Chapter 1

INTRODUCTION

LESSON 1
BASIC ECONOMIC CONCEPTS

OBJECTIVES:
1. To define economics.
2. To discuss the importance of economics.
3. To discuss why we study economics.
4. To identify the fundamental economic activities and factors of production.
5. To compare the divisions of economics.

A. Basic Terms
 Needs – basic requirements for survival like food, water, and shelter. In recent years, we
have seen a shift of certain items from wants to needs like telephone services, motor
vehicles, and education.
 Moslow’s Hierarchy of Needs

 Wants – the various desires of man that must be satisfied with goods and services. Wants
are defined as something that a person would like to possess; either immediately or at later
time. Wants are not as important as needs, because a person can live without wants.
 Goods – things (tangible or intangible) that are produced, sold, bought, and utilized which
satisfy a person’s needs and wants.
 Services – the efforts rendered by someone for a price such as haircuts, doctor’s visits, legal
consulting, etc. which also satisfy human needs and wants. Non-physical, intangible parts of
the economy, as opposed to goods which we can touch or handle.
 Consumer Goods – goods that are intended for final use by the consumer like milk, soft
drinks, and food.
 Capital Goods – goods that are used in the creation or production of other goods like
buildings, machinery, and equipment.
 Essential or Necessity Goods – goods that are used to satisfy the basic needs of man such as
food, clothing, shelter, and medicine.
 Luxury Goods – goods that man may do without but are used to contribute to his comfort
and well-being, such as chocolates, perfumes, and expensive cars.
 Durable Goods – goods that last more than 3 years when used on a regular basis.
 Non-durable Goods – goods that last less than 3 years when used on a regular basis.
 HUMAN WANTS ARE UNLIMITED WHILE THE MEANS TO SATISFY THOSE WANTS ARE
LIMITED

B. Scarcity and Trade-off

 Scarce – means very small in amount.
 Scarcity – a situation that arises from the assumption of unlimited needs and wants and the
fact that resources to obtain goods and services are limited.
o It implies that we cannot have all that we want; hence, we need to make the best
use of scarce resources to satisfy our wants as much as possible.
o It limits our options and forces us to make hard choices which mean that in order to
get something, we must give up something else. There is always a trade-off to be
able to satisfy unlimited wants with limited resources.
o Trade-off will not only apply to individuals, families, and businesses but also to
governments or societies.
o Scarcity is the reason why people must “economize”.

C. Economics: Defined
 Economics is a study of how we manage our scarce resources.
 Economics is the proper allocation and efficient use of available resources for the maximum
satisfaction of human needs wants.
 Economics is concerned with production, distribution, and use of material goods and
services, and the study of human efforts to satisfy unlimited needs and wants with limited
resources.
 Economics helps us understand and predict price changes, and how the economy as a whole
works.

D. Reasons for Studying Economics

1. Economics helps us understand the marketplace and economic system.
2. Whether we are workers, employers, or the owners of a firm, economics is relevant to us.
3. As ordinary citizens, we can influence the public sector to make intelligent decisions about
how much money should be spent on basic services like education or health services.

E. Fundamental Economic Activities

1. Production – the process of transforming raw materials to a finished product.
2. Distribution – the physical apportionment of goods and services from the producers to the
consumers; it is simply called marketing distribution or trade.
3. Exchange – the transfer of ownership over goods and services from one person to another
and this is usually accomplished using money or credit.
4. Consumption – the process of using goods and services in the direct satisfaction of human
needs and wants; it is regarded as the most important function in economics because it is
the ultimate end of economic activity; without consumption, there would be no need for
production and distribution.

F. Factors of Production
1. Land – includes all the natural resources, including mineral deposits, water, air, trees,
poultry, livestock, and all other forms of these raw materials used in production of goods
and services.
2. Labor – any form of human effort like physical or mental, which is exerted in the production
of goods and services.
 3. Capital – refers to the machinery, tools, equipment, and structures used in the production of
goods and services.
4. Entrepreneurship – the ability of an individual to provide the right kind of good or service at
the right place and time, to the right people at the right price.
 Entrepreneur – the person who puts together or organizes the other factors of
production (land, labor, capital) to create goods and services which can satisfy the
needs and wants of man. He is innovative and a risk taker.

G. Divisions of Economics
1. Microeconomics:
 It studies the economy in parts. It deals with the economic behavior of individual
units such as the consumers, firms, and owners of the factors of production.
 It studies the decisions of individuals and businesses and the interaction of those
decisions.
 It explains the prices and quantities of goods and services, how market system works
and the effect of government regulations and taxes to individuals.
 It is concerned primarily with the market activities on individual economic units.
2. Macroeconomics:
 It deals with the economic behavior of the whole economy or its aggregates such as
government, business, and household, and how they grow and fluctuate.
 It is the division of economics that deals with aggregates. It presents pictures of
totals: income, output, employment, spending, and price level. It studies the
economy as a whole.
 It is concerned with the discussion of topics like gross national product, level of
employment, national income, general level of prices, total expenditures, and total
consumption.
 It treats the economic system as a whole rather than individual economic units of
which it is composed.
BA CORE 101 BASIC MICROECONOMICS

Chapter 1

LESSON 2
FUNDAMENTAL ECONOMIC PROBLEMS AND ECONOMIC SYSTEMS

OBJECTIVES:
1. To identify and briefly discuss the four fundamental economic problems.
2. To define economic systems.
3. To identify and describe the types of economic system.

A. Why Economic Problems Exist?

1. Economic problems exist because of two fundamental facts:
1. resources are limited; and
2. human wants are unlimited.
2. Human wants cannot all be possibly satisfied because resources are scarce.

B. The Four Fundamental Economic Problems

All nations, big or small, developed or underdeveloped, must find answers to the following
fundamental economic problems:
1. What goods or services are to be produced?
 Explanation:
 This refers to the choice of goods or services that the economy should
produce.
 Will a country produce rice, coconuts, bananas, or manufacture bags, shoes,
and garments? Or if a country is preparing for war, should it concentrate on
the manufacture of ammunitions, rocket ships, nuclear weapons, and the
like?
 Since resources are scarce, no economy can produce every product desired
by the members of society.
 Basic needs of the people are given top priority.
 The decision of what goods and services are to be produced would depend
on what is needed and what is wanted. It also depends on culture,
availability of resources, and climate.
2. How many goods or services are to be produced?
 Explanation:
 This refers to the quantity of each good or service that the economy will
have to produce to make up the total output.
 Suppose that a country has decided to manufacture shoes. How many pairs
should be manufactures? Or, if rice production is decided on, how much
should be the total output?
 No economy can produce goods and services enough to satisfy all members
of the economy.
3. How are the goods or services produced?
 Explanation:
 This refers to the choice of technique of production and the manner of
combining resources to come up with the desired output.
 Since a good can be produced with different techniques, the problem is
which of these to use.
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 The economy that decides on the production of shoes will also have to come
up with the decision on how the shoes will be manufactured. What
materials will be used? Will production involve the use of more labor or the
use of more machinery? How will the available resources be combined to
come up with the most efficient output of shoes?
 The least costly but efficient method must be chosen in order to save
resources. This means maximum output with minimum input without
sacrificing quality of the goods and services.
 A labor-intensive technology makes use of more labor than capital while a
capital-intensive technology makes use of more capital than labor.
4. For whom are the goods or services produced?
 Explanation:
 This refers to the choice of who will benefit from the production of goods
and services.
 In other words, this refers to the target market which the producers will sell
their products.
 Will the shoes be sold to high income buyers or to low income buyers? Will
the target market be males, females, or children? Will the shoes
manufactured be sold to domestic consumers or to the foreign markets?
C. The Economic Systems
 Economic System – comprised of the various processes of organizing and motivating labor,
producing, distributing, and circulating of the fruits of human labor, including products and
services, consumer goods, machines, tools, and other technology used as inputs to future
production, and the infrastructure within and through which production, distribution, and
circulation occurs in a particular society; OR SIMPLY, this is the framework in which society
decides on its economic problems.
 The principal objective of an economic system is to solve the fundamental economic
problems. It has varied concepts, strategies, and ways of improving the living conditions of
people. However, all economic systems have one common goal: a high standard of living for
all the citizens.

D. The Types of Economic System

1. Traditional Economy – an economic system that answers the four fundamental economic
problems based on social customs and on how the society has dealt with these questions in
the past.
 Decisions on what, how, and for whom to produce are made by referring to the
traditional manner of doing things.
 Production is carried in the methods used by the forefathers and is therefore very
primitive. Example: A farmer engaged in the production of rice does exactly what his
father did when he planted rice more than 50 years ago.
 This type of economic system is very backward since it does not allow for change.
 This is usually practiced in underdeveloped regions and in mountainous areas where
transportation and communication are practically non-existent.
 A country’s customs can differ greatly from that of a neighboring country so
traditional economies vary from one another.
2. Command Economy – an economic system where the means of production are owned and
controlled by the government and the answers to the four fundamental economic problems
are dictated by the government through the head of the nation or a group of men
designated by the head to make decisions.
 Its decisions are arrived at by planners or government men who dictate what, how,
and for whom to produce.
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 This system works under the principle that “the interests of the society should
prevail over that of the individuals.”
 The government decides how to answer the four fundamental economic problems
for the country rather than by giving individuals the chance to decide what they
want or need.
 The government plans what to produce and how resources should be allocated.
Individual preferences are not considered at all. Consumers buy what is available
and may have to do without what they want or what they need.
 The consumer’s freedom of choice is curtailed, and the system does not enable him
to participate in the decision-making process regarding the answers to the society’s
fundamental economic problems.
 This type of economy is difficult for the individual because it is impossible for the
government to know exactly what is best for every citizen.
3. Market Economy – an economic system wherein the means of production are privately-
owned and answers the fundamental economic problems by considering consumer’s choice.
 The four fundamental economic problems are answered in the marketplace by the
interaction of buyers and sellers. For example, the question of what to produce may
be based on what trend is popular right now. The producer would create a product
that he thinks would sell well to the public in hopes of making a profit. The question
of how to produce is usually based on the producer’s choice. A product may be
produced with more workers or more machines and computers to save on labor
costs. For whom to produce is based on the buyers who decide what they want or
need and what price they are willing to pay for the products.
 Competition is supreme, there is consumer sovereignty, and the price of the goods is
the guiding factor for producers to know what and how much to produce.
 The market prices serve as signals to the producers about what goods to produce
and how much of these goods should be produced. High prices indicate that goods
are in demand and serve as go signals for production. However, prices tend to fall
when goods are not in good demand and serve as a red light to decrease or limit
production. The problem of production is therefore solved by the price mechanism.
4. Mixed Economy – a blend of the different types of economic system.
 It is seldom that an economic system exists in its pure form.
 While the economy of United States is basically market-oriented, there exist forms
of government regulation and control. On the other hand, the People’s Republic of
China’s economy is basically command-oriented in nature, yet it cannot be said that
it does not use the price system at all.
 The Philippine economy is a mixture of the three forms of economic systems
discussed above. In the mountains and isolated barrios, most farmers are still
traditional in their production methods. While most buyers and sellers are
influenced by the price system, it cannot be denied that the government plays a
significant role in decision-making with regards to production, business, and
industry. The existence of price control, strict government regulations, government
support, and subsidy programs are proofs of the importance of government
participation in decision-making in the country’s production activities.
 In a mixed economy like ours, the questions of what to produce and how to
produce, answered predominantly through the price mechanism, are modified
through government intervention in the form of direct controls, taxes, and subsidies.
 The problem of for whom to produce is also solved by the price mechanism coupled
with different forms of government regulation. The economy will produce those
goods or services that will satisfy the wants of those people who have the money to
pay for them.
BA CORE 101 BASIC MICROECONOMICS

 Predominantly, the Philippine economy is market economy in nature but the best
way to describe its economic system is mixed economy.
BA CORE 101 BASIC MICROECONOMICS

CHAPTER 1
LESSON 3
The Circular Flow Model

OBJECTIVES:
1. To explain the economic activities that take place within the economy.
2. To define and explain the circular flow model.
3. To describe the interaction between the household and the firm.

Introduction
There are two basic activities undertaken in any economy: production and consumption.
The firms perform the production function while households undertake consumption. To be
able to produce, firms need the economic resources consisting of land, labor, and capital. The
individuals comprising the households own these resources. When the economic resources are
used in the production of goods and services, employment of these resources occurs.
A price is paid to resource owners whenever these resources are used in production.
Rent is paid to the land owner, interest to the capitalist and wage to labor. The goods and
services produced by these firms are consumed by households. The interaction between
households and firms regarding production, consumption, employment and income generation
results to the circular flow of goods and services in the economy.

A. Definition
• The Circular Flow Model is a model that is used to show the flow of resources and
income through an economy.
BA CORE 101 BASIC MICROECONOMICS

• It is a simple economic model showing the relationship between money income and
spending for the economy.

• The circular flow model is only a model, a simplification of a complex reality. However, it
is necessary to be understood in order to have a clear understanding of the complexities
that are encountered in the economic activities of a nation.

In other words, it offers a simple way of organizing all of the economic transactions
occur between household and firms in the economy. To see the circular in its simplest form, we
will begin with an economy in which there is no government, no financial markets, and imports
or exports.

B. The Interrelationship Between the Household Sector and Business Sector

In Simple economy, there are two players, basically these are the households and the
firms, industries or businesses.

Economic activities take place through the interrelationship that exists between two
economic units:

1. the household, which is the basic consuming unit; and

2. the business firm, which is the basic producing unit.

C. The Circular Flow Model

The Factor Market or Resource Market which appears at the top or upper part of the
diagram in which firms obtain the labor, services, capital, and natural resources that they need
from the household. It is the place where resources or the services or resource suppliers are
bought and sold.

The Goods and Services Market, which appears at the bottom of the diagram in which
households buy goods and services that firms produce. The place where goods and services
produced by businesses are bought by and sold to the households.

Firms-produce goods and service using inputs such as land, labor, capital and
entrepreneurship.

Household-owns the factors of production and consumes all the goods and services
produced by the firm.

In the Factor Market (Resource Market) household are sellers and firms are buyers.
Household provides firms the inputs that the firms use to produce goods and services.
Households own all economic resources either directly as workers or entrepreneurs or
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indirectly through their ownership of business corporations. They sell their resources to
businesses that will need them in order to produce goods and services. This is represented by
the outer arrow from the household going to the business sector.

In return, the firm pays the household, wages for the labor, rent for the land, profit for
the capital of household sector. So firms make factor payment-wages, interest payments, rents,
royalties and all of that in exchange for the factors services they buy, in short, costs of the
business firm. But these payments made by the firm are considered as flows of income in the
form of wages etc. to the household. This represented by the inner arrow from the business
sector going to the household sector.

In other words, the upper portion of the circular flow diagram shows the movement of
resources such as land, labor, capital, to be used by the firm in producing goods and services.
Productive resources, therefore flow from the household to businesses, and money flows from
businesses to the household.

In the Goods and Services Market (Product market) household are buyers and firms
are sellers. Households buy the output of Goods and services that firms produce. In the product
market, businesses combine the resources owned by the households (i.e., land, labor, capital)
in order to produce and sell goods and services (e.g., cellular phone, signature shirt, pizza, etc.)
This is represented by the outer arrow from the business sector going to the household sector.
In return, the households receive income from selling their resources to the businesses.
Consequently, the households use the (limited) income they received from sale of resources
the sale of resources in order to buy goods and services that the businesses produced in the
form of consumption expenditure or payments for goods and services. The payments represent
the income received by the firm. Households make payments for the things they buy in product
markets. This is represented by the inner arrow from the household sector going to the
business sector.

The monetary flow of consumer (household) spending on goods and services yields sales
revenues for businesses. Businesses compare those revenues to their costs in determining the
profitability and on whether or not a particular good or service should continue to be produced
and sold. In simplest manner, In the Lower portion of the diagram, presents the movement of
goods and services provided by the firm to the household.

By Convention, when firms use labor, capital or natural resources that they themselves
own, they are counted as “buying” those factors from the households that are ultimate owner
firm owners. All production costs or expenses incurred by the firms can be viewed or called as
factor payments.
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In this simple economy, households spend their income on consumer goods as soon as
they receive it and firms sell their output to households as soon as they produce it. According to
Doland Lindsey, “The fluid that the economy’s plumbing working is not water but money”
Because money is what we use as means of payment for buying goods and services, May it be
in a form of coins, paper currency, bank account balances on which checks can be written.

In a nutshell, as shown in the circular flow there is a clockwise real flow of economic
resources and finished goods and services (represented by the outer arrows in circular)and a
counterclockwise money flow of income(wages, salaries etc.) and consumption expenditures
or payment for goods and services (represented by the inner arrows in circular).