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Chapter 1
ECONOMICS AND ITS IMPORTANCE
Learning Objectives
1. Understand the nature of Economics and its importance.
3. Learn the very basic concept and its application through the working of a simple
model.
Key terms:
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Principles Of Economics (with Taxation and Agrarian Reform)
Economics is first and foremost the study of human, behavior in making choices. A
household faces many decisions. It must decide who among the households will do such
task and what each member gets in return. Who cooks breakfast, who does the laundry, etc.
In other words, the household must allocate its scarce resources among its various
members taking into account each member’s abilities, efforts and desires.
Economics is a social science concerned with the efficient allocation and utilization
of scarce resources for the satisfaction of the society’s unlimited wants and needs.
In most societies, resources are allocated not by a single central planner but through
the combined actions of millions of households and firms. Economists therefore study how
people make decisions; how much they work, what they purchase, how much they save out
of their income and how they invest their savings. Economists also study how people
interact with one another. For instance, they determine how the buyers and sellers of a
good together determine the price at which the goods is sold and the quantity that is sold.
Lastly, economists analyze forces and trends that affect the whole economy.
Methodology of Economics
The study of economic behavior starts from an economic theory. Economic theory is
an attempt to find explanations for observed economic phenomena. Its usefulness aims for
the establishment of a cause and effect relationship. It helps us understand why a person
makes a certain economic decision or why a particular outcome is realized. A formal
statement of an economic theory is called economic model, usually a mathematical
statement of a presumed relationship between two or more variables. A variable is a value
that can change from time to time or from observation to observation. The most common
ways of expressing this are in words, graphs and equations. For example, it the Law of
Demand in which graphically the principle could be validated with the derivation of the
demand curve and the use of the demand functions.
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Principles Of Economics (with Taxation and Agrarian Reform)
Division of
Economics Production Prices Income Employment
The two kinds of questions that economists attempt to answer: positive and
normative.
Positive Economics seeks to understand the behavior and the operation of the
economic system without making judgments about whether the outcomes are good or bad.
It describes what exists and how it works. Ex. What determines wage rates in the rural
areas? What would happen if we abolished the corporate income tax? Answers for these
questions are the subject of positive economics.
Positive Economics is divided into two: descriptive economics and economic theory.
1. Descriptive Economics is simply the collection and presentation of data that describe
phenomena and facts. Ex. In the Phil., the National Statistics Office produces an
enormous amount of date, as do the NEDA and other non-government agencies.
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Principles Of Economics (with Taxation and Agrarian Reform)
It helps us understand how the world works, but the formulation of the economic policy
requires a second step. It requires us to be specific about the grounds for judging one
outcome superior to another.
3. Growth. An increase in the total output of an economy It output grows faster than
population, output per capita rises and standard of living increases.
Foundation of Economics
1. Scarce/limited resources
Unlimited Wants
What is economic wants? This is the desire of consumers to obtain satisfaction from
the various goods and services they consume. It covers a wide range of products from
necessities (food, shelter, and clothing) to luxuries (cars, mobile phones, etc.)
Firms and government agencies also strive to satisfy economic goals. To achieve this,
they need capital investment and social infrastructures.
All these wants are unlimited. In other words, individuals and institutions have
innumerable unfilled wants. The objective of all economic activity is to fulfill wants.
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Principles Of Economics (with Taxation and Agrarian Reform)
Scarce Resources
Economic resources refer to all natural, human and manufactured resources that go
into the production and services that includes factory, equipments, tools, machinery,
transportation and communication facilities, all types of labor, land and mineral services.
1. Land – it includes all natural resources – all gifts of nature that we used in the
production process.
Ex. Arable land, forests, mineral and oil deposits, water resources
2. Labor – refer to all the physical and mental talents of individuals available and usable
in producing goods and services. The income realized to those who supply labor is
called wages that include salaries and all wage and salary supplements such as
bonuses, commissions and royalties.
Ex. Teachers, engineers, factory workers, physicians, professional basketball players
3. Capital – includes all produced goods used again to produce consumer goods and
services. The income received from using capital is interest income.
Economic System
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Principles Of Economics (with Taxation and Agrarian Reform)
Economic Model
All models simplify reality in order to improve our understanding of it. The economy
consists of millions of people engaged in many activities – buying, selling, manufacturing
and so on. To understand how the economy is organized and work, we need a model that
would explain it further.
1. Circular Flow Diagram. A visual model of the economy that shows the income
received and payments made by each sector of the economy. In this model (2
sector), the economy has two types of decision makers – households and firms. The
inner loop of the diagram (Fig. 1)) represents the flow of goods and services using
the inputs such as labor, land and capital combined efficiently by the entrepreneur.
These inputs are known as the factors of production owned by the household who in
return consume all the goods and services produced by the firm.
Households and firms interact in two types of markets. In the product market,
households are buyers and firms are sellers. Households buy the goods and services
produced by the firm. In the resource market, households are sellers and firms are buyers.
Households are the provider of the inputs that firms used to produce goods and services.
The outer loop of the diagram represents the flow of payments or income. The
households spend money to buy goods and services from the firm. From the revenue that
the firms realized, a part of it will be used to p ay for the payments of inputs such as wages
for the workers, rental also member of households. Hence, payment for goods and services
flows from the household to firm, and money income in the form of wages, rent and profit
flows from firms to households.
Fig. 1.1 The Circular Flow Chart n a Two Sector Model, No Saving Economy
Revenue Expenditures
PRODUCT MARKET
Firm Sell, Household Buy
FIRMS HOUSEHOLDS
Produce and Sell Purchase and Consume
Goods and Services Own and Sell Inputs of
Production
Inputs For Labor and
Production Capital
RESOURCE MARKET
Household Sell
Firm Buy
Wages, Rent, Profit Money Income
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Fig. 1.2 The Circular Flow Chart in a Two-Sector Model, Saving Economy
Consumption Expenditures
(Purchase of Goods and Services)
Businesses Households
The savings of the household is a leakage in the circular flow i.e. a saving leakage.
Figure 1.2 shows that household savings would not result to a decrease in government
spending if it is loaned up to business firms to finance investment. If production depends
upon the relationship of revenues of businesses and disbursement of money income, if
follows that the value of the output depends upon the households decision to consume and
save and the businesses intention to invest.
Consumption Expenditures
Output of Goods
and Services
Money Income
Investment household
Spending Saving
Taxes
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The government collects taxes and spends it for different government expenses.
Figure 1.3 shows that taxes impose on the value of output decreases the money flow to the
household. Tax receipts if not spent, are leakages in the circular flow. The circular flow of
money income depends upon the household’s intention to consume, businesses intention
to invest and the government’s plan to tax and spend.
Exports
Gov’t Expenditures
Consumption Expenditutes
Output of Goods
and Services
Factors of Production
Money Income
Investment Household
Spending Saving
Taxes
Imports
Imports, taxes and savings is a leakage in the circular flow. Imports do not remain in
the circular flow therefore it constitutes outflows. Exports and investment spending is an
injection. From exports the economy retrieve funds for the circular flow through the
receipts of sales from the rest of the world. The circular flow showing this outflows and
injections is drawn in Figure 1.4
2. Production Possibility Frontier. A graph that shows the various combination of two
commodities that the economy can possibly produce given the available factors of
production and available production technology.
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Assumptions:
1. Full employment and productive efficiency. Full employment means the economy
make use of all its available resources while productive efficiency is production of
goods and services in the least costly way.
2. Fixed resources. The available resources are fixed both in quantity and quality.
4. Two goods.
Table 1.2 Production Possibility Schedule of Clothing and Machinery with Full
Employment and Productive Efficiency
A B C D E
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Principles Of Economics (with Taxation and Agrarian Reform)
Each point on the PPC represents some maximum output of the 2 products. The
curve is a production frontier because it shows the limit of attainable output.
At point A, the economy would be devoting all of its resources in the production of
machinery while on point E all of its resources would be utilized for clothing production.
These two alternatives are unrealistic extremes because an economy typically produces
both capital and consumer goods as in B, C, D and E. Moving from alternative A to E,
production of clothing increases at the expense of machinery production.
To achieve the various combinations of clothing and machinery that fall on the PPC,
the society must achieve both full employment and productive efficiency Point lying inside
(to the left, which is pt. G) of the curve are also attainable but they reflect inefficiency.
Points inside the curve imply that the economy could have more of both clothing and
machinery if it achieved full employment and productive efficiency. Point lying outside (to
the right, which is pt. H) represents a greater output. Point H is not attainable given the
available supply of resources and technology.
The amount of other products that must be foregone to obtain one unit of a specific
good is called “opportunity cost”. From alternative A to B, in fig. 1.5, the cost of one unit of
clothing is less than one unit of machinery. But considering the cost through the additional
production alternatives, B to C, C to D and D to E – the cost foregone for each additional unit
of clothing is greater than the opportunity cost of the preceding one. For example, from A
to B – 1 thousand units of machinery for 1 hundred thousand units of clothing, B to C – 2
thousand units of machinery for 1 hundred thousand more units of clothing, C to D – 3
thousand units of machinery for 1 hundred thousand more units of clothing and D to E – 4
thousand more units of machinery for 1 hundred thousand units of clothing.
1. In this example, opportunity costs are being measured in real terms rather than in
money terms.
Ex. The marginal opportunity cost of the 2 hundred thousand units of clothing I 3
thousand units of machinery, that is (=10 – 7). The total opportunity costs for the 2
hundred thousand units of clothing is 3 thousand units of machinery (= 1 thousand
units of machinery for 1 hundred thousand units of clothing plus 2 thousand units of
machinery for another hundred thousand units of clothing).
This example illustrate the Law of Increasing Opportunity Costs which states that
the more unit of a product is produced, the greater is the opportunity cost.
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Appendix:
Graphs and their meaning
Graphs are most often used to illustrate economic models. It helps an individual
visualize and understand economic relationships. Most of the economic principles or
models that explain relationships between two sets of economic facts can be conveniently
represented with two-dimensional graphs.
Construction of a Graph
Table 1.3 is a hypothetical example that shows the direct relationship between two
variables.
Y C Pt.
0 75 A
100 150 B
200 225 C
300 300 D
400 375 E
500 450 F
Fig. 1.6 shows graphically how consumption changes as income changes. Income as the in
dependent variable represents the horizontal axis and consumption as the dependent
variable represents the vertical axis as customary.
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The vertical and horizontal of the graph is arranged to reflect the range of values of
consumption and income and the scales are marked in convenient increment. The values
marked on the scales cover all the value in Table 1.3
Each point on the graph represents an income value and its associated consumption
value. To plot the point that represents one of the income-consumption combination in
Table 1.3 a perpendicular line was drawn from the appropriate values on the vertical and
horizontal axes. For example, to plot pt. D (the 300 income – 300 consumption point),
perpendiculars were drawn up from the horizontal (income) axis at 300 and across from the
vertical (consumption) axis at 300. The perpendicular intersects at point D representing a
particular income-consumption combination. A line or smooth curve was drawn to connect
all income-combination points. The line represents the income-consumption line showing
that the relationship is linear.
The positively slope line depicts the relationship between income and consumption.
A direct relationship implies that two variables change in the same direction. An increase in
consumption is associated with an increase in income and vice versa.
In contrast, two sets of data maybe inversely related. Table 1.4 and Fig. 1.7 shows
the relationship between the price of pizza and quantity purchased at a pizza chain. The
figure shows an inverse relationship because two variables change in opposite directions.
When pizza price increases, the quantity purchased decrease and vice versa. The seven data
points in Table 4 are plotted in Figure 1.7.
Table 1.4 The Relationship Between Pizza Prices and Quantity Purchased
100 0 A
85 3 B
70 6 C
55 9 D
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Fig. 1.7
The independent variable is the cause or source and the one that changes first. The
dependent variable is the effect in outcome and it changes because of the change in the
independent variable. In the income consumption example, income is the independent
while consumption is the dependent. Similarly, in example 2, the quantity of pizza
purchased is the dependent variable.
Thus, in Fig. 1.6, all factors other than income that might affect consumption are presumed
to be constant. Similarly, in Fig. 1.7, all factors other than pizza price that might affect
quantity purchased are assumed unchanged.
In reality, other things are not equal. They often change and when they change, the
relationship presented in the two tables and graphs will change and the lines plotted on the
graph will shift to new locations.
Slope of a Line
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Lines are described in terms of their slopes. The slope of the straight line is the ratio
of the vertical (Y axis) change to the horizontal change (X axis) change between any two
points of the line.
Positive Slope:
Between pt. C to D in gif. 1.6, the vertical change is P75 and the horizontal change is
P100, therefore:
Vertical change
Slope =
horizontal change
75
100
.75
The slope of .75 is positive because consumption and income change in the same
direction.
Negative Slope
Between any two of the identified points in Fig. 1.7 say point B to C, the vertical
change is – 15 and the horizontal change is 3. Therefore:
-15
Slope = 3
= -.5
The slope is negative because the pizza price and quantity purchased have an inverse
relationship. The slope of -.5 means that lowering the price by 15 will increase quantity
purchased by 3.
Many variables are unrelated or independent of one another. For ex. The quantity
of mobile phones purchased is not related to the price of mangoes. Fig. 1.8 (a)
represents the price of mangoes on the vertical axis and the quantity of mobile phones
on the horizontal axis. The relationship is represented by a line parallel to the vertical
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axis implying that the same quantity of mobile phones is purchased no matter what is
the price of mangoes. The slope of the line is infinite.
Fig. 1.8
c
Price of Infinite
Mango Zero
Quantity of Annulment
Mobile Phone Rate
(a) (b)
Vertical Intercept
Without plotting the points, a line can be located on the graph if we know its slope
and vertical intercept.
The vertical intercept of a line is the point where the line meets the vertical axis. In
Fig. 1.6, the vertical intercept is P75, which means that if the current income is zero,
consumers would still spend P75 and they could do this through borrowing or selling
some of their assets. In Fig. 1.7 P100 is the vertical intercept, which shows that at the
price of P100 no pizza would be purchased because of its higher price.
Y = a + bX
a = vertical intercept
X = independent variable
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P = 100 – 5Q
Where the vertical intercept is 100 and the negative slope is -5.
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Exercise 1.1
TRUE OR FALSE.
_________ 1. In the circular flow diagram, households receive income through the product
market.
__________2. The resource market is where household buy goods, services, and businesses
sell goods and services.
__________3. The price of a new mobile phone can be determined in the product market.
__________4. In the circular flow diagram, household spends income in the resource
market.
__________8. PPC is bowed out from the point of origin because it reflects the law of
increasing opportunity cost.
__________10. In the circular flow diagram 2 sector model, businesses are on the buying
side of the product market and selling side of the resource market.
__________11. Households are on the selling side of the resource market and buying side of
the product market.
__________12. Economics is grounded on two basic facts: limited wants and unlimited
resources.
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Exercise 1.2
1. Unemployment rate of the Phil. For the 2nd quarter of 2004 is 13.7%
2. Total exports as of June 2004 is $3.313B and total imports are $3.28B.
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A 0 15
B 1 13
C 2 10
D 3 5
E 4 0
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1. The numbers in the production possibility schedule stand for the (physical quantities,
money values) of food and automobile.
2. The numbers represent the (maximum, minimum) amounts of food and automobile that
the economy can produce with its available resources.
3. If all of the resources were devoted to food production, _____ units of clothing and
_______units of automobile will be produced.
4. If the economy wishes to produced thirteen thousand units of automobile, _____ units
of food will be produced.
5. If the economy decreases the production of automobile from thirteen to ten thousand,
food production will be increased by ____ units.
6. If the economy increases production of food from one to two thousand, automobile
production decreases by _____ units.
7. If economy (can, cannot) produces thirteen thousand of automobile and two hundred
thousand units of food because such combination is (within, beyond) the available
resources of the economy.
8. The economy (would, would not) produce the ten thousand units of automobile and two
hundred thousand units of food because such a combination means that the economy
(is, is no t) maximizing the resources.
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Exercise 1.4
A. Provide examples of each type of economic system. Classify the Philippines according to the
type of economic system and explain your answer.
B. Complete the statements below by matching them with the correct terms.
Competition
Each person
Freedom of exchange
Profits
Self interest
In a market economy, people buying and selling material goods and one another’s skills
have ______________
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2. Derive demand and supply schedule and curves with the application of demand and
supply model.
3. Identify application of supply and demand and use them for analysis.
4. Examine what determines the demand and supply of goods in a competitive market.
5. Understand how supply and demand together set the price of a good and quantity sold.
Key terms:
Market demand
Substitute goods
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Chapter 2
DEMAND AND SUPPLY: MARKET EQUILIBRIUM
Resources are scarce and human wants are insatiable. These two facts are the
foundation or root problems of economics. How to maximize consumer satisfaction
depends on the efficient management of these limited resources. So, the decision of
choices about what and how much goods, comes to fore. All consumers want quality life.
What goods and services do we consumers desire? Having a nice house to live in, a nice
cloth to wear, good education, having one’s own car and so forth are all-important. But
what determines what goods and services the consumer’s want? How do consumers decide
what to buy? The following sections will help you understand the demand and how the
consumers fulfill their demand for goods and services based on their needs, income, prices
and ll possible available alternatives.
The buyers want the price that will give them the most value for the least cost.
Assuming all things are equal, with a given income, the buyer will tend to buy more units of
an item at lower prices or less units at higher prices.
What demand? Demand is a schedule of the different quantities of a good that the
buyers are willing and able to buy at different prices at a given time. For example, a buyer
has P6 to spend for product X. the schedule below shows the different quantities of X the
buyer is willing and able to buy corresponds to given set of prices in the market.
P 0.10 60 units
0.20 30 units
0.30 20 units
0.40 15 units
Table 2.1
At price P0.10 the quantity demanded is 60 units. At price P0.40 the quantity
demanded is 15 units. The term, quantity demanded is the amount of good that the buyers
are willing and able to buy at some particular price. The specific quantity of 60 units that
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Law of Demand
The law of demand indicates that as price increases, a smaller quantity will be
bought as price decreases, a larger quantity will be bought. It indicates an inverse
relationship between price and quantity demanded.
The law of demand can also be explained in terms of income and substitution effect.
1. Income effect means that a decrease in the price of a product will increase the
purchasing power on one’s money income; hence, you are able to buy more of the
product than before. For example, the buyer has P20, at price P5 per unit, he can
buy 4 units of the product. If the price goes down to P2 per unit, he can n ow buy 10
units instead of 4 units.
2. Substitution effect indicates that, at a lower price, one has the incentive to
substitute the cheaper good for similar goods, which are now relatively more
expensive. For example, at a lower price, beef is relatively more attractive and it is
substituted for pork.
The income and substitution effects combine to make consumers able and willing to buy
more of a product at a low price than at a high price.
Figure 2.1
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Types of Demand
1. Individual demand
Demand for final goods is primary demand or consumer demand while demand for the
factors of production is derived demand or producer demand.
Demand for the factors of production like bakers, oven, yeast, flour, and othes depends
on the desire and income level of the consumers for the final goods like bread, cakes,
pastries and other bakery products.
Table 2.1
Quantity Demand
1. Number of buyers.
2. Consumer income.
3. Consumers’ tastes and preferences.
4. Prices of related goods.
5. Consumer expectations with respect to future prices and income.
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1. Numbers of Buyers
There will be an increase in demand if there are more buyers in the market. Fewer
buyers will be reflected by a decrease in demand.
2. Consumers’ Income
(a) Superior good or normal good is good which demand increases as consumer income
increases.
(c) A decrease in consumer income will cause a decline in the demand for a
good.
A favorable change in consumers’ tastes and preferences for a product will cause
demand to increase. An unfavorable change in consumers’ tastes and preferences
will cause demand to decrease.
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which are offensive at one time, may not be offensive at another time because of the
changes in fashion and tastes.
5. Substitute Goods ( or competing goods) are goods which are used in place of other
goods. For example, butter and margarine. If the price of butter goes up, demand for
margarine will increase. If the price of butter goes down, demand will decrease. The
price of one good and the demand for the other are directly related.
Butter Margarine
Price Demand will
Price Demand will
Complementary goods are goods that go together. For example, car and gasoline. If
you buy a car you must buy gasoline. If the price of gasoline up, demand for car will
decrease. If the price of gasoline goes down, the demand for car will increase. The price of
one good and the demand for the other are inversely related.
6. Expectations
Consumer expectations of higher future prices may prompt them to buy now in
order to “beat” the anticipated price rises. Similarly, these expectations of the higher
future income may induce the consumers to increase their current spending. On the
other hand, consumer expectations of lower future prices and income will cause a
decrease in the demand for the good.
Increase Increase
Decrease Decrease
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Supply
The job of sellers is to supply what buyers demand. What and how much will be
produced and who will produce it are an important question that directly affects us as
consumers. What decisions will the sellers make depend on many things. The following
sections will help you understand the relationship between supply and price in a market
economy.
Supply
Supply is a schedule of the different quantities of goods that the sellers are willing
and able to sell at different prices at a given time. For example,
Table 2.3
P10 0 Units
20 500 Units
30 1000 Units
40 1500 Units
50 2500 Units
No seller is willing to sell any units of X at P10. When the price is P20, sellers are
willing to supply 500 units. At P50 a unit, the sellers are willing to supply 2,500 units. Zero
units, 500 units, and 2500 units are quantity supplied.
Quantity supplied is the amount of goods that the sellers are willing and able to sell
at some particular price. For supply to be effective, sellers must be willing and able to sell
the product.
Law of Supply
The supply schedule illustrates the law of supply: as price increases, a larger quantity will
be sold; as price decreases, a smaller quantity will be sold. The law of supply indicates a
direct relationship between price and quantity supplied.
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Fig. 2.4
Types of Supply
Table 2.4
Quantity Supply
P 10 10 15 7 32
20 12 20 10 42
30 14 25 13 52
40 16 30 16 62
50 18 35 19 72
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1. Number of sellers
1. Number of Sellers
More sellers will increase supply. Fewer sellers will decrease supply.
More Increase
Fewer Decrease
Prices of human, natural and capital resources often change. These changes affect a
producer’s ability to supply goods at a certain price. Increasing cost of production
decreases supply. Decreasing costs increases supply.
Increase Decrease
Decrease Increase
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4. Expectations
Quantity supplied is affected by the change in price. It refers to the movement from one
point to another point on a stable supply curve.
Example
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A change in supply is affected by one or more of the determinants of supply. Like demand,
“supply” refers to a schedule or curve; therefore, a “change in supply” must mean that the
entire schedule has changed and that graphically the curve has shifted its position.
Example,
In a market economy, prices are determined by the interaction of demand and supply,
the decision of the buyers to buy and the decisions of the sellers to sell. Buyers will buy
more goods at lower prices than at higher ones. Sellers will sell more goods at higher prices
than at lower ones. But at a certain point, there is a price, which will be satisfactory to both
the buyers and the sellers. Hence, the quantity the buyers are willing to buy will be equal to
the quantity of the sellers are willing to offer for sale. There is no surplus or shortage exists.
No pressure for the price to change, there is a market equilibrium.
Graphically, the interaction of the demand curve and the supply curve of the product will
indicate the equilibrium point. The price and quantity determined by the interaction are
the equilibrium price and equilibrium quantity.
Table 2.5
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Name: Score:
Section: Room: Date:
Exercise 2.1
5. The law of demand states that as price rises buyers will purchase
(more/less/zero/the same) quantity of the product.
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Principles Of Economics (with Taxation and Agrarian Reform)
Name: Score:
Section: Room: Date:
Exercise 2.2
Presented below are the demand schedules for rice (in kilogram/month) of three
households.
P35 1 4 4
30 2 6 8
25 3 8 12
20 4 10 16
15 5 12 20
1. Assuming the above three households comprise the entire rice consuming public.
Compute the market demand in column (5) above.
4. Household B doubles its purchase of rice. Derive the new market demand schedule
in column (6) above.
5. Plot the new market demand curve on the graph in No. 1 and label it (b).
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Principles Of Economics (with Taxation and Agrarian Reform)
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Name: Score:
Section: Room: Date:
Exercise 2.3
Which figure (A) , (B) , (C) or (D) illustrates the effect of each of the following on the
demand for product X?
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Principles Of Economics (with Taxation and Agrarian Reform)
Name: Score:
Section: Room: Date:
Exercise 2.4
Identify the following pairs. Write C for complements and S for substitutes.
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Name: Score:
Section: Room: Date:
Exercise 2.5
2. When more units of a commodity are offered for sale at each price, there has been
an increase in (supply, quantity supplied).
4. Which of the following could not cause a change in the supply of commodity X?
b. An increase in population
5. The law of supply indicates a (an) (direct, inverse) relationship between price and
quantity supplied.
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Name: Score:
Section: Room: Dare:
Exercise 2.6
P35 1 4 4
30 2 6 8
25 3 8 12
20 4 10 16
15 5 12 20
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Principles Of Economics (with Taxation and Agrarian Reform)
E. Plot the new Market supply curve in the graph in (B) and label it (b).
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Principles Of Economics (with Taxation and Agrarian Reform)
Name: Score:
Section: Room: Date:
Exercise 2.7
Which figure – (A), (B), (C) or (D) – illustrate the effect of each of the following on the
supply of product X?
5. The producers expect the price of product X to increase in the near future.
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Principles Of Economics (with Taxation and Agrarian Reform)
Name: Score:
Section: Room: Date:
Exercise 2.8
Terms:
G. Shortage N. Surplus
7. An increase in the price of one product causes a decrease in the demand for
another product.
9. An increase in the income of the consumers causes a decrease in the demand for
these goods.
10. The demand curve shifts either to the left or to the right.
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Principles Of Economics (with Taxation and Agrarian Reform)
Name:_______________________________________ Score______________
Section_________________Room_________________Date_______________
Exercise 2.9
Demand Supply
Quantity
Price Price Quantity supplied
demanded
(P) (X) (P) (X)
20 4000 20 1000
40 3000 40 1500
60 2000 60 2000
80 1000 80 2500
1. From the above demand and supply schedules, the equilibrium price and
quantity are P_____ and _____ units.
2. If the price were set at P20, there would be a (surplus/shortage) of good equal
to_________units
3. If the price were set at P80, there would be a (surplus/shortage) of good equal
to_________units.
10. If the quantity supplied is doubled at each price, level and quantity demanded
remains unchanged, the new equilibrium price and quantity will be
P______and_______units.
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Principles Of Economics (with Taxation and Agrarian Reform)
Name:__________________________________________________Score:_________
Section:_______________________Room:_____________________Date:__________
Exercise 2.10
1. I f the demand is DD and supply is SS, the equilibrium price and quantity will be
A. P and Q C. P and Q
B. P and Q D. P and Q
2. If demand shifts to DD with no changes in supply (SS), the new equilibrium point will
be
A. A C. C
B. B D. E
3. If demand is DD and supply is SS the mew equilibrium price and quantity will be
A. P and Q C. P and Q
B. P and Q D. P and Q
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Principles Of Economics (with Taxation and Agrarian Reform)
A. a movement from DD to D D
B. a movement form D D to DD
C. a movement up along DD or D D
A. a movement from SS to S S
B. a movement from S S to SS
C. a movement up along SS or S S
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Principles Of Economics (with Taxation and Agrarian Reform)
A. An increase in supply
B. A decrease in supply
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Principles Of Economics (with Taxation and Agrarian Reform)
Name:_________________________________________________Score:__________
Section:______________Room:_____________________________Date___________
Exercise 2.11
Illustrate graphically the effect of each of the following on the equilibrium price (P) and
equilibrium quantity (Q). (The following symbols stand for: D ( demand), S ( supply),
(increase), (decrease), - (constant), > (greater than), < (less than), = (equal to)
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Principles Of Economics (with Taxation and Agrarian Reform)
Name:____________________________________________Score:________
Section:___________________Roo:____________________Date:_________
Exercise 2.12
Examine and indicate the effect of each of the following events on the demand for (D),
supply of (supply), equilibrium price (P) and equilibrium (Q) of product X.
for decrease
_ for constant
EVENT D P S Q
1. Series of studies that X provides many
– –
Nutritional benefits for a healthy body.
2. An increase in the price of X –
3. An increase in consumer income
assuming X is a normal good. – –
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Principles Of Economics (with Taxation and Agrarian Reform)
Learning objectives
1. Know the approaches in the computation of GDP, GNP and other national income
accounts as well as the purpose of measuring these accounts.
2. Understand related concepts such as nominal and real GDP/GNP, price index and
GDP deflator.
3. Determine the types of transaction that are included or excluded from the
measurement of GNP.
5. Explain the problem of double counting and know the approach of summing value-
added of final goods.
Key terms:
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CHAPTER 3
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Principles Of Economics (with Taxation and Agrarian Reform)
The executive of a firm wants to know how well firm is performing. What measures
should he undertake to improve the financial standing of the firm? Accounting date provide
him with the information he needs to assess the operation of the firm. What accounting
does to the firm is what it does for the economy as a whole. National income accounts
provide the framework of the economy’s performance and the economy’s stage of
economic development. Hence policies can be formulated to improve the performance of
the economy.
Gross National Product is the market value of all final goods and services produced in
the economy during a given period of time, usually one year.
Final Goods are goods which are for final consumption by the end user. While
intermediate goods are goods which are to be processed, further into other goods. To
avoid counting, only final goods and services are counted as part of GNP. For example, a
consumer buys leather, the price paid for leather is counted as part of GNP if it will not be
sold again and it is in its final form. However, if a shoemaker uses leather to produce a pair
of shoes, leather will be counted as part of that pair of shoes. If both the leather and the
shoes were counted, the leather would be added in twice and so exaggerate the GNP.
GNP may increase if there is an increase in (a) the prices, (b) the quantities, or (c)
both the prices and the quantities of goods and services produced. To reflect the real
output, we adjust the GNP figures by using the consumer price index (CPI) as deflator or
inflator. Adjusted or real GNP is the money GNP divide by CPI.
Consumer Price Index (CPI) is a tool used to measure the changes in the prices of the
commodities.
CPI = P x 100
P
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Principles Of Economics (with Taxation and Agrarian Reform)
2. Leisure time
GNP does not reflect the improvements in efficiency. The workers today produce
more goods and services than the workers did it 40 years ago. Increases in efficiency
have allowed people more free time, which is not reflected in GNP.
3. Housewives’ services
The services of a housewife are free and GNP does not count those that are given
away free. GNP measures only goods and services that command a price.
4. Resale
GNP counts only new goods produced for sale. Resold or transferred goods are not
counted because no wealth is created. Goods produced during a specific year are
counted. Those produced before or after are not added into GNP for the year. For
example, year 2002 GNP did not include goods produced in year 2001 and those in
year 2003.
5. Transfer payments
Gift, grants, retirement and pension payments and others are not included in
GNP because they do not affect the production of goods and service.
6. Security
Buying and selling of stocks and bonds do not affect the production of goods or
operation of the business. Thus, they are not counted.
This method measures all the money spent on goods and services by the
following sectors:
(a) Personal consumption expenditures (C)
Spending of consumers on final goods and services.
Net Exports are the value of the goods sold outside the country (exports)
less the value of the goods sold in the country that are made abroad
(imports).
Xn = Export – Import
This method accounts for all the money received for the production
of goods and services.
Add: Rents
Wages and salaries
Interests
Proprietor’s income
Corporate income
Indirect business taxes
Depreciation
Equals: GNP
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Principles Of Economics (with Taxation and Agrarian Reform)
Industry
a. Transport, communication-------------------------- P xx
and storage
b. Commerce---------------------------------------------- P xx
c.
Services------------------------------------------------- P xx
Less: Net factor income from the rest of the world-------------- (P xx)
This method measures the value of the goods and services produced
based on the value added at each stage of production or distribution and
included in the cost to the ultimate consumer.
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Principles Of Economics (with Taxation and Agrarian Reform)
Value added is the difference between the cost of materials goods and the
value of the sales of goods. For example, if a firm buys materials for P100 and
produces from a product while sells for P250, the value added by the firm is P150.
Candy Manufacturing
Sales Value of
Materials/Product Value Added
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Principles Of Economics (with Taxation and Agrarian Reform)
Personal Savings(S)
S = DI – C
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Principles Of Economics (with Taxation and Agrarian Reform)
Name:___________________________________________Score:______
Section:_______________Room:______________________Date:_____
Exercise 3.1
1. _______ measures the market value of all the final goods and services produced.
4. The _____________ method to GNP counts the money received for productions.
6._______________ is the difference between the cost of materials or product and the sale
s value of goods.
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Principles Of Economics (with Taxation and Agrarian Reform)
Name:____________________________________________Score:_____
Section:_________________Room:_____________________Date:____
Exercise 3.2
Matching Type: Write the letter of the best alternative on the blank provided.
TERMS:
______7. An allowance for capital goods consumed in the production of this year’s output.
______8. The part of profit paid out to the stockholders or owners of the corporations.
______10. The difference between gross private domestic investment and depreciation.
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Principles Of Economics (with Taxation and Agrarian Reform)
Name: _____________________________________Score:_______
Section:___________Room:_____________________Date:_______
Exercise 3.3
______1. A 3-teaching hour decline in the length of workweek of the UE faculty members.
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Principles Of Economics (with Taxation and Agrarian Reform)
Name:______________________________________ Score:___________
Section:_________________Room:______________Date:_____________
Exercise 3.4
1. Compute the following price indices’ and analyze what the data mean:
II. Compute the following price indices and analyze what the data mean:
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Principles Of Economics (with Taxation and Agrarian Reform)
Name:______________________________________Score:___________
Section:__________________Room:_____________Date:__________
Exercise 3.5
The three parts of this question represent three different problems. The figures are billions
of pesos, and they refer to a specific year an (x) opposite each item means the value is not
given.
Problem
Total of A B C
A. For each problem, compute GNP, NNP, NI, PI, DI, and S
B. Compute the total of the ff:
a. Dividend in problems B and C
b. Gross investment in problem A
c. Consumption expenditures in problem C
d. Net exports in problem A and B
e. Personal savings in problem A
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Principles Of Economics (with Taxation and Agrarian Reform)
Name:______________________________________Score:_______
Section:___________________Room:______________Date:_______
Exercise 3.6
Compute:
A. GNP D. PI
B. NNP E. DI
C. NI F. S
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Principles Of Economics (with Taxation and Agrarian Reform)
Learning Objectives
1. Use the linear consumption model to understand consumer behavior and explain why
it best describes a consumption function.
2. Discuss the determinants of consumption and saving and give example each.
3. Understand the concept of AC, APS, MPS and how to calculate it.
4. Define investment in economic sense and distinguish it from the accounting concept.
6. Determine the equilibrium level of output in the economy through aggregate spending
approach and saving = investment approach.
Key terms:
Savings investment
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Principles Of Economics (with Taxation and Agrarian Reform)
CHAPTER 4
Consumption Function
An equation showing the relationship between the level of consumption and the
level of disposable income. C = f (Y) meaning consumption depends on income.
C=a+bY
Intercept, > 0
income
Ex. C =40 + 80 Y
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Principles Of Economics (with Taxation and Agrarian Reform)
Consumption Schedule
A schedule showing the amounts households plan to spend for consumer goods at
different levels of disposable income.
Table 4.1
Consumption Schedule
Y C
(1) (2)
P 4000 P 5000
6000 6500
8000 8000
10000 9500
12000 11000
Column (1) shows the different levels of disposable income while column (2) represents
consumption spending. Columns (1) and (2) taken together is called the consumption
schedule.
At lower levels of income P4000 and P6000 household spend a larger proportion of their
disposable income than that of a higher one and people tend to dissave,C>Y. As income
rises to P8000 they tend to break-even. Consumption is exactly equal to disposable income,
no savings/no dissavings. At incomes P10000 and P12000 households tend to save, C < Y.
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12000
10000
8000
6000
4000
2000
Y
0 2000 4000 6000 8000 10000 12000
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Principles Of Economics (with Taxation and Agrarian Reform)
Fig. 4.1
Saving Function
Savings is unspent income. It shows how much households plan to hold back from
consumption at different levels of income. Since disposable income is also the basic
determinant of savings, it can be noted that savings is a function of income. Savings depend
on income; household savings increases with increases in income and falls with decrease in
income.
Table 4.2 shows the various amounts of savings that households will undertake at
different levels of income. Savings is disposable income minus consumption.
Table 4.2
Saving Schedule
Y C S
8000 8000 0
Column (1) shows the levels of disposable income while column (2) represents
consumption. Column (3) savings is derived by subtracting (2) from (1).
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Principles Of Economics (with Taxation and Agrarian Reform)
Households will be at break-even and savings is zero. At high levels spending will be less
than income and there is savings. This table illustrates the positive relationship between
income and savings.
Fig. 4.2
Figure 4.2 shows the income-savings relationship. If a point falls along the income
(Y) axis, households are breaking even hence savings is equal to zero. However, if a point
lies above the income (Y) axis, there is a saving, (S+) and below the income axis,
dissaving (S-).
The fraction of total income that is consumed is the average propensity to consume
(APC). The fraction of total income that is saved is the average propensity to save (APS).
That is
APC = Consumption = C
Income (Y) Y
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Principles Of Economics (with Taxation and Agrarian Reform)
APS = Saving = S
Income Y
Example:
Table 4.3
To calculate APC, we use the data on income and consumption, for example,
at P4000, AP 5000 = +1.25
4000
Columns (4) and (5) shows the APC and APS at the different levels of
income.
The marginal propensity to consume is the extra amount that people consume when
they receive an extra disposable income. The response of consumption to change in income
is called MPC. On the other hand, marginal propensity to save (MPS) is the proportion or
fraction of any change in income that is saved.
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Principles Of Economics (with Taxation and Agrarian Reform)
MPC + PMS = 1
.75 + .25 = 1
C1
C0
C2
Y
.
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Principles Of Economics (with Taxation and Agrarian Reform)
S2
S0
S1
If households consume more at each level of disposable income they save less.
Graphically, the movement is from C to C in Fig 4.3(a) and S to S in 4.3(b (. On the other
hand, if households consume less, they save more. The movement is toward the opposite
direction.
Investment
Table 4.4
10 P0
8 5
6 10
4 15
2 20
0 25
Table 4.4 shows the amount of investments and the expected rate of return.
Suppose no investment opportunity will yield an expected rate of return of 10% but there
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Principles Of Economics (with Taxation and Agrarian Reform)
are P5B worth of investment opportunities with expected rates of return 8%. People will
continue to invest until such a time when expected rate of return of P25B will be zero.
Fig 4.4
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Principles Of Economics (with Taxation and Agrarian Reform)
Aggregate supply describes what output business would be willing to produce and
sell given prices, costs, and market conditions. Aggregate supply is a function of available
inputs, technology and the price level. The equilibrium level of income refers to that income
level where aggregate demand equals aggregate supply.
Example 1
Table 4.5
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Principles Of Economics (with Taxation and Agrarian Reform)
Fig 4.4 shows the graphical presentation of the equilibrium level income. The 45 line, which
used to be the reference line, is now referred to as the aggregate supply. It shows the exact
equality between spending and the different levels of income. Consumption line is plotted
using the data from table 4.5 so with the consumption plus investment line (C+I). The point
where aggregate demand equals aggregate supply at income P10,000 is called the
equilibrium level of income.
Savings – Investment
Example 2
Table 4.6
(Output/Income)
Table 4.6 shows the planned level of savings and the planned level of investment. Recall
that Y = C=S. To determine savings (col.3), simply subtract column (2) from column (1) S=Y-
C. Note that the level of investment spending is constant at P500. This is the autonomous
investment. It doesn’t change the level of income.
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Principles Of Economics (with Taxation and Agrarian Reform)
Table 4.5
Multiplier Effect
The multiplier effect shows the number of times in which the ultimate increase in
income exceeds the initial increase in investment spending. It is also the reciprocal of MPS.
K= 1 = 1 = Y , since S=I, Ke = Y
1-MPC MPS S I
Ke = 1 Ke = 1
1 – MPC MPS
= 1 = 1
1-.80 .20
= 1 = 5
.20
= 5
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Principles Of Economics (with Taxation and Agrarian Reform)
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