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Chapter 1 Economics and the Real World

Economics is the proper allocation and efficient use of

available resources for the maximum satisfaction of human
wants. Economics is classified as social science because it
deals with the study of mans life and how he lives with other
-a jobless man is likely to create a social crime of stealing.
-geography determines the main sources of income like fishing
-political policies affects the economic activities
Methods of Economics
As a science, it is a systematic body of knowledge. It uses scientific
methods in gathering data, analyzing the data and making conclusions. Data
are obtained through observations and interviews called empirical method.
Limitations of Economic Method
-Biases and values of those who gets data
-It cannot be examined objectively
Division of Economics
Microeconomics. It deals with the economic behavior as individual
units such as the consumers, firms and the owners of the factors of
production such as price of rice, number of workers of WU-P, income of Mr.
Macroeconomics. It deals with the economic behavior of the whole
economy or its aggregate such as government, business and household.
They are GNP, inflation and level of employment.
History of Economics
The word economics was derived from an ancient Greek word
oikonomos which means household management that applied more on
proper management of city-states.
Adam Smith (1776), the Father of Economics
Plato recommended division of labor to improve production.
Aristotle explained the functions of money.
Romans believed that agriculture was the only honorable industry.
St. Thomas Aquinas crusaded for the distributive justice for
distribution of good and compensatory justice for fair exchange of goods and
Schumacher, the author of Small is Beautiful, suggested intermediate

Karl Marx, the father of modern socialism said that socialism is the
lower stage of post-capitalism, and communism as the higher state of post
Basic Economics Problems
1. What goods and services to produce and how much.
2. How to produce the goods and services.
3. For whom are the goods and services.
Economic Systems
It is a set of economic institutions that dominates a given economy.
Capitalism. The factors of production and distribution are owned and
managed by private individuals or corporations. There is private property,
economic freedom, free competition and profit motive.
Communism. It is exactly the opposite of capitalism where the factors
of production are owned and managed by the state. There is no private
property, no free competition, no economic freedom, no profit motive and
presence of central planning.
Socialism. It is the combination of capitalism and communism
Vital Criteria to Judge an Economic System
-Justice and Equity
-Economic Freedom
Goal of Economics
-Economic growth
-Full employment
-Price stability
-Economic freedom
-Equitable distribution of income and wealth
-Economic security

Chapter 2 The Prices of Goods and Services

It is the value of product or service. It is
expressed in terms of monetary value.
It is the schedule of various quantities of
commodities which buyers are willing and able to
purchase at a given price, time and place. It is determine by income,
population, taste and preference, price expectations and prices of related
Law of Demand
Consumers are most likely to buy more goods and services as price
decreases and buy less goods and services as price rises.
-Income Effect
-Substitution Effect
It is the schedule of various quantities of commodities which producers
are willing and able to produce and offer at a given price, place and time. Its
determinants are technology, cost of production, number of sellers, prices of
other goods, price expectations, taxes and subsidies.
Law of Supply
As price increases, quantity supply also increases, and as price
decreases, quantity supply also decreases.
Price System
-It is a mechanism of allocating goods and services through the rise or
fall of prices caused by the interplay of supply and demand forces.
-One favorable argument for the price system is its efficiency in
distributing goods and services.
-Another argument in favor of the price system is the presence of
personal freedom.
Criticisms Against The Price System
-Self-interests of businessmen force them to drive away their rivals
through cut-throat competition.

-Another case against the price system is the unfair distribution of

goods and services.
-Social goods like anti-pollution, rural electrification, irrigation, or
highways can not be allocated efficiently through price system.

Chapter 3 Elasticity and Consumer Behavior

Elasticity of Demand.
It refers to the
reaction or response of the buyers to changes in
price of goods and services.
1. Elastic demand. A change in price results
to a
greater change on quantity demanded. Example
luxury goods.
2. Inelastic demand. A change in price results
to a lesser change in quantity demanded. This means buyers are not
sensitive to price change.
3. Unitary demand. A change in price results to an equal change in
quantity demanded. Examples are shoes and clothings.
4. Perfectly elastic demand. Without change in price, there is an
infinite change in quantity demanded.
5. Perfectly inelastic demand. A change in price creates no change
in quantity demanded. Example is medicine.
Determinants of Demand Elasticity
1. Number of good substitute.
2. Price increase in proportion to income.
3. Importance of the product to the consumers.
Elasticity Formula
Economic significance of Demand Elasticity

Wage determination
Farm production guide
Maximize profits
Imposition of sales taxes

Elasticity of Supply
It refers to the reaction or response of the sellers/producers to price
change of goods.
1. Elastic supply. A change in price results to a greater change on
quantity supplied. Producers are very sensitive to price like manufacturing

2. Inelastic supply. A change in price results to a lesser change in

quantity supplied. Producers have a very weak response to price change like
coconut planters.
3. Unitary supply. A change in price results to an equal change in
quantity supplied. Examples are semi-industrial or semi agricultural products.
4. Perfectly elastic supply. Without change in price, there is an
infinite change in quantity supplied.
5. Perfectly inelastic supply. A change in price has no effect in the
quantity supplied.
Determinants of Supply Elasticity
The time involved in the ability of producers to respond to price
Theory of Consumer Behavior
1. Law diminishing marginal utility. A law of economics stating that

as a person increases consumption of a product - while keeping consumption of

other products constant - there is a decline in the marginal utility that person
derives from consuming each additional unit of that product.
When you have that first bite of chocolate cake it seems like you just can't
get enough of it! However, as you eat your second piece and third piece you may
start to realize you have had enough cake. For each additional unit of a good (in this
case for each additional piece of cake) the added satisfaction you receive from
consuming the good decreases.

2. Indifference curve. Indifference curves show different combination

of goods which give consumers the same utility. In other words, consumers
will be indifferent to the different combination of goods because they give
same utility.
Diagram of Indifference Curve

This diagram shows three indifference curves. If we take Indifference

Curve I1, it means that the consumer would be equally happy with say:
10 Good Y, and 1 Good X
5 Good Y, and 5 Good X

1 Good X and 10 Good X

Any point on each indifference curve gives consumer same net utility.
Diminishing Returns and Indifference Curves
Indifference curves tend to be negatively sloped because of
diminishing returns. If you gain more good X, the utility of X starts to show
diminishing returns additions to total utility are increasingly small.
Therefore, as you get more good X, the extra good X is worth less.

Indifference Map
Indifference Curves and Budget Line. To maximize welfare, a
consumer will examine his budget and see the furthest indifference curve he
can reach.

The blue line represents the maximum combination of goods you can
buy give your limited budget. The point where the budget line meets an
indifference curve, shows the best combination of goods, given the existing
budget constraint.
The Budget Line
As we have already seen, a consumers choices are limited by the
budget available. Total spending for goods and services can fall short of the
budget constraint but may not exceed it.
Chapter 4 Production

Goods produced by men are economic goods however there are

goods produced without costs and they are called free goods.
Production is the creation of goods and services to satisfy human
Factors of Production
1. Land is an original gift of nature
2. Labor which is an exertion of physical ad mental efforts of
3. Capital are finished products which is used to produce other goods.
4. Entrepreneur is the organizer and coordinator of the land, labor and
The factors of production are called the inputs of production and the
goods and services that have been created by the inputs are called outputs
of production.
The factors of production are classified as fixed factor (fixed input) and
variable factor (variable input).
A fixed factor remains constant regardless of the volume of
production. This means whether you produce or not, the factor of production
remain unchanged like land and capital.
In the case of variable factor, it changes in accordance with volume.
No production means no variable factor. More production means more
variable factors. Examples are labor and entrepreneur.
The theory of production is the process of transforming both fixed
and variable inputs into finished goods and services.
Law of Diminishing Returns
A concept in economics that if one factor of production (number of
workers, for example) is increased while other factors (machines and
workspace, for example) are held constant, the output per unit of the
variable factor will eventually diminish.
Although the marginal productivity of the workforce decreases as
output increases, diminishing returns do not mean negative returns until (in
this example) the number of workers exceeds the available machines or
workspace. In everyday experience, this law is expressed as "the gain is not
worth the pain."
Costs of Production
A cost incurred by a business when manufacturing a good or producing
a service. Production costs combine raw material and labor. To figure out the
cost of production per unit, the cost of production is divided by the number
of units produced. A company that knows how much it will cost to produce an

item, or produce a service, will have a clearer picture of how to better price
the item or service and what will be the total cost to the company.
Economies of Scale
Economies of scale are factors that cause the average cost of
producing something to fall as the volume of its output increases.
Economies of scale can be classified into two main types: Internal
arising from within the company; and External arising from extraneous
factors such as industry size.
Economies of Scale occur for various reasons.
1. Specialization and division of labour. In large scale operations
workers can do more specific tasks. With little training they can become very
proficient in their task, this enables greater efficiency. A good example is an
assembly line with many different jobs.
2. Technical. Some production processes require high fixed costs e.g.
building a large factory. If a car factory was then only used on a small scale it
would be very inefficient to run. By using the factory to full capacity average
costs will be lower.
3. Bulk buying. If you buy a large quantity then the average costs will
be lower. This is because of lower transport costs and less packaging. This is
why supermarkets get lower prices from suppliers than local corner shops.
4. Spreading overheads. If a firm merged it could rationalize its
operational centers. E.g. it could have one head office rather than two.
5. Risk Bearing economies. Some investments are very expensive
and perhaps risky, therefore only a large firm will be able and willing to
undertake the necessary investment. E.g. pharmaceutical industry needs to
take risks in developing new drugs.
6. Marketing Economies of scale. There is little point a small firm
advertising on a national TV campaign because the return will not cover the
high sunk costs.
7. The container principle. To increase capacity 8 fold it is necessary
to increase surface area only 4 fold.
8. Financial economies. A bigger firm can get a better rate of
interest than small firms.
9. External economies of scale. This occurs when firms benefit from
the whole industry getting bigger. E.g. firms will benefit from better
infrastructure, access to specialized labor and good supply networks.
Most of the above economies of scale are internal. It means the
economies benefit the firm when it grows in size
Techniques of Production
Labor-intensive. A process or industry that requires a large amount
of labor to produce its goods or services. The degree of labor intensity is
typically measured in proportion to the amount of capital required to produce
the goods/services; the higher the proportion of labor costs required, the
more labor intensive the business.

Labor intensive industries include restaurants, hotels, agriculture and

mining. Advances in technology and worker productivity have moved some
industries away from labor-intensive status, but many still remain.
Capital-intensive. A business process or an industry that requires
large amounts of money and other financial resources to produce a good or
service. A business is considered capital intensive based on the ratio of the
capital required to the amount of labor that is required.
Some industries commonly thought of as capital intensive include oil
production and refining, telecommunications and transports such as railways
and airlines.
The amount of money that a company actually receives during a
specific period, including discounts and deductions for returned
merchandise. It is the "top line" or "gross income" figure from which costs
are subtracted to determine net income.
Revenue is calculated by multiplying the price at which goods or
services are sold by the number of units or amount sold. Revenue is also
known as "REVs."
Total revenue = price times unit sold
TR = PxQ
Total revenue total cost = profit
TR>TC: Produce more
TR<TC: Stop production
TR=TC: Maintain production
Chapter 5 Market Structure
1. Perfect/pure type
1.1. perfect or pure competition
1.2. pure monopoly
2. Imperfect/non-pure type
2.1. monopolistic competition
2.2. oligopoly
Perfect competition is a market structure where many firms offer a
homogeneous product. Because there is freedom of entry and exit and
perfect information, firms will make normal profits and prices will be kept low
by competitive pressures.
Features of perfect competition
-Many firms.
-Freedom of entry and exit; this will require low sunk costs.
-All firms produce an identical or homogeneous product.

-All firms are price takers, therefore the firms demand curve is
perfectly elastic.
-There is perfect information and knowledge.
Definition of Monopoly
A pure monopoly is defined as a single seller of a product, i.e. 100% of
market share.
In the UK, a firm is said to have monopoly power if it has more than
25% of the market share. For example, Google share 90% of search engine
Problems of Monopoly
Higher Prices. Firms with monopoly power can set higher prices than
in a competitive market.
Allocative Inefficiency. A monopoly is allocatively inefficient because
in monopoly the price is greater than MC. In a competitive market the price
would be lower and more consumers would benefit. A monopoly results in
dead-weight welfare loss indicated by the red triangle.
Productive Inefficiency. A monopoly is productively inefficient
because output does not occur at the lowest point on the AC curve.
Inefficiency. It is argued that a monopoly has less incentive to cut
costs because it doesnt face competition from other firms.
Supernormal Profit. A Monopolist makes Supernormal Profit leading
to an unequal distribution of income.
Higher Prices to suppliers. A monopoly may use its market power
and pay lower prices to its suppliers. E.g. Supermarkets have been criticized
for paying low prices to farmers.
Diseconomies of scale. It is possible that if a monopoly gets too big
it may experience dis-economies of scale. higher average costs because it
gets too big.
Lack of incentives. A monopoly faces a lack of competition and
therefore, it may have less incentive to work at product innovation and
develop better products.
Charge higher prices to suppliers. Monopolies may use their
supernormal profits to charge higher prices to suppliers.
How Monopolies can develop
Horizontal Integration. Where two firms join at the same stage
of production.
e.g. two banks
Vertical Integration. Where a firm gains market power by
controlling different
stages of the production process. A good
example is the oil industry, where the
leading firms produce, refine
and sell oil.
Legal Monopoly. E.g. Royal Mail or Patents for producing a

Internal Expansion of a firm. Firms can increase market share

by increasing their
sales and possibly benefiting from economies
of scale. For example, Google
became a monopoly
dominating the search engine market.

Being the First Firm e.g. Microsoft has created monopoly

power by being the
first firm.

Monopolies also need barriers to entry to protect them from new firms
entering the market. Barriers to entry can include brand loyalty through
advertising and economies of scale
An Oligopoly is an industry dominated by a few firms, e.g.
supermarkets, petrol, car industry e.t.c.
The main features of oligopoly:
-An industry which is dominated by a few firms.
-Example. UK definition of an oligopoly is a five firm concentration ratio
of more than 50% (this means they have more than 50% of the market
-Interdependence of firms, firms will be affected by how other firms set
price and output.
-Barriers to entry, but less than monopoly.
-Differentiated products, advertising is often important
-Most common market structure
Monopolistic Competition
Monopolistic Competition is a market structure which combines
elements of monopoly and competitive markets. Essentially a monopolistic
competitive market is one with freedom of entry and exit, but firms are able
to differentiate their products. Therefore, they have an inelastic demand
curve and so they can set prices. However, because there is freedom of
entry, supernormal profits will encourage more firms to enter the market
leading to normal profits in the long term.
A monopolistic competitive industry has the following
-Many firms
-Freedom of entry and exit
-Produce differentiated products. Therefore firms have inelastic
demand, they are price makers because the good is highly differentiated
-Make normal profits in the long run, but could make supernormal
profits in the short term
-Are allocatively and productively inefficient.

Contestable Market
A contestable market occurs when there is freedom of entry and exit
into the market. Thus in a contestable market, there will be low sunk costs.
(Costs which cant be recovered when leaving the market).
Factors which determine the contestability of a market
When considering the contestability of markets it is important to
consider the different barriers to entry a new firm may face
-Sunk Costs. If Sunk costs are high this makes it difficult for new firms
to enter and leave the market. Therefore it will be less contestable. For
example, if a new firm had to purchase raw materials, that it wouldnt be
able to resell on leaving the market, this may act as a deterrent.
-Levels Of Advertising And Brand Loyalty. If an established firm
has significant brand loyalty such as Coca Cola, then it will be difficult for a
new firm to enter the market. This is because they would have to spend a lot
of money on advertising which is a sunk cost. Even if they spend money on
advertising it may not be sufficient to change customer loyalty to very strong
brands. It depends on the industry, customer loyalty would be fairly low for a
product like petrol because it is quite homogenous. But, for soft drinks
people have greater attachment to their brand
-Vertical Integration. If a firm does not have access to the supply of
a good then the market will be less contestable. E.g. Oil firms could restrict
the supply of petrol to petrol stations, making it difficult for new firms to
enter. If you wish to sell electricity to domestic customers, a big issue is
whether you can gain access to the electricity grid. The national electric grid
is a natural monopoly, but government regulation can make sure firms have
a fair access to the grid. Giving access to different stages of production can
make the market more contestable. (How vertical barriers can restrict
-Access To Technology And Skilled Labor. For some industries like
car production it is difficult for new firms to have the right technology.
Nuclear power may require skilled labor that is difficult to get. This makes
the market less contestable. If you wished to compete with Google, you may
find it hard to employ the best software engineers because Google pays its
employees a very good wage and is seen as an attractive company to work

Chapter 6 Factor Markets and Income Distribution

Determinants of Factor Demand

-Demand for goods and services. Direct demand and derived demand.
-Price of factors of production.

Employment Decisions Re Demand for Labor

-MRP > MRC: employ more man-hours of labor
-MRP < MRC: reduce man-hours of labor
-MRP = MRC: maintain man-hours of labor
Factor Market
The law of supply governs the behavior of resources in the factor
market just like the behavior of goods and services in the product market.
The suppliers of goods and services have one common goal: profit
Backward bending Supply
Labor Market
Labor is treated like any other good in
the market, except demand comes from the firm
instead of the consumer.
The price a firm pays for labor is known
as the wage. In addition to a wage, workers also
commonly receive fringe benefits such as
insurance and vacation time.
Real wage: Wage adjusted for inflation.
The demand curve for the labor market shows how much labor firms
will buy at each wage. Firms must determine how much labor is needed for
a profit-maximizing level of production.
Marginal revenue product (MRP): Revenue increase resulting from the
purchase of an additional unit of labor. The firm maximizes profits by
purchasing additional labor until the MRP is equal to the market wage. If the
costs of any factors necessary to produce a good change, the MRP will be
affected and the amount of labor demanded by the firm will also change.
Adding up all the firms labor demand curves will equal the market labor
demand curve.
If demand increases (decreases) for a good that a particular type of
labor produces, the demand for that type of labor will also increase

The supply curve for the labor market shows how much labor workers
or households will provide at each wage.
There are two alternatives for each households time: leisure and
working at home.
As the market wage changes, decisions concerning work will also
change. There are two effects of a wage change, which work in opposite
-Substitution effect: If the marginal benefit of leisure or working at
home is higher than the market wage, the household should choose either
leisure or working at home. This means that as the wage rises (falls),
households are more (less) likely to choose the labor market.
-Income effect: As the wage rises (falls), households are less (more)
likely to spend more time in labor market. With a higher (lower) wage, they
can work less (more) to make the same income.
The relative strengths of the income and substitution effects will
determine the shape of the households labor supply curve.
If the substitution effect is stronger, the curve will be upward sloping.
If the income effect is stronger, the curve will be downward sloping.
If the substitution and income effects are equal, the curve will be
Most people have a backward-bending labor supply curve, which is
upward sloping for low wages, vertical or nearly vertical at higher wages, and
bends backward with a downward slope for the highest wages.
Market labor supply, on the other hand, is a straight, upward sloping
line. It is not backward-bending because, as a whole, more workers will be
attracted to higher-paying jobs.
As with other goods, the supply and demand for labor create an equilibrium
wage rate and quantity in the market when they are equal. There are several
possible inefficiencies, which may cause the wage to differ from equilibrium:
-Income tax: Workers pay a tax on their income, and it affects the amount of
time they are willing to work.
-Minimum wage: The government sets in the market a minimum wage, which
firms are forced to pay.
-If the minimum wage is lower than the market equilibrium
wage, then there is no
impact because firms will pay the equilibrium wage.
-If the minimum wage is higher than the market equilibrium
wage, labor supplied will be
higher than labor demanded, and some workers will
be unable to find jobs.
-Discrimination: Firms may choose to hire or set wages based on factors that
are not related to productivity, such as race, age, or gender. Nonprofit maximizing
decisions are inefficient.

-Unions by bargaining with firms for higher wages, unions decrease

demand for labor. Some workers will then move to nonunion firms, which can
compete with lower costs because they pay lower wages. However, union

firms often have other benefits that offset the higher cost of labor, such as
lower turnover.

Income Distribution
It is the allocation of income among the owners of the factors of
Social philosophers crusaded not only for social and political equality
but also for economic equality.
Rousseau contended that private property is a robbery and it did not
exist in the state of nature.
Babeuf stated that nature has given every man an equal right in the
enjoyment of all goods.
Proudhon claimed that employers robbed laborers by not rendering
them full value of their labor.
Marx claimed that in the process of accumulating wealth for himself ,
they robbed and exploited the worker.
Types of Income Distribution
1. Personal Distribution. Allocation of income among persons or
households. The degree of income inequality among households or families
(shown in the Lorenz curve).
2. Functional Distribution. allocation of income among the factors of
production: land, labor, capital and entrepreneur. The income of the factors
of production are rent for land, wages for labor, interest for capital, and
profits for entrepreneur.
Lorenz Curve
The Lorenz curve is a useful tool used by those interested in statistics
and economics to give a picture of
distribution. Its plots the % of household
income on the vertical scale against the % of
households on the horizontal. An example is
shown right.
The Gini Coefficient is derived from the
same information used to create a Lorenz
Curve. The co-efficient indicates the gap
between two percentages: the percentage of
population, and the percentage of income
received by each percentage of the
population. In order to calculate this you

divide the area between the Lorenz Curve and the 45 line by the total area
below the 45 line eg.
Area between the Lorenz Curve and the 45 line / Total area below the
45 line
The resulting number ranges between:
0 = perfect equality where say, 1% of the population = 1% of income,
1 = maximum inequality where all the income of the economy is
acquired by a single recipient.
* The straight line (45 line) shows absolute equality of income. That is,
10% of the households earn 10% of income, 50% of households earn 50% of
* The Lorenz Curve itself shows actual distribution of income. The
further the Lorenz Curve is away from the 45 line, the more unequal is the
distribution of income.
* Lorenz Curves are typically drawn from gross income. Once
disposable income is taken into account, the Lorenz Curve will most likely
move inwards. This is because, as we shall see, the net effect of taxes and
other distributional measures of government is to bring everyones
disposable incomes closer together.
* Those countries where the wealth is in the hands of a few, such as oil
sheikdoms, will have Lorenz Curves extremely bowed.
Lorenz curves may also be drawn to show the extent of inequality in
the distribution of wealth. Such curves are likely to be even further away
from the line of complete equality than are those of the distribution of
income. This is because most people have some disposable income while not
everyone has assets.
Causes of Income Inequality

Intelligence and talents

Education and training
Unpleasant and risky jobs
Ownership of productive factors
Luck and connections

Wage and Salary

The person receiving a salary is not paid a smaller amount for working
fewer hours, nor is he paid more for working overtime. Someone who is paid
wages receives a pay rate per hour, multiplied by the number of hours
worked. This person is considered to be a "non-exempt" employee.
Economic Rent

Economic rent is the positive difference between the actual payment

made for a factor of production (such as land, labor or capital) to its owner
and the payment level expected by the owner, due to its exclusivity or
scarcity. In short economic rent is any unearned income.
A financial benefit that is realized when the
amount of revenue gained from a business activity
exceeds the expenses, costs and taxes needed to
sustain the activity. Any profit that is gained goes to
the business's owners, who may or may not decide
to spend it on the business.

Chapter 7 Business Organization

A business organization is an individual or group of
people that collaborate to achieve certain commercial
goals. Some business organizations are formed to
earn income for owners.

One of the first decisions that you will have to

make as a business owner is how the business
should be structured. All businesses must adopt
some legal configuration that defines the rights and
liabilities of participants in the businesss ownership, control, personal
liability, life span, and financial structure. This decision will have long-term
implications, so you may want to consult with an accountant and attorney to
help you select the form of ownership that is right for you. In making a
choice, you will want to take into account the following:
Your vision regarding the size and nature of your business.
The level of control you wish to have.
The level of structure you are willing to deal with.
The businesss vulnerability to lawsuits.
Tax implications of the different organizational structures.
Expected profit (or loss) of the business.
Whether or not you need to re-invest earnings into the business.
Your need for access to cash out of the business for yourself.
Sole Proprietorship
The vast majority of small businesses start out as sole proprietorships.
These firms are owned by one person, usually the individual who has day-today responsibility for running the business. Sole proprietorships own all the
assets of the business and the profits generated by it. They also assume

complete responsibility for any of its liabilities or debts. In the eyes of the
law and the public, you are one in the same with the business.
Advantages of a Sole Proprietorship
Easiest and least expensive form of ownership to organize.
Sole proprietors are in complete control, and within the parameters
of the law, may make decisions as they see fit.
Profits from the business flow-through directly to the owners
personal tax return.
The business is easy to dissolve, if desired.
Disadvantages of a Sole Proprietorship
Sole proprietors have unlimited liability and are legally responsible
for all debts against the business. Their business and personal assets
are at risk.
May be at a disadvantage in raising funds and are often limited to
using funds from personal savings or consumer loans.
May have a hard time attracting high-caliber employees, or those
that are motivated by the opportunity to own a part of the business.
Some employee benefits such as owners medical insurance
premiums are not directly deductible from business income (only
partially as an adjustment to income).
In a Partnership, two or more people share ownership of a single
business. Like proprietorships, the law does not distinguish between the
business and its owners. The Partners should have a legal agreement that
sets forth how decisions will be made, profits will be shared, disputes will be
resolved, how future partners will be admitted to the partnership, how
partners can be bought out, or what steps will be taken to dissolve the
partnership when needed; Yes, its hard to think about a break-up when the
business is just getting started, but many partnerships split up at crisis times
and unless there is a defined process, there will be even greater problems.
They also must decide up front how much time and capital each will
contribute, etc.
Advantages of a Partnership
Partnerships are relatively easy to establish; however time should be
invested in developing the partnership agreement.
With more than one owner, the ability to raise funds may be

The profits from the business flow directly through to the partners
personal tax return.
Prospective employees may be attracted to the business if given the
incentive to become a partner.
The business usually will benefit from partners who have
complementary skills.
Disadvantages of a Partnership
Partners are jointly and individually liable for the actions of the other
Profits must be shared with others.
Since decisions are shared, disagreements can occur.
Some employee benefits are not deductible from business income on
tax returns.
The partnership may have a limited life; it may end upon the
withdrawal or death of a partner.
Types of Partnerships that should be considered:
1. General Partnership. Partners divide responsibility for management
and liability, as well as the shares of profit or loss according to their internal
agreement. Equal shares are assumed unless there is a written agreement
that states differently.
2. Limited Partnership and Partnership with limited liability. Limited
means that most of the partners have limited liability (to the extent of their
investment) as well as limited input regarding management decision, which
generally encourages investors for short term projects, or for investing in
capital assets. This form of ownership is not often used for operating retail
or service businesses. Forming a limited partnership is more complex and
formal than that of a general partnership.
3. Joint Venture. Acts like a general partnership, but is clearly for a
limited period of time or a single project. If the partners in a joint venture
repeat the activity, they will be recognized as an ongoing partnership and
will have to file as such, and distribute accumulated partnership assets upon
dissolution of the entity.
A Corporation, chartered by the state in which it is headquartered, is
considered by law to be a unique entity, separate and apart from those who
own it. A Corporation can be taxed; it can be sued; it can enter into
contractual agreements. The owners of a corporation are its shareholders.
The shareholders elect a board of directors to oversee the major policies and
decisions. The corporation has a life of its own and does not dissolve when
ownership changes.

Advantages of a Corporation
Shareholders have limited liability for the corporations debts or
judgments against the corporation.
Generally, shareholders can only be held accountable for their
investment in stock of the company. (Note however, that officers can
be held personally liable for their actions, such as the failure to
withhold and pay employment taxes.
Corporations can raise additional funds through the sale of stock.
A Corporation may deduct the cost of benefits it provides to officers
and employees.
Can elect S Corporation status if certain requirements are met. This
election enables company to be taxed similar to a partnership.
Disadvantages of a Corporation
The process of incorporation requires more time and money than
other forms of organization.
Corporations are monitored by federal, state and some local
agencies, and as a result may have more paperwork to comply with
Incorporating may result in higher overall taxes. Dividends paid to
shareholders are not deductible from business income; thus this
income can be taxed twice.
An autonomous association of people who voluntarily cooperate for
their mutual social, economic, and cultural
There are 5 different types of cooperatives:
Consumer: owned by consumers who buy goods or services from
their cooperative
Producer: owned by producers of commodities or crafts who have
joined forces to process and market their products
Worker: owned and democratically governed by employees who
become co-op members
Purchasing: owned by independent businesses or municipalities to
improve their purchasing power
Hybrid: a combination of co-op types, where people with common
interests band together.
Business Management
Management in businesses and organizations is the function that
coordinates the efforts of people to accomplish goals and objectives by using

available resources efficiently and effectively. Management includes

planning, organizing, staffing, leading or directing, and controlling an
organization to accomplish the goal.
Styles of Management
Management styles are characteristic ways of making decisions and
relating to subordinates. Management styles can be categorized into two
main contrasting styles, autocratic and permissive. Management styles
are also divided in the main categories of autocratic, paternalistic, and
6 Management Styles
According to Hay-McBer there are six key leadership or management
DIRECTIVE. The DIRECTIVE (Coercive) style has the primary objective
of immediate compliance from employees:
-The do it the way I tell you manager
-Closely controls employees
-Motivates by threats and discipline
Effective when:
-There is a crisis
-When deviations are risky
Not effective when:
-Employees are underdeveloped little learning happens with this style
-Employees are highly skilled they become frustrated and resentful at
the micromanaging.
AUTHORITATIVE. The AUTHORITATIVE (Visionary) style has the
primary objective of providing long-term direction and vision for employees:
-The firm but fair manager
-Gives employees clear direction
-Motivates by persuasion and feedback on task performance
Effective when:
-Clear directions and standards needed
-The leader is credible
Ineffective when:
-Employees are underdeveloped they need guidance on what to do
-The leader is not credible people wont follow your vision if they
dont believe in it

AFFILIATIVE. The AFFILIATIVE style has the primary objective of

creating harmony among employees and between manager and employees:
-The people first, task second manager
-Avoids conflict and emphasizes good personal relationships among
-Motivates by trying to keep people happy
Effective when:
-Used with other styles
-Tasks routine, performance adequate
-Counselling, helping
-Managing conflict
Least effective when:
-Performance is inadequate affiliation does not emphasise
-There are crisis situations needing direction
PARTICIPATIVE. The PARTICIPATIVE (Democratic) style has the
primary objective of building commitment and consensus among employees:
-The everyone has input manager
-Encourages employee input in decision making
-Motivates by rewarding team effort
Effective when:
-Employees working together
-Staff have experience and credibility
-Steady working environment
Least effective when:
-Employees must be coordinated
-There is a crisis no time for meetings
-There is a lack of competency close supervision required
PACESETTING. The PACESETTING style has the primary objective of
accomplishing tasks to a high standard of excellence:
-The do it myself manager
-Performs many tasks personally and expects employees to follow
his/her example
-Motivates by setting high standards and expects self-direction from
Effective when:
-People are highly motivated, competent
-Little direction/coordination required
-When managing experts

Least effective when:

-When workload requires assistance from others
-When development, coaching & coordination required
COACHING. The COACHING style has the primary objective of longterm professional development of employees:
-The developmental manager
-Helps and encourages employees to develop their strengths and
improve their performance
-Motivates by providing opportunities for professional development
Effective when:
-Skill needs to be developed
-Employees are motivated and wanting development
Ineffective when:
-The leader lacks expertise
-When performance discrepancy is too great coaching managers may
persist rather
than exit a poor performer
-In a crisis
The key to being an effective leader is to have a broad repertoire of
styles and to use them appropriately.
Social Responsibility of Management

Increasing concern for the social responsibility of management, it is now

recognized that besides taking care of the financial interest of owners, managers of
business firms must also take into account the interest of various other groups such
as employees, consumers, the government and the community as a whole.

Social responsibility is defined as the obligation and commitment of

managers to take steps for protecting and improving societys welfare along
with protecting their own interest. The managers must have social
responsibility because of the following reasons:
1. Organizational Resources - An organization has a diverse pool of
resources in form of men, money, competencies and functional expertise.
When an organization has these resources in hand, it is in better position to
work for societal goals.
2. Precautionary measure - if an organization lingers on dealing with
the social issues now, it would land up putting out social fires so that no time
is left for realizing its goal of producing goods and services. Practically, it is
more cost-efficient to deal with the social issues before they turn into
disaster consuming a large part if managements time.
3. Moral Obligation - The acceptance of managers social
responsibility has been identified as a morally appropriate position. It is the

moral responsibility of the organization to assist solving or removing the

social problems
4. Efficient and Effective Employees - Recruiting employees
becomes easier for socially responsible organization. Employees are
attracted to contribute for more socially responsible organizations. For
instance - Tobacco companies have difficulty recruiting employees with best
skills and competencies.
5. Better Organizational Environment - The organization that is
most responsive to the betterment of social quality of life will consequently
have a better society in which it can perform its business operations.
Employee hiring would be easier and employee would of a superior quality.
There would be low rate of employee turnover and absenteeism. Because of
all the social improvements, there will be low crime rate consequently less
money would be spent in form of taxes and for protection of land. Thus, an
improved society will create a better business environment.
But, managers social responsibility is not free from some criticisms,
such as High Social Overhead Cost - The cost on social responsibility is a
social cost which will not instantly benefit the organization. The cost of social
responsibility can lower the organizational efficiency and effect to compete in
the corporate world.
Cost to Society - The costs of social responsibility are transferred on
to the society and the society must bear with them.
Lack of Social Skills and Competencies - The managers are best at
managing business matters but they may not have required skills for solving
social issues.
Profit Maximization - The main objective of many organizations is
profit maximization. In such a scenario the managers decisions are controlled
by their desire to maximize profits for the organizations shareholders while
reasonably following the law and social custom.
Social responsibility can promote the development of groups and
expand supporting industries.

Chapter 8 National Income

National Income is the total value a countrys final

output of all new goods and services produced in one year.
Understanding how national income is created is the
starting point for macroeconomics.

Flow of Goods and Services

National income, output, and expenditure are generated by the activities of

the two most vital parts of an economy, its households and firms, as they engage in
mutually beneficial exchange.


The primary economic function of households is to supply domestic
firms with needed factors of production - land, human capital, real capital
and enterprise. The factors are supplied by factor owners in return for a
reward. Land is supplied by landowners, human capital by labour, real
capital by capital owners (capitalists) and enterprise is provided by
entrepreneurs. Entrepreneurs combine the other three factors, and bear the
risks associated with production.

The function of firms is to supply private goods and services to
domestic households and firms, and to households and firms abroad. To do
this they use factors and pay for their services.

Factor incomes
Factors of production earn an income which contributes to national
income. Land receives rent, human capital receives a wage, real capital
receives a rate of return, and enterprise receives a profit.
Members of households pay for goods and services they consume with
the income they receive from selling their factor in the relevant market.

Production function

The simple production function states that output (Q) is a function (f)
of: (is determined by) the factor inputs, land (L), labour (La), and capital (K),
i.e. Q = f (L, La, K)

The Circular flow of income

Income (Y) in an economy flows
from one part to another whenever
a transaction takes place. New
spending (C) generates new income
(Y), which generates further new
spending (C), and further new

income (Y), and so on. Spending and income continue to circulate around the
macro economy in what is referred to as the circular flow of income.
The circular flow of income forms the basis for all models of the macroeconomy, and understanding the circular flow process is key to explaining
how national income, output and expenditure is created over time.

Injections and withdrawals

The circular flow will adjust following new injections into it or new
withdrawals from it. An injection of new spending will increase the flow. A net
injection relates to the overall effect of injections in relation to withdrawals
following a change in an economic variable.

Savings and investment

The simple circular flow is,
therefore, adjusted to take into
injections. Households may choose
to save (S) some of their income
(Y) rather than spend it (C), and
this reduces the circular flow of
income. Marginal decisions to save
reduce the flow of income in the
economy because saving is a
withdrawal out of the circular flow. However, firms also purchase capital
goods, such as machinery, from other firms, and this spending is an injection
into the circular flow. This process, called investment (I), occurs because
existing machinery wears out and because firms may wish to increase their
capacity to produce.

The public sector

In a mixed economy with a government, the simple model must be
adjusted to include the public
sector. Therefore, as well as save,
households are also likely to pay
taxes (T) to the government (G),
and further income is withdrawn
out of the circular flow of income.
Government injects income back
into the economy by spending (G)
on public and merit goods like
defense and policing, education,
and healthcare, and also on support
for the poor and those unable to work.

Including international trade

Finally, the model must be adjusted to include international trade.
Countries that trade are called open economies, the households of an open
economy will spend some of their
income on goods from abroad,
called imports (M), and this is
withdrawn from the circular flow.
Foreign consumers and firms will,
however, also wish to buy domestic
products, called exports (X), and
this is an injection into the circular

Ways of Calculating National Income

Any transaction which adds value involves three elements
expenditure by purchasers, income received by sellers, and the value of the
goods traded. For example, if a student purchases a textbook for 30,
spending = 30, income to the bookseller = 30, and the value of the book
= 30. All of the transactions in an economy can be looked at in this way,
giving us three ways to measure national income.
There are three methods of calculating national income:
The income method, which adds up all incomes received by the
factors of production generated in the economy during a year. This includes
wages from employment and self-employment, profits to firms, interest to
lenders of capital and rents to owners of land.
The output method, which is the combined value of the new and
final output produced in all sectors of the economy, including manufacturing,
financial services, transport, leisure and agriculture.
The expenditure method, which adds up all spending in the
economy by households and firms on new and final goods and services by
households and firms.
Chained value measurement
The components of national output are valued according to their
importance to the overall economy. The weights used were based on
estimates made every 5 years, but, from 2003, an annual adjustment to the
weightings was introduced to improve the reliability of the weighting - a
process called annual chain linking. This allowed for a more up-to-date, and
therefore a more accurate measure of changes to the level of national

It is an allowance for capital goods like machines which have been

consumed in the process of production. A machine depreciates not only
because of use through time but also as a result of obsolescence or
The productive life of a machine may be 5 or 10 years.
For example, if the useful life of the machine is 5 years, its cost is
P10,000, and its junk value is 200, as yearly depreciation is computed:
Double Counting
The simplest way to think about national income is to consider what
happens when one product is manufactured and sold. Typically, goods are
produced in a number of 'stages', where raw materials are converted by
firms at one stage, then sold to firms at the next stage. Value is added at
each, intermediate, stage, and, at the final stage, the product is given a
retail selling price. The retail price reflects the value added in terms of all the
resources used in all the previous stages of production.
Final output
In accounting terms, only the value of final output is recorded. To avoid
the problem of double counting, only the value of the final stage, the retail
price, is included, and not the value added in all the intermediate stages the costs of production, plus profits. In short, national income is the value of
all the final output of goods and services produced in one year.
For example, consider the production of a motor car which has a retail
price of 25,000. This price includes 21,000 for all the costs of production
(6,000 for components, 10,000 for assembly and 5,000 for marketing)
plus P4,000 for profit. To avoid double-counting, the national income
accounts only record the value of the final stage, which in this case is the
selling price of 25,000.
When goods are bought second-hand, the transaction does not add
new value and will not be included in national output. If second-hand goods
are included, double-counting will occur, and this would falsely inflate the
value of national income.
For example, if the car in question is sold in two years time for
15,000 it would provide the owner with money, but the sale will not add to
national income. If it were included in national income, it would make the
value of the car 35,000 - the initial 25,000 plus the second hand value of
15,000. This is clearly not the case, so any future second-hand sales are not
included when valuing national income. Such second-hand transactions are
called transfers.

Gross National Product

GNP is the total value of all final goods and services produced within a
nation in a particular year, plus income earned by its citizens (including
income of those located abroad), minus income of non-residents located in
that country. Basically, GNP measures the value of goods and services that
the country's citizens produced regardless of their location. GNP is one
measure of the economic condition of a country, under the assumption that a
higher GNP leads to a higher quality of living, all other things being equal.
How to compute GNP
If you spend much time listening to politicians or watching financial
news programs on TV or on the internet, youve undoubtedly heard the
terms GDP and GNP. The terms come up in discussions of the economy
or big picture financial matters, and sometimes seem interchangeable. But
what are GDP and GNP, and what is the difference between the two?
Both represent an attempt to measure the total economic output of a
nation during a given period (usually one year), and serve as barometers to
measure both the level and direction of a countrys economic activity.
GDP, or Gross Domestic Product is calculated either by measuring all
income earned within a country, or by measuring all expenditures within the
country, which should approximately be the same.
GNP, or Gross National Product uses GDP, but adds income from
foreign sources, less income paid to foreign citizens and entities.
GNP can be either higher or lower than GDP, depending on whether or
not a country has a positive or negative result from net foreign inflows and
outgo. Though GNP is still calculated, the United States shifted to GDP as its
primary economic measure in 1991, in part because most countries in the
world use GDP to measure the size and direction of their economies. As a
result, GNP numbers are less common than GDP figures.
Both GDP and GNP are complicated, and best summarized in a side-byside comparison:

Gross Domestic Product GDP

Gross National Product


What is it?

A measure of the total economy of a


Same as GDP

How its

Measuring all income earned within a

country, or by measuring all
expenditures within the country,
which should approximately match

GDP, plus income from

foreign sources, less income
paid to foreign citizens and

Gross Domestic Product GDP

Gross National Product


Why is it

It measures both the size and

direction of economic activity
(growth, stagnation or contraction)
expansions and recessions are based
on changes in GDP

Same as GDP

Who uses it?

Politicians, economists, large

companies (especially multinationals)

Same as GDP

What does it
mean to me?

Shows the relative strength of the

nations economy compared to that of
other nations; provides a base from
which to measure economic changes

Same as GDP

What is the
GDP/GNP of the

$15,684,800,000,000 as of 2012

$15,097,083,000,000 as of

GDP/GNP in the

Per Capita

Per Capita
GDP/GNP in the

Highest: United States

$15,684,800,000,000 (2012)
Lowest: Tuvalu $37,874,581

The Gross Domestic Product of a

country divided by its total population

Highest: Luxembourg
$107,206 (2012)
Lowest: Democratic Republic
of the Congo $237 (2012)

Highest: United
Lowest: N/A

The Gross National Product

of a country divided by its
total population

Highest: Qatar
$87,030 (2011)
Lowest: Democratic
Republic of the Congo
$350 (2011)

Gross Domestic Product GDP

What is the Per

GDP/GNP of the

$49,922 (2012)
World Rank: 11th

Gross National Product


$48,890 (2012)
World Rank: 10th

(Statistical sources: The World Bank GDP By Country, IMF World Economic
Outlook Database, April 2013, Wikipedia, List of Countries by GNI (PPP) Per
Capita )
GNP = C + G + I + NX +NFP
The calculation is explained below:
Consumption (C) is the total consumption by a household. It consists
of the entire consumer spending such as food, clothing etc. The major
component of GNP is consumers' consumption which forms 2/3rd of total
consumers demand.
Goods and services (G) also forms a large part of the GNP after
consumers' consumption. Government purchases consist of expenses
incurred by the government in the form of salaries for employees, Defense
and spending by state and local government for maintenance of
infrastructure etc. One very important thing which should be kept in mind is
transfer payments made by the Government such as unemployment
compensation should not be included.
Investment spending (I) consists of spending which is made by
businesses in order to keep it running and to increase its productivity.
Investment spending should not be confused with purchase and sale of
stocks and bonds. Investment which goes in construction of houses and
building should also not be a part of the Gross National Product.
The net exports (NX) refer to net exports that are the total exports
minus imports. Exports are goods which a country sells to the rest of the
world and imports are goods which a country purchases for rest of the world.
If the imports are more than exports the net exports are negative resulting in
trade deficit and if the exports are more than imports then there is a positive
net exports resulting in trade surplus. A trade deficit reduces a country's GNP
and is not a healthy sign for an economy and on the other hand trade surplus
results in positive gross national product and is a healthy sign for an
Net factor payments (NFP) refer to the total amount of payments
that a country pays to the rest of the world for inputs used in production of

goods and services minus the payment received from the rest of the world
for providing with inputs for their production of goods and services.

Limitations of GNP
The most commonly used measure for human well-being is GNP. Apart
from the fact that this is distributed unequally within countries, the Human
Development Report 1996 notes the following limitations to GNP as a
measure, which serve to obscure a real picture of the nature of societies:
1. It registers only goods and services exchanged for money. Unpaid
work and work done in the community are discounted. The 1995 report
estimated that GNP excludes, on average, two thirds of womens work and a
quarter of mens.
2. Socially useful work, such as child-care and care of the elderly, is
given equal value to weapons manufacturing and other destructive
3. Destruction and reconstruction are both counted. Addictive eating
and drinking count in terms of purchase of food and alcohol, and in terms of
the diet industry and rehabilitation. Wars count in terms of weapons
construction, and rebuilding infrastructure and houses afterwards.
4. Environmental degradation, pollution and resource depletion are not
valued or accounted for.
5. Leisure time is not valued.
6. It ignores human freedom. National income accounting puts no
value on freedom, human rights or participation.
Using measurements of life expectancy, education and real income to
create a human development index, the report ranks countries according to
this index rather than GNP. This approach attempts to provide a better
picture of human development and to expand notions of growth.

Consumption can be defined in different ways, but is usually best
described as the final purchase of goods and services by individuals. The
purchase of a new pair of shoes, a hamburger at the fast food restaurant, or
the service of getting your house cleaned are all examples of consumption. It
is also often referred to as consumer spending. Many topics in economics
explore how the income of families and individuals affects consumption and
spending habits.

Factors Influencing Consumption

According to Keynes, two types of factors influence the consumption
function: subjective and objective. The subjective factors are endogenous
or internal to the economic system itself. The subjective factors relate to
psychological characteristics of human nature, social structure, social
institutions and social practices.

These are likely to remain more or less stable during the short period.
Established behaviour pattern undergoes material change only over long
periods. These factors fundamentally determine the form of the consumption
function (i.e., slope and position of the propensity to consume, the curve).
The objective factors affecting the consumption function are
exogenous, or external to the economy itself. These factors may at times
undergo rapid changes. Thus, objective factors may cause a shift in the
consumption function.
Subjective Factors:
(1) behaviour patterns fixed by the psychology of human nature
(2) the institutional arrangements of the modern social order, and
social practices relating to the behaviour patterns of business firms with
respect to wage and dividend payments and retained earnings, and the
institution controlling the distribution of income.
Human behaviour regarding consumption and savings out of increased
income depends on psychological motives. There are motives which lead
individuals to refrain from spending out of their incomes. Keynes enlists
eight such motives:
1. The Motive of Precaution: The desire to build up a reserve
against unforeseen contingencies.
2. The Motive of Foresight: The desire to provide for anticipated
future needs, e.g., in relation to old age, family education, etc.
3. The Motive of Calculation: The desire to enjoy interest and
appreciation, because a larger real consumption, at a later date, is preferred
to a smaller immediate consumption.
4. The Motive of Improvement: The desire to enjoy a gradually
increasing expenditure since it gratifies the common instinct to look forward
to a gradually improving standard of life rather than otherwise.
5. The Motive of Independence: The desire to enjoy a sense of
independence and the power to do things.
6. The Motive of Enterprise:
The desire to secure a mass de
manoeuvre to carry on speculation or establish business projects.
7. The Motive of Pride: The desire to possess or to bequeath a
8. The Motive of Avarice: The desire to satisfy pure miserliness, i.e.,
unreasonable, but insistent abstinence from expenditure as such.
To this, Keynes adds a corresponding list of motives on consumption
such as enjoyment,
short-sightedness, generosity,
ostentation and extravagance.
Subjective motivations also apply to the behaviour patterns of business
corporations and governmental bodies. In this respect, Keynes listed the
following motives for accumulation:
(a) The Motive of Enterprise:
The desire to do big things, to
expand, to secure resources to carry out further capital investment.

(b) The Motive of Liquidity: The desire to face emergencies and

difficulties successfully.
(c) The Motive of Improvement: The desire to secure a rising
income and to demonstrate successful management.
(d) The Motive of Financial Prudence: The desire to ensure
adequate financial provision against depreciation and obsolescence and to
discharge debts.
Keynes maintains that the strength of all these motives may vary
considerably according to the institution and the organization of the
economic society. Since economic and social institutions and organizations
are formed by habits, race, education, morals, present hopes and past
experiences, techniques of capital equipment and the prevailing distribution
of wealth and established standard of life all these factors are unlikely to
vary in the short run. They, therefore, affect secular progress only very
gradually. In other words, these factors, subject to slow change and over a
long period, may be considered as given or stable.
Objective Factors:
Objective factors, subject to rapid changes and causing violent shifts in
the consumption function, are considered below:
1. Windfall Gains or Losses: When windfall gains or losses accrue to
people their consumption level may change suddenly. For instance, the postwar windfall gains in stock exchanges seem to have raised the consumption
spending of rich people in the U.S.A., and to that extent, the consumption
function was shifted upward.
2. Fiscal Policy: The propensity to consume is also affected by
variations in fiscal policy of the government. For instance, imposition of
heavy taxes tends to reduce the disposable real income of the community;
so its level of consumption may adversely change. Similarly, withdrawal of
certain taxes may cause an upward shift of consumption function.
3. Change in Expectations: The propensity to consume is also
affected by expectations regarding future changes. For instance, an expected
war considerably influences consumption by creating fears about future
scarcity and rising prices. This leads people to buy more than they
immediately need, i.e., to hoard. Thus, the ratio of consumption to current
income will rise, which means that the consumption function will be shifted
4. The Rate of Interest: In the long run, substantial changes in the
market rate of interest may also influence consumption. A significant rise in
the rate of interest may induce people to reduce their consumption at each
income level, because people will save more in order to take advantage of
the high interest rate.
In addition to these four factors, Keynes also mentioned changes in the
wage level, in accounting practices with respect to depreciation (indicating
the difference between income and net income), as the objective factors
affecting the consumption function.

Keynes disciples, however, considered his list of objective factors

inadequate and have listed others which we consider below:
1. The Distribution of Income: With the given level of income,
aggregate consumption will vary if income is distributed in different ways
among the people. A community with a greatly unequal distribution of
income tends to have a low propensity to consume on the whole, while a
community with a high degree of equality of income will have a high
propensity to consume in general.
2. Holding of Saving Liquid Assets: The larger the amount of
such savings (i.e., holding of liquid assets, like cash balances, savings
accounts and government bonds), the more likely people will tend to spend
out of their current income, because the holding of savings in the form of
liquid assets, will give them a greater sense of security. A change in the real
value of such assets held by them, owing to general price changes, might
also affect the consumption function.
3. Corporate Financial Policies: Business policies of corporations
with respect to income retention, dividend payments, and re-investments,
produce some effect on the propensity of equity holders to consume. A
cautious dividend policy followed by corporations and corporate savings will
reduce the consumption function by reducing the residual disposable income
of the shareholders (who are consumers, in a way).
All the above-mentioned factors will affect the consumption function in
one direction or another. However, all of them are relatively unchanging in
the normal short run and, therefore, cannot explain the changes in total
consumption during the short-run period. Income is the only variable which
will change considerably in the short run and affect consumption. Thus, it
may be asserted that consumption varies only in the level of income.
In the real world people are influenced by other factors
-Life cycle factors e.g. students more likely to borrow and spend
during university days.
-Behavioral factors e.g. people may be influenced by general
Consumption Function
It is functional relationship between income and consumption.
At low incomes, people will spend a high proportion of their income.
The average propensity to consume could be one or greater than one. This
means people spend everything they have. When you have low income, you
dont have the luxury of being able to save. You need to spend everything
you have on essentials.
However, as incomes rise, people can afford the luxury of saving a
higher proportion of their income. Therefore, as income rise, spending
increases at a lower rate than disposable income. People with high incomes
have a lower average propensity to spend.

Implications of Consumption Function

If you cut income tax for those on low income, they tend to have a
higher marginal propensity to consume this extra income. Therefore, there is
a large increase in spending. People with high incomes will tend to have a
lower marginal propensity to consume. If they benefit from a tax cut, they
will save a greater proportion.

An asset or item that is purchased with
the hope that it will generate income or
appreciate in the future. In an economic
sense, an investment is the purchase of goods
that are not consumed today but are used in
the future to create wealth. In finance, an
investment is a monetary asset purchased
with the idea that the asset will provide
income in the future or appreciate and be sold at a higher price.

Determinants of Investment
The quantity of investment demanded in any period is negatively
related to the interest rate. This relationship is illustrated by the investment
demand curve.
A change in the interest rate causes a movement along the
investment demand curve. A change in any other determinant of investment
causes a shift of the curve.
The other determinants of investment include expectations, the
level of economic activity, the stock of capital, the capacity
utilization rate, the cost of capital goods, other factor costs,
technological change, and public policy.

According to Keynesian economics, the amount left over when the cost
of a person's consumer expenditure is subtracted from the amount of
disposable income that he or she earns in a given period of time.

Multiplier And Accelerator Of Investment

Investment create more income several times. This multiplied effect of
investment is called multiplier effect.
For example, if the government increased spending by P1 billion, there
would be an initial increase in Aggregate Demand of P1bn. However, if this
injection eventually caused real GDP to increase by P2 billion, then the
multiplier would have a value of 2.0.

Multiplier-K = Y/I =
The term investment multiplier refers to the concept that any increase
in public or private investment spending has a more than proportionate
positive impact on aggregate income and the general economy. The
multiplier attempts to quantify the additional effects of a policy beyond those
that are immediately measurable.

Accelerator Effect

The effect of consumption on investment is accelerator effect. More

consumption stimulates further investment. For instance, many are buying
shoes. This encourages businessmen to put up shoe factories because the
demand for such goods is increasing.
In the real world, there are many other variables that influence
investment levels apart from Output (and demand). Firms will also take into
account interest rates, state of technology, expectations of future,
confidence. There are also time lags in investment. Also, it can be difficult to
get accurate statistics about the state of demand.
Therefore, a fall in the rate of economic growth doesnt necessarily
lead to a fall in investment. However, empirical evidence suggests the level
of investment does tend to be more volatile than the level of economic
growth. It is one factor that creates a more volatile business cycle.
Micro Example of Accelerator Effect
A firm will invest depending on demand for its products. The rise in
demand for iPads will cause Apple to be investing in increasing capacity to
meet future demand. If the iPad drops out of fashion, Apple could be left with
a lot of spare capacity and so would cut back investment drastically.

Paradox of Thrift
The paradox of thrift is an economic theory that states that the more
people save, the less they spend and thus the less they stimulate the
How it works/Example:
Developed by economist John Maynard Keynes, the paradox of thrift
works this way: Assume everybody receives 1,000 of income. They save
50% (500) and spend the rest (500). This means everybody is spending
500, which supports demand for products, which in turn creates jobs,
encourages entrepreneurship, and generates tax revenue for the
Now let's assume that everybody decides they need to save more for
retirement. They start saving 750 of their 1,000 and spending only 250.
Suddenly, there is a drop in the demand for goods and services. Businesses
can't make a profit, and so they lay off workers, which raises unemployment
and lowers the tax revenue to the government. The unemployed people, who

now are out their income, stop spending altogether, which worsens the
problem even more. The whole thing continues on a downward spiral.
Why it Matters:
Saving is a good thing, but as Keynes theorized, too much of it can
harm the economy. Some level of spending is necessary to maintain a
healthy economy, ensure that people have jobs, and continue providing tax
revenue to the government.
Some critics of the paradox of thrift remind us that savings is often
investinginvesting in companies that use the money to build factories,
expand operations and hire more employees. Accordingly, savings doesn't
necessarily halt the economy.

Chapter 9 Business Cycles: Unemployment and Inflation

The business cycle is the four phases of economic growth and
subsequent decline. It's more commonly called the boom and bust cycle.
The goal of economic policy is to keep the economy in a healthy
growth rate -- fast enough to create jobs for everyone who wants one, but
slow enough to avoid inflation.
Unfortunately, life is not so simple. Many
factors can cause an economy to spin out of control, or settle into
The most important, over-riding factor is confidence -- of investors,
consumers, businesses and politicians. The economy grows when there is
confidence in the future and in policymakers, and does the opposite when
confidence drops.

The 4 Stages of the Business Cycle

There are four phases that describe
the business cycle. At any point in
time you are in one of these stages:
Contraction - When the economy
starts slowing down. It's usually
accompanied by a bear market.
Trough - When the economy hits
bottom, usually in a recession.
Expansion - When the economy
starts growing again. It's usually
signaled by a bull market. Recovery
Peak - When the economy is overheated, and is in a state of
"irrational exuberance." This is when inflation rears its ugly head. Prosperity

Theories of Business Cycle

1. Exogenous
Outside, or exogenous, factors that influence economies are those over
which countries -- and the businesses located within them -- cannot control.
Additionally, the more a country is tied to the global economy, the less
control it has over exogenous influences that can cause an economic
downturn. Again, wars and natural disasters are primary examples of
exogenous factors operating outside an economy.When examining effects
outside of a model, certain exogenous factors must be considered. For
instance, while analyzing the reasons why gas supply is in shortage, the
reasons behind the shortage are exogenous. For example, a war in the
Middle East would effect the oil supplies, as would a natural disaster or peak
oil. Because none of these changes occur within the model, they are
considered exogenous factors.
2. Endogenous
Endogenous factors effect business and economic cycles in regard to
supply and demand. For example, if the gas market is balanced, the price will
be relatively stable. When there happens to be a gas shortage, supply
decreases or shrinks. When this occurs, demand for gas increases and so
does its price. Equilibrium is reached once again when purchasers adjust to
higher gas prices. Because the factors effecting equilibrium occur within the
model, they are considered endogenous.
Internal, or endogenous, influences may include certain casual factors,
such as over production. When a specific industry miscalculates and
overproduces a particular product, it results in excess inventory. With excess
inventory comes a decrease in the need for laborers, which often effects
other industries. All of these example are endogenous, as they occur within
an industry.

Simply put, unemployment is a situation in which an individual in an
economy is looking for a job and can't find one. That said, economists divide
unemployment into a number of different categories, since defining types of
unemployment more precisely sheds some light on why unemployment
occurs and what can be done about it.
Voluntary versus Involuntary Unemployment
At a very basic level, unemployment can be broken down into
voluntary unemployment- unemployment due to people willingly leaving
previous jobs and and now looking for new ones- and involuntary
unemployment- unemployment due to people getting laid off or fired from
their previous jobs and needing to find work elsewhere.
Not surprisingly, economists generally view involuntary unemployment
as a larger problem than voluntary unemployment since voluntary
unemployment likely reflects utility-maximizing household choices.

Types of Unemployment
1. Frictional Unemployment
The easiest type of unemployment to explain is known as frictional
unemployment. Frictional unemployment is unemployment that occurs
because it takes workers some time to move from one job to another. While
it may be the case that some workers find new jobs before they leave their
old ones, a lot of workers leave or lose their jobs before they have other work
lined up. In these cases, a worker must look around for a job that it is a good
fit for her, and this process takes some time. During this time, the individual
is considered to be unemployed, but unemployment due to frictional
unemployment is usually thought to last only short periods of time and not
be specifically problematic from an economic standpoint. This is particularly
true now that technology is helping both workers and companies make the
job search process more efficient.
Frictional unemployment can also occur when students move into the
work force for the first time, when an individual moves to a new city and
needs to find work, and when women re-enter the work force after having
children. (Note in the last case, however, that maternity leave doesn't count
as unemployment!)
2. Cyclical Unemployment
It's probably not surprising that unemployment is higher during
recessions and depressions and lower during periods of high economic
growth. Because of this, economists have coined the term cyclical
unemployment to describe the unemployment associated with business
cycles occurring in the economy. Cyclical unemployment occurs during
recessions because, when demand for goods and services in an economy
falls, some companies respond by cutting production and laying off workers
rather than by reducing wages and prices. (Wages and prices of this sort are
referred to as "sticky.") When this happens, there are more workers in an
economy than there are available jobs, and unemployment must result.
As an economy recovers from a recession or depression, cyclical
unemployment tends to naturally disappear. As a result, economists usually
focus on addressing the root causes of the economic downturns themselves
rather than think directly about how to correct cyclical unemployment in and
of itself.
3. Structural Unemployment
There are two ways to think about structural unemployment. One way
is that structural unemployment occurs because some labor markets have
more workers than there are jobs available, and for some reason wages don't
decrease to bring the markets into equilibrium. Another way to think about
structural unemployment is that structural unemployment results when
workers possess skills that aren't in high demand in the marketplace and lack
skills that are in high demand. In other words, structural unemployment
results when there is a mismatch with workers' skills and employers' needs.
Structural unemployment is thought to be a pretty significant problem,

mainly because structural unemployment tends to be largely of the longterm variety and retraining workers is not a cheap or easy task.
4. Seasonal unemployment is, not surprisingly, unemployment that
occurs because the demand for some workers varies widely over the course
of the year. (Pool lifeguards, for example, probably experience a decent
amount of seasonal unemployment.) Seasonal unemployment can be
thought of as a form of structural unemployment, mainly because the skills
of the seasonal employees are not needed in certain labor markets for at
least some part of the year. That said, seasonal unemployment is viewed as
less problematic than regular structural unemployment, mainly because the
demand for seasonal skills hasn't gone away forever and resurfaces in a
fairly predictable pattern.

Full Employment
State of economy in which all eligible people who want to work can find
employment at prevailing wage rates.

Theories of Employment
Classical It states that employment increases at lower wages.
Employers are willing to hire more at lower wages because it is profitable
when there is a lower cost of production.
Keynesian It states that employment is determined by the
aggregate or total demand for good and services. When people, together
with the business and government sectors, purchase more goods and
services, it induces more production and hire more workers.

Inflation means a sustained increase in the general price level.
However, this increase in the cost of living can be caused by different
factors. The main two types of inflation are
Types of Inflation
1. Demand Pull Inflation. This occurs when AD increases at a faster
rate than AS. Demand pull inflation will typically occur when the economy is
growing faster than the long run trend rate of growth. If demand exceeds
supply, firms will respond by pushing up prices.
2. Cost Push Inflation. This occurs when there is an increase in the
cost of production for firms causing aggregate supply to shift to the left. Cost
push inflation could be caused by rising energy and commodity prices.
3. Wage Push Inflation. Rising wages tend to cause inflation. In
effect this is a combination of demand pull and cost push inflation. Rising
wages increase cost for firms and so these are passed onto consumers in the

form of higher prices. Also rising wages give consumers greater disposable
income and therefore cause increased consumption. Trades unions were
powerful, this helped cause rising nominal wageswhich is a significant factor
in causing inflation.
4. Imported Inflation. A depreciation in the exchange rate will make
imports more expensive. Therefore, the prices will increase solely due to this
exchange rate effect. A depreciation will also make exports more competitive
so will increase demand.
5. Temporary Factors. The inflation rate can also increase due to
temporary factors such as increasing indirect taxes. If you increase VAT rate
from 17.5% to 20%, all goods which are VAT applicable will be 2.5% more
expensive. However, this price rise will only last a year. It is not a permanent
Chapter 10 The Philippine Financial System
Necessity of Finance
Functions of Money
Medium of Exchange
Standard of Value
Store of Value
Development of Money in the Philippines
Monetary Standards
Money Supply
Monetary Theory
Bases of Credit
Social Philosophy of Credit
Banking in the Philippines
Universal Banking
Central Banking
Global Banking

Chapter 11 Public Finance

Public Finance
Fiscal functions
Fiscal policy

Basic Rules and Principles in Philippine Taxation

It is the inherent power by which the sovereign state imposes financial
burden upon persons and property as a means of raising revenues in order to
defray the necessary expenses of the government ( Tax Digest by Crescencio
Co Untian, 2002). Taxation is the imposition of financial charges or other
levies , upon a taxpayer (an individual or legal entity) by a state such that
failure to pay is punishable by law.

What is Taxation?
It is a mode by which government make exactions for revenue in order
to support their existence and carry out their legitimate objectives. It is the
most pervasive and the strongest of all the powers of the government. Taxes
are the lifeblood of the government, without which, it cannot subsist.
The first known system of taxation was in Ancient Egypt around 3000
BC - 2800 BC in the first dynasty of the Old Kingdom. In Biblical times, tax is
already prevalent. According to Genesis 47:24 : But when the crop comes in,
give a fifth of it to Pharaoh. The other four-fifths you may keep as seed for
the fields and as food for yourselves and your households and your children.

History of Taxation
Earliest taxes in Rome are called as portoria were customs duties on
imports and exports. Augustus Caesar introduced the inheritance tax to
provide retirement funds for the military. The tax was five percent on all
inheritances except gifts to children and spouses . In England, taxes were
first used as emergency measures.

History of Taxation in the Philippines

The pre-colonial society, being communitarian, did not have taxes.
During the Spanish Period , new income-generating means were introduced
by the government such as the : Manila-Acapulco Galleon Trade,Polo Y
Servicio (Forced Labor), Bandala,Encomienda System,Tribute .
Manila-Acapulco Galleon Trade was the main source of income for
the colony during its early years. The Galleon trade brought silver from
Nueva Castilla and silk from China by way of Manila .

Polo Y Servicio is the forced labor for 40 days , of men ranging from
16 to 60 years of age who were obligated to give personal services to
community projects . One could be exempted from the polo by paying a fee
called falla (which was worth one and a half real) . Bandala is one of the
taxes collected from the Filipinos. It comes from the Tagalog word mandala ,
which is a round stock of rice stalks to be threshed.
Encomienda are large tracts of land given to a person as reward for a
meritorious act. The encomenderos were given full authority to manage the
encomienda by collecting tribute from the inhabitants and govern people
living on it. Tribute was the residence tax during the Spanish times. It may be
paid in cash or kind, partly, or wholly. But in 1884, the tribute was replaced
by the cedula personal or personal identity paper, equivalent to the present
community tax certificate.
That in the 19th century, the cedula served as an identification card
that had to be carried at all times. A person who could not present his or her
cedula to a guardia civil could then be detained for being indocumentado.
Andres Bonifacio and other Katipuneros tore their cedulas in August 1896,
signaling the start of the Philippine Revolution.
The cdula was imposed by the Americans on January 1, 1940, when
Commonwealth Act No. 465 went into effect, mandating the imposition of a
base residence tax of fifty centavos and an additional tax of one peso based
on factors such as income and real estate holdings. The payment of this tax
would merit the issue of a residence certificate. Corporations were also
subject to the residence tax.

The Development of the Community Tax

A sample cedula in the 1920s. Also known as a residence certificate,
is a legal identity document in the Philippines. Issued by cities and
municipalities to all persons that have reached the age of majority and upon
payment of a community tax, it is considered as a primary form of
identification in the Philippines and is one of the closest single documents
the Philippines has to a national system of identification, akin to a driver's
license and a passport.
What is a cedula?
A person is required to present a cedula when he or she acknowledges
a document before a notary public ; takes an oath of office upon election or
appointment to a government position; receives a license , certificate or
permit from a public authority ; pays a tax or fee ; receives money from a
public fund ; transacts official business ; or receives salary from a person or
Taxation has four main purposes or effects:
Revenue. The taxes raise money to spend on armies, roads, schools
and hospitals, and on more indirect government functions like market
regulation or legal systems.
Redistribution. This refers to the transferring wealth from the richer
sections of society to poorer sections.

Repricing. Taxes are levied to address externalities; for example,

tobacco is taxed to discourage smoking, and a carbon tax discourages use of
carbon-based fuels.
Representation. As what goes with the slogan; no
taxation without representation; it implies that: rulers tax citizens, and
citizens demand accountability from their rulers as the other part of this
The main purpose of taxation is to accumulate funds for the
functioning of the government machineries . No government in the world can
run its administrative office without funds and it has no such system
incorporated in itself to generate profit from its functioning. The
governments ability to serve the people depends upon the taxes that are
collected. Taxes are indispensable in the government operation and without
it, the government will be paralyzed.

Why Tax?
Tax law in the Philippines covers national and local taxes. National
taxes refer to national internal revenue taxes imposed and collected by the
national government through the Bureau of Internal Revenue (BIR) and local
taxes refer to those imposed and collected by the local government. The
1987 Philippine Constitution sets limitations on the exercise of the power to
tax. The rule of taxation shall be uniform and equitable. The Congress shall
evolve a progressive system of taxation. (Article VI, Section 28, Paragraph 1).
The Congress may, by law, authorize the President to fix within
specified limits, and subject to such limitations and restrictions as it may
impose, tariff rates, import and export quotas, tonnage and wharfage dues,
and other duties or imposts within the framework of the national
development program of the Government (Article VI, Section 28, Paragraph
The President shall have the power to veto any particular item or items
in an appropriation , revenue, or tariff bill , but the veto shall not affect the
item or items to which he does not object (Article VI, Section 27, Paragraph
2). The Supreme Court has the power to: review, revise, reverse, modify, or
affirm on appeal or certiorari , as the law or the Rules of Court may provide,
final judgments and orders of lower courts in all cases involving the legality
of any tax , impost, assessment, or toll, or any penalty imposed in relation
thereto (Article VIII, Section 5, Paragraph 2b).

Tax Aviodance vs. Tax Evasion

Tax avoidance and tax evasion are the two ways by which tax payers
try to reduce the amount they have to pay to the Bureau of Internal
Revenue. While both these terms have the same objective, tax avoidance
and tax evasion differ in the means by which the purpose of paying lesser
amount of tax is obtained.

Tax evasion happens when there is fraud through pretension and the
use of other illegal devices to lessen ones taxes, there is tax evasion, underdeclaration of income, and non-declaration of income and other items
subject to tax, Under-appraisal of goods subject to tariff , and overdeclaration of deductions.
Tax avoidance is the legal usage of the tax regime in a single territory
to one's own advantage to reduce the amount of tax that is payable by
means that are within the law. This is the means by which tax payers try to
reduce tax within the means allowed by law. Tax avoidance should me made
in good faith and at arms length, otherwise it will not be regarded as such. A
good example of tax avoidance is the use of the depreciation method in
claiming deductible expenses to lessen the income tax.

What are the elements of tax evasion?

Tax evasion connotes the integration of three factors: (1) end to be

achieved, i.e. the payment of less than that known by the taxpayer to be
legally due, or the non-payment of tax when it is shown that the tax is due;
(2) an accompanying state of mind which is known as evil, in bad faith,
willful, or deliberate and not accidental; and (3) a course of action or a
failure of action which is unlawful.

What is an example of tax evasion?

A simple example of this method is the understatement by the tax

payer of his revenues in order to minimize or reduce the taxes which will be
imposed thereon. As an illustration, Mr. Salazar reported only Php1 million as
his income when in truth he was able to earn Php10 million.

The Forms of Taxes Imposed on Persons and Property

A) Personal, capitation or poll taxes These are taxes of fixed amount
upon residents or persons of a certain class without regard to their property
or business
B) Property taxes 1. Real Property Tax - an annual tax that may be
imposed by a province or city or a municipality on real property such as land,
building, machinery and other improvements affixed or attached to real
2. Estate Tax (Inheritance Tax) - a tax on the right of transmitting
property at the time of death and on the privilege that a person is given in
controlling to a certain extent the disposition of his property to take effect
upon death.
3. Gift or Donors Tax - a tax on the privilege of transmitting ones
property or property rights to another or others without adequate and full
valuable consideration.
4. Capital Gains Tax - tax imposed on the sale or exchange of
property . Those imposed are presumed to have been realized by the seller

for the sale, exchange or other disposition of real property located in the
Philippines, classified as capital assets.
C. Income Taxes - Taxes imposed on the income of the taxpayers
from whatever sources it is derived. Tax on all yearly profits arising form
property, possessions, trades or offices.
D. Excise or License Taxes - Taxes imposed on the privilege,
occupation or business not falling within the classification of poll taxes or
property taxes. These are imposed on alcohol products; on tobacco
products ; on petroleum products like lubricating oils, grease, processed gas
etc; on mineral products such as coal and coke and quarry resources; on
miscellaneous articles such as automobiles.
Under these lies two other taxes: 1.Documentary Stamp Tax - a tax
imposed upon documents, instruments, loan agreements and papers and
upon acceptance of assignments, sales and transfers of obligation and etc. 2.
Value added tax - is imposed on any person who, in the course of trade or
business sells, barters, exchanges, leases, goods or properties, renders
services, or engages in similar transactions.

Who Should Pay Taxes?

1. Individuals a. Resident Citizen b. Non-resident Citizen c. Resident
Aliens d. Non-resident Aliens
2. Corporations a. Domestic Corporations b. Foreign Corporations
3. Estate under judicial settlement
4. Trusts irrevocable both as to the trust property and as to the income.

Tax Exemptions
The Constitution expressly grants tax exemption on certain
entities/institutions such as:
1. Charitable institutions, churches , parsonages or convents
appurtenant thereto, mosques , and nonprofit cemeteries and all lands,
buildings and improvements actually, directly and exclusively used for
religious, charitable or educational purposes (Article VI, Section 28,
Paragraph 3).
2. Non-stock non-profit educational institutions used actually, directly,
and exclusively for educational purposes. (Article XVI, Section 4 (3)).
3. Exempted to tax as stated in the Article 283 of Rules and
Regulations Implementing Local Government Code of 1991 (RA 7160): Local
water districts, Cooperatives duly registered under RA 6938, otherwise
known as the Cooperative Code of the Philippines, Non-stock and non-profit
hospitals and educational institutions, Printer and/or publisher of books or
other reading materials prescribed by DECS (now DepEd) as school texts or
references, insofar as receipts from the printing and / or publishing thereof
are concerned.

Requirements of Good Tax System

Economists and social philosophers have developed the various ideas

about a good tax system. Many of these ideas came from the book Wealth of
Nations written by Adam Smith. These are the canons of taxation: equity,
certainty, convenience and economy. Smith said:
The time of payment, the manner of payment, the quantity to be paid
ought all to be clear and plain to the contributor, and to every other person.
Every tax ought to be levied at the time, or in the manner, in which it is most
likely to be convenient for the contributor to pay it.
1. The distribution of the tax burden should be equitable or
fair. This means a person has to pay tax based on his ability to pay. Others
claim that tax payment should be based on benefits received.
2. Taxes should not ruin an efficient market system. Taxes
increase the cost of production, and this means higher prices. Such situation
discourages both buyers and sellers or producers. At a higher price, there is
a decline in quantity demanded. In the case of producers, a higher cost of
production is a disincentive.
3. Taxes should serve as tools in facilitating economic stability
and economic growth. Taxes can greatly help solve or minimize the
economic problems of inflation and unemployment. For instance, if taxes are
properly spent on projects which maximize employment, then it is not only
good for the jobless people but also to the national economy. And when
production rises, the price level tends to fall. More production means more
supply, and this is the best way to combat inflation. Regarding economic
growth, the key to economic development is investments in certain economic
sectors. The development of such key sectors leads to economic growth.
4. Tax administration should be efficient. This refers to the
productivity of tax collection. In less developed countries
Tax collection is not efficient when there are many incomes and
wealth that are not reported. Another, dishonest tax collectors do not
perform their jobs well. Likewise, a tax system should be understandable to
the taxpayers. It should be written in simple and clear language. It is noted
that some professionals and businessmen do not know what tax to pay and
how much. Such problems of comprehension is even greater to the less
schooled individuals.
5. The cost of tax administration and its compliance should be
economical. The basic objective of taxation is to raise funds for government
programs. But if the manner of raising such money is expensive in proportion
to the taxes to be collected, then it is not a good tax system. Taxes should be
enough to meet the needs of public services. Thus, economy is essential in
the collection of taxes.
Other Good Requirements
1. Equity: The distribution of the tax burden should be equitable.
Everyone should be made to pay his or her fair share.
2. Neutrality: Taxes should be chosen so as to minimize interference
with economic decisions in otherwise efficient markets. Such interferences
impose excess burden which should be minimized.

3. Efficiency: Where tax policy is used to achieve other objectives

such as to grant investment incentives, this should be done so as to
minimize interference with the equity of the system.
4. Certainty: The tax which each individual is bound to pay ought to
be certain and not arbitrary. The time of the payment, the manner of
payment, and the quantity to be paid, all ought to be clear and plain to the
contributor, and to every other person.
5. Economy: Every tax ought to be so contrived as to both take out
and keep out of the pockets of the people as little as possible over and above
what it brings into the public treasury of the state. Administration and
compliance costs should be as low as is compatible with the other objectives.
6. Simplicity: The tax system should permit fair and non-arbitrary
administration and it should be understandable to the tax-payer. It means
that the tax-system should be easily comprehensible to the tax-payer, i.e.,
its nature, method and basis of estimation should all be easily followed by
each tax-payer.
7. Convenience: Every tax ought to be levied at the time, or in a
manner in which it is most likely to be convenient for the contributor to pay
8. Productivity: A tax system to be thoroughly sound and enduring
must be able to generate enough revenue to meet the requirements of the
9. Elasticity: In the system, there should be a capacity to respond
quickly to the changes in the demand for revenue.
10. Diversity: The tax system should be such that it depends on a
number of taxes, so that every class of citizen may be called upon to
contribute something towards the state revenue.
11. Fiscal Objectives: The tax structure should facilitate the use of
fiscal policy for stabilization and growth of objectives.

Approaches to Equitable Taxation

Benefits Received Principle. People pay their taxes in accordance to
the benefits they received from government projects. Those who do not
receive benefits do not pay taxes.
Ability-to-pay Principle. States that the people should pay their
taxes - as contribution cost of government - on the basis of their ability to
pay. This progressive taxation approach places an increased tax burden on
individuals, partnerships, companies, corporations, trusts and certain estates
with higher incomes.

Tax Structures
Progressive. A tax that takes a larger percentage from the income of
high-income earners than it does from low-income individuals. Basically,
taxpayers are broken down into categories based on taxable income; the

more one earns, the more taxes they will have to pay once they cross the
benchmark cut-off points between the different tax bracket levels.
Regressive. A regressive tax is one that is inversely proportional to
income the lower the income, the higher the tax in relation to income.
Most regressive taxes are assessed on products and services in which the tax
is a percentage of the cost of the product or service. Hence, when paying the
tax, a poor person pays as much as the wealthy person. The most common
forms of regressive taxes are sales taxes and value added taxes (VAT). The
inequitable effects of a regressive tax is often mitigated by payments to the
poor and by exempting essential products and services, such as food, from
the regressive tax.
Proportional. Proportional taxes apply the same tax rate to any
income level, or for any size tax base. So if Bill earns 50,000 and Jane earns
100,000, and the tax rate is 10%, then Bill will owe 5,000 in taxes while
Jane will owe 10,000. Many state income taxes and almost all sales taxes
are proportional taxes.
Income Taxation
If you were able to make your own Income Tax Return (ITR) because
you fully understand Philippine taxation laws, then good for you. But for the
majority who rely on accountants or their companies to prepare their ITRs,
here is a simple and concise explanation of the income tax law in the
Who are required to file Income Tax Returns (ITR)?
According to the Bureau of Internal Revenue (BIR), the following are
required to submit Income Tax Returns:
Filipino citizens residing in the Philippines receiving income from
sources within or outside the Philippines
Filipino citizens not residing in the Philippines receiving income from
sources within the Philippines

Resident or non-resident aliens receiving income from sources within

the Philippines

Domestic corporations receiving income from sources within and

outside the Philippines

Foreign corporations receiving income from sources within the


Taxable partnerships

Estates and trusts engaged in trade or business

What is Taxable Income?

Taxable income is the gross income of the taxpayer less any

deductions and/or personal and additional exemptions authorized by the Tax
Code or other special laws.
Gross income means all income derived from whatever source. It
includes, but is not limited to, Compensation for services, in whatever form
paid; Gross income derived from the conduct of trade or business or the
exercise of profession; Gains derived from dealings in propert; Interest;
Rents; Royalties; Dividends; Annuities; Prizes and winnings; Pensions; and
Partners distributive share from the net income of the general professional
Exclusions from Gross Income include Life insurance; Amount
received by insured as return of premiu; Gifts, bequests and devise;
Compensation for injuries or sickness; Income exempt under treaty;
Retirement benefits, pensions, gratuities, etc; Miscellaneous item; income
derived by foreign government; income derived by the government or its
political subdivision; prizes and awards in sport competition; prizes and
awards which met the conditions set in the Tax Code; 13th month pay and
other benefits; GSIS, SSS, Medicare and other contributions; gain from the
sale of bonds, debentures or other certificate of indebtedness; and gain from
redemption of shares in mutual fund.
What are the allowable deductions from gross income?
Except for taxpayers earning compensation income arising from
personal services rendered under an employer-employee relationships, a
taxpayer may opt to avail either of the following allowable deductions from
gross income:
Optional Standard Deduction an amount not exceeding 40% of
the net sales for individuals and gross income for corporations; or
Itemized Deductions which include the following: Expenses;
Interest; Taxes; Losses; Bad Debts; Depreciation; Depletion of Oil and
Gas Wells and Mines; Charitable Contributions and Other Contributions;
Research and Development; and Pension Trusts
A maximum of P2,400 premium payments on health and/or
hospitalization insurance may also be claimed as deduction, provided the
annual family gross income is not be more than P250,000 and for married
individuals, the spouse claiming this deduction is the one claiming additional
exemptions for the qualified dependents.
What are the allowable personal and additional exemptions?
Individuals who are earning compensation income, engaged in
business or deriving income from the practice of profession are entitled to
the following Personal Exemptions:
For single individual or married individual judicially decreed as legally
separated with no qualified dependents P50,000
For head of family P50,000

For each married individual P50,000 (to be claimed only by the

spouse deriving gross income)

Taxpayers may also claim an Additional Exemption of P25,000 for

each qualified dependents, up to four (4) dependents.
How is income tax payable computed?
The formula to compute the income tax payable is:
Gross Income
Less: Allowable Deductions (Itemized or Optional)

Net Income

Less: Personal & Additional Exemptions

Net Taxable Income

Applicable Tax Rate (see Tax Rate Table below)

Income Tax Due

Less: Tax Withheld

Income Tax Payable

What is the income tax rate in the Philippines?

For individuals earning purely compensation income and those
engaged in business and practice of profession, the applicable tax rate table
is as follows:
Tax Rate
More than
But less than
P500 + 10% of the Excess over P10,000
P2,500 + 15% of the Excess over P30,000
P8,500 + 20% of the Excess over P70,000
P22,500 + 25% of the Excess over P140,000
P50,000 + 30% of the Excess over P250,000
P125,000 + 32% of the Excess over P500,000
in 2000 and onward
For domestic corporations, the corporate tax rate is 30% of the Net
taxable income from all sources starting January 1, 2009.
For proprietary educational institutions and non-stock, non-profit
hospitals, the tax rate is 10% of the Net taxable income, provided that the
gross income from unrelated trade, business or other activity does not
exceed 50% of the total gross income.
For GOCCs, agencies & instrumentalities, the tax rate is 32% of the Net
taxable income from all sources.

For all taxable partnerships, the tax rate is also 32% of the Net taxable
income from all sources.
International Carriers are taxed 2.5% on their Gross Philippine Billings.
For Regional Operating Headquarters (ROHQ), the tax rate is 10% of
Taxable Income.
Here's a step-by-step guide for manual computation. You may also use
the tax calculator below.
Step 1: Determine your taxable income.
To compute your taxable income, follow this formula:
Taxable income = (Monthly Basic Pay + Overtime Pay + Holiday Pay +
Night Differential) - (SSS/PhilHealth/Pag-IBIG deductions - Tardiness Absences)
Let's say Employee A is married with one dependent, and has a basic
monthly pay of P25,000. Based on the tables of government contributions,
Employee A will pay:

P581.30 - SSS contribution (View SSS contribution table)

P312.50 - PhilHealth contribution (View PhilHealth contribution


P100 - Pag-IBIG contribution

Employee A's taxable income will therefore be P24,006.20. Here's how

it is computed:
Taxable income = P25,000 - (P581.30 + P312.50 + P100)
= P25,000 - 993.8
= P24,006.20
Step 2: Using your taxable income, compute your income tax
by referring to the Bureau of Internal Revenue (BIR) tax table.
In the BIR table, look for your pay period (usually it's "Monthly" for
employed taxpayers), then your status ("S/ME" means single/married with no
dependent, "ME1/S1" means married/single with one dependent, and so on).
There are 8 columns under each pay period. Under the columns are
taxable income amounts and their corresponding tax rates. As the taxable
income increases, the tax rate also goes up.
In the row indicating your status, look for the highest amount that does
not exceed your taxable income.
Let's use Employee A, with status "ME1/S1," as example. The highest
amount that does not exceed Employee A's taxable income of P24,006.20 is
P17,917 (ME1/S1 row, Column 6).

The heading of Column 6 reads "1,875.00 + 25% over."

This means Employee A's tax is P1,875 plus 25% of the difference of
his taxable income (P24,006.20) and the amount in the table (P17,917).
Here's the computation:
Tax = 1,875 + [(24,006.20-17,917) X .25]
= 1,875 + (6,089.2 x .25)
= 1,875 + 1,522.3
= P3,397.30

Chapter 11 Land Reform in the Philippines

General Principles
- Agrarian reform program is founded on the right of
farmers and regular farm workers, who are landless, to

own directly or collectively the lands they till, or in case of other farm
workers, to receive a just share on the fruits thereof
- To this end, the State shall encourage and undertake the just
distribution of all agricultural lands, subject to the priorities and retention
limits set forth in the law, taking into account ecological, developmental, and
equity considerations and subject to the payment of just compensation
- The State shall respect the right of small landowners, and shall
provide for voluntary land-sharing
Historical Background
Historically, agrarian-related remedies extended by past regimes and
administrators proved to be totally unable to fulfill the promise of alleviating
the quality of life of the landless peasants. The land laws have invariably
contained provisions that enabled powerful landowners to circumvent the
law, or even use the law to sustain and further strengthen their positions in
Pre-Spanish Era - Land was not unequally distributed before the
Spaniards came to the Philippines. - The notion of private property was
unknown then. - The community (barangay) owned the land.
Spanish Period (1521-1898) - One of the major initial policies of the
governorship of Legazpi was to recognize all lands in the Philippines as part
of public domain regardless of local customs. - As such, the crown was at
liberty to parcel out huge tracts of Philippine lands as rewards to loyal civilian
and military as rewards.
In effect, communal ownership of land gradually and slowly took the
backseat. Private ownership of land was introduced. With this arrangement,
every municipal resident was given his choice of the land for cultivation, free
from tax.
Large tracts of uncultivated lands not circumscribed within a given
municipality were granted by the Spanish monarch to deserving Spaniards.
This kind of ownership became known as the encomienda.
The encomienda system in the Spanish colonies began as a result of
a Royal Order promulgated in December of 1503. By virtue of this Royal
Order, encomiendas were granted to favor Spanish officials and clerics who
were entrusted the responsibility to look after the spiritual and temporal
developments of the natives in a colonized territory.
In return for such a duty, the encomiendas enjoyed the right to have a
share in the tribute ( tributo ) paid by the natives. Legazpi himself had
granted encomiendas to the friars, like the Agustinians in Cebu and Manila.
Almost all the grants that Legazpi extended to the Spanish officials and
friars were confined to what would eventually become the provinces of
Cavite, Laguna, Batangas, and Bulacan.
Much later, in place of the encomiendas, the Spanish authorities began
to group together several barangays into administration units. They termed
these units as pueblos or municipios which were governed by

gobernadorcillos. Together, the cabezas and gobernadorcillos made up of the

landed class known as caciques (landed class).
At the passing of time, the Filipino caciques intermarried with
Spaniards. This gave such class as mestizo cast which exists to this day.
Through this enviable position, the cabezas the gobernadorcillos gained
more and more stature or prestige with the Spanish civil and ecclesiastical
authorities, and the common people.
In time, the caciques were given the prerogative of collecting taxes as
well. This act vested in them great power. Certainly, this did not help to
endear them to the ordinary people.
Caciquism as an institution became deeply rooted in Philippine soil.
This paved the way to many present-day agrarian problems and unrests. As
the cacique system grew, it also became more oppressive. This brought
about colonial uprisings during the 19 th century, which tended to occur in
the areas with much agricultural activity such as Central Luzon.
Agrarian-related problems were the only source of major conflicts
during this time. Land was available in the entire archipelago. The major
sources of conflict and rebellion were really the harsh Spanish impositions,
such as: tributo, polo, encomienda, etc.
During the 19 th century, several developments occurred that solidified
the land tenure system, and aroused antagonism over its injustices and
inequalities. Since the Spaniards did not levy a land tax or a head tax ( cedula ),
and few records of land-ownership were kept, the Spanish government
issued two Royal Decrees: decreto realenga (1880) and the Maura Law
(1894) These decrees ordered the caciques and natives, to secure legal title
for their lands or suffer forfeiture.
The Filipino peasants, either ignorant of the processes of the law or of
the Spanish-written instructions, were just slow to respond. The landowners
(caciques) were quick to react. They did not only register their own
landholdings but also took advantage of the ignorance of the peasants, by
claiming peasant lands adjacent to their own holdings.
It was estimated that 400,000 Filipino peasants were left without titles.
No option was left for those dispossessed because documented titles to the
land prevailed over verbal claims. Hence, most Filipino landed peasants
became mere tenants in their own lands.
The Royal Decree of 1894 (Maura Law) deprived many Filipino
peasants of their own lands through scheming and treacherous ways of both
Spaniards and caciques.
Other strategies of dispossessing peasants of their landholdings were:
1. Outright purchase at a low price of real estates ( realenga ) by a Spaniard
or a cacique, from a badly-in-need peasants. 2. Mortgage system (pacto de
retroventa); this is equivalent of todays mortgage system ( sangla ).
The mortgage system is equivalent of todays mortgage system
( sangla ), where a landowner who has loaned a peasant some money
becomes this peasant landlord. This happened simply because the system

required the land to be collateral. While the peasant had not paid back his
loan, he paid the landlord rent for the use of his own land.
Another source of land-related conflict by the late 19 th century was
the friar lands. Many farmers questioned the amount of land in grant given
by the Spanish crown to the religious orders (i.e. Augustinians, Dominicans,
Franciscans, and Recollect Orders). Tenants ( inquilinos ) paid tax termed as
canon to the friars.
Philippine Revolutionary Government (1898-1899) - After the
first Philippine Republic was established in 1899, the government of Emilio
Aguinaldo declared its intention to confiscate large estates, esp. the friar
American Regime (1898-1935) - The Americans, considered by
Filipino revolutionists, as messiahs (liberators from Spanish colonial rule),
finally unmasked their true color. They themselves became the new
colonizers by virtue of the Treaty of Paris (Dec. 10, 1898).
The Treaty of Paris ended the Spanish-American War, and Spain
ceded the Philippines, Guam and Puerto Rico to America.
Despite the apparent desire of the American government to improve
the land-tenure situation of the country, the following land laws and policies
did not help in any way: 1) Treaty of Paris 2) Land Registration Act of 1902 3)
Public Land Act of 1907 4) Cadastral Act of 1907 5) Friar Lands Act of 1907
Commonwealth Era (1935-1946) - The government headed by
Manuel Quezon, passed and implemented the Rice Tenancy Act of 1933 (i.e.
Act No. 4054). - Its purpose was to regulate the share tenancy contracts by
establishing minimum standards.
The Act provided for better tenant-landlord relationship, a 50-50
sharing of the crop, regulation of interest to 10% per agricultural year, and
safeguards against arbitrary dismissal by the landlord. The desire of Quezon
to placate both landlords and tenants pleased neither. By early 1940s,
thousands of tenants in Central Luzon were ejected from their farmlands, and
rural conflict was more acute than ever.
Japanese Occupation (1941-1945) - The Japanese occupation had a
tremendous impact on the agrarian issue. From the ranks of the peasant and
labor organization, and from the merger of the Communist Party of the
Philippines and the Socialist Party emerged the HUKBO NG BAYAN LABAN SA
The HUKBALAHAP was headed by a charismatic peasant leader, Luis
Taruc . In addition to fighting the Japanese, the Huks also took upon the
cause of the peasant against the landlords who often collaborated with the
Japanese to maintain their dominant position.
Third Philippine Republic a. Roxas Administration (1946-1948) In 1946, Roxas proclaimed the Rice Share Tenancy Act of1933 effective
throughout the country. - R.A. No. 34 of 1946, known as Tenant Act, provided
for a 70-30 sharing arrangements, and regulated share-tenancy contracts.

b. Quirino Administration (1948-1953) - There were no agrarian

reform laws passed during the Quirino administration. Instead, the agrarian
reform policy of his predecessor was continued but with little success.
c. Magsaysay Administration (1953- 1957) - This administration
signed into law two land-related bills: the Agricultural Tenancy Act of 1954
(R.A. No.1199), and Land Reform Act of 1955 (R.A. No. 1400).
The Agricultural Tenancy Act of 1954 allowed tenants to shift from
share tenancy to leasehold. - In leasehold system, a tenant pays for a fixed
amount to the landlord instead of the variable share. - The Act also
prohibited the ejection of tenants, unless the Court of Agrarian Relations
found just cause.
d. Garcia Administration (1957-1961) - This administration did not
make any law or major pronouncements on agrarian reform. No new policies
were made.
e. Macapagal Administration - He signed into law the Agricultural
Land Reform Code of 1963 (R.A. No. 3844). This code provided for the
purchase of private farmlands with the intention of distributing them in small
lots to the landless tenants on easy terms of payment.
In comparison with previous agrarian legislations, the law lowered the
retention limit to 75 hectares, whether owned by individuals or corporations.
- It prohibited sharehold tenancy and established the leasehold system. - It
was viewed that a 75-retention limit was just too high for the growing
population density.
f. Marcos Administration 1. Pre-Martial Law (First term, 1965-69) The
Agricultural Land Reform Code continued to be implemented by Marcos.
Second term (1969-73) Congress amended the Agricultural Land Reform
Code .
Agrarian Reform Special Fund Act (R.A. No. 6390) was passed. Martial
Law (1972-1981) - On Sept. 21, 1971, Marcos declared Martial Law. Five days
later, he issued Presidential Decree (P.D.) No. 2, declaring the entire country
a land reform area.
Oct. 21,1971, Marcos again issued P.D. No. 27 (Tenant
Emancipation Act). This launched Operation Land Transfer (OLT),
transferring tenants ownership of land they tilled to them, and providing the
instruments and mechanisms needed. Marcos Administration (Third term,
1981-86) - Continued P.D. No. 2 and P.D. No. 27.
g. Aquino Administration (1986-1992) - Upon assumption into
power, Aquino declared that her government will expand the land reform
program in the country to reflect a true liberation of the Filipino farmer from
the clutches of landlordism and transform him into a truly reliant citizen,
participating in the affairs of the nation.
Aquino described her agrarian reform as the most fundamental and
far-reaching program of government for it adheres to the economic wellbeing and dignity of many Filipinos. She made agrarian reform as the
centerpiece of her government.

The primary governing law on agrarian reform during the Aquino

administration was R.A. No. 6657, known as Comprehensive Agrarian
Reform Law (CARL) of 1988. This was signed into law on June 10, 1988,
and became effective on June 15, 1988.
The R.A. No. 6657 is intended to promote social justice and
industrialization providing the mechanism for its implementation and for
other purposes.
Salient Features of RA 6657
-Most comprehensive and ambitious agrarian reform law Major social
reform agenda of the government and a key strategy in achieving poverty
reduction and equity, social justice, economic and political empowerment to
the landless and the poorest sector of the country
-A nation where there is equitable landownership with empowered
agrarian reform beneficiaries (ARBs) who are effectively managing their
economic and social development for a better quality of life.
-Land Tenure Improvement - addressed the inequality of resources
-Agrarian Justice Delivery - provision of agrarian legal assistance (ALA)
and the adjudication of cases
-Program Beneficiaries Development - Constitutes the provision of
trainings, credit access, and construction of infrastructure projects,
particularly Farm to Market Roads (FMRs) and Communal Irrigation Projects
(CIPs) to make their newly-awarded lands productive
Equitable distribution and ownership of the land based on the principle of
land to the tiller or owner-cultivatorship To redistribute of all public and
private agricultural lands regardless of crops raised and tenurial
arrangement including the provision of the necessary support services.
-Landowners are entitled to retain 5 hectares of their land. In addition,
each child of the landowner may be awarded three hectares.
-Land acquired were distributed to landless residents of same
Barangay or municipality in the following order of priority.
-Agricultural lessees and share tenants
-Others directly working on the land regular farmworkers
-Seasonal farmworkers ther farmworkers actual tillers or
occupants of public
-collectives or cooperatives of the above beneficiaries
-Only those who met the qualifications are eligible as beneficiaries:
landless as defined in RA 6657, Filipino citizen At least 15 years of age or
head of the family at the time of acquisition of the property Has willingness,
ability and aptitude to cultivate and make the land productive.
-CARP implementation was not the sole responsibility of DAR alone but
was the program of the entire government. CARP in its twenty years of
implementation encountered political and economic difficulties.
-Sec. 7. Determination of Just Compensation: Sec. 7. Determination of
Just Compensation Two (2) other factors are included in the determination of
just compensation: Value of standing crop 70% of zonal valuation.

-Sec. 9. Award to Beneficiaries: EPs, CLOAs, and other titles awarded

under the agrarian reform program shall be indefeasible and imprescriptible
after one (1) year from its registration with the Registry of Deeds. Ministerial
duty of Register of Deeds to register title in the name of RP after LBP duly
certifies that the necessary deposit in favor of the landowner has been
made, and to cancel previous titles pertaining thereto
-Sec. 11. Payment by Beneficiaries: Sec. 11. Payment by Beneficiaries
Specifies when amortization shall commence: one (1) year from the date of
registration of the CLOA; or, one (1) year from the date or actual occupancy
if the occupancy took place after the registration of the CLOA. Payment by
Beneficiaries (Contd) Payments for first three (3) years SHALL be reduced to
a certain amount as established by the PARC
-Sec. 12.Transferability of Awarded Lands: Sec. 12.Transferability of
Awarded Lands Prohibition for a period of ten (10) years against sale,
transfer, or conveyance of awarded lands except THROUGH THE DAR, and
only under the following conditions: Through hereditary succession, or To the
government, or To the LBP, or To other qualified beneficiaries.
-Sec. 22. Conversion of Lands: Sec. 22. Conversion of Lands DAR may,
with due notice to the affected parties and subject to existing laws, authorize
the reclassification or conversion of lands and its disposition after five (5)
years from its award when: the land ceases to be economically feasible and
sound for agricultural purposes, or the locality has become urbanized and
the land will have greater economic value for residential, commercial or
industrial purpose.
-Who may apply for conversion: the beneficiary, or the landowner with
respect only to his/her retained area which is tenanted.
Chapter 12 Economic Growth and Development
A country's economic health can usually be
measured by looking at that country's economic
growth and development.
Economic Growth
A country's general economic health can be
measured by looking at that country's economic
growth and development. Let's take a separate
look at what indicators comprise economic growth versus economic
Let's first examine economic growth. A country's economic growth is
usually indicated by an increase in that country's gross domestic product, or
GDP. Generally speaking, gross domestic product is an economic model that
reflects the value of a country's output. In other words, a country's GDP is
the total monetary value of the goods and services produced by that country
over a specific period of time.

Example of Economic Growth

For example, let's say that a special berry grows naturally only in the
country of Utopia. Natives to Utopia have used this berry for many years, but
recently a wealthy German traveler discovered the berry and brought
samples back to Germany. His German friends also loved the berry, so the
traveler funded a large berry exporting business in Utopia. The new berry
exporting business hired hundreds of Utopians to farm, harvest, wash, box
and ship the berries to grocers in Germany.
In one calendar year, the berry exporting business added over one
million pesos to Utopia's GDP because that's the total value of the goods and
services produced by the new berry exporting business. Since Utopia's GDP
increased, this means that Utopia experienced economic growth.
Economic Development
Now let's take a look at economic development. A country's economic
development is usually indicated by an increase in citizens' quality of life.
'Quality of life' is often measured using the Human Development Index,
which is an economic model that considers intrinsic personal factors not
considered in economic growth, such as literacy rates, life expectancy and
poverty rates.
While economic growth often leads to economic development, it's
important to note that a country's GDP doesn't include intrinsic development
factors, such as leisure time, environmental quality or freedom from
oppression. Using the Human Development Index, factors like literacy rates
and life expectancy generally imply a higher per capita income and therefore
indicate economic development.
The economic development of a country or society is usually
associated with (amongst other things) rising incomes and related increases
in consumption, savings, and investment. Of course, there is far more to
economic development than income growth; for if income distribution is
highly skewed, growth may not be accompanied by much progress towards
the goals that are usually associated with economic development.

Comparison chart



Economic Development

Economic Growth

Economic development implies an upward

movement of the entire social system in
terms of income, savings and investment
along with progressive changes in
socioeconomic structure of country
(institutional and technological changes).

Economic growth refers to an

increase over time in a country`s
real output of goods and services
(GNP) or real output per capita

Development relates to growth of human

capital indexes, a decrease in inequality

Growth relates to a gradual

increase in one of the components



Economic Development

Economic Growth

figures, and structural changes that improve

the general population's quality of life.

of Gross Domestic Product:

consumption, government
spending, investment, net exports.

Qualitative.HDI (Human Development Index),

gender- related index (GDI), Human poverty
index (HPI), infant mortality, literacy rate etc.

Quantitative. Increases in real GDP.

Brings qualitative and quantitative changes

in the economy

Brings quantitative changes in the


Economic development is more relevant to

measure progress and quality of life in
developing nations.

Economic growth is a more

relevant metric for progress in
developed countries. But it's widely
used in all countries because
growth is a necessary condition for

Concerned with structural changes in the


Growth is concerned with increase

in the economy's output

Chapter 13 Social Responsibility

Social responsibility is an ethical framework which
suggests that an entity, be it an organization or
individual, has an obligation to act for the benefit of
society at large. Social responsibility is a duty every
individual has to perform so as to maintain a balance
between the economy and the ecosystems.
Being Socially Responsible means that people and organisations must
behave ethically and with sensitivity toward social, cultural, economic and
environmental issues. Striving for social responsibility helps individuals,
organisations and governments have a positive impact on development,
business and society with a positive contribution to bottom-line results.

Individual Social Responsibility (ISR) to achieve Corporate Social

Responsibility (CSP)
ISP may appear to be a new concept in relation to CSP, but it is a
concept as old as The Golden Rule Do unto others as you would have them
do unto you. ISR expands on this by promoting a proactive stance towards
positively influencing and affecting the people and environments outside
your immediate circle. ISR is at the roots of CSR, because a corporate
comprises of individuals and hence determines the social responsibility
culture it creates. This is the intermingled relationship between CSR and ISR.
Individuals are becoming more socially responsible and, in response to this
Corporations and Companies need to become more socially responsible to
meet consumer demand.
The individual social responsibility includes the engagement of each
person towards the community where he lives, which can be expressed as an
interest towards whats happening in the community, as well as in the active
participation in the solving of some of the local problems. Under community
we understand the village, the small town or the residential complex in the
big city, where lives every one of us. Each community lives its own life that
undergoes a process of development all the time. And everyone of us could
take part in that development in different ways, for example by taking part in
cleaning of the street on which he lives, by taking part in organization of an
event, connected with the history of the town or the village or by rendering
social services to children without parents or elderly people. The individual
social responsibility also could be expressed in making donations for
significant for the society causes social, cultural or ecological. There are
many ways of donating, as for example donating of goods or donating money
through a bank account or online
Social Responsibility can be negative, in that it is a responsibility to
refrain from acting (resistance stance) or it can be positive, meaning there
is a responsibility to act (proactive stance). Being socially responsible not
only requires participating in socially responsible activities like recycling,
volunteering and mentoring, but to actually make it a lifestyle. Only through
a commitment to embrace and embed social responsibility into your personal
value and belief system can you truly become socially responsible in all you

ISO 26000: Guidance on social responsibility identifies seven core

social responsibility subjects:
1. Organizational governance
2. Human rights
3. Labor practices
4. The environment

5. Fair operating practices

6. Consumer issues
7. Community involvement and development
In addition to the core subjects, ISO 26000 also defines seven
key principles of socially responsible behavior:
1. Accountability
2. Transparency
3. Ethical behavior
4. Respect for stakeholder interests
5. Respect for the rule of law
6. Respect for international norms of behavior
7. Respect for human rights