Introduction to Applied

Economics

Slides prepared by Leigh Lim

Basic Terms in Economics
 Goods are physical objects
 Services are work done for people
 Scarcity is a situation in which people cannot

have everything that they want because of

limited resources
 Resources are the most basic elements that

people use to produce the goods and services

that they want
 Choice means selecting one thing over another
 Trade-offs is a situation in which they have to

choose between two things/activities that

cannot be had or done at the same time
Definition of Economics
 Economics is a study of how individuals,
business firms, governments, and societies as
a whole make choices under conditions of
scarcity.
Definition of Economics
 Economics as a study of wealth
◦ Utilization of wealth for production and
consumption
 Economics as a study of making choices
◦ Opportunity cost: forgone benefits of an alternative
when making a choice
 Economics as a study of allocation
◦ Allocation of scarce resources to answer unlimited
human wants
Definition of Economics
 Economics as a social science
◦ As a science, uses scientific method of inquiry
◦ As a social science, uses the scientific method to
study how society creates its material wealth, how it
make this wealth available to its people with
minimum difficulties and it expands its wealth
 Resources and the study of economics
◦ Natural resources, Human resources, Physical or
man-made resources
Definition of Economics
 Resources and the study of economics (cont.)
◦ Raw materials: inputs of production subject to
further processing and transformation
◦ Factor inputs: transforming inputs that process the
raw materials and intermediate inputs into final
goods and services
◦ Resources are limited: time-consuming, competing
uses
Definition of Economics
 Human wants and economic analysis
◦ Human wants are differentiated human needs
brought about by differences in income, taste,
environment, socioeconomic status, etc.
 Scarcity as a source of economic problem
◦ Scarcity: limitation of resources to answer the
expanding human wants
◦ Economic goals of society: material survival,
stability and growth
◦ Scarcity vs. Shortage vs. Surplus
Definition of Economics
 Allocation and the act of economizing
◦ Allocation: Social mechanism of distributing limited
resources to meet expanding human wants
 Market system as an allocation mechanism
◦ Market: state where buyers and sellers transact on
the purchase or sale of a good or service
◦ Price as cost (sacrifice) and benefit (satisfaction)
◦ The problem of scarcity is addressed through the
changes in price and the corresponding responses
of the buyers and sellers
Definition of Economics
 Market system (cont.)
◦ How can the market system address shortage? or
surplus?
◦ 3 basic economic questions:
◦ What to produce: increasing prices = high demand
◦ How to produce: maximize profit by lowering cost
of production
◦ For whom to produce: allocating a higher
proportion of output to members of a society with
high purchasing power
Definition of Economics
 Command system as an allocation mechanism
◦ The state or agency of the government may be in
charge in the allocation of resources by using its
political power in addressing the basic economic
problems of production and distribution
◦ Used in times of calamities, disasters or national
emergencies when the market system cannot fully
operate
◦ Used in normal times by totalitarian and socialist
states to pursue industrialization and self-reliance,
dictated by the planning agency of the government
Definition of Economics
 Tradition in the process of allocation
◦ Useful in situations where the operation of a market
may not be appropriate or the power of an
organized state has no control over a certain
community
◦ Uses culture, social norms to temper wants by use
of community pressure and criticisms; resources
are communally owned and distribution is
collectively practiced
◦ Used by indigenous communities
Economics as a Applied Science
 Economics is a social science and it deals with
how people interact with one another to
sustain, stabilize and develop the material
dimension of a society
 Many of the principles, laws and theories

developed in economics can be applied to a

number of fields.
A Framework in Understanding
Decisions using Economic Analysis
 Marginal Benefit – additional benefit derived
from an additional activity
 Marginal Costs – additional cost incurred from
an additional production of a good or service
 MB>MC = Net MB positive = Total Net Benefit
increasing
 MB<MC = Net MB negative = Total Net Benefit
decreasing
 MB=MC = Net MB zero = Total Net Benefit
maximum
Variations in Benefits and Costs due
to Stage of Recognition
 Explicit costs: easily recognized since they
are expressed in monetary terms and may
involve actual financial outlays
 Implicit costs: may not have to incur any

monetary expense; opportunity costs

 Explicit benefits: can be measured in

monetary terms or levels of satisfaction or

utility
 Implicit benefits: non-measureable
Variations in Benefits and Costs due
to Stage of Recognition
 Spacial Dimensions in the Issue of
Recognition
◦ Implicit benefits and implicit costs are harder to
recognize because of the spacial consideration of
the decision maker who may not be aware of the
social or public effect of his actions
◦ Exclusion of implicit social benefits and implicit
social costs will lead to improper allocation of
resources with its accompanying consequences
Variations in Benefits and Costs due
to Stage of Recognition
 Temporal Dimension in the Issue of
Recognition
◦ Present benefits and present costs are readily
realized while future benefits and future costs (which
are implicit benefits and implicit costs) are too
distant in time to affect the awareness of the decision
maker
◦ Exclusion of future benefits and future costs will lead
to improper allocation of resources with its
accompanying consequences
Variations in Benefits and Costs due
to Differences in Valuation
 Even if the decision maker recognizes the
implicit benefits and implicit costs of his
action, the differences between marginal
benefits and marginal costs can still persist
 The proper pricing and valuation of these

implicit costs may have an effect on the

optimal decision
Variations in Benefits and Costs due
to Differences in Valuation
 Spacial Dimension in the Issue of Valuation
◦ Even if the decision maker has recognized the
social benefits and social costs of his action,
various individuals may have different valuation of
these social impacts
 Temporal Dimension in the Issue of Valuation
◦ Discount rate: rate which a stream of future values
is reduced to make them comparable with present
values
Economics as an Applied Science
 Social, economic and business issues arise
because of the differences in marginal costs
and marginal benefits
 These imbalances result in the improper

allocation of resources and manifest in

various problems and issues in society
 These are due to the non recognition as well

as the differences in valuing the implicit

components of the benefits and costs
Basic Economic Problems Confronting
the Dev’t of the Phils. in the 21st Cen.
 Poverty and Unequal Distribution of Income
◦ Absolute Poverty: lack of income to buy the basic
food and necessities for subsistence living
◦ Poverty Threshold: income needed to purchase the
minimum nutritional requirements and other basic
necessities for daily survival
◦ Poverty Incidence: proportion of households in the
country with family income lower than the poverty
threshold
Basic Economic Problems Confronting
the Dev’t of the Phils. in the 21st Cen.
 Poverty (cont.)
◦ Relative Poverty: the structure on how the national
income is being distributed among households in
an economy
◦ Lorenz Curve: shows the share of the various
household groups on the total national income
◦ Gini Coefficient: measure of income inequality
derived from the Lorenz Curve
 Perfect equality = 0; Perfect inequality = 1
Basic Economic Problems Confronting
the Dev’t of the Phils. in the 21st Cen.
 Demographic Changes and its Economic
Implications
◦ Population growth, is it good or bad?
◦ Economics of Childbirth: looks at the benefits and
costs of having a child
 Low Investment in Human Resource
Development
◦ Knowledge capital: heavy investments in higher
education, science and technology, and research
and development
Basic Economic Problems Confronting
the Dev’t of the Phils. in the 21st Cen.
 Weak Infrastructure
◦ How to finance? Borrowing, taxation, public-private
partnership
 Pursuing Food Security
◦ Food security vs. food self-sufficiency
 Slow Adaptation of Modern Technology
◦ Labor intensive technology vs. Capital intensive
technology
Basic Economic Problems Confronting
the Dev’t of the Phils. in the 21st Cen.
 Environmental Sustainability and the
Country’s Development Thrust
◦ The environment is part of natural resources where
we derive income from the utilization of its wealth.
◦ However, excessive use of our natural resources
may compromise its ability to provide income and
other benefits in the future.
Synthesis
 We started with the realization that we live in an
environment of limited resources
 These limited resources must be properly used to
give us the highest level of satisfaction, welfare and
net benefit
 Economics gives us three major mechanisms or
systems of allocating resources
 The tools of applied economics can be used in
understanding socioeconomic and business issues
 The tools of applied economics can also be used in
proposing alternative solutions to socioeconomic
and business problems