressed to the government. There must be

proper allocation of all the resources for the benefit of the whole

society. In a market economy though absolute equality of every

member, as to the distribution of resources can never be achieved.

 GROWTH OVER TIME
This is the last basic decision problem that a society or nation must

deal with, Societies continue to live on, They also grow in numbers. On

the one hard people have definite lives, but societies (or nations) have

longer, if not indefinite lives. All the problems of choice, consumption,

production, and distribution have to be the seen in the context of how

they will affect future events.

TYPES OF ECONOMIC
SYSTEMS
 TRADITIONAL ECONOMY

Traditional economy is basically a substance economy. A family

produces goods only for own consumption. The decisions on what,

how, how much, and for whom to produce are made by the family head

in accordance with traditional means of production.

 COMMAND ECONOMY

Command economy is a type of economy wherein the manner of

production is dictated by the government. The government decides on

what, how, how much, and for whom to produce. It is an economic system

characterized by collective ownership of most resources, and the existence

of a central planning agency of the state in this system, all productive

enterprises are owned by the people and administered by the state

 MARKET ECONOMY
Market economy or capitalism's basic characteristic is that the resources

are privately owned, and the people themselves make the decisions. It is an

economic system wherein most economic decisions and the means of

production are made by the private owners. Under this economic system,

factors of production are owned and controlled by individuals, and people

are free to produce goods and services to meet the demand of consumers,

who in turn are also free to choose goods according to their own likes.
 SOCIALISM
Socialism is an economic system wherein key enterprises are owned by the

state, in this system private ownership is recognized. However, the state has

control over a large portion of capital assets, and is generally responsible

for the production and distribution of important goods. In a socialist

economy the main emphasis is on equitable distribution of income and

wealth. As such, it is considered as an economy bordering between

capitalism and communism.

 MIXED ECONOMY

This economy is a mixture of market system and command system. The

Philippine economy is described as a mixed economy since it applies a

mixture of three forms of decision-making. However, it is more oriented

rather than command or traditional.