FINMAN REVIEWER FOR MIDTERMS 4.

Price expectations
5. Government subsidies
CHAPTER 5: APPLICATIONS OF
6. Change in production costs or
MICROECONOMICS THEORY AS A
technological advances
BASIS FOR UNDERSTANDING THE KEY
ECONOMIC VARIABLES AFFECTING Market is an abstract concept that
THE BUSINESS encompasses the forces generated by the
buying and selling decisions of economic
INTRODUCTION TO MICROECONOMICS
participants.
Microeconomics focuses on the behavior
and purchasing decisions of individuals and Equilibrium is a state of balance between
firms. The market price is determined based conflicting forces such as supply and
on demand and supply. demand.
Demand is the quantity of a good or service
that consumers are willing to purchase at a 1. Short run market equilibrium - time
range of prices at a particular time. period of insufficient length to permit
decision makers to adjust fully to a
Demand Curve Shift when demand
change in market condition.
variables other than the price change.
2. Long-run market equilibrium - time
FACTORS AFFECTING THE DEMAND OF period of sufficient length to enable
A PRODUCT OTHER THAN ITS PRICE: decision makers to adjust fully to a
1. Consumer income and wealth change in market condition
2. Price of substitute goods or services
3. Price of complement products SHORT-RUN TOTAL COST:
4. Consumer tastes 1. Variable cost
5. Group boycott
2. Average fixed cost
6. Size of the market
3. Average variable cost
7. Expectations of price increase
4. Marginal cost
Price Elasticity of Demand relationship 5. Average total cost
between percentage change in quantity 6. Fixed cost
demanded and percentage change in price.
(degree of consumer response to variation in LONG-RUN TOTAL COST:
price)
1. Constant returns to scale
Supply direct relationship between the price 2. Increasing returns to scale
of a good and the amount of it offered for 3. Decreasing returns to scale
sale.
PROFITS
Supply Curve Shift when supply variables
other than the price change. 1. Normal
2. Economic
FACTORS AFFECTING THE SUPPLY OF A
PRODUCT OTHER THAN ITS PRICE: Marginal product is the additional product
obtained from employing one additional unit
1. Price of other goods of a resource.
2. Number of producers
3. Government price control
The Role of Money in the Economy (in measure includes the financial
reference of Financial Management: institution (e.g. large-denomination
Principles and Applications Volume 1; 2015 time deposits and term Eurodollars).
Edition by Ma. Elenita Cabrera) M3 refers primarily to money used as
a unit of account.
Money is any item or commodity that is
• L. In addition to M3, this measure
generally accepted as a means of payment
includes liquid and near-liquid assets
for goods and services or for repayment of
(e.g. short-term Treasury notes, high-
debt, and that serves as an asset to its
grade commercial paper and bank
holder.
acceptance notes).
Money serves three main purposes:
The Sources of the Demand for Money are:
1. Medium of exchange - It is
• Transaction demand - Money
acceptable in exchange for goods
demanded for day-to-day payments
and services. This critical function
through balances held by households
avoids the inefficiencies of barter
and firms (instead of stocks, bonds or
exchange. A market economy would
other assets). This kind of demand
be impossible without money.
varies with GDP; it does not depend
2. Store of Value - It is durable for
on the rate of interest.
exchange at a later date. This
• Precautionary demand - Money
requires a stable value so that
demanded as a result of
purchasing power is retained over
unanticipated payments. This kind of
time.
demand varies with GDP.
3. Standard Value or Unit of Account - It
• Speculative demand - Money
is usable for quoting prices.
demanded because of expectations
about interest rates in the future. This
The Key Measures for the Money Supply
are: means that people will decide to
• M1 - The narrowest measure of the expand their money balances and
money supply. It includes currency in hold off on bond purchases if they
circulation held by the demand expect interest rates to rise. This kind
deposits, other checkable deposits, of demand has a negative
and traveler's checks. MI refers relationship with the interest rate.
primarily to money used as a medium
of exchange. INTEREST RATES
• M2 - In addition to MI, this measure The interest rates link the future
includes money held in savings to the present. It allows individuals to
deposits, money market deposit evaluate the present value (the value
accounts, noninstitutional money today) of future income and costs. In
market mutual funds and other essence, it is the market price of earlier
short-term money market assets (e.g. availability.
"overnight" Eurodollars). M2 refers
primarily to money used as a store of
value.
• M3 - In addition to M2, this
 From the viewpoint of a potential
borrower, the interest rate is the
premium that must be paid in order to
acquire goods sooner and pay for them
later. From the lender's viewpoint, it is a
reward for waiting - a payment for
supplying others with current purchasing
power. The interest rates allow the
lender to calculate the future benefit
(future payments earned) of extending a
loan or saving funds today.
Money rate of interest on a loan has three
components.
• Pure-interest component is the real price
one must pay for earlier availability.
• Inflationary-premium component
reflects the expectation that the loan
will be repaid with pesos of less
purchasing power as the result of
inflation.
• Risk-premium component reflects
the probability of default (the risk
imposed on the lender by the
possibility that the borrower may be
unable to repay the loan).
CHAPTER 6: APPLICATIONS OF
MACROECONOMICS THEORY AS A
BASIS FOR UNDERSTANDING THE
KEY ECONOMIC VARIABLES
AFFECTING THE BUSINESS
INTRODUCTION TO MACROECONOMICS
Macroeconomics is a branch of
economics that studies the behavior of an
overall economy, which encompasses
markets, businesses, consumers,
governments and foreign sectors. A
straightforward model of the flow of
resources and money movement across
the sectors of the national economy is a
major tool for the analysis of the
economy's performance.
SIGNIFICANCE OF MACROECONOMICS
Macroeconomics looks at the economy as
a whole. It focuses on measures of economic
output, employment, inflation and trade
surpluses or deficits. It also examines the
spending of the three major segments of the
economy, consumers, business and
government. Macroeconomics examines
economy-wide phenomena such as inflation,
price levels, rate of economic growth,
national income, gross domestic product
(GDP), and changes in unemployment.
• Nominal Gross Domestic Product
(GDP) - The price of all goods and
services produced by a domestic
economy for a year at current market
prices.
• Real GDP - The price of all goods and
services produced by the economy at
price level adjusted (constant) prices.
Price level adjustment eliminates the
effect of inflation on the measure.
• Potential GDP - The maximum amount
of production that could take place in an
economy without putting pressure on the
general level of prices.
• Net Domestic Product (NDP) - GDP
minus depreciation.
• Gross National Product (GNP) - The
price of all goods and services produced
by labor and property supplied by the
nation's residents.
CALCULATION OF GDP
Two ways to calculate GDP:
1. The income (output) approach - Adds
up all incomes earned in the production
of final goods and services such as
wages, interests, rents, dividends, and so
forth.
2. The expenditure (input) approach -
Adds up all expenditures to purchase
final goods and services by households,
businesses and the government.
Specifically, it includes personal
consumption expenditures, gross private
investment in capital goods (e.g.,
equipment) and also the country's net
exports.
AGGREGATE DEMAND AND SUPPLY
• Aggregate supply and aggregate
demand are the total supply and total
demand in an economy at a particular
period of time and a particular price
threshold. Aggregate supply is an
economy's gross domestic product
(GDP), the total amount a nation
produces and sells. Aggregate demand is
the total amount spent on domestic
goods and services in an economy.
Aggregate supply and aggregate
demand convey how much firms are
willing to produce and how much
consumers are willing to demand at a
specific price point.
PRODUCTION
At the core of any business is production -
turning inputs into outputs that customers will
buy. The inputs used by a business in the
production process can be divided into five
big categories:
• Labor
• Capital
• Land
• Intermediate inputs
• Business know-how
SHORT-TERM PROFIT MAXIMIZATION
AND LONG-TERM DECISION
• Short-term profit maximization
focuses on achieving the highest
profit, assuming that fixed costs are
constant and cannot be changed.
• Long-term profit maximization
assumes that a business can vary all
its inputs even going as far as
shutting down. This also includes the
results of a company's big strategic
decisions such as, coming up with
new products, entering new markets,
offering low prices or trying to get
maximum efficiency from their
workforce.
BUSINESS CYCLES
A business cycle is a fluctuation in
aggregate economic output that lasts for
several years. It reflects the recession and
expansion in an economy and is depicted as
a series of peaks and troughs.
• The peak is the date on which a
recession starts.
• A recession is a period of negative GDP
growth.
• The trough is the date on which the
recession ends and the economy starts
heading up again.
The expansion is the time from the trough,
through recovery and all the way to the next
peak.
FISCAL POLICIES: THEIR NATURE AND
EFFECT ON ECONOMY
Fiscal Policy refers to decisions about
government spending, taxes and debt in both
the short run and the long run. The level of
government spending is set by the political
system and that spending is funded through
a combination of taxation and borrowing
Fiscal Policy Action
1. Increase government spending
a. How It Can Help: Can create jobs
and boosts GDP, and perhaps do
something useful with the spending
— for example, building new bridges
and highways.
b. How It Can Hurt: Can boost inflation
and widen the budget deficit, leading
to higher interest rates and lower
private investment
2. Lower taxes
How It Can Help: Can create jobs and
boost GDP, and provide incentives for
work and investment
How It Can Hurt: Can boos inflation
and widen the budget deficit, leading
to higher interest rates and lower
private investment
3. Accept wider budget deficit
a. How It Can Help: Can create jobs and
boosts GDP. Other impacts depend on
the particular combination of spending
and tax changes
b. How It Can Hurt: Can lead to higher
interest rates and lower private
investment. Over the long run, can lower
productivity and GDP growth.
MONETARY POLICIES: THEIR NATURE
AND EFFECT ON THE ECONOMY
The monetary policies of the country
formulated and eventually implemented by
the central bank pertain to the use of interest
rates, direct lending to financial institutions,
and other policy tools to influence the
economy and support the financial system.
GOALS OF MONETARY POLICIES
CONTROLLING INFLATION
Inflation is a sustained upward movement in
the average price level of goods and
services, usually measured on an annual
basis. Deflation on the other hand is
described as a decrease in the price levels.
There are generally two causes for inflation:
a. Demand-pull inflation. This occurs
when aggregate spending exceeds the
economy’s normal full-employment
output capacity. This generally happens
at the peak of a business cycle and is
characterized by real GDP exceeds
potential GDP. Because labor is short, bid
up the price and inflation occurs.
b. Cost-push inflation. Occurs from an
increase in the cost of producing goods
and services. It is usually characterized
by decreases in aggregate output and
employment because consumers are not
willing to pay the inflated prices.
There is an inverse relationship between
inflation and employment. When the
employment rate is low, inflation tends to
increase. Inflation tends to decrease when
the unemployment rate is high.
SMOOTHING OUT THE BUSINESS
CYCLE
In the Philippines, the Bangko Sentral ng
Pilipinas (BSP) has the primary responsibility
for fighting recessions.
As the country's central bank, the BSP was
designed to have some independence. If the
BSP were not independent, it could come
under pressure to adopt monetary policies
that could benefit the political party in power
but are not necessarily good for the country
as a whole. For instance, the BSP could cut
interest rates just before election in order to
gain votes for the party in power. So when
the economy slows and the unemployment
rate starts to rise, the first thing that
economists, businessmen, and politicians
want to know is this; "What is the BSP going
to do about it?"
In response to rising unemployment, the
main thing that the BSP can do is cut interest
rates. Lower interest rates stimulate
purchases of things like cars and homes,
thus boosting the economy.
ENSURING FINANCIAL STABILITY
On October 19, 1987, when the stock market
in the United States unexpectedly On
October 19, 1987, when the stock market
declined since the 1929 crash at the plunged
by 22% in the beststion, investors lost $500
billion in one day. To reassure and prevent
them from taking out all their money from the
big banks and Wall Stream of the bankruptcy,
Fed Chairman Alan Greenspan issued a
one- sentence statement before the markets
opened the next day:
"The Federal Reserve, consistent with its
responsibilities as the nation's central bank
affirmed today its readiness to serve as a
source of liquidity to support the economic
and financial system."
This was the Federal Reserve performing
one of its main functions: Serving as lender
of last resort in a financial crisis. This is also
the role the Fed played during the housing
bust of 2007 and 2008.
Having a lender of last resort is necessary for
a well-functioning market economy. In many
ways, that is still the central bank's biggest
job because a meltdown in the financial
market would paralyze the economy making
it impossible for companies and individuals to
borrow the money they need to continue
operation, to expand and improve their
businesses.
MONETARY POLICY VERSUS FISCAL
POLICY
What are the similarities and differences
between monetary policy and fiscal policy?
Both can speed up or down the economy.
The central bank can cut or raise interest
rates and Congress can boost or cut
spending or cut or raise taxes.
But several differences favor monetary policy
as a tool when it comes to fighting inflation or
smoothing out the business cycle as
opposed to fiscal policy.
1. Monetary policy is both more flexible and
less political than fiscal policy. The
central bank acts more quickly than
Congress and the President because it
does not have to go through the lengthy
political process of passing legislation.
2. The central bank when it does act, can
take action in a series of small steps.
That means it can cut or raise rates a little
bit at a time and see how the economy
reacts before it goes further. In contrast,
Congress has to expend so much
political energy to pass a big tax or
spending bill that it can be done just once
a year (or sometimes not at all). That
makes monetary policy much more
flexible than fiscal policy.
3. When the economy recovers from a
downturn, the central bank can take back
a monetary stimulus, more easily than
Congress can take back a tax cut or
added spending.
LONG-TERM EFFECTS OF MONETARY
POLICY
Economists generally agree however, that
monetary policy affects the long-term rate of
inflation but has little direct effect over the
long-term on the rate of unemployment or the
potential rate of growth. That is, if the central
bank stimulates the economy in an attempt
to keep the unemployment rate low, the main
result will be accelerating inflation. Workers
will push up wages and businesses will push
up prices potentially leading to a wage-price
spiral.
The best way to improve long-term growth
has nothing to do with the Central bank.
Instead, the country has to invest in physical
and human capital and in the creation of
knowledge. These sorts of investments can
help cut unemployment as well because
firms that are growing and succeeding can
hire plenty of workers and keep them
employed.
There are however, two indirect ways by
which effective monetary policy can improve
long-term outcomes.
1. Low inflation makes the future more
predictable making it easier for the
business and individual to plan and make
good decisions. This will improve growth
and employment in the long run.
2. If the Central bank is able to smooth out
the business cycle, recessions will be few
and mild. This act makes it easier for
businesses to take more risks in terms of
investing in new technologies and
opening up new business lines.
In other words, the central bank's best long-
term contribution to the economy through its
monetary policies is to manage it well by
minimizing its ups and downs rather than
stimulating it excessively.
MONETARY POLICY TOOLS
How does Bangko Sentral ng Pilipinas (BSP)
achieve its goals?
There are three main tools for monetary
policy that the BSP can use:
CONTROL OVER SHORT-TERM
INTEREST RATES
The monetary regulator primarily controls
short-term rates through open market
operations. Short-term rates impact loans
like credit cards, auto loans, and adjustable-
rate mortgages. Long-term rates affect loans
such as 30-year fixed-rate mortgages and
long-term corporate borrowing.
The BSP can influence short-term interest
rates via open market operations which
increase or decrease the amount of money
available to banks for lending out.
When the BSP wants to change monetary
policy by lowering or raising interest rates, it
takes a more roundabout route. To illustrate:
A. Banks are required to keep a portion of
their deposits in cash in their vaults or on
reserve with the BSP. The more reserves
they have, the more they can lend.
B. The BSP aims to lower interest rates by
increasing banks' reserves through open
market operations. In this process, the
BSP buys government bonds or
securities from financial institutions,
thereby increasing their reserves. This
allows banks to lend more to borrowers,
lowering short-term interest rates, or lend
to other banks, enabling further lending
activity.
C. Open market operations also work in
reverse. If the BSP wants to raise rates,
it sells some government securities it
already owns. Then it reduces the money
in the account of the purchaser. The net
effort is that loss money is available to be
loaned out and interest rates rise.
The BSP targets the CB overnight rate to
indirectly influence credit card and auto loan
rates. If the economy exceeds potential GDP
with high inflation, the BSP raises the funds
rate to slow down the economy. Conversely,
if the economy is below potential with low
inflation, the BSP lowers the funds rate to
stimulate growth. While consumers don't
directly pay the funds rate, it affects other
rates like money market rates, credit cards,
auto loans, and adjustable-rate mortgages.
Although these rates may not move exactly
in line with the funds rate, they generally
follow its direction. The BSP's influence over
interest rates doesn't extend to long-term
loans.
THE DISCOUNT WINDOW
The Central bank's prime weapon against a
financial crisis is its ability to lend vulnerable
financial institutions as much money as they
need. To do this, it uses a monetary tool
called the discount window.
The discount window, broadly speaking,
includes all of the different ways in which the
Central bank can lend money directly to
financial institutions that are in trouble. The
purpose of the discount window is to give
financial institutions access to funds if they
run short.
Under normal circumstances, the use of the
discount window is usually viewed as a sign
that a bank is mismanaged, so banks are
reluctant to use it. But in a financial crisis, it
is an indispensable tool for getting money
into the financial system quickly.
THE RESERVE REQUIREMENT AND
OTHER REGULATIONS
The monetary authority or BSP also has the
power to change the reserve and marginal
requirements. It is a well-known fact that
banks have to keep a portion of their deposits
either in cash in their vaults or on reserve
with the BSP.
SUPPLY-SIDE POLICIES
The link between taxes and incentives is the
essential insight of supply-side economics.
This economic theory holds that bolstering
an economy's ability to supply more goods is
the most effective way to stimulate growth. A
decrease in taxes (especially for businesses
and individuals with high income) increases
employment, savings, and investments; and
is an effective way to stimulate the economy.
The tax revenue lost from the reduction in
taxes is more than offset by the increase in
taxes from increased economic activity.
However, this predicted effect only occurs
when rates are too high.
Supply-side economics focuses on the
marginal tax rate, the tax one pays on the last
peso of income he/she earns. For example,
when the marginal tax rate is 35%, if one
earns an extra peso, the government gets
35% and the individual gets 65%.
Different people may have different marginal
tax rates depending on their level of income
and the tax code. The marginal tax rate is
important because it determines one's
incentives for working a bit more. If a
person's marginal tax rate were 90%, for
example, it would not encourage that person
to increase his hour of work because the
government would be taking 90% of every
additional peso he made. But if the marginal
tax rate were only 10%, the government's
share would be minimal.
Supply-side economics argues that cutting
taxes gives people incentive to work and
invest more.
CHAPTER 7: COMPETITION AND
POLICIES TOWARDS MONOPOLIES AND
OLIGOPOLIES, PRIVATIZATION AND
DEREGULATION
COMPETITION
Competition as a dynamic process means,
rivalry or competitiveness between or among
parties (for example, producers or input
suppliers) to deliver a better deal to buyers in
terms of quality, price and product
information.
• PRICE TAKERS
In a price-taker market, the firms all
produce identical products (e.g., eggs,
rice or regular unleaded gasoline) and
each seller is small relative to the total
market. Price takers can sell all their
 output at the market price, but cannot sell
any of their output at a higher price.
When a firm is a price taker, there is no
pricing decision to be made.
Price takers try to choose the output level
that will maximize profit, given their costs
and the price determined by the market.
They cannot thrive or even survive in a
competitive environment unless they are
sensitive to cost. To compete, each firm
has to provide a high level of delivered
benefits per peso, compared with what
consumers can find elsewhere.
• PRICE SEARCHERS
These are firms that face a downward-
sloping demand for their product. This
means that the amount the firms are able
to sell is inversely related to the price they
charge. To maximize their profits, price
searchers must not only decide how
much to produce, but also what price to
charge.
Historically, the term pure competition
refers to a market structure characterized
by a large number of small firms
producing an identical product in an
industry (market area) that permits
complete freedom of entry and exit.
These markets are increasingly referred
to as "price-takers market."
• SIGNIFICANCE OF COMPETITION
Competition motivates businesses to
produce efficiently, cater to the views of
consumers and search for innovative
improvements.
The price-taker model highlights the
importance of the competitive process.
Competition puts pressure on producers to
operate efficiently and use resources wisely.
Each competing firm will have a strong
incentive to produce its products as
economically as possible. Holding quality
constant, lower costs will mean more profit.
Therefore, pursuit of profit will encourage
each firm to minimize its cost of production to
use the set of resources least valued in other
uses to produce the desired output. Firms
that fail to keep costs low will be driven from
the market.
If firms are going to be successful in
competitive markets, they must also be
innovative and forward looking. The
production techniques and product offerings
that lead to success today will not
necessarily pass the competitive market test
tomorrow. Producers who survive in a
competitive environment cannot become
complacent. On the contrary, they must be
willing to experiment and quick to adopt
improved methods.
INCOME INEQUALITY AND POVERTY
Differences in resource prices and the
productivity of individuals will cause incomes
to vary. Of course, economic inequality is
present in all societies. Neither politics nor
central planning will eliminate it. Money
income is only one component of economic
well-being. Factors such as leisure, noncash
transfer benefits, the non-monetary
advantages and disadvantages of a job, and
the expected stability of future income also
affect people's economic welfare.
Money income is quite important, however,
because it makes it possible to buy market
goods and services. It is also easy to
measure and is therefore widely used as a
yardstick of economic well-being and
inequality prevailing in society.
MARKET ENTRY BARRIERS
There are four factors that makes it difficult
for potential competitors to enter a market:
1. ECONOMIES OF SCALE
 Generally, when the fixed costs in an
industry are large, bigger firms can
generally achieve lower average total
per-unit costs than smaller ones.
Economies of scales and high fixed
costs, however, are not a significant
barrier to entry. When the assets needed
to enter the market can be leased,
transferred to another location, or resold
later without a major loss of value. In
some markets though, this will not be the
case. For example, ship-building, much
of the equipment used to produce ships
is of little use in producing other things.
The firm will have to continue to operate
for a lengthy period of time as long as the
variable operating costs are recoverable.
Potential competitors will recognize that
it will be extremely difficult to displace the
current incumbent because of the
massive amount of investment required
and the long recovery period involved.
The current incumbent firm becoming the
dominant firm will tend to emerge in the
industry and if the market is a captured
market, the cost advantages resulting
from its size will protect it from potential
rivals.
2. CONTROL OVER AN ESSENTIAL
RESOURCE
Control over a resource essential to
produce a product may also insulate a
firm from direct competitors. Resource
monopolies are seldom complete
because over time supplies in other parts
of the world may be discovered which
could make a particular country or firm
lose its advantage. Profit opportunities
provide challengers with an incentive to
search for mineral deposits, new
technologies, and substitute resources.
3. GOVERNMENT LICENSING
Licensing is a requirement that one
obtains permission from the government
in order to perform certain business
activities or work in various occupations.
Sometimes, these licenses cost little and
are designed to ensure certain minimum
standards. Often, however, they are
costly and a major deterrent to the entry
of potential rivals. Legal barriers are the
oldest and considered most effective
method of protecting a business firm from
potential competitors. Tariffs that raise
the price of imported goods and quotas
that limit the quantity of imports have
restricted entry and reduced the
competitiveness of various markets for
centuries. Today, governments continue
to establish barriers that restrict the right
to buy and sell goods. For example, to
compete in the transportation and
communication industries, one must
obtain a government franchise which
grants the business. firm exclusive rights
to operate in specific business
endeavors. Each of these measures
reduces competition and protects the
profits of favored firms.
4. PATENTS
Most countries have patent laws to give
inventors a property right to their
inventions. A firm that develops a new
drug can use patent protection to restrain
production by others for 17 years from
the time the patent is issued. Although
consumers will pay higher prices than if
open competition were permitted, that
may benefit from additional investment in
research and more rapid development of
new products by firms seeking a market
with patent protection. Without the profit
potential accompanying patents, the
incentive to engage in research and new
products would be slowed.
Economists criticize high barriers to market
entry for the following reasons:
1. The ability of consumers to discipline
producers is weakened. Reduced
competition results in allocative
inefficiency.
2. The unregulated monopolist or
oligopoly group can often gain by
 restricting output and raising price,
and
3. Legal barriers to entry encourage
firms to engage in masterful rent
seeking activities when licenses or
other entry barriers erected by the
government enhance the profitability
and provide protection from the rigors
of market competition; people expend
scarce resources to secure and
maintain these political favors. From
an efficiency standout, these rent-
seeking costs related to getting and
keeping monopoly power add to the
welfare losses resulting from the
allocative inefficiencies.
Economists suggest at least four policy
options to counteract the problems that result
from high barriers to entry. These are:
1. Control the structure of the industry to
ensure the presence of rival firms
2. Reduce artificial barriers that limit
competition (e.g.. licensing requirements,
tariffs, and quotas)
3. Regulate the price and output of firms in
the market.
4. Supply the market with goods produced
by a government firm.
I. MONOPOLY MODEL
Derived from two Greek words meaning
"single seller," monopoly is defined as a
market characterized by.
1. A single seller of a well-defined product
for which there are no good substitutes,
and;
2. High barriers to the entry of any other
firms into the market for that product
There is always a degree of monopoly. Even
though there aren't many marketplaces
where one seller supplies all of the output,
the monopoly model aids in our
understanding of how markets with a small
number of dominant enterprises function.
Also, these firms hold a degree of market
power, allowing them to influence prices, limit
competition, and impact overall market
efficiency. The monopoly model helps
analyze and predict their behavior, essential
for investors and regulators.
A monopoly does not have to worry about
what other businesses do; instead, it must
worry about whether customers will buy its
goods or spend their money on something
else. As a result, unlike completely
competitive firms, monopolies do not set
prices. Instead, it uses its authority to
determine the market price.
II. OLIGOPOLY MARKET
Oligopoly means "few sellers." The
distinguishing characteristics of an
oligopolistic market are:
1. A small number of rival firms. There are
only a few firms in the market, typically
between 3 and 10. This gives each firm a
significant amount of market power.
2. Interdependence among the sellers
because each is large relative to the size
of the market. The firms in the market are
interdependent, meaning that the actions
of one firm can have a significant impact
on the others. This can lead to price
collusion, where firms agree to charge
the same price, or price wars, where
firms compete aggressively on price.
3. Substantial economies of scale.
Oligopolistic firms may differentiate their
products in order to compete with each
other. This can be done through
branding, advertising, or by offering
unique features or services.
4. High entry barriers to the market. It is
difficult for new firms to enter the market,
due to factors such as high startup costs,
economies of scale, and brand loyalty.
Examples:
• Airlines: The airline industry is an
oligopoly, with a few major airlines
controlling most of the market share.
• Telecommunications: The
telecommunications industry is another
oligopoly, with a few major companies
providing phone, internet, and cable
services.
• Pharmaceuticals: The pharmaceutical
industry is an oligopoly, with a few major
companies developing and selling
prescription drugs.
• Automobiles: The automobile industry
is an oligopoly, with a few major
manufacturers controlling most of the
market share.
COMPETITION FACTORS
a. Interdependence among Oligopolistic
Firms
In an oligopolistic market, there are few
sellers, and the supply choices made by
one company have a big impact on
competitors' demand, prices, and profits.
This increases the intricacy of the firm's
decision-making process. Every
company bases its business decisions on
the policies that it anticipates its main
competitors will adopt, as they will impact
the market demand for all of the
competitors' goods
b. Substantial Economies of Scale
To attain the lowest possible cost per unit
in an oligopolistic business, large-scale
production (in comparison to the entire
market) is typically necessary.
c. Significant Economies of Scale
It might not be possible for a prospective
rival to begin small and progressively
expand to the ideal size since it needs to
capture a significant portion of the market
before it can reduce its cost per unit. This
appears to include the manufacturing of
cars, diesel engines, and refrigerators.
New rivals may also be prevented by
other factors such as government-
imposed entrance restrictions, patent
rights, and control over a vital resource.
from joining lucrative oligopolistic
markets. The difference between a
competitive price searcher market and an
oligopoly is the presence of substantial
entry barriers.
PRICE AND OUTPUT UNDER OLIGOPOLY
Unlike monopolists or price takers,
oligopolists are unable to estimate their own
costs and the level of market demand in
order to calculate the product price that will
yield the highest profit. An oligopolistic firm's
demand is also influenced by how its direct
competitors set their prices.
Economics is unable to forecast intricate
rivalry without making some very strong
assumptions about how each firm will
respond to a change in the quality or price of
its competitors' products.
In an oligopoly market, companies can sell
either similar or distinct products. When
products are identical (like milk or gas),
competition focuses mainly on price, with
limited room for differentiating through other
means. However, when products are
different (think smartphones or cars),
companies compete fiercely on features,
quality, and advertising, each trying to
convince consumers their product is far
better than the rest. So, while price matters
in both cases, differentiation opens up a
whole new battleground for attracting
customers.
Monopoly vs Oligopoly
• As to Competition
o Monopoly - The seller controls the
price as there is no competition in
the market
 o Oligopoly - The competition in the
market determines the price and
keeps in mind the competitor’s
actions.
• As to market structure
o Monopoly - This market structure
is a high barrier to entry and exit
as the industry is generally capital
intensive.
o Oligopoly - This market structure,
the barrier of entry is generally
high because of the economies of
scale in the industry.
• As to price
o Monopoly - A firm is a price
maker
o Oligopoly - A firm is a price
taker.
III. FINANCIAL MANAGEMENT IN
PUBLIC SECTOR
An enterprise owned, controlled, and
managed by the state for the benefit of the
general public is known as a public sector
enterprise (PSE). Building a solid industrial
base and providing the necessary
infrastructure for the nation's economy to
grow is the main goal of public enterprise.
PSEs have more stringent policies,
procedures, and financial decision
accountability because the government
finances them with public taxes. The
government finances the majority of the
public sector industries' budgets, and they
are heavily regulated both directly and
indirectly in terms of funding and price. Due
to the obligation to prepare additional
information in accordance with the
Commission on Audit and other diverse
groups of interested parties' requirements,
the accounting information system used by
the public sector differs significantly from that
used by the private sector.
The basic objectives of accounting and
financial reporting for government units
are to provide:
1. Financial information useful for making
economic, political and social decisions
and demonstrating accountability and
stewardship.
2. Information useful for evaluating
managerial and organization's
performance.
3. Information useful for planning and
budgeting, and for predicting the impact
of the acquisition and allocation of
resources on the achievement of
operational objectives.
4. Financial information useful for
determining and predicting the flows,
balances and requirements of short-term
financial resources of the public sector
unit.
INEFFECTIVENESS, INEFFICIENCY AND
CORRUPTION IN PSE
Majority of public sector enterprises are well-
managed, ineffectiveness, inefficiency and
corruption found in private enterprise are
also present in PSES.
The causes of these ineffectiveness,
inefficiency and corruption could be traced to
any one or combination of the following:
1. Government is not truly profit-oriented.
Its emphasis is on employment
generation and protection which could
lead to overstaffing, indiscipline and low
productivity.
2. Political interference is very high in
PSES.
3. Short-tenure managers appointed by the
government to manage these units only
take steps for short-term gains ignoring
long-term implication.
4. Less flexibility is prevalent in PSES.
Business needs quick decision and
action and this is not possible in a
bureaucratic organization.
5. Constant fear of COA queries and from the government throughout the
parliamentary questions increase the privatization process. Privatization
tendency of "passing the buck" and usually includes disinvestment.
delaying decisions.
OBJECTIVES OF DISINVESTMENT
WAYS TO REFORM PSES /PRIVATIZATION
1. DE-LICENSING OR DEREGULATION The major objectives of the
This entails the private sector disinvestment/privatization can be
implementing a more lenient licensing summarized as follows:
regulation. The private sector is now
1. REVENUE COLLECTION
permitted in some areas that were
previously only open to public The government is making a way out of
enterprises. Additionally, more freedom necessity to raise revenues to bring down
the fiscal deficit as a commitment made
to choose how to do business is granted
to those private investors. to the IMF
2. IMPROVEMENT IN EFFICIENCY
2. REDUCING THE BUDGET
This is being undertaken to ensure
ALLOCATION
greater accountability and improved
PSES are taught to become more
efficiency. These financial institutions and
profitable in order to become self-
mutual funds are expected to off load
sufficient and less reliant on government
funding. Instead of depending to the them into the secondary market. This will
enable the investor to demand more
government for assistance, they might be
accountability and efficiency from the
permitted to fund their short- and long-
management of PSES.
term financial needs through external
3. MARKET DISCIPLINE
financing agencies.
Disinvestment is resorted to meet
3. REFORMING THE DECISION MAKING
SYSTEMS budgetary targets and to bring the PSES
The process of reform, which takes into to meet the market discipline,
account the significance of decision- competitiveness and to emphasize on
making mechanisms, enables PSEs to profitability and maximization of
develop their own policies on material shareholders wealth.
4. RESOURCES MOBILIZATION
procurement, financing, investments,
With the help of a disinvestment
product pricing, pay structures, and other
program, the government would be in a
areas.
4. DISINVESTMENT OR PRIVATIZATION position to garner sufficient resources.
Through the process of disinvestment, Out of such funds, the government can
the PSE sells up its shareholdings in make available some funds as loans to
order to lower its equity stake. The PSES
5. DIRECT PARTICIPATION OF PUBLIC
government may choose to keep some
Such disinvestment would enable the
influence over it or sell off some of its
public, to participate in the equity of
holdings. Giving private enterprise total
PSES.
management control over the PSE is
6. ENCOURAGE EMPLOYEE
known as privatization. This is
OWNERSHIP
nationalization's reverse scenario.
Government personnel, mutual funds, This would encourage the employees to
private individuals, and their buy shares of PSES and thereby become
their owner also. This would ultimately
organizations purchase equity shares
 develop the sense of belongingness
among them. It may motivate them to
work harder and improve the work
culture.
7. REDUCTION OF BUREAUCRATIC
CONTROL
With the reduced holding of the
government in the equity of PSES, the
bureaucratic hold and control would also
be reduced considerably; it may provide
more autonomy to the management of
these PSES.
ARGUMENTS FOR/AGAINST
a. Disinvestment/Privatization Process The
disinvestment/privatization process is
advocated for the following reasons:
1. The basic problem with PSEs is
neither the equality of assets nor the
skilled manpower, but the overall
decision making system. These
enterprises would realize true
potential only when they are
privatized. In the private sector, the
decision making process is quick and
decisions are linked with the
competitive market changes. When
PSEs are privatized, the locked-up
investments are used to obtain
maximum potential.
2. The disinvestment and privatization
process would bring in better
corporate governance, transparency,
corporate responsibility, exposure to
competitive forces, improvement in
work environment and so forth.
3. The market participation in capital of
PSEs through stock exchanges
would enable the market to discover
the latent worth of PSES. The market
capitalization also increases.
4. The loss-making PSEs can be
successfully revived by asking the
strategic partner to infuse fresh
capital and by exercising excellent
management control over sick PSES.
The disinvestments/privatizations of
PSEs are criticized for the following
reasons:
1. Selling of profit making and dividend
paying PSE would result in loss of regular
source of income to the government.
2. There would be chances of "asset
stripping" by the strategic partner. Most of
the PSEs have valuable assets in the
shape of plant, machinery, land and
buildings. It may be possible that the
strategic partner may very well dispose of
these assets, make money and leave the
PSEs as a sick enterprise.
3. The government's policy of
disinvestment includes the disposal of
both profit making, as well as potentially
viable PSES.
CHAPTER 8: UNDERSTANDING THE
ROLE OF THE FINANCIAL MARKETS
AND INSTITUTIONS
Financial institutions and financial markets
are the backbone of any economic setup of a
nation and thus have to work in sync to
ensure the financial stability of the economy
and the progress of the nation.
STRUCTURE AND FUNCTION OF THE
FINANCIAL MARKET
A financial market can be defined as an
organizational or institutional framework
within which suppliers of excess funds can
transact with the demanders of such funds.
The structure of the financial market broadly
divides into the Money Market and Capital
Market. The money market caters to short-
term fund requirements, while the capital
market takes care of long-term funding
needs.
For instance, Treasury Bills, Commercial
Papers, Trade bills etc., are traded in the
Money Market, whereas Shares,
Debentures, Bonds, Derivatives etc., are
traded in the Capital Market.
Money Market: Primarily for short-term,
usually up to one year.
Capital Market: For long term investments,
generally over one year.
The primary components of the financial
market structure include primary markets,
secondary markets, stock market, bond
market, etc. In addition, the financial market
regulates the availability of funds and the
return on these funds.
Primary Markets - Where new stocks are
issued and bought by investors for the first
time.
Secondary Markets - After issuance, the
stocks can then trade on secondary markets.
Stock Market - It is where buyers and sellers
transact with stocks or shares of ownership
of a corporation.
Bond Market - It's a financial market where
participants can issue new debt or buy and
sell debt securities mostly in the form of
bonds.
FINANCIAL INSTITUTION
A financial institution is a company engaged
in the business of dealing with financial and
monetary transactions such as deposits,
loans, investments, and currency exchange.
Financial institutions are vital to a functioning
capitalist economy in matching people
seeking funds with those who can lend or
invest it. Financial institutions help regulate
the economy, ensure fair financial practices,
and facilitate prosperity.
CATEGORIES OF FINANCIAL
INSTITUTIONS
• CENTRAL BANKS CENTRAL
Banks are the financial institutions
responsible for overseeing and
managing all other banks. In the United
States, the central bank is the Federal
Reserve Bank (Fed), which is
responsible for conducting monetary
policy and supervising and regulating
financial institutions. Individual
consumers do not have direct contact
with a central bank. Instead, large
financial institutions work directly with the
Fed to provide products and services to
the general public.
• RETAIL AND COMMERCIAL BANKS
Traditionally, retail banks offered
products to individual consumers, while
commercial banks worked directly with
businesses. Today, most large banks
offer deposit accounts, loans, and limited
financial advice to both consumers and
businesses. Products offered at retail
and commercial banks include checking
and savings accounts, certificates of
deposit (CDs), personal and mortgage
loans, credit cards, and business banking
accounts.
• CREDIT UNIONS
A credit union is a type of nonprofit
financial institution providing traditional
banking services and is created, owned,
and operated by its members. Credit
unions are not publicly traded and only
need to make enough money to continue
daily operations, so they often can afford
to provide reduced fees and better
interest rates than banks.
• SAVINGS AND LOAN (S&L)
Associations Savings and loan
associations provide individual
consumers with checking accounts,
personal loans, and home mortgages.
Financial institutions are owned by their
customers or community. A savings and
loan is a type of thrift that is required by
law to produce a certain number of loans
secured by residential real estate, but the
aim of most savings and loans is to lend
for residential mortgages.
• INVESTMENT BANKS
 Investment banks are financial
institutions that provide services and act
as an intermediary in complex
transactions—for instance, when a
startup is preparing for an initial public
offering (IPO), or when one company is
merging with another. They can also act
as a broker or financial advisor for large
institutional clients such as pension
funds. Investment banks help individuals,
businesses, and governments raise
capital through the issuance of securities.
• BROKERAGE FIRMS
Brokerage firms assist individuals and
institutions in buying and selling
securities among available investors.
Customers of brokerage firms can place
trades of stocks, bonds, mutual funds,
exchangetraded funds (ETFs), and some
alternative investments.
• INSURANCE COMPANIES
Financial institutions that help individuals
transfer the risk of loss are known as
insurance companies. Individuals and
businesses use insurance companies to
protect against financial loss due to
death, disability, accidents, property
damage, and other misfortunes. These
companies can also include the self-
insurance programs of other financial
institutions such, as a savings and loan
holding company.
• MORTGAGE COMPANIES
Financial institutions that specialize in
originating or funding mortgage loans are
mortgage companies. While most
mortgage companies serve the individual
consumer market, some specialize in
lending options for commercial real
estate only. Mortgage companies focus
exclusively on originating loans and seek
funding from financial institutions that
provide the capital for the mortgages.
STOCK MARKET
Stock markets are venues where buyers and
sellers meet to exchange equity shares of
public corporations. Stock markets are
components of a free-market economy
because they enable democratized access
to investor trading and exchange of capital.
Stock markets create efficient price
discovery and efficient dealing.
The stock market allows buyers and sellers
of securities to meet, interact, and transact.
The markets allow for price discovery for
shares of corporations and serve as a
barometer for the overall economy. Buyers
and sellers are assured of a fair price, high
degree of liquidity, and transparency as
market participants compete in the open
market.
Stock markets provide a secure and
regulated environment where market
participants can transact in shares and other
eligible financial instruments with
confidence, with zero to low operational risk.
Operating under the defined rules as stated
by the regulator, the stock markets act as
primary markets and secondary markets.
As a primary market, the stock market allows
companies to issue and sell their shares to
the public for the first time through the
process of an initial public offering (IPO). This
activity helps companies raise necessary
capital from investors.
The stock market ensures price
transparency, liquidity, price discovery, and
fair dealings in trading activities.
The stock market guarantees all interested
market participants have access to data for
all buy and sell orders, thereby helping in the
fair and transparent pricing of securities. The
market also ensures efficient matching of
appropriate buy and sell orders.
Stock markets need to support price
discovery where the price of any stock is
determined collectively by all of its buyers
and sellers. Those qualified and willing to
trade should get instant access to place
orders and the market ensures that the
orders are executed at a fair price.
KINDS OF STOCK MARKET
• COMMON AND PREFERRED STOCK
Common stock—sometimes referred to
as ordinary shares—represents partial
ownership in a company. This stock class
entitles investors to generated profits,
usually paid in dividends. Common
stockholders elect a company's board of
directors and vote on corporate policies.
Holders of this stock class have rights to
a company's assets in a liquidation event,
but only after preferred stock
shareholders and other debt holders
have been paid. Company founders and
employees typically receive common
stock.
On the other hand, preferred stock, or
preference shares, entitles the holder to
regular dividend payments before
dividends are issued to common
shareholders. As mentioned above,
preferred shareholders also get repaid
first if the company dissolves or enters
bankruptcy. Preferred stock doesn't carry
voting rights and suits investors seeking
reliable passive income.
• GROWTH STOCKS
As their name suggests, growth stocks
refer to equities expected to grow at a
faster rate compared to the broader
market. Generally, growth stocks tend to
outperform during times of economic
expansion and when interest rates are
low.
• INCOME STOCKS
Income stocks are equities that provide
regular income by distributing a
company's profits, or excess cash,
through dividends that are higher than
the market average. Typically, these
stocks—think utilities—have lower
volatility and less capital appreciation
than growth stocks, making them suitable
for risk-averse investors who seek a
regular income stream.
• BLUE-CHIP STOCKS
Blue-chip stocks are well-established
companies that have a large market
capitalization. They have a long
successful track record of generating
dependable earnings and leading within
their industry or sector. Conservative
investors may top-weight their portfolio
with blue-chip stocks, particularly in
periods of uncertainty.
• CYCLICAL
Cyclical stocks are directly affected by
the economy's performance and typically
follow economic cycles of expansion,
peak, recession, and recovery. They
usually display more volatility and
outperform other stocks in times of
economic strength when consumers
have more discretionary income.
• DEFENSIVE STOCKS
Defensive stocks generally provide
consistent returns in most economic
conditions and stock market
environments. These companies
typically sell essential products and
services, such as consumer staples,
healthcare, and utilities.
• IPO STOCK
When a company goes public, it issues
stock through an initial public offering
(IPO). IPO stock typically gets allocated
at a discount before the company's stock
lists on the stock exchange. It may also
have a vesting schedule to prevent
investors from selling all of their shares
when the stock commences trading.
Market commentators also use the term
"IPO stocks" when referring to recently
listed stocks.
• PENNY STOCKS
A penny stock is equity valued at less
than $5 and is considered highly
speculative. Although some penny stocks
trade on major exchanges, many trade
through the OTCQB— a middle-tier over-
 the-counter (OTC) market for U.S. stocks
operated by OTC Markets Group.
Investors should consider using limit
orders when placing buy and sell orders
in penny stock, as they often have a large
spread between the bid and ask price.
• ESG STOCKS
Environmental, social, and corporate
governance (ESG) stocks emphasize
environmental protection, social justice,
and ethical management practices. For
instance, an ESG stock may be a
company that agrees to reduce its carbon
emissions at a greater rate than national
and industry targets or one that
manufactures equipment for renewable
energy infrastructure.
STOCK EXCHANGE
A stock exchange is a centralized location
where the shares of publicly traded
companies are bought and sold. Stock
exchanges differ from other exchanges
because the tradable assets are limited to
stocks, bonds and exchange traded products
(ETPs).
A stock exchange is a marketplace where
securities, such as stocks and bonds, are
bought and sold. Bonds are typically traded
Over-the-Counter (OTC), but some
corporate bonds can be traded on stock
exchanges.
LISTING OF SECURITIES ON STOCK
EXCHANGE
Listing means the admission of securities to
dealings on a recognized stock exchange of
any incorporated company, other financial
institutions or corporations, and so forth.
A company desiring to get a listing has to
enter into a listing agreement with the
concerned stock exchange and is required to
pay the specified listing fees. The company
is required to comply with all clauses of the
listing agreement and to send details of book
closure, record dates, copies of annual,
semi-annual, and quarterly reports, and cash
flow statements to the respective stock
exchange where the securities are listed.
The securities of an entity may be listed
at any of the following stages:
• At the time of public issue of shares or
debentures
• At the time of rights issue of shares or
debentures
• At the time of bonus issue of shares
• Shares issued on amalgamation or
merger
TOP PUBLICLY LISTED COMPANIES IN
THE PHILIPPINES
 AYALA LAND
A subsidiary of Ayala Corporation, Ayala
Land, Inc. is the largest property
developer in the Philippines, with core
businesses in strategic landbank
management, residential development,
shopping centers, corporate businesses,
and hotels.
 BDO
BDO Unibank, also known as BDO and
Banco De Oro, is the largest bank in the
Philippines belonging to the SM Group of
Companies. It is a universal bank with
subsidiaries operating in leasing and
financing, investment banking, private
banking, insurance, and stock brokerage.
 GLOBE TELECOM
Globe Telecom, also known as Globe, is
a major telecommunications services
company operating one of the largest
mobile, fixed-line, and broadband
networks in the Philippines.
 JG SUMMIT HOLDINGS
JG Summit Holdings, Inc. is a leading
conglomerate involved in a variety of
industries: food and beverages, real
estate and hotels, air transportation,
banking, petrochemicals,
telecommunications and in power
distribution.
 SAN MIGUEL
San Miguel Corporation is Southeast
Asia’s largest publicly listed food,
beverage and packaging company as
well as the Philippines’ largest
corporation in terms of revenue.
CHAPTER 9: INTERNATIONAL TRADE
INTERNATIONAL TRADE
It is an exchange involving a good or service
conducted between at least two different
countries. Consumer goods, raw materials,
food, and machinery all are bought and sold
in the international marketplace. The
exchanges can be imports or exports.
Importing refers to the bringing of goods and
services into the Philippines from another
country. These goods and services can be for
personal use, commercial sale, or further
processing within the country.
Exporting refers to the sending of goods and
services out of the Philippines to another
country. These goods and services are
typically produced in the Philippines and sold
internationally.
Historical Overview
 ANCIENT ORIGINS
International trade traces its roots back to
ancient times when civilizations engaged
in trade to acquire goods and resources
not locally available. The
Mesopotamians, Egyptians, and
Phoenicians established trade networks
as early as 3000 BCE, fostering the
exchange of commodities such as
spices, textiles, metals, and agricultural
products.
 MERCANTILISM
Mercantilism is economic nationalism for
the purpose of building a wealthy and
powerful state. Adam Smith coined the
term “mercantile system” to describe the
system of political economy that sought
to enrich the country by restraining
imports and encouraging exports. This
system dominated Western European
economic thought and policies from the
sixteenth to the late eighteenth centuries.
The goal of these policies was,
supposedly, to achieve a “favorable”
balance of trade that would bring gold
and silver into the country and also to
maintain domestic employment.
 INDUSTRIAL REVOLUTION AND FREE
TRADE
The Industrial Revolution (18th to 19th
centuries) brought about revolutionary
changes in international trade.
Technological advancements, such as
the steam engine, mechanization, and
improved transportation infrastructure,
facilitated mass production and trade on
a global scale.
 POST-WORLD WAR II
Following World War II, global efforts
were made to promote international trade
cooperation. The General Agreement on
Tariffs and Trade (GATT), established in
1947, aimed to reduce trade barriers and
promote economic growth. In 1995, the
GATT evolved into the World Trade
Organization (WTO), which oversees
trade agreements and dispute
resolutions among member nations.
 DIGITAL ERA
The digital revolution of the late 20th and
early 21st centuries has transformed
international trade. The rise of the
internet and e-commerce platforms has
revolutionized the way businesses
conduct cross-border transactions.
GAINS FROM INTERNATIONAL TRADE
These are the benefits an individual or
country experiences when they engage in
trade with others. Such as:
 Increased Efficiency and Specialization -
This means they can produce more
 efficiently and at a lower cost than other
countries.
 Access to Resources and Technology -
Access to new technologies can boost
productivity and innovation in domestic
industries.
 Increased Competition and Innovation -
Trade exposes domestic industries to
foreign competition, which can drive
them to become more efficient and
innovative.
 Economic Growth and Job Creation -
Increased trade can lead to economic
growth by expanding markets, boosting
exports, and attracting foreign
investment.
OBSTACLES TO FREE TRADE
Trade barriers are typically divided into tariff
and non-tariff barriers. Tariff barriers are
official constraints on the importation of
certain goods and services in the form of a
special levy. Nontariff barriers are indirect
measures that discriminate against foreign
manufacturers in the domestic market or
otherwise distort and constrain trade.
Tariffs are surcharges that an importer must
pay above and beyond taxes levied on
domestic goods and services. Tariffs are
transparent and are typically set ad valorem,
that is, based on the value of the product or
service. Tariffs were used widely in the
nineteenth century but were incrementally
reduced over time.
Non-tariff barriers are any obstacles to trade
that are not in the form of a tariff. They can
take many different forms and are often not
anchored in laws and official regulations, and
therefore are not transparent. It is difficult to
fight non-tariff barriers because often the
offending party will not admit that a barrier is
in place and therefore will not enter into
negotiations for its removal.
FOREIGN EXCHANGE RATES
Foreign exchange rates, which show the
value of one currency in relation to another,
are essential to international trade and
finance. The cost of exchanging currencies is
determined by these rates, which are
frequently shown as pairs with a base and
quote currency.
Exchange rates are always changing due to
a number of factors, such as interest and
inflation rates, market sentiment, political
stability, and economic performance. In
particular, in fixed or managed float systems,
central banks may step in to stabilize rates.
Businesses involved in international trade,
investors navigating foreign markets, and
policymakers formulating economic
strategies all need to understand these rates.
In the end, foreign exchange rates are a
reflection of the complex interactions
between economic forces worldwide.
 Factors Influencing Exchange Rates
The currency exchange rate is one of the
most significant indicators of a nation's
relative economic health, aside from
variables like interest rates and inflation.
In most free market economies around
the world, a nation's degree of trade is
heavily influenced by its exchange rates.
For this reason, one of the most closely
monitored, scrutinized, and manipulated
economic indicators by governments is
inflation. However, exchange rates also
affect an investor's portfolio's real return,
which makes them significant on a
smaller scale. We now examine a few of
the main factors influencing changes in
currency rates.
1. Inflation - tends to deflate the value of a
currency because holding the currency
results in reduced purchasing power.
2. Interest Rates – if interest returns in a
particular country are higher relative to
other countries individuals and
 companies will be enticed to invest in that
country as a result there will be an
increased demand for the country's
currency.
3. Balance of Payments - is used to refer
to a system of accounts that catalogs the
flow of goods between the residents of
two countries for instance if Philippines is
a net exporter of goods and therefore has
a surplus balance of trade countries
purchasing the goods must use the
country's currency this increases the
demand for the currency and its relative
value.
4. Government Interventions - through
intervention buying or selling the
currency in the foreign exchange markets
the central bank of a country may support
or depressed the value of its currency.
5. Other Factors - that may affect
exchange rates are political and
economic stability extended stock and
market rallies and significant declines in
the demand for major exports.
INTERACTION IN FOREIGN CURRENCY
MARKETS
 Exchange Rate Determination
Equilibrium exchange rates in floating
markets are determined by the supply of
and demand for the currencies.
 Fixed Exchange Rate
A fixed exchange rate is an exchange
rate where the currency of one country is
linked to the currency of another country
or a commonly traded commodity like
gold or oil. Nowadays, countries usually
link their currencies to their trading
partners like the United States dollar.
 Managed Float
In a managed float exchange rate
system, currency values fluctuate based
on market forces, but central banks
intervene to influence rates when
necessary. This approach offers a
balance between the flexibility of a free
float and the stability of a fixed rate,
allowing countries to adjust to economic
conditions while maintaining some
control over currency values. Successful
management requires skillful
coordination and timely interventions to
prevent excessive volatility and promote
economic stability.
SPOT RATES AND FORWARD RATES
The two kinds of Foreign Exchange Rates
transactions:
A. Spot Transaction - refer to the current
exchange rate at which currencies can
be bought or sold for immediate delivery
or settlement. In other words, spot rates
reflect the price of one currency in terms
of another currency at the present
moment. Spot rates are used for
transactions that require immediate
completion, such as purchasing goods or
services from foreign suppliers or
exchanging currencies for travel
purposes.
B. Forward Transaction - on the other
hand, are exchange rates agreed upon
now for the delivery of currencies at a
specified future date. These rates are
determined by the current spot rate
adjusted for the interest rate differential
between the two currencies over the
specified time period. Forward rates
 allow businesses and investors to hedge
against potential fluctuations in currency
values by locking in exchange rates for
future transactions. They are commonly
used in international trade to manage
currency risk associated with future
payments or receipts.
Both spot rates and forward rates are
crucial in the foreign exchange market,
serving different purposes for
businesses, investors, and financial
institutions involved in international
transactions.
CROSS RATES
Cross rates refer to the exchange rate
between two currencies, typically when
neither currency is the domestic currency of
the country where the exchange rate is
quoted. In other words, cross rates are
calculated by comparing the exchange rates
of two currencies with a common third
currency, allowing for the direct exchange
between the two currencies.
Cross rates are important in international
finance and trading, especially in situations
where direct exchange rates may not be
readily available or when transactions
involve currencies that are not commonly
traded in the foreign exchange market. They
allow for efficient currency conversions and
facilitate international trade and investment.
MANAGING FOREIGN EXCHANGE RISK
Managing foreign exchange risk involves
employing various strategies to mitigate the
potential negative impacts of currency
fluctuations. These strategies include
forward contracts, currency options, and
swaps to lock in exchange rates or hedge
against unfavorable movements.
Additionally, techniques like netting,
matching, natural hedging, and
diversification help spread exposure and
reduce risk. Continuous monitoring and
analysis of exchange rate movements are
essential to adjust strategies as needed and
ensure stability in international transactions.
AVOIDANCE OF EXCHANGE RATE RISK
IN FOREIGN
Avoidance of exchange rate risk in foreign
transactions, as advocated by Cabrera,
typically involves several strategic measures
aimed at minimizing exposure to currency
fluctuations. One common approach is
geographical diversification, where
businesses expand their operations into
regions with stable currencies to reduce
reliance on volatile ones. Another tactic is
currency denomination, conducting
transactions in the currency of the party with
the lowest exchange rate risk. Additionally,
forward contracts can be employed to lock in
exchange rates for future transactions,
providing a hedge against uncertainty. By
implementing these strategies, businesses
can effectively mitigate the impact of
exchange rate fluctuations on their foreign
dealings, contributing to more stable and
predictable financial outcomes.
CURRENCY MARKETS
Also known as forex markets, are
decentralized global platforms where
currencies are traded. They enable the
exchange of one currency for another,
facilitating international trade and
investment. Participants include banks,
corporations, governments, and individual
traders. These markets operate 24/5 and are
the largest and most liquid in the world, with
exchange rates determined by supply and
demand dynamics influenced by various
factors like interest rates and economic
indicators. Currency markets play a vital role
in the global economy by facilitating currency
exchange and supporting international
commerce.
FOREIGN INVESTMENT DECISIONS
Foreign investment decisions involve the
allocation of capital across borders to acquire
assets or establish operations in foreign
countries. These decisions are influenced by
various factors such as market potential,
political stability, regulatory environment,
economic conditions, and exchange rate
risk. Investors assess the potential returns
and risks associated with foreign
investments, considering factors like market
growth prospects, competitive landscape,
and legal considerations. Additionally, they
evaluate currency risk and implement
strategies to manage exposure to
fluctuations in exchange rates. Foreign
investment decisions are crucial for
businesses seeking growth opportunities
and diversification, as well as for
governments aiming to attract investment
and stimulate economic development.
Successful foreign investment decisions
require thorough analysis, risk assessment,
and strategic planning to maximize returns
and mitigate risks in a globalized economy.
ANALYSIS OF FOREIGN TRANSACTIONS
Analysis of foreign transactions involves
evaluating currency exchange rates,
transaction costs, and associated risks such
as exchange rate fluctuations, political
instability, and regulatory compliance. It also
considers market conditions, legal
requirements, financial reporting
implications, and performance evaluation to
make informed decisions and maximize
returns in international dealings.
FUNDING OF FOREIGN TRANSACTIONS
Funding foreign transactions involves
securing the necessary financial resources to
facilitate cross border trade and investment.
Various mechanisms and instruments are
utilized to fund international transactions,
ensuring the smooth flow of capital between
parties in different countries. Here are some
common methods of funding foreign
transactions:
1. Letters of Credit (L/C): Letters of Credit
are widely used in international trade. A
bank issues a letter of credit on behalf of
the buyer, guaranteeing payment to the
seller once specified conditions (e.g.,
shipping documents) are met. This
provides assurance to both parties and
mitigates payment risks.
2. Export and Import Financing: Financial
institutions provide export and import
financing to support international trade.
Export financing helps sellers by
providing working capital before
receiving payment, while import financing
assists buyers in covering the cost of
imported goods.
3. Trade Credit Insurance: Trade credit
insurance protects businesses against
non-payment or insolvency of buyers.
This insurance mitigates the risk of
default, allowing companies to engage in
international transactions with more
confidence.
4. Foreign Exchange Markets: Foreign
exchange markets (Forex) are essential
for funding foreign transactions.
Companies convert currencies to
facilitate trade, manage currency risks,
and ensure that payments align with the
agreed-upon terms.
5. Foreign Direct Investment (FDI):
Companies may fund foreign
transactions through direct investment in
overseas operations, such as setting up
subsidiaries, acquiring assets, or
establishing joint ventures. FDI provides
a long-term commitment and a means of
securing a presence in foreign markets.
6. Export-Import Banks: Many countries
have export-import banks that provide
financial support to businesses engaged
in international trade. These banks offer
credit insurance, loan guarantees, and
other financial instruments to facilitate
foreign transactions.
7. International Commercial Loans:
Businesses can secure loans from
 international banks or financial
institutions to fund their foreign
transactions. These loans may be
structured to meet specific needs, such
as trade finance or project financing.
8. Trade Finance Platforms: Online trade
finance platforms have emerged to
facilitate and streamline the funding of
international transactions. These
platforms connect buyers, sellers, and
financiers, providing a digital
infrastructure for trade financing
9. Prepayment and Advance Payments:
In certain transactions, the buyer may
make prepayments or advance
payments to the seller before goods or
services are delivered. This provides
working capital to the seller and builds
trust between the parties.
BALANCE OF PAYMENTS
The exchange rate system is a necessary
tool for international transactions involving
different currencies. The national goal of
these transactions is to accomplish gains
from trade and investment activities, which
are recorded in the balance-of-payments
account. The balance of payments (BOP) is
an accounting statement that summarizes all
the economic transactions between the
residents of the home country and those of
all other countries.
BOP ACCOUNTS
CURRENT ACCOUNT
The current IMF standards for reporting a
country’s BOP distinguish four main
categories: current account, capital account,
financial account, and official reserves
account. Each category is made up of
several subcategories. To maintain the
balance of the total credit and total debit, the
statistical discrepancy is also included in a
BOP statement. Statistical discrepancy
reflects net errors and omissions in collecting
data on international transactions.
CAPITAL ACCOUNT
The capital account, as defined by the IMF,
records two types of transactions: acquisition
or disposal of non produced, nonfinancial
assets and capital transfers. Nonproduced,
nonfinancial assets include natural
resources (e.g., oil fields, coal mines, and
forests); contracts, leases, and licenses
(e.g., rights to use natural resources, permits
to operate certain types of businesses, and
marketable licenses); and marketing assets
(brand names, trademarks, logos, and
domain names). These assets are neither
outcomes from production processes such
as machines and equipment (which belong to
the current account) nor investments in
financial assets such as equity shares or
bonds (which belong to the financial
account).
Capital transfers include changes in asset
ownership that do not involve a quid pro quo
transaction between residents and
nonresidents, such as court-ordered
transfers of asset ownership, debt
forgiveness, and investment grants.
OFFICIAL RESERVES
Account The official reserves account,
include gold, special drawing rights (SDRs),
reserve positions in the IMF, and convertible
foreign currencies. To most countries, foreign
currency is by far the largest component of
total international liquidity. Each government
normally keeps foreign exchange reserves in
the form of foreign treasury bills, short-term
and long-term government securities, euros,
and the like.
INTERNATIONAL INSTITUTION AND
AGREEMENTS
International institutions and agreements are
key components of the global governance
system, facilitating cooperation and
coordination among nations on various
issues.
International Institutions: are
organizations created by multiple countries
to address common challenges and promote
cooperation. These institutions can be global
or regional in scope and cover a wide range
of issues, including economics, security,
human rights, and the environment.
Examples of international institutions include
the United Nations (UN), International
Monetary Fund (IMF), World Bank, World
Health Organization (WHO), and regional
organizations like the European Union (EU)
and African Union (AU). These institutions
serve as platforms for diplomatic dialogue,
conflict resolution, and the development of
common policies.
International Agreements: also known as
treaties or accords, are formal commitments
between two or more countries to cooperate
on specific issues. These agreements can
cover a broad range of topics, such as trade,
environmental protection, human rights,
disarmament, and more. Treaties are legally
binding and often require ratification by the
participating countries' legislative bodies to
become effective. Examples of international
agreements include the Paris Agreement on
climate change, the North Atlantic Treaty
Organization (NATO) treaty for mutual
defense, and trade agreements like the North
American Free Trade Agreement (NAFTA) or
its successor, the United States-Mexico-
Canada Agreement (USMCA).
INTERNATIONAL MONETARY SYSTEM
The international monetary system refers
primarily to the set of policies, institutions,
practices, regulations, and mechanisms that
determine foreign exchange rates. This
system comprises currencies from individual
countries and monetary unions (e.g., the
Eurozone and CFA franc zone in Africa), as
well as composite currency units such as the
Special Drawing Right (SDR)
The International Monetary System (IMS)
plays a crucial role in shaping and facilitating
foreign exchange transactions. Here are
several key aspects highlighting the use of
the International Monetary System in the
realm of foreign exchange:
 Exchange Rate Determination
 Currency Pegs and Bands
 Currency Reserves
 Balance of Payments and External
Stability
 International Trade and Investment
 Hedging and Risk Management
HISTORY OF THE INTERNATIONAL
MONETARY SYSTEM
The international monetary system evolved
through key stages:
1. Gold Standard (19th century - World War
I): Currencies tied to gold for stable
exchange rates.
2. Interwar Period: Gold standard faced
challenges post-World War I, leading to
economic instability.
3. Bretton Woods Agreement (1944):U.S.
dollar pegged to gold, established IMF
and World Bank.
4. Bretton Woods System (1944-1971):
Major currencies pegged to the U.S.
dollar, promoting stability, but collapsed
due to imbalances.
5. End of Gold Standard (1971):U.S.
abandoned gold standard, marking the
shift to fiat currency.
6. Floating Exchange Rates (1973
Onward): Market-driven currency values
introduced flexibility and volatility.
7. Euro Introduction (1999):Euro created for
Eurozone economic integration, reducing
currency fluctuations.
8. Rise of Cryptocurrencies (2009
Onward):Emergence of decentralized
 digital assets like Bitcoin challenging
traditional systems.
MULTINATIONAL CORPORATIONS
Multinational Corporations (MNCs), also
known as Multinational Enterprises (MNEs)
or Transnational Corporations (TNCs), are
large companies that operate and conduct
business activities in multiple countries.
These corporations have a significant
international presence, with operations such
as production, marketing, and sales
extending beyond their home country's
borders. Here are some key characteristics
and features of multinational corporations:
Global Presence: MNCs have subsidiaries,
branches, or affiliates in various countries,
allowing them to conduct business on a
global scale. These entities are often
integrated into the corporation's overall
structure, contributing to its international
operations.
Diverse Operations: Multinational
corporations engage in a wide range of
activities, including manufacturing,
marketing, research and development, and
distribution, across multiple countries. They
may tailor their operations to local markets
while maintaining a global strategic
framework.
Global Supply Chains: MNCs typically
manage complex global supply chains. They
source inputs, components, or services from
different countries to optimize efficiency,
reduce costs, and enhance competitiveness.
Cultural Sensitivity: Operating in diverse
cultural and regulatory environments
requires MNCs to be culturally sensitive and
adaptable. They often tailor their products,
services, and marketing strategies to suit the
preferences and needs of local consumers.
Foreign Direct Investment (FDI):
Multinational corporations make substantial
investments, known as foreign direct
investment (FDI), in the countries where they
operate. This may involve establishing
production facilities, acquiring local
companies, or forming strategic
partnerships.
INTERNATIONAL TRADE AGREEMENTS
International trade agreements are formal
agreements between countries or regions
that facilitate and regulate trade and
economic relations. These agreements aim
to reduce barriers to the movement of goods,
services, and investments across borders,
fostering economic cooperation and
enhancing global trade. Here are some key
aspects of international trade agreements:
Tariff Reduction or Elimination: Many
trade agreements focus on reducing or
eliminating tariffs on imports and exports
between member countries. Tariffs are taxes
imposed on imported goods, and lowering
them promotes free and fair trade.
Trade Facilitation: Trade agreements often
include measures to streamline and facilitate
customs procedures, reduce bureaucratic
barriers, and simplify documentation
requirements. These initiatives aim to make
the process of importing and exporting more
efficient.
Market Access: Agreements may address
market access by removing non-tariff
barriers such as quotas, licensing
requirements, and technical regulations. This
helps create a more level playing field for
businesses in member countries.
Services Trade: Some agreements go
beyond the trade of goods and include
provisions for the liberalization of trade in
services, such as financial,
telecommunications, or professional
services. This enhances opportunities for
cross-border service providers.
Investment Protection: Agreements may
include provisions to protect foreign
investments by establishing rules for fair and
non-discriminatory treatment, dispute
resolution mechanisms, and compensation
for expropriation.
Regional vs. Bilateral Agreements: Trade
agreements can be regional, involving
multiple countries within a specific
geographic area (e.g., the European Union),
or bilateral, involving two countries. Regional
agreements often promote deeper economic
integration.
Examples of Trade Agreements: Notable
trade agreements include the North
American Free Trade Agreement (NAFTA),
which has been replaced by the United
States-Mexico-Canada Agreement
(USMCA), the Comprehensive and
Progressive Agreement for TransPacific
Partnership (CPTPP), and the European
Union's trade agreements with various
countries.
WTO Rules: The World Trade Organization
(WTO) sets rules for global trade and
provides a forum for negotiations. Bilateral
and regional agreements should comply with
WTO rules.
CHAPTER 10: THE TIME VALUE OF
MONEY
Introduction of time value of money
The time value of money is the concept that
the value of money today is worth more than
the value of that same lump sum in the future,
assuming you put today's money to good
use. This principle is based on the idea that
a rational investor would prefer to receive a
certain amount of money today rather than
the same amount in the future. Three
reasons make this principle reliable.
The time value of money is a fundamental
financial concept rooted in the idea that the
value of money today is greater than the
value of the same amount in the future,
assuming proper utilization. Three key
reasons underpin the reliability of this
principle:
Opportunity Cost: also termed implicit cost,
highlights the comparison between the value
of money today and its potential future
financial returns. Investing money today
provides an opportunity for it to grow over
time, emphasizing the importance of
considering alternative uses for current
funds.
Inflation: Inflation, the increase in the
personal consumption expenditures price
index reflecting the cost of goods and
services, is a crucial factor. In a post-
pandemic world where inflation is a real
concern, the time value of money becomes
more pertinent. As inflation erodes the
purchasing power of money, the principle
emphasizes the impact of time on the value
of currency.
Uncertainty: The uncertainty factor asserts
that money in hand now holds more value
than hypothetical future money. Until funds
are realized, they remain subject to various
uncertainties. Planning and making
investments with present money are
considered more reliable than relying solely
on anticipated future resources.
The time value of money serves as a
reminder to consider the potential growth,
inflationary effects, and uncertainties
associated with financial decisions,
encouraging individuals and businesses to
make informed choices that account for the
temporal aspect of money.
Factors in the equation to solve for the
time value of money: the present value of
money and the future value of money.
Present Value (PV)
PV represents the current value of a future
sum of money, discounted at a certain rate.
It's the amount that, if invested today, would
grow to the future sum.
Future Value (FV)
FV is the value of a sum of money at a future
point in time, taking into account
compounding interest
Interest Rate (r): The interest rate
represents the cost of money or the return on
investment. It is expressed as a percentage
and is a critical factor in TVM calculations.
Number of Periods (n): The number of
periods refers to the length of time over
which a financial transaction occurs. It could
be the number of years, months, or any other
defined time interval.
Compounding: Compounding refers to the
process where the interest earned or
charged on an investment or loan is added to
the principal amount, leading to exponential
growth or accumulation of wealth.
Discounting: Discounting is the process of
calculating the present value of a future sum
of money by applying a discount rate. It's the
inverse of compounding.
SIMPLE INTEREST VS. COMPOUND
INTEREST
Simple interest is a linear calculation that
considers interest only on the principal, while
compound interest accounts for the
compounding effect, providing a more
accurate representation of the time value of
money over extended periods.
Simple interest is calculated using the
following formula:
I=P×r×t
Where:
I is the interest earned.
P is the principal amount (initial investment).
r is the interest rate per period.
t is the number of periods.
What is Compound Interest?
Its interest is calculated not only on the initial
amount of money you deposit (known as the
principal) but also on the interest
accumulated over time.
SIMPLE INTEREST VS. COMPOUND
INTEREST
Compound Interest Formula
CASH FLOW STREAMS
Two types of cash flow streams are ordinary annuity is an annuity where the
possible, the annuity and the mixed stream. cash flow occurs at the end of each period.
Whereas an annuity is a pattern of equal In an annuity due the cash flows occur at the
periodic cash flows, a mixed stream is a beginning of each period.
stream of unequal periodic cash flows that
reflect no particular pattern.
Future value of a mixed stream
Example 1: Shrell Industries, a cabinet
manufacturer, expects to receive the
following mixed stream of cash flows over the
next 5 years from one of its small customers.

ORDINARY ANNUITY (FUTURE VALUE)

PRESENT VALUE

If Shrell expects to earn 8% on its

investments, how much will it accumulate by
the end of year 5 if it immediately invests
these cash flows when they are received?
This situation is depicted on the following FUTURE VALUE OF ANNUITY DUE
timeline.
It is assumed that periodic payments will be
paid at the beginning of each period when
the annuity is due. This indicates that interest
will be accrued on an annuity that is payable
within the first accounting period. The
amount of interest accumulation periods that
are included in the two different forms of
annuities is what differentiates them from
PRESENT VALUE OF A MIXED STREAM one another.
Frey Company, a shoe manufacturer, has
been offered an opportunity to receive the
following mixed stream of cash flows over the
next 5 years. If the firm must earn at least 9%
on its investments, what is the most it should
pay for this opportunity?
The two basic types of annuities are the
ordinary annuity and the annuity due. An Illustration: Ordinary Annuity vs Annuity Due

PRESENT VALUE OF ANNUITY DUE
The concept of the present value of an
annuity due refers to the current value of a
series of cash flows that originate from an
annuity due and begin almost immediately.
The payments that are received from the
annuity are normally distributed at the
beginning of each period. In solving the
present value of annuity due we can utilize
the
PRESENT VALUE - DISCOUNTING
The present value is consistently lower than
the future value due to accrued interest. To
calculate the future worth, a corporation
progresses through time by the term
accumulation. Present value is calculated by
discounting future cash flows back in time.
We can use this formula to easily determine
the present value of 1.
PRESENT VALUE OF SERIES OF
UNEQUAL CASH FLOWS
Calculating the present value of a sequence
of cash flows that are not equal to one
another is accomplished by adding up the
present values of each individual cash flow.
In the field of finance, the purpose of
employing software like a spreadsheet is to
compute the present value of a sequence of
numerous cash flows that are unequal.
PRESENT VALUE OF PERPETUITY
The term "perpetuity" refers to a security that
provides payment for an unending period of
time. In the world of finance, perpetuity refers
to an unending sequence of cash flows that
are identical to one another. Thus, the
present value of a perpetuity is calculated by: