Chapter 2: Application of Demand and Supply

I. Basic Principles of Demand and Supply

The principle of supply and demand is one of the most important concepts in
microeconomics. It helps us understand how and why transactions on markets take
place and how prices are determined. To learn more about supply and demand we
mainly need to look at consumers and producers.

Consumers
In this case, consumers are all the economic units that are potentially willing to buy a
certain good or service. The actual demand for said good or service depends on
different variables. For now we will focus only on the most important one, the price.
For most goods and services we can say that demand will increase as the price falls
and vice versa. This actually seems pretty obvious: Just think about how many people
would buy a Ferrari if they were not that expensive.

Producers
Producers on the other hand are the ones that are potentially willing to produce and
sell a certain good or service. The actual supply again depends on multiple variables,
yet as we did before we will focus only on the price for now. For most goods and
services this implies that supply will decrease as the price falls and vice versa. Again,
the reasoning behind this is rather simple: If you were to sell ice cream you would
probably try and sell as much as you could if prices were high, because you could
make a good profit. However, if prices were to fall (maybe even beyond your
production cost) it would not be profitable to sell ice cream anymore and you would
produce less.

Illustration
Now these relationships are a lot easier to understand if we look at a simple
illustration (see below). The x-axis of this graph represents quantity (Q) and the y-axis
stands for price (P). 
 If we look back at the behavior of the consumers, we said they were willing to buy
more (i.e. a higher quantity) of a good or service if the price falls. So for every price
there is a quantity demanded, which will be higher the lower the price is. Now if we
plot all these quantity-price combinations we get a graph called the demand curve (D).

Now we can do the same thing for the producers. But since they are willing to produce
less (i.e. a lower quantity) as the price falls, the graph we receive is somewhat similar
to a mirror image of the demand curve. We call this the supply curve (S).
 
The point where both curves (D and S) intersect is called the market equilibrium
(E*). At this point (and price) the consumers are willing to buy exactly as much of a
good or service as the producers are willing to sell, and the market clears. This is the
best possible situation for all actors, thus they will always tend to get to this outcome.
This means the two curves will keep shifting until the equilibrium quantity and price
are reached. 

II. The Market

In Economics, the term “Market” does not refer to a particular place as such but it
refers to a market for a commodity or commodities. It refers to an arrangement
whereby buyers and sellers come in close contact with each other directly or indirectly
to sell and buy goods.

For the existence of a market, buyers and sellers need not personally meet each
other at a particular place. They may contact each other by any means such as a
telephone or telex. Thus, the term “Market” is used in economics in a typical and
specialized sense, it does not refer only to a fixed location. It refers to the whole area
of operation of demand and supply along with the conditions and commercial
relationships facilitating transactions between buyers and sellers.

Types of Markets
 Markets vary widely for a number of reasons, including the kinds of products sold,
location, duration, size, and constituency of the customer base, size, legality, and
many other factors. Aside from the two most common markets—physical and virtual—
there are other kinds of markets where parties can gather to execute their
transactions.

1. Black Market
A black market refers to an illegal market where transactions occur without the
knowledge of the government or other regulatory agencies. Many black markets
exist in order to circumvent existing tax laws. This is why many involve cash-only
transactions or other forms of currency, making them harder to track.

2. Auction Market
An auction market brings many people together for the sale and purchase of
specific lots of goods. The buyers or bidders try to top each other for the purchase
price. The items up for sale end up going to the highest bidder.

3. Financial Market
The blanket term financial market refers to any place where securities, currencies,
bonds, and other securities are traded between two parties. These markets are the
basis of capitalist societies, and they provide capital formation and liquidity for
businesses. They can be physical or virtual.

III. Demand
Demand is an economic principle referring to a consumer's desire to purchase goods
and services and willingness to pay a price for a specific good or service. Holding all
other factors constant, an increase in the price of a good or service will decrease the
quantity demanded, and vice versa. Market demand is the total quantity demanded
across all consumers in a market for a given good. Aggregate demand is the total
demand for all goods and services in an economy. Multiple stocking strategies are
often required to handle demand.

 Demand schedule
a table describing all of the quantities of a good or service; the demand schedule is
the data on price and quantities demanded that can be used to create a demand
curve.
 Demand curve
a graph that plots out the demand schedule, which shows the relationship between
price and quantity demanded.

IV. The Law of Demand

All other factors being equal, there is an inverse relationship between a good’s price
and the quantity consumers demand; in other words, the law of demand is why the
demand curve is downward sloping; when price goes down, people respond by
buying a larger quantity.

Markets have two agents: buyers and sellers. Demand represents the buyers in a
market. Demand is a description of all quantities of a good or service that a buyer
would be willing to purchase at all prices.

According to the law of demand, this relationship is always negative: the response to
an increase in price is a decrease in the quantity demanded.

For example, if the price of scented erasers decreases, buyers will respond to the
price decrease by increasing the quantity of scented erasers demanded. A market for
a good requires demand and supply.

V. Non-Price Determinants of Demand

Here are examples of how the five determinants of demand other than price can shift
the demand curve.

1. Income of the buyers: If you get a raise, you're more likely to buy more of both
steak and chicken, even if their prices don't change. That shifts the demand
curves for both to the right.
2. Consumer trends: During the mad cow disease scare, consumers preferred
chicken over beef. Even though the price of beef hadn't changed, the quantity
demanded was lower at every price. That shifted the demand curve to the left.
3. Expectations of future price: When people expect prices to rise in the future,
they will stock up now, even though the price hasn't even changed. That shifts the
demand curve to the right. For this reason, the Federal Reserve sets up an
expectation of mild inflation. Its target inflation rate is 2%. 
4. The price of related goods: If the price of beef rises, you'll buy more chicken
even though its price didn't change. The increase in the price of a substitute, beef,
shifts the demand curve to the right for chicken. The opposite occurs with the
demand for Worcestershire sauce, a complementary product. Its demand curve
 will shift to the left. You are less likely to buy it, even though the price didn't
change, since you have less beef to put it on. 
5. The number of potential buyers: This factor affects aggregate demand only.
When there's a flood of new consumers in a market, they will naturally buy more
product at the same price. That shifts the demand curve to the right. That
happened when standards were lowered for mortgages in 2005. Suddenly, people
who hadn't been eligible for a home loan could get one with no money down. More
people bought homes until the demand outpaced supply. At that point, prices rose
in response to the shift in the demand curve.

VI. Shifts of the Demand Curve

A shift in the demand curve is when a determinant of demand other than

price changes. It occurs when demand for goods and services changes even though
the price didn't.

o The curve shifts to the left if the determinant causes demand to drop.

That means less of the good or service is demanded at every price. That happens
during a recession when buyers' incomes drop. They will buy less of everything,
even though the price is the same.
o The curve shifts to the right if the determinant causes demand to increase. This
means more of the good or service are demanded at every price. When the
 economy is booming, buyers' incomes will rise. They'll buy more of everything,
even though the price hasn't changed. 

VII. Supply

Supply is a fundamental economic concept that describes the total amount of a

specific good or service that is available to consumers. Supply can relate to the
amount available at a specific price or the amount available across a range of prices if
displayed on a graph. This relates closely to the demand for a good or service at a
specific price; all else being equal, the supply provided by producers will rise if the
price rises because all firms look to maximize profits.

o Supply curve
A graphical representation of the quantity producers are willing to make when the
product can be sold at a given price.

VIII. The Law of Supply

The law of supply is the microeconomic law that states that, all other factors being
equal, as the price of a good or service increases, the quantity of goods or services
that suppliers offer will increase, and vice versa. The law of supply says that as the
price of an item goes up, suppliers will attempt to maximize their profits by increasing
the quantity offered for sale.

The chart below depicts the law of supply using a supply curve, which is upward
sloping. A, B and C are points on the supply curve. Each point on the curve reflects a
direct correlation between quantity supplied (Q) and price (P). So, at point A, the
quantity supplied will be Q1 and the price will be P1, and so on.
 The supply curve is upward sloping because, over time, suppliers can choose how
much of their goods to produce and later bring to market. At any given point in time
however, the supply that sellers bring to market is fixed, and sellers simply face a
decision to either sell or withhold their stock from a sale; consumer demand sets the
price and sellers can only charge what the market will bear. If consumer demand rises
over time, the price will rise, and suppliers can choose devoted new resources to
production (or new suppliers can enter the market) which increases the quantity
supplied. Demand ultimately sets the price in a competitive market, supplier response
to the price they can expect to receive sets the quantity supplied.  

The law of supply is one of the most fundamental concepts in economics. It works
with the law of demand to explain how market economies allocate resources and
determine the prices of goods and services.

IX. Non-Price Determinants of Supply

Changes in non-price factors that will cause an entire supply curve to shift (increasing
or decreasing market supply)

1. Resource prices—a rise in resource prices will cause a decrease in supply or

leftwardshift in supply curve; a decrease in resource prices will cause an increase
in supply orrightward shift in the supply curve.
2. Technology—a technological improvement means more efficient production and
lowercosts, so an increase in supply, or rightward shift in the curve results.
 3. Taxes and subsidies—a business tax is treated as a cost, so decreases supply;
asubsidy lowers cost of production, so increases supply.
4. Prices of related goods—if price of substitute production good rises, producers
mightshift production toward the higher priced good, causing a decrease in supply
of theoriginal good.
5. Producer expectations—expectations about the future price of a product can
causeproducers to increase or decrease current supply
6. Number of sellers—generally, the larger the number of sellers the greater the
supply.

X. Shifts of the Supply Curve

The supply curve depicts the supplier’s positive relationship between price and
quantity.

 Price changes and movement along supply curve

If the price of the good or service changes, all else held constant such as price of
substitutes, the supplier will adjust the quantity supplied to the level that is consistent
with its willingness to accept the prevailing price. The change in price will result in a
movement along the supply curve, called a change in quantity supplied, but not a shift
in the supply curve. Changes in supply are due to non-price changes.

 Non-price changes and shifts of the supply curve

If production costs increase, the supplier will face increasing costs for each quantity
level. Holding all else the same, the supply curve would shift inward (to the left),
reflecting the increased cost of production. The supplier will supply less at each
quantity level.

If production costs declined, the opposite would be true. Lower costs would result in
an increase in output, shifting the supply curve outward (to the right) and the supplier
will be willing sell a larger quantity at each price level. The supply curve will shift in
relation to technological improvements and expectations of market behavior in very
much the same way described for production costs.

Technological improvements that result in an increase in production for a set amount

of inputs would result in an outward shift in supply.
Supply will shift outward in response to indications of heightened consumer
enthusiasm or preference and will respond by shifting inward if there is an
assessment of a negative impact to production costs or demand.
CHAPTER 3

ECONOMICS AS AN APPLIED SCIENCE

It is a social science, one of the most rigorous social sciences that follow all the
steps of scientific method.
What makes economics an applied science?
 formulation of general theories through testing, mainly using data from the past.

Economics as pure science, formulates various laws and applied economics applies
them in practice in solving various problems. Robbins and all others before him treated
economics as a pure positive science. But recently, applied economics assumed greater
importance. As pure science and applied science go hand-in-hand, so Economics is
also pure as well as applied science.
The scope of economics means the limits or boundaries of Economics. According to
Adam Smith and A.C. Pigou Economics studies the causes of material wealth.They
gave a very narrow scope to the study of economics by limiting it only to those activities
relating to wealth.
According to Prof. Marshall, “Economics is a study of economic activities of a
man. It is only concerned with the wealth getting and wealth-using activities of a
man,” Prof. A.C. Pigou also restricted the scope of economics to the study of
economic welfare.
Robbins finds the welfare definition of economics rather restrictive as it
excludes non-material things from its scope. Services of doctors, teachers, lawyers,
domestic servants etc. are scarce and satisfy wants in our daily life but they are non
material. Similarly, all economic activities are not conductive to economic welfare.

APPLIED ECONOMICS IN RELATION TO PHILIPPINE ECONOMIC PROBLEM

The Philippines’ economic freedom score is 63.8, making its economy the 70th freest
in the 2019 Index. Its overall score has decreased by 1.2 points, with drops in scores for
monetary freedom, government integrity, and the tax burden outweighing a higher score for
property rights. The Philippines is ranked 15th among 43 countries in the Asia–Pacific
region, and its overall score is above the regional and world averages.
Continued strong economic growth, driven in part by ambitious state-funded
infrastructure projects, has allowed the government to prioritize domestic law-and-order
issues over economic policy concerns. Investors remain concerned about President
Duterte’s heavy-handed rule, although Duterte has consolidated support from Congress.
The absence of entrepreneurial dynamism thwarts development. Despite the adoption
of some fiscal reforms, deeper institutional reforms are needed in interrelated areas:
business freedom, investment freedom, and the rule of law. The judicial system
remains weak and vulnerable to political influence.

PHILIPPINE ECONOMIC PROBLEMS

1. POVERTY
2. UNEMPLOYMENT RATE
3. INCOME INEQUALITY
4. POOR QUALITY OF INFUSTRUCTURE

THE PHILIPPINES BASIC ECONOMIC PROBLEM

Economic problems are hindrances to the development.

The major obstacles to development are the following:

POVERTY

Poverty and inequality in the Philippines remains a challenge. In the past 4 decades, the
proportion of households living below the official poverty line has declined slowly and
unevenly.

Causes of Poverty

The main causes of poverty in the country include the following:

 Low to moderate economic growth for the past 40 years;

 Weakness in employment generation and the quality of jobs generated;
 Failure to fully develop the agriculture sector;
 High inflation during crisis periods;
 High levels of population growth;
 High and persistent levels of inequality (incomes and assets), which dampen
the positive impacts of economic expansion; and
 Recurrent shocks and exposure to risks such as economic crisis, conflicts,
natural disasters,and “environmental poverty.”

UNEMPLOYMENT

Unemployment has remained high in the Philippines, at almost twice the level of
neighboring countries, despite relatively fast employment growth in the past decade.
Employment growth was not sufficient to reduce unemployment because of rapid
population growth and increased labor force participation.

In 2018, the unemployment rate in the Philippines was at approximately 2.52 percent and on
a steady downward trend from 3.6 percent in 2014. The Philippines’ economy relies
heavily on remittances from overseas, i.e. money sent home by Filipino emigrants and
workers in other countries.

INFLATION

Inflation is defined as an increase in the general level of prices for goods and services.
It is measured as an annual percentage increase. As inflation rises, the value of the money
you own, buys a smaller percentage of a good or service.

There are two main causes of inflation: Demand-pull and Cost-push. Both are
responsible for a general rise in prices in an economy. But they work differently.

Demand-pull inflation results when prices rise because aggregate demand in an economy
is greater than aggregate supply.

Cost-push inflation is a result of increased production costs, such as wages and raw
materials and decreased aggregate supply.

In the Philippines, the volatility of inflation has been caused by factors such as
disturbances in agricultural food supply or movements in international oil prices. As a
result, the headline inflation rate may reach double-digit levels.

ASEAN ICON

Amartya Sen was born on November 3, 1933, Santiniketan, India.

 An Indian economist who was awarded the 1998 Nobel Prize in Economic Sciences
for his contributions to welfare economics and social choice theory and for his
interest in the problems of society’s poorest members.

 Sen was best known for his work on the causes of famine, which led to the
development of practical solutions for preventing or limiting the effects of real
or perceived shortages of food.

 Welfare economics seeks to evaluate economic policies in terms of their effects

on the well-being of the community.

 Sen, who devoted his career to such issues, was called the “conscience of his
profession.”
  His influential monograph Collective Choice and Social Welfare (1970)—which
addressed problems such as individual rights, majority rule, and the availability
of information about individual conditions—inspired researchers to turn their
attention to issues of basic welfare.

 Sen devised methods of measuring poverty that yielded useful information for
improving economic conditions for the poor. For instance, his theoretical work on
inequality provided an explanation for why there are fewer women than men in
some poor countries in spite of the fact that more women than men are born
and infant mortality is higher among males.

 Sen claimed that this skewed ratio results from the better health treatment and
childhood opportunities afforded to boys in those countries.
As for our country the Philippines there is one economist who truly became a big part of our
success. He was Cielito Flores Habito, born April 20, 1953 in Cabuyao City, Lagunaor
simply “Ciel” Habito is a Filipino economist, professor, and columnist. He served
concurrently as the Director-General of the National Economic and Development
Authority and Socio-Economic Planning Secretary during the Ramos administration.
CHAPTER 4

SCIENTIFIC APPROACH IN THE EMPIRICAL TESTING OF AN ECONOMIC THEORY

An economic theory is a formal explanation of the relationship between economic

variables. A theory gives a reason why something happens, offers a cause-and-effect
interpretation for a set of events, or shows the effect on one variable when another changes.
For example, one important economic theory deals with the relationship between changes in
the price of an item and the quantity of the item demanded by consumers.

In order to obtain a valid and predictable relationship between economic variables, theories
are explored within a framework of a model.

This framework includes several elements:

1. Variables – Typically, a theory is created to provide an explanation for something. This is

why the first step in developing a model is the selection of two variables to explore.
Ordinarily these variables have a cause-and-effect relationship. In economics, disputes may
occur because a variety of factors can be considered in analysing a problem, and only one
or a few of those factors are chosen as variables when developing a theory to explain the
problem. In exploring reasons for a slow-growing economy, for example, some economist
focus on the relationship between supply and growth, and some on the price level.

2. Assumptions – They are the conditions held to be true while exploring the relationship
between variables. For example, if students were to develop an economic theory about
relationship between changes in the number of employers and changes in the number of
available summer jobs, assumptions could be made about demographics, the economy in
general, the number of students wanting to enrol in summer school, and so on.

3. Data Collection and Analysis – When developing a theory, researchers collect and
analyse data to determine how the variables are related. In other words, a theory can be
supported by showing that the relationship between the variables is logically or statistically
valid using econometrics, which is the use of statistical techniques to describe the
relationships between economic variables.
4. Conclusions – The conclusion in a model gives the resulting relationship between the
variables based on the assumptions, logic, data analysis that went into the model. It is
important to understand that different assumptions, data collection methods, or statistical
techniques can cause the conclusions of studies to vary.

POSITIVE AND NORMATIVE ECONOMICS

While discussing the scope of economics, we also think of whether economics is a positive
or normative science.

Positive economics is the study of what is, and how the economy operates. It asks
questions as: How do price restrictions affect market forces? Or how does the market for rice
corn work? These questions fall under the heading of economic theory.

Normative economics is the study of what the objectives of the economy should be.
Normative economics ask such questions as : What should the distribution of income be?
What should tax policy be designed to do successfully? In discussing such questions,
economist must carefully outline what goals they must set.

Therefore, the task of an economist is not to condemn or advocate but to explore and
explain. However, economics should not be treated as only positive science. It should be
allowed to pass moral judgments of an economic situation. It is, therefore, considered both
positive and normative science. Thus, Economics is the social science that studies the
allocation of scarce resources to satisfy unlimited wants. This involves analyzing the
production, distribution, trade and consumption of goods and services. Economics is
said to be positive when it attempts to explain the consequences of different choices
given a set of assumptions or a set of observations, and normative when it prescribes
that a certain action should be taken.
 Measuring the Economy

 There are different methods to assess economic growth such as Gross National
Product (GNP) and Gross Domestic Product (GDP)
 The Gross Domestic Product (GDP) measures the value of goods and services by a
nation
 The Gross National Product (GNP) measures the value of goods and services
produced by a nation and income from foreign investments.

GNP/ GDP: Expenditure Approach

The expenditure method is a system for calculating gross domestic product (GDP) that
combines consumption, investment, government spending, and net exports. It is the most
common way to estimate GDP.

How the Expenditure Method Works

Expenditure is a reference to spending. In economics, another term for consumer spending

is demand. The total spending, or demand, in the economy is known as aggregate demand.
This is why the GDP formula is actually the same as the formula for calculating aggregate
demand. Because of this, aggregate demand and expenditure GDP must fall or rise in
tandem.

However, this similarity isn't technically always present in the real world—especially when
looking at GDP over the long run. Short-run aggregate demand only measures total output
for a single nominal price level, or the average of current prices across the entire spectrum of
goods and services produced in the economy. Aggregate demand only equals GDP in the
long run after adjusting for price level.

The expenditure method is the most widely used approach for estimating GDP, which is a
measure of the economy's output produced within a country's borders irrespective of who
owns the means to production. The GDP under this method is calculated by summing up all
of the expenditures made on final goods and services. There are four main aggregate
expenditures that go into calculating GDP: consumption by households, investment by
businesses, government spending on goods and services, and net exports, which are equal
to exports minus imports of goods and services.

The Formula for Expenditure GDP is:

GDP=C+ I + G + (X – M)

 C= Consumer spending on goods and services

 I= Investor spending on business capital goods
 G= Government spending on public goods and services
 X-M = Net exports (difference between exports and imports of goods and services)

Example of Expenditure Approach

Assume the consumer spending for country XYZ was ₱ 500,000 for the first three
months of the year. The government spending, on the other hand, stood at ₱400,000. Upon
carrying out extensive research, a policymaker discovers that fixed investment expenditure
in the economy stood at ₱300,000 made up of ₱70,000 on machinery purchases, ₱130,000
on inventory investment, and ₱100,000 on residential investment.

If the country exported goods worth ₱400,000 for the period and imported goods
worth ₱300,000, the net exports, in this case, would amount to ₱400,000- ₱300,000=
₱100,000.

Calculation of GDP using the expenditure approach would be:

GDP= C + I + G + (X-M)

XYZ GDP = ₱500,000 + ₱300,000 + ₱400,000 + (₱400,000- ₱300,000)

= ₱500,000 + ₱300,000 + ₱400,000 + ₱100,000

= ₱1, 300, 000

GNP/ GDP: Income Approach

The income approach looks at the final income in the country.

National Income is the sum of all the income payments derived from the four factors of
production from (land, labor, capital and entrepreneur) such as the rent, wages, interests
and normal profit.

Components of National Income

A. Compensation of Employees
Include wages and salaries paid to employees. It also includes wage and salary
supplements, payments by employers into social insurance and into variety of private
pension, health and welfare funds for workers.
B. Rents
Consist of the income received by the households and business that supply property
resources.
C. Interest
Consist of the money paid by the private business to the suppliers of money capital

D. Normal Profit
It is the sum of the Proprietors’ Income and Corporate Profits.

Proprietor’s Income is consist of net income of sole proprietorships, partnerships, and other
unincorporated businesses.

Corporate Profits are the earnings of the owners of corporations, classified into:

1. Corporate income taxes

2. Dividends
3. Undistributed corporate profits

To arrive at the Gross Domestic Product from the National Income, there are 3 factors
to be added to National Income as follows:
 Indirect business Taxes (general sales taxes, business property taxes, license fees
etc.) should be added to NI. They are not considered to be payments to a factor of
production, but they are part of total expenditures.

Depreciation is also called capital consumption allowance or consumption of fixed

capital. It is defined as the cost of the used capital goods in a given period of time.

Depreciation= Gross Investment – Net Investment

Net primary income used to be the Net Factor Income from Abroad. This is the
difference between the aggregate flow of factor payments from the rest of the world.

The Formula for getting GDP through Income Approach is:

Total National Income= Compensation of Employees + Rents + Interest + Proprietor’s

Income + Corporate Profits

GDP = Total National Income + Indirect business taxes + Depreciation + Net foreign factor
income

Example of Income Approach:

Personal consumption expenditures ₱ 12, 000

Government purchases 1, 600
Net private domestic investment 1, 000
Net exports 550
Net foreign factor income earned 200
Consumption of fixed capital (depreciation) 1, 300
Indirect business taxes 910
Compensation of employees 11, 200
Rents 700
Interest 650
Proprietors' income 1, 600
Corporate income taxes 960
Dividends 800
Corporate profits 2, 800
Note: To calculate for GDP through income approach, we must first get the Total National
Income

Solution:

Total National Income= Compensation of Employees + Rents + Interest + Proprietor’s

Income + Corporate Profits

= ₱ 11, 200 + ₱ 700 + ₱ 650 + ₱ 1, 600 + ₱ 2, 800

= ₱ 16, 950

GDP= Total National Income + Indirect business taxes + Depreciation + Net foreign factor
income

= ₱ 16, 950 + ₱ 910 + ₱ 1, 300 + ₱ 200

= ₱ 19, 360
CHAPTER 5.

MARKET EQUILIBRIUM
Equilibrium is a point of balance or a point of rest. A more complex definition is a state in market
where economic forces are balanced and in the absence of external influences the (equilibrium)
values of economic variables will not change.

It is the point at which quantity demanded and quantity supplied is equal. Market equilibrium, for
example, refers to a condition where a market price is established through competition such that the
amount of goods or services sought by buyers is equal to the amount of goods or services produced
by sellers. This price is often called the equilibrium price.

In the graph below the point at which the demand curve meets the supply curve is the equilibrium
price.

DEMAND AND SUPPLY IN RELATION TO BASIC COMMODITIES

MARKET EQUILIBRIUM

If the forces of demand and supply operate together, we can show price is determined in
market economy. Alfred Marshall, a British economist, defined the Law of Demand and Supply.

Equilibrium is a state of balance when demand is equal to supply. The equality means that
the quantity that sellers are willing to sell is also the quantity that sellers are willing to sell is also the
quantity that buyers are willing to buy for a price. As market experience, equilibrium is an implicit
agreement between how much buyers are willing to transact. The price at which demand and supply
are equal is the equilibrium price. In Figure 2.5, market equilibrium is attained at the point of
intersection of the demand and supply curves.
Figure 2.5.Market Demand and Supply Curves for Fish in the Quinta Market for One Week

In Figure 2.5, the price of good in the market is the equilibrium price. It is the price at which
the quantity demanded is equal to the quantity supplied. This is how most commodities in the market
are priced by their producers or sellers.

Determination of Market Equilibrium

Market equilibrium is attained when the quantity demanded is equal to the quantity supplied.

Assuming that the demand function for Good X is Q d = 60 – P/2 and the supply function for
Good X is Q s = 5 + 5P.

Applying the equations, we derive the following demand and supply schedules given the
following prices:

Demand Schedule of Good X Supply Schedule of Good X

Price
Php 0 60 5
2 59 15
4 58 25
6 57 35
8 56 45
10 54 55
12 55 65
14 53 75
16 52 85

Equilibrium quantity is attained where Q d = Q s

Equilibrium quantity is 55 since quantity supplied and quantity demanded are both 55 at the
price of Php 10, which is the equilibrium price.

Example of Determination of Market Equilibrium

Assume a demand and a supply function as the following:

P = 50 -2Q d (Demand) P = 20 + 4Q s Q s = Supply in thousands

 The demand curve is downward sloping with the negative slope -2 while the supply curve is
upward sloping with positive slope .4 at equilibrium, the price at which the buyers are willing to buy a
certain volume is also the price at which the sellers are willing to sell the same volume. To compute
equilibrium price (P) and quantity (Q), we have to equate the demand and supply functions, as
follows:

50 - 2Q d = 20 + 4Q s

At equilibrium, P = 40 and Q = 5 as illustrated by the demand and supply schedule and graph
below.

Figure 2.6 Demand – Supply Graph

Effect of change in Demand and Supply

APPLICATION OF SUPPLY AND DEMAND TO HOUSING SHORTAGE

With close to 10 Million Filipinos, limited land area and shortage of funds to build houses for all the
Filipino Families, the country continues to suffer from a shortage in mass housing that is expected to
reach 6.5 million units by 2030, Profriends aPresident and CEO Guillermo Choa told reporters in a
briefing in Makati City. (Danessa O. Rivera, GMA News October 2,2014). Housing shortage has been
a perennial problem in the country with accumulated backlog of about 3.92 million units from 2001 to
2011. (Source:Subdivision and Housing Developers Association (SHDA).

As population increases, the demand for housing also increases. The supply of houses less
than the existing demand for them since more and more Filipinos are added to the population
annually. There is seemingly a lack-of government priority to build homes for the homeless. Filipinos
are seen putting up shanties and makeshift homes in the streets, under bridges, close to the railroad
tracks, and near creeks, which proves dangerous since these overflow during typhoons and inundate
the areas, causing risk to the lives of the poor who have no other choice.

Hardly does housing grow faster than population to decrease the housing backlog. It is the
poor who suffer an increasing backlog of decent-housing due to increasing population.

There is obviously an excess demand compared to the supply of housing even among
ordinary Filipinos.

ADDITIONAL INFORMATION ( ACROSS BORDERS)

On a study by Kenny(2015) titled Modelling the demand and supply sides of the housing market:
evidence from Ireland showed that the analysis suggests that in the long-run the demand side of the
market can be modelled using a stable relationship between house prices, the housing stock, income
and mortgage interest rates. To model the supply side of the market, the empirical section of the
paper tests the data for the existence of a stable ratio of house prices to construction costs (including
land costs) which is consistent with `normal profits' in the house building sector. Impulse response
functions are employed in order to shed light on the issue of short-term dynamics about the identified
cointegrating relationships. Interestingly, the dynamics implied by the VECM specification suggest
significant constraints on the supply side of the market and the potential for house prices to
overshoot their long-run equilibrium level following a sudden increase in housing demand.

Factors affecting supply and demand of housing

A look at factors affecting the demand and supply of housing.

Demand-side factors

1. Affordability. Rising incomes mean that people are able to afford to spend more on housing.
During periods of economic growth, demand for houses tends to rise. Also, demand for
housing tends to be a luxury good. So a rise in income causes a bigger % rise in demand.
This graph shows that house prices (and therefore demand for housing can rise much faster than
earnings, suggesting there are many other factors influencing demand – at least in the short run.

2. Confidence

Demand for houses depends on consumer confidence. In particular, it depends on people’s

confidence about the future of the economy and housing market. If people expect prices to rise,
demand will rise so people can gain from rising wealth. In a boom, demand for houses rises faster
than incomes as seen in the graph above.

3. Interest Rates

Interest rates play a big factor in determining the cost of mortgage interest repayments.

The majority of UK homeowners still prefer to take out variable mortgage rates (unlike the continent
where fixed rate mortgage deals are more common). Therefore any change in the base rate by the
Bank of England will immediately affect the mortgage interest payments. This is a major factor in
determining the affordability of housing. Mortgage payments take a high % of people’s personal
disposable income. (average is 25%, but, for some homeowners, it is higher.) If you have a £150,000
mortgage a 0.5% change in base rates will change your monthly payments by about £60 a month.
Therefore, even small changes in interest rates can deter people from buying.
When interest rates reached 15% in 1992, demand for housing collapsed, causing a large fall in
demand for housing. The relatively low-interest rates of the 90s and 2000s encouraged more to buy a
house.

However, in 2008-09, interest rates were cut to 0.5%. Even though interest rates were very low,
demand also remained low. This was because, other factors were reducing demand for housing –
like the recession and prospect of rising unemployment.

4. Population

A very important factor. It is not just the number of people but demographic changes. e.g. growing
number of single people living alone has led to increasing demand for houses.

The demand for housing doesn’t just depend on the population but also the average size of a
household. Certain social and demographic factors are causing a rise in the number of households
(faster than the population increase). These demographic changes include issues such as:

age of people leaving home

Increased life expectancy, leading to more single old people

Divorce rates, – increasing number of single-parent families.

5. Mortgage availability

Another factor that determines the effective demand for houses is the willingness of banks to lend
mortgages. If banks give mortgages with bigger income multiples, then the effective demand for
houses is greater. The willingness of banks to lend mortgage finance can vary depending on the
strength of the interbank lending sector. The Credit crisis of 2008, has seen a sharp rise in the cost of
interbank lending and a fall in availability of mortgage finance. Many mortgage products have been
withdrawn, making it more difficult for would-be homeowners to get on the property ladder.

 For example, mortgages such as 125% and 100% mortgages have been withdrawn. Banks
are increasingly demanding a higher deposit before lending mortgages.
6. Economic growth and real incomes. Rising incomes enable people to afford bigger mortgages
and encourages demand for housing. In boom times, demand for housing grows rapidly suggesting
demand for houses is income-elastic
7. Cost of renting.

This shows 22% increase in the cost of renting – despite the financial crisis and housing ‘crash’ – this
helped to cause UK house prices to continue rising after 2011.

If the cost of renting rises, then households will make greater efforts to try and buy a house as buying
a house through mortgage becomes relatively cheaper. The UK housing market has been buoyed by
expensive renting costs, which encourages buy to let lenders and encourages households to stretch
their budget as much as possible to get on the housing ladder.

Factors affecting supply

 The number of new houses being built. The graph above shows how the number of new
houses built in Great Britain has varied over the past century. The peak was in the late 1960s
with over 400,000 built per year, Inthe late 1990ss and early 2000s that has fallen to 150,000
(less than required)
 Planning restrictions on the use of land. A big issue in the UK is planning restrictions and
limitations on building on green-belt land
 Local opposition to new home builds. There is widespread opposition to building new houses
as local communities usually prefer to live in smaller villages without increased congestion.
 The profitability of building new houses. This is dependent on the demand for houses and
prices. In a boom, builders are usually keener to build more. Falling house prices can lead to
a restriction in supply.
 See factors that affect supply.
CHAPTER 6

Lesson 2.3 ELASTICITIES OF DEMAND AND SUPPLY

The concept of elasticity gives the exact measurement of the responsiveness of the quantity
demanded (supplied) to changes in other variables.

Elasticity - elasticity of demand refers to price elasticity of demand. It is the degree of responsiveness
of quantity demanded of a commodity due to change in price, other things remaining the same.

1. ELASTIC

 Perfect Elastic – The demand is said to be perfectly elastic if the quantity demanded
increases infinitely (or by unlimited quantity) with a small fall in price or quantity demanded
falls to zero with a small rise in price. Thus, it is also known as infinite elasticity.
 Relatively Elastic – The demand is said to be relatively elastic if the percentage change in
demand is greater than the percentage change in price i.e. if there is a greater change in
demand there is a small change in price. It is also called highly elastic demand or simply
elastic demand.

2. INELASTIC

 Perfect Inelastic – The demand is said to be perfectly inelastic if the demand remains
constant whatever may be the price (i.e. price may rise or fall). Thus, it is also called zero
elasticity. It also does not have practical importance as it is rarely found in real life.
 Relatively Inelastic – The demand is said to be relatively inelastic if the percentage
change in quantity demanded is less than the percentage change in price i.e. if there is a
small change in demand with a greater change in price. It is also called less elastic or
simply inelastic demand.

3. UNITARY ELASTIC

The demand is said to be unitary elastic if the percentage change in quantity demanded is equal to
the percentage change in price. It is also called unitary elasticity.

ELASTICITY OF DEMAND

PRICE ELASTICITY OF DEMAND – The price elasticity of demand of a good measure how
much quantity demanded of a good change when its price changes.
 Arc Elasticity – is a concept based on finite changes in quantity demanded and price
between two points on the demand curve.
 Point elasticity – is a concept based on infinitesimal changes in quantity demanded
and price from the point on the demand curve.
INCOME ELASTICITY OF DEMAND – The income elasticity of demand measures the
responsiveness of quantity demand of a good to income changes.
CROSS-PRICE ELASTICITY – The cross-price elasticity of demand measures the
responsiveness of quantity demanded of a good to price changes of another good.

ELASTICITY OF SUPPLY
 PRICE ELASTICITY OF SUPPLY – Price elasticity of supply is defined as the responsiveness
of quantity supplied of a good to its market price. It is the percentage of quantity supplies
divided by the percentage change in price.

Lesson 2.4 Market Structure

Significance of Market Structure

The type of market structure in which the business operates will determine the amount of market
power or control the business owner will enjoy. Greater market power means a greater ability to
control prices, differentiate the products one offers for sale, thus, leading to opportunities for more
profits.

Perfect Competition – A market is described to be perfectly competitive if it satisfies the following

characteristics:

 Producers and consumers are PRICE TAKERS. This means that there are numerous
firms or producers in the market where an individual firm sells a very small portion of total
market output, thus has no influence over the price of the of the product. There are also
many buyers or consumers where an individual consumer buys a very small share of the
total market output and will not have an impact over the price of the product.
 Good sold are HOMOGENOUS OR UNDIFFERENTIATED. The products sold by all firms
are perceived to be identical by consumers and are perfectly suitable. Consumers will
therefore not care who they will buy from. There is also no incentive for one firm to raise
its price above what the other firms are offering because doing so can only result in losing
their customers.
 There is FREE ENTRY AND EXIT. This implies that it should not be difficult for new firms
to enter the market and to exit if firms are not able to earn profits. If there is opportunity to
earn profits, then firms can purchase resources to produce the good. If firms fail to earn
profits and wish to close, then it can release or relocate the resources for other uses.

For Instance, if you go to Davao City, you will see several stalls selling pomelo and will also
observe that there are many people who buy pomelo. Comparing the price of pomelo from one
stall to another will show that the price converges to a common value. For many consumers,
pomelos grown in Davao are perceived to be homogenous, and it does not matter to them which
farm in Davao grew these pomelos.

The demand curve shows the quantity that consumers will purchase at different price levels,
while the supply curve show the quantity that producers will supply in the market at different
prices.
 Perfectly Competitive Price and Output

Imperfect Competition

1. Monopoly – A firm becomes the sole producer or seller in the market because of barriers to
entry or conditions that discourage new firms to enter the market. Restrictions on entry
includes:
 Government-issued franchise, license, patent, copyright or trademark.
 Ownership of patent or copyright is invested in a single seller.
 High start-up cost.
 The producers will enjoy economies of scale, which are savings from a large range of
outputs.
 A single seller has control of entire supply of raw materials.

Electricity is one example of product that is under the monopoly market structure. There are no
close substitutes for the product. Electric Distribution company being the only producer and seller
of the product, the firm becomes a price maker.

2. Oligopoly – Is a market dominated by a small number of strategical interacting firms. There

are few competitors in the market that selling homogenous or differentiated products. Its
characteristics are:
 Action of each firm affects other firms
 Interdependence among firms

These strategically interacting firms try to raise their profits by colluding with each other to raise
prices to detriment of consumers. For example, Oil industry, producers of oil from all around the
world can manage to raise prices by agreeing with each other on what prices to charge the
consumers. Thus, countries that use a lot of oil have no choice but to buy from these producers
at high prices.

3. Monopolistic Competition – This type of market possesses features of the monopolistic and
perfectly competitive markets. It is characterized by many small competitors and entry by new
firms is not restricted. Its key characteristics are:
 A blend of competition and monopoly
 Firms sell differentiated products which are highly substitutable but are not perfect
substitutes
  Many sellers offer heterogenous or differentiated products similar but not identical and
satisfy the same basic need
 Changes in product characteristics to increase appeal using brand, flavor consistency
and packaging as means to attract customers.
 There is free entry and exit in the market that enables the existence of many sellers
 It is like a monopoly in that the firm can determine characteristics of product and has
some control over price and quantity.

The clothing industry can be classified into this category of market structure. The material
used may be the same, but each brand offers divergent styles to choose from. A firm that can
set a new fashion trend can be monopolist in the short-term period until other firms try to
introduce a new design.

Lesson 2.5 Supply – Demand and the Philippine Labor Market

Labor Supply – also known as the labor force, refers to the portion of the population, 15 years old
and over who are willing and able to work, including those who are actively seeking work but have
not found work and those who are unemployed. The country’s labor supply is vital to the economy,
since their contribution to production of goods and services determines the value of the country’s
Gross Domestic Product.

According to the Philippine Statistics Authority, the preliminary results of the Annual Labor and
Employment Estimates for 2019 based on the average of the four Labor Force Survey (LFS) rounds
(January, April, July and October) reported an annual labor force participation rate of 61.3 percent
out of the 72.9 million population 15 years old and over.

Population Growth – The Philippine census is an official count of the population of a certain local
administrative unit in the Philippines. The population is enumerated every 5 years.
Philippine Population Surpassed the 100 Million Mark (Results from the 2015 Census of Population)
As of 1 August 2015, the Philippines had a total population of 100,981,437 persons based on the
2015 Census of Population (POPCEN 2015).

It is logical to say that more Filipinos means more mouth to feed; thus, demand for products and
services will naturally increase. Housing, school buildings, health care and food may no longer be
enough to meet the needs of the growing population.

Wages – The new minimum wage rate are different per regions and sectors. The metro manila has
the highest minimum wage because it is harder to live in manila where all the major companies and
offices are situated in. Many Filipinos from the provinces transferred to Manila because they believed
it is where the opportunities are, resulting to rising of the demand in manila. A 537 pesos minimum
wage is acceptable for single Filipino but for those who have families to sustain, it is barely enough.
The Minimum Wage Rate

(As of February 2020)

CHAPTER 7
LESSON 2.4 (MARKET STRUCTURES)

Pure or perfect competition is rare in the real world, but the model is important because it helps
analyze industries with characteristics like pure competition. This model provides a context in which
to apply revenue and cost concepts developed in the previous lecture.

Examples of this model are stock market, agricultural industries and internet related industries.

Characteristics

1. Many sellers: there are enough so that a single seller’s decision has no impact on market price.

2. Homogenous or standardized products: each seller’s product is identical to its competitors’.

3. Firms are price takers: individual firms must accept the market price and can exert no influence on
price.

4. Free entry and exit: no significant barriers prevent firms from entering or leaving the industry.

Demand Curve

The individual firm will view its demand as perfectly elastic. A perfectly elastic demand curve is a
horizontal line at the price. The demand curve for the industry is not perfectly elastic, it only appears
that way to the individual firms, since they must take the market price no matter what quantity they
produce. Therefore, the firm’s demand curve is a horizontal line at the market price.

Imperfect competition is a competitive market situation where there are many sellers, but they are
selling heterogeneous (dissimilar) goods as opposed to the perfect competitive market scenario. As
the name suggests, competitive markets that are imperfect in nature. Imperfect competition is the
real-world competition. Today some of the industries and sellers follow it to earn surplus profits. In
this market scenario, the seller enjoys the luxury of influencing the price in order to earn more profits.
If a seller is selling a non-identical good in the market, then he can raise the prices and earn profits.
High profits attract other sellers to enter the market and sellers, who are incurring losses, can very
easily exit the market.

Characteristics

1. Companies sell identical products

2. They cannot influence how much they charge for these products

3. Market share has no bearing on prices

4. Everyone is privy to the same information

5. Firms can enter or exit the market without incurring any costs

It is immediately apparent that very few businesses in the real world operate this way, bar perhaps a
few exceptions, such as vendors at a flea or farmer’s market. If and when the forces listed above are
not met, competition is said to be imperfect—it is labeled this way because differentiation results in
certain companies gaining an advantage over others, enabling them to generate higher profit than
peers, sometimes at the expense of customers.

There are four types of imperfect markets:

Monopoly (only one seller) - Oligopoly (few sellers of goods) - Monopolistic competition (many
sellers with highly differentiated product) - Monopsony (only one buyer of a product)

Monopolistic competition refers to a market situation with a relatively large number of sellers
offering similar but not identical products. Examples are fast food restaurants and clothing stores.

Characteristics

1. A lot of firms: each has a small percentage of the total market.

2. Differentiated products: variety of the product makes this model different from pure competition
model. Product differentiated in style, brand name, location, advertisement, packaging, pricing
strategies, etc.

3. Easy entry or exit.

Demand Curve

The firm’s demand curve is highly elastic, but not perfectly elastic. It is more elastic than the
monopoly’s demand curve because the seller has many rivals producing close substitutes; it is less
elastic than pure competition, because the seller’s product is differentiated from its rivals.

Oligopoly exits where few large firms producing a homogeneous or differentiated product dominate
a market.

Examples are automobile and gasoline industries.

Characteristics

1. Few large firms: each must consider its rivals’ reactions in response to its decisions about prices,
output, and advertising.

2. Standardized or differentiated products.

3. Entry is hard: economies of scale, huge capital investment may be the barriers to enter.

Demand Curve

Facing competition or in tacit collusion, oligopolies believe that rivals will match any price cuts and
not follow their price rise. Firms view their demands as inelastic for price cuts, and elastic for price
rise. Firms face kinked demand curves. This analysis explains the fact that prices tend to be inflexible
in some oligopolistic industries.
Pure monopoly exists when a single firm is the sole producer of a product for which there are no
close substitutes.

Examples are public utilities and professional sports leagues.

Characteristics

1. A single seller: the firm and industry are synonymous.

2. Unique product: no close substitutes for the firm’s product.

3. The firm is the price maker: the firm has considerable control over the price because it can control
the quantity supplied.

4. Entry or exit is blocked.

Barriers to Entry

Economies of scale is the major barrier. This occurs where the lowest unit cost and, therefore, low
unit prices for consumers depend on the existence of a small number of large firms, or in the case of
monopoly, only one firm. Because a very large firm with a large market share is most efficient, new
firms cannot afford to start up in industries with economies of scale. Public utilities are known as
natural monopolies because they have economies of scale in the extreme case. More than one firm
would be inefficient because the maze of pipes or wires that would result if there were competition
among water companies or cable companies. Legal barriers also exist in the form of patents and
licenses, such as radio and TV stations. Ownership or control of essential resources is another
barrier to entry, such as the professional sports leagues that control player contracts and leases on
major city stadiums. It has to be noted that barrier is rarely complete. Think about the telephone
companies a couple decades ago; there was no substitute for the telephone. Nowadays, cellular
phones are very popular. It creates a substitute for your house phone, causing the traditional
telephone companies to lose their monopoly position.

Demand Curve

Monopoly demand is the industry or market demand and is therefore downward sloping. Price will
exceed marginal revenue because the monopolist must lower price to boost sales and cannot price
discriminate in most cases. The added revenue will be the price of the last unit less the sum of the
price cuts which must be taken on all prior units of output. The marginal revenue curve is below the
demand curve.

Technological Development

Technological advance is a three-step process that shifts the economy ‘s production possibilities
curve outward enabling more production of goods and services.

1. Invention: is the discovery of a product or process and the proof that it will work.

2. Innovation: is the first successful commercial introduction of a new product, the first use of a new
method, or the creation of a new form of business enterprise.

3. Diffusion: is the spread of innovation through imitation or copying.

Expenditures on research and development (R&D) include direct efforts by business toward
invention, innovation, and diffusion. Government also engages in R&D, particularly for national
defense. Finding the optimal amount of R&D is an application of basic economics: marginal benefit
and marginal cost analysis. Optimal R&D expenditures occur when the interest rate cost of funds is
equal to the expected rate of return.

Many projects may be affordable but not worthwhile because the marginal benefit is less than
marginal cost. Often the R&D spending decision is complex because the estimation of future benefits
is highly uncertain while costs are immediate and more clear-cut.

The Role of Market Structure In Technological Development

1. Pure competition: the small size of competitive firms and the fact that they earn zero economic
profit in the long run leads to serious questions as to whether such producers can finance substantial
R&D programs.  The firms in this market structure would spend no significant amount.  However,
firms of the same industry may gather their resources and develop R&D programs.

2. Monopolistic competition: there is a strong profit incentive to engage in product development in

this market structure as the firms depend on product differentiation to stand out from a large number
of rivals. However, most firms remain small which limits their ability to secure inexpensive financing
for R&D and any economic profits are usually temporary. Therefore, spending on R&D is limited in
this market structure.

3. Oligopoly: many of the characteristics of oligopoly are conducive to technical advances including:
their large size, ongoing economic profits, the existence of barriers to entry and a large volume of
sales. Firms in oligopoly spent the highest amount on R&D among the four different market
structures.

4. Pure monopoly: monopoly has little incentive to engage in R&D as the profit is protected by
absolute barriers to entry, the only reason for R&D would be defensive – to reduce the risk of a new
product or process which would destroy the monopoly.

CHAPTER 8

I. THE PHILIPPINE PESO AND THE FOREIGN CURRENCY

The Story of Philippine Money

 The chief means of trading was barter. Records show that Chinese came to Philippines
to trade porcelain, silk and metal ware in exchange for gold, pearls, beeswax and medical
plants, which Philippines is naturally rich in.
Excavations also unearthed gold ingots, known as piloncitos, the first recognized form of
coinage in the country. Barter rings in different sizes, gold ornaments and beads were the other
objects used as medium of exchange during the pre-colonial period.

Definition of Money
 Money can be anything that is generally accepted in payments for goods and services

The Filipino Peso

 The Philippine currency exists as both coins and bank note (bills)
 The Philippine peso (Filipino: piso; sign: ₱; code: PHP) is the
official currency of the Philippines. It is subdivided into 100 centavos (Filipino:
sentimo).
 The peso is usually denoted by the symbol "₱".
 The ISO 4217 code for the Philippine peso is PH
 The Philippine coins and banknotes are minted and printed at the Security Plant
Complex of the Bangko Sentral ng Pilipinas (Central Bank of the Philippines) in
Quezon City

What is Currency?
 In economics, currency is a generally accepted medium of exchange. It is any form of
money in general circulation in a country
 An exchange rate is the rate at which one currency may be converted into another, also
called rate of exchange of foreign exchange rate or currency exchange rate.
 The foreign exchange rate is simply the price of one currency in terms of another, or
how much one currency can be exchanged for another, in the same way that the price of
a good is determined by how much money can be exchanged for it.

Money Changing
 The main function of a foreign exchange department is to make money for the bank by
speculating on whether a particular currency will rise or fall against another. Banks
compete fiercely with each other using experienced market traders and millions of
dollars or currency equivalents are exchanged daily.
Exchange rate is important for several reasons:
 It serves as the basic link between the local and the overseas market for various goods,
services and financial assets. Using the exchange rate, we are able to compare prices of
goods, services, and assets quoted in different currencies.
 Exchange rate movements can affect actual inflation as well as expectations about
future price movements. Changes in the exchange rate tend to directly affect domestic
prices of imported goods and services. A stronger peso lowers the peso prices of
imported goods as well as import-intensive services such as transport, thereby lowering
the rate of inflation. For instance, an increase in the value of the peso from US$1:P50 to
US$1:P40 will lower the price of a $1 per liter gasoline from P50.00 (P50 X $1) to
P40.00 (P40X $1).
 Exchange rate movements can affect the country’s external sector through its impact on
foreign trade. An appreciation of the peso, for instance, could lower the price
competitiveness of our exports versus the products of those competitor countries whose
currencies have not changed in value.
 The exchange rate affects the cost of servicing (principal and interest payments) on the
country’s foreign debt.

How is the exchange rate determined?

Under the system of freely floating exchange rates, the value of the dollar in terms of the
peso is determined in the interbank foreign exchange market (by the forces of supply and
demand just like any commodity or service being sold in the market). Under a fixed exchange
rate system, a par value rate is set Exchange Rate September 2019 Department of Economic
Research 2 between the peso and the dollar by the central bank. The par value may be
adjusted from time to time.

How does the exchange rate change?

Under a floating exchange rate system, if more dollars are demanded than are offered,
the price of the dollar in terms of the peso will tend to increase; that is, it will cost more pesos to
acquire one dollar. If, on the other hand, more dollars are offered than are demanded, the value
of the dollar in terms of the peso will tend to decrease; that is, it will cost less pesos to acquire
one dollar. In contrast, under a fixed rate system, a change in the exchange rate is effected
through an official announcement by the central bank.

What is the country’s foreign exchange policy?

At present, the country's exchange rate policy supports a freely floating exchange rate
system whereby the Bangko Sentral ng Pilipinas (BSP) leaves the determination of the
exchange rate to market forces. Under a marketdetermined exchange rate framework, the BSP
does not set the foreign exchange rate but instead allows the value of the peso to be
determined by the supply of and demand for foreign exchange.
 Thus, the BSP’s participation in the foreign exchange market is limited to tempering
sharp fluctuations in the exchange rate. On such occasions of excessive movements, the BSP
enters the market mainly to maintain order and stability. When warranted, the BSP also stands
ready to provide some liquidity and ensure that legitimate demands for foreign currency are
satisfied.

Foreign exchange market

 The foreign exchange market (forex, FX, or currency market) is a form of
exchange for the global decentralized trading of international currencies. For example,
one can swap the U.S. dollar for the euro.
 Foreign exchange transaction is a type of currency transaction that involves two
countries. Generally, a foreign exchange transaction involves conversion of currency of
one country with that of another. This can take place on the foreign exchange market,
also known as the Forex Market.

The conversion of currency in a foreign exchange transaction can be performed

through:
1. buying or selling of goods and services on credit;
2. borrowing or lending funds.

What Are the Functions of Foreign Currency Exchange Markets?

 Primary Function- The primary function of foreign currency exchange markets is to
convert the currency of one country into another currency
 International Transactions- Foreign currency exchange markets serve to facilitate
international financial transactions
 Currency Value- The value of a country's currency can influence international trade,
consumers' purchasing power and inflation.
 Investment- Fund managers and investment professionals use the foreign currency
exchange market to help diversify their portfolios and potentially increase their returns.
 Loss Protection- International companies that work in multiple countries are subject to
gains and losses based on exchange rate fluctuations

Forex Trading
Forex, the word, means FOReign EXchange market. This is an international market
where the buying and selling of money is done freely and 24 hours a day. All forex trading
involve the buying of one currency and the selling of another, simultaneously. Currency quotes
are given as exchange rates; that is, the value of one currency relative to another. The relative
supply and demand of both currencies will determine the value of the exchange rate.
The trading of foreign currency is the exchange of money issued in one country for
money issued in another. Foreign currency trading takes place in the highly-solvent
 foreign exchange market. Currencies are traded for one another at exchange rates, which are
relative prices determined by market supply and demand.

Foreign Exchange Risk

 Exchange risk is simple in concept: a potential gain or loss that occurs as a result of an
exchange rate change.

About BPI Forex Corporation

` BPI Forex Corporation is a wholly-owned subsidiary of the Bank of the Philippine Islands (BPI)
established in response to increasing foreign exchange demand following a liberalized foreign
exchange environment in the country. It delivers hassle - free service and offers very attractive
exchange rates for your currencies

LIST OF CURRENCIES
Aside from the US Dollar, BPI Forex Corporation transacts in the following currencies:

Australian Dollar Japanese Yen

Korean Won Malaysian Ringgit
Bahrain Dinar New Zealand Dollars
British Pound Saudi Riyal Singapore
Brunei Dollar Dollar Swedish Kroner
Canadian Dollar Swiss Franc
Chinese Yuan Taiwan Dollars
Euro Thailand Baht
Hong Kong Dollar
Indonesian Rupiah

PHILIPPINE PESO EXCHANGE RATES TABLE

Feb 09, 2020 05:15 UTC

Philippine Peso 1.00 PHP inv. 1.00 PHP

US Dollar 0.019620 50.967309
Euro 0.017925 55.788592
British Pound 0.015225 65.680859
Indian Rupee 1.403017 0.712750
 Philippine Peso 1.00 PHP inv. 1.00 PHP
Australian Dollar 0.029401 34.012020
Canadian Dollar 0.026112 38.296427
Singapore Dollar 0.027266 36.675081
Swiss Franc 0.019182 52.131001
Malaysian Ringgit 0.081281 12.303035
Japanese Yen 2.153390 0.464384

THE EFFECT OF SUPPLY & DEMAND ON THE RATE OF EXCHANGE

The major determinants of exchange rates are the supply and demand for currencies.
Exchange rates rise and fall based on the underlying economic conditions that prompt traders,
investors and others to want more of a particular currency. Import and export companies,
speculators, bankers and central banks all have a need for buying currencies, and their
interaction with each other creates the supply and demand for foreign exchange
Supply And Demand

The supply of foreign exchange stems from foreign demand for U.S. dollars. When
people or businesses in another country wish to purchase American products, they purchase
dollars with their currency in order to have the dollars to buy the goods. Their increase in
demand for dollars will be matched by an increase in supply of their currency. A significant
increase in the overseas demand for US products will have the effect of driving up the value of
the dollar vis-a-vis the other currency. Until 1971, exchange rates were heavily controlled by
central banks, but since then they have “floated,” with very limited intervention from
governments.

Determinants of Supply and Demand

There are numerous economic factors that determine the supply and demand for
different currencies. Economic changes that alter the relative strength of different countries are
major factors. The economic strength of the Japanese and German economies following World
War II, for example, was behind the appreciation of those currencies. Government debt is also a
contributing factor. If investors fear a country may default on its debt, they will drop their
investments and switch them to another currency. Interest rates also cause shifts in capital
accounts as investors move their assets from one currency to another, seeking higher returns.
Speculators look for opportunities in foreign exchange markets and can sometimes influence
price changes.
 THE PHILIPPINE HOUSING SHORTAGE AND THE REAL ESTATE
BOOM: Rent and Price Structure

House is a basic commodities but the problem is that housing is unaffordable for those who need
it.

Housing shortage- is present when there is insufficient housing to accommodate the population
in an area, when the supply of houses cannot the demand.
(Supply < Demand)

Indications of Housing shortage:

1. Presence of homeless people
What does homelessness means?
 Lack of regular shelter
 People seeking temporary housing
2. Slums and squatter settlements- are urban areas which are heavily populated, and
the residents have poor quality housing and poor access to basic services.

Lack of safe shelter

 Without shelters, people are not protected against the weather elements and may be
exposed to strong winds and cold winters
 Houses in slums and aquatter settlements have weak foundations

The Philippine housing market reveals a tremendous gap between the demand and
supply of housing. At the root of this housing shortage is the fact that the majority of households
are unable to pay for the cost of housing and land. The global financial turmoil and high inflation
have slowed down the Philippines raging real estate boom. Although luxury condominium prices
continue to rise, the residential sector is definitely slowing.
The average price of a luxury 3 bedroom condominium in Metro Manila rose 13.35% to
Q2 2008 from a year earlier. Adjusted for inflation, residential prices increased only 3.3% over
the year. The minimum housing cost of P150 thousand per unit is 3.8 times the yearly wages of
an unskilled laborer in 1997. Likewise, a P250 thousand unit housing is 3.1 times the annual
income of an employee earning a median income of P6,700 per month. The minimum housing
cost of P150 thousand per unit is
3.8 times the yearly wages of an unskilled laborer in 1997. Likewise, a P250 thousand unit
housing is 3.1 times the annual income of an employee earning a median income of P6,700 per
month. This ratio is expected to be on the rise given the high rate of increase of housing prices
in the country. Average annual housing price appreciation in the Philippines (i.e. Manila) is 32
percent per year, the highest among other major cities in Asia (HABITAT and World Bank
1993).
PHILIPPINES DOES NOT PUBLISH OFFICIAL HOUSE PRICE STATISTICS
 Colliers International has quarterly data of capital values in the Makati-CBD. Economics
statistics are available from government agencies - Bangko Sentral ng Pilipinas, National
Statistical Coordination Board and National Economic Development Agency.
 The construction and real estate sectors make up around 20% of the Philippine
economy, slightly ahead of manufacturing. Over the past few years, construction in the
Philippines has been flourishing amid a climate of political stability and upbeat business
sentiment, spurred by growth in overseas foreign worker remittances, inbound
investments into business process outsourcing, rising numbers
 Final results of the 2010 Annual Survey of Philippine Business and Industry (ASPBI)
showed that a total of 2,873 establishments were engaged in real estate activities. About
86.8 percent (2,493) were establishments with total employment of less than 20 while
13.2 percent (380) were establishments with total employment of 20 and over. About 8
out of 10 establishments were engaged in real estate activities with own or leased
property.

AVERAGE RENT PER SQUARE METER (Based on 2016 Lamudi Listings)

HIGHEST
1. Makati P920 per square meter per month
2. Taguig P895 per square meter per month
3. Pasay P860 per square meter per month
LOWEST
1. San Juan P470 per square meter per month
2. Las Pinas P478 per square meter per month
3. Manila P610 per square meter per month

RELATION BETWEEN RENT AND PRICE

The relation between rent and price is commonly misunderstood.

RICARDIAN THEORY
 Rent is a surplus above cost. It does not, therefore enter into price.
 Price depends on the cost of production on the marginal land which is no-rent land.
 In other words, rent is not included in the costs which determine price. It is only when
price has risen high enough due to the forces of demand and supply that rent on any plot
appears. Thus, rent is the effect or result of price and not the cause of it.
 The figure clearly shows that rent does not enter into price. Rectangle D represents the
cost of raising produce on ‘D’ class of land. It is seen that cost goes on rising with falling fertility.
The market price must cover the cost of production on ‘D’ land, if the produce of D land is
needed to meet the total demand.
And when the cost of production on ‘D’ land is being covered by the price, ‘A’, ‘B’ and ‘C’
lands are earning a surplus called rent. There is no rent in the rectangle on ‘D’. We can
conclude, therefore, that, according to the Ricardian theory, rent is determined by, but does not
determine, price. Rent is thus price-determined and not price- determining.

In another sense also, it may be argued that rent does not form a part of price. Land is a
free gift of nature. No payment is necessary to maintain the total supply of land. In this sense,
rent is not a part of the supply price of land and consequently of the products of land.

MODERN VIEW
 Modern economists do not agree with the Ricardian view given above. They point out
certain cases in which rent will enter into price. When we think, for example, not of all the
land in the country but of the land available for particular uses rent does form an element
of price. This is clear from the concept of opportunity cost. Most of the land is capable of
being put to several alternative uses. If it is put to one use, it is not available for another
use.

 The cost of putting land to one use is represented by the loss undergone in not putting it
to the next best use. To withdraw it from one use for the sake of another, therefore,
some payment has to be made. This is called opportunity cost or transfer price. This
payment for the use of land in a particular use enters into price.
  From the point of view of an individual firm, all rents of all factors must of course be
included in the cost of production, and must, therefore, enter into price. If a farmer is
using land belonging to someone else, the rent that he pays is obviously a cost for him.
In the case of an owner-cultivator too the rent as a cost is there but its presence is
obscured. The payment that he could have received, if he did not cultivate himself, is the
opportunity cost of this land.

 Further, prices are determined by the scarcity of the products in relation to

demand. The rent that an entrepreneur pays is part of his cost of production. If the rent
is high, the entrepreneur will tend to hire less land; and conversely, he will use more
land, if rent is low. If he uses more land, the supply of land for other purposes is
reduced; if he uses less land, the supply available for other purposes is increased. Thus
rent, by influencing relative scarcity of land for different uses, affects the prices of
different products.

Effect of Economic Progress on Rent:

The progress of society can be in different directions. Effects of this progress on rent
are, therefore, bound to vary with the directions in which the society progresses.
We shall study this effect in its various aspects.

a) Increase of Population:An increase in population results in higher rent. Larger numbers

need more food. An extra supply of food can be secured only by ploughing less fertile
land, because the more fertile or better situated lands are already under the plough.The
only other alternative is more intensive cultivation of superior lands already in use. In
either case, this involves greater expenses which farmers will not willingly incur unless
they are rewarded by higher prices. Thus more fertile lands will earn higher rents. Hence
increase in population increases rent.

b) Improved Means of Transportation: Such an improvement may bring about either a

fall or an increase in rents. Rents would tend to fall on lands which were already in use
and were near the markets. But rents would tend to rise on lands which were fertile but
were previously far away from such markets. Thus it was seen that when ocean
transport improved between America and Britain, rents fell in Britain, while they rose in
America.

c) Improved Methods of Agricultural Production: Better methods cause rent to fall as

they result in larger production without a parallel increase in demand. Therefore, lands
on the margin go out of use, prices tend to fall, and rents come down.
 We may see that, we can trace the effect of economic progress on rent through the
change in price. If the price falls, rent falls too, and vice versa. For instance, when population
increases, price rises on account of increase in demand and rent rises too.

II. THE ROLE OF SAVING AND INVESTMENT IN AN ECONOMY

Saving and Investment are two crucial elements of macro-economics. The term Saving
and Investment sometimes make us confusing and we use these terms in interchangeably. So
concept of Saving & Investment should be cleared.

Spending less on consumption than available one’s disposable income called individual
saving or simply saving. It bears no risk or a slight of risk at all. It can be deposited in a bank
or pension fund, buy a business, pay down debt etc. The common element of saving is the
claim on asset that can be used to pay for future consumption. If there is return on the saving
in the form of dividend, interest, rent on capital gain there can be a net gain in individual saving
and they in individual wealth.

Savings
Saving is what households (i.e. participants in the consumption account) do. The level of
saving in the economy depends on a number of factors:
 A higher real interest rate will give a greater return on saving as banks offer more
favourable rates.
 Poor returns on risky forms of saving, e.g. stocks and bonds, make it more
advantageous to hold money savings (in contention between Keynesian and Monetarist
views here, mostly because of differences in definitions).
 Poor expectation for future economic growth, increase households' savings as a
precaution for a grim future.
 More disposable income after fixed expenditures (such as mortgage, heating bill, basic
goods purchases) have been made (in contention between Keynesian and Monetarist
views here, mostly because of differences in definitions).
 Perceived likelihood of plunder of the future value of savings, via legal or extralegal
means, will make saving less attractive (in contention between Keynesian and
Monetarist views here, mostly because of differences in definitions).
These factors affect the marginal propensity to save (MPS) - the greater this MPS, the
more saving households will do as a proportion of each additional increment of income
Investment
 Investment is made into capital (ie. plant and machinery, also 'human capital' - training
and education), with intent to increase productivity, efficiency and output of goods and
services

In national accounting terms, stocks, bonds, mutual funds, and other items whose value
is risky, are NOT investments. They fall into the savings account, not the investment account. In
monetary terms, the relationship between savings and investment is modeled, rather than being
an accounting identity. Stocks and bonds are considered to be important intermediary forms of
savings as it gets transformed into a capital investment that produces value. Mutual funds, CDs,
BICs, GICs, pension obligations, insurance annuities, and other forms of savings marketed by
financial intermediaries, all consist of stocks, bonds, and cash balances, which in turn pay for
the capital that increases productivity, efficiency and output of goods and services.

THE 2 FORMS OF INVESTMENT

A). Voluntary
 normal investment → plant equipment etc.
 planned increases in inventory.
B). Involuntary
 unplanned increases in inventories, output not consumed.

III. RENT

OVERVIEW
In economics, economic rent is any payment to an owner or factor of production in
excess of the costs needed to bring that factor into production. In classical economics,
economic rent is any payment made (including imputed value) or benefit received for no
produced inputs such as location (land) and for assets formed by creating official privilege over
natural opportunities (e.g., patents). In the moral economy of neoclassical economics, economic
rent includes income gained by labor or state beneficiaries of other "contrived" (assuming the
market is natural, and does not come about by state and social contrivance) exclusivity, such as
labor guilds and unofficial corruption.
Economic rent is also independent of opportunity cost, unlike economic profit, where
opportunity cost is an essential component. Economic rent is viewed as unearned revenue,
whereas economic profit is a narrower term describing surplus
 income greater than the next best risk-adjusted alternative. Unlike economic profit, economic
rent cannot be theoretically eliminated by competition, since all value from natural resources
and locations yields economic rent.
When economic rent is privatized, the recipient of economic rent is referred to as a
rentier. According to Robert Tollison (1982), economic rents are "excess returns" above the
"normal levels" that are generated in competitive markets. More specifically, a rent is "a return
in excess of the resource owner's opportunity cost". Henry George, best known for his proposal
for a single tax on land, defines rent as "the part of the produce that accrues to the owners of
land (or other natural capabilities) by virtue of ownership" and as "the share of wealth given to
landowners because they have an exclusive right to the use of those natural capabilities."
On the other hand, law professors Lucian Bebchuk and Jesse Fried define the term as
"extra returns that firms or individuals obtain due to their positional advantages." In simple
terms, economic rent is an excess where there is no enterprise or costs of production.

The following includes all types of economic rent:

Classical rent (land rent)

In political economy, including physiocracy, classical economics, Georgism, and other schools
of economic thought, land is recognized as an inelastic factor of production. Land, in this sense,
means exclusive access rights to any natural opportunity. Rent is the share paid to freeholders
for allowing production on the land they control. Observing that a tax on the unearned rent of
land would not distort economic activities, Henry George proposed that publicly collected land
rents (land value taxation) should be the primary (or only) source of public revenue, though he
also advocated public ownership, taxation, and regulation of natural monopolies and monopolies
of scale that cannot be eliminated by regulation.

Neoclassical Paretian rent

Neoclassical economics extends the concept of rent to include factors other than natural
resource rents.
 The excess earnings over the amount necessary to keep the factor in its current
occupation.
 The difference between what a factors of production is paid and how much it would need
to be paid to remain in its current use.
 A return over and above opportunity cost or the normal return necessary to keep a
resource in its current use.
Monopoly rent
Some returns are associated with legally enforced monopolies like patents or copyrights. In
addition, companies like Microsoft and Intel have important de facto monopolies that can be
quite valuable. Some businesses, like public utilities, are by their nature monopolies.

TERMINOLOGY RELATING TO RENT

Gross rent

Gross rent refers to the rent paid for the services of land and the capital invested on it. It
consists of economic rent, interest on capital invested for improvement of land, and reward for
the risk taken by the landlord in investing his or her capital.

Scarcity rent
Scarcity rent refers to the price paid for the use of homogeneous land when its supply is limited
in relation to demand. If all units of land are homogeneous but demand exceeds supply, all land
will earn economic rent by virtue of its scarcity.

Differential rent
Differential rent refers to the rent that arises owing to differences in fertility of land. The surplus
that arises due to difference between the marginal and intra-marginal land is the differential rent.
It is generally accrued under conditions of extensive land cultivation. The term was first
proposed by David Ricardo.

Contract rent
Contract rent refers to rent that is mutually agreed upon between the landowner and the user. It
may be equal to the economic rent of the factor.

Information rent
Information rent is rent an agent derives from having information not provided to the principal.

IV. MINIMUM WAGE

OVERVIEW
Minimum wage is a basic government-imposed price control. Price controls set a floor
indicating what minimum price must be paid for certain good or services. Governments set price
controls to ensure individuals receive a fair wage at various jobs. Minimum wage positions
usually require basic, nontechnical skills. Companies paying workers minimum wage may be
able to avoid offering employment benefits. Minimum wage also allows employers to use more
part-time workers and avoid overtime pay.
 Federal governments use minimum wage laws to ensure a basic quality of life among all
citizens within its borders. These laws attempt to improve an individual’s position in the
economic income brackets. Rather than have copious amounts of underpaid or poor citizens,
minimum wage laws seek a level of economic equality. Governments can use minimum wage
laws to force companies to pay all individuals equally, regardless of race, creed, sex or other
feature.
Minimum wage laws sometimes have unintended consequences. A major consequence
is increasing an individual’s income tax liability. Nations with progressive income tax systems
require individuals to pay more taxes as their income increases. Setting a high minimum wage
or using incremental increases can force individuals into higher tax brackets. Additionally, high
minimum wage laws significantly increase a company’s labor expense, potentially forcing it to
lay off current employees.
Price controls in a free market economy can distort the basic theory of supply and
demand. Businesses often make decisions based on the supply and demand concept. For
example, when consumer demand for certain products increases, companies must increase
their production output to meet this demand. Increasing supply usually requires additional labor.
Companies may forgo additional labor if government price controls force companies to pay
employees higher wages than the job position is worth.
Minimum wage laws may create difficulties for higher paid workers. Federal
governments often revisit their minimum wage laws to ensure unskilled workers are adequately
compensated for their services. However, skilled or long-term employees do not receive
benefits from minimum wage laws. These individuals can earn a set level of income for several
years without an increase, depending on the company for which they work. Consistently raising
the minimum wage may then require companies to increase wages to higher-paid individuals,
increasing the cost of doing business.
 Salary Structures and Wages Computation in the Philippines

V. TAXES

OVERVIEW

Taxation is a term for when a taxing authority, usually a government, levies or imposes a
tax. The term "taxation" applies to all types of involuntary levies, from income to capital gains to
estate taxes. Though taxation can be a noun or verb, it is usually referred to as an act; the
resulting revenue is usually called "taxes."
`Taxation is differentiated from other forms of payment, such as market exchanges, in
that taxation does not require consent and is not directly tied to any services rendered. The
government compels taxation through an implicit or explicit threat of force. Taxation is legally
different than extortion or a protection racket because the imposing institution is a government,
not private actors.
Tax systems have varied considerably across jurisdictions and time. In most modern
systems, taxation occurs on both physical assets, such as property and specific events, such as
a sales transaction. The formulation of tax policies is one of the most critical and contentious
issues in modern politics.
Different Types of Taxation
As mentioned above, taxation applies to all different types of levies. These can include (but
are not limited to):

Income tax: Governments impose income taxes on financial income generated by all entities
within their jurisdiction, including individuals and businesses.

Corporate tax: This type of tax is imposed on the profit of a business.

Capital gains: A tax on capital gains is imposed on any capital gains or profits made by people
or businesses from the sale of certain assets including stocks, bonds, or real estate.

Property tax: A property tax is asses by a local government and paid for by the owner of a
property. This tax is calculated based on the property and land values.

Inheritance: A type of tax levied on individuals who inherit the estate of a deceased person.

Sales tax: A consumption tax imposed by a government on the sale of goods and services.
This can take the form of a value-added tax (VAT), a goods and services tax (GST), a state or
provincial sales tax or an excise tax.

2019 TRAIN Tax Tables and BIR Income Tax Rates

 VI. ECONOMIC ICONS

OVERVIEW

Even the rules of the economic game have radically changed. Several generations ago
debt was bad and banks were never to be trusted. Now, avoiding a mortgage and student loans
is considered irresponsible. Thirty to forty years ago central bankers saw price stability as the
mandate behind their existence. Now they have a dual mandate which also includes full
employment.
Most economists will love some of the names on this list and hate others. But regardless
of whether you think a particular thinker included here was brilliant or foolish, noble or wicked,
you are living with the consequences of their actions.

John Maynard Keynes (1882-1946)

The flow of history is a river that most ride, but every so often a man, through sheer brilliance or
force of will, builds a dam and redirects the course of civilization. John Maynard Keynes was
such a man. As the most influential economist since 1900, some would argue in history, Keynes'
influence is difficult to overstate. He was the son of a successful economist and trafficked in the
circles of the intellectual elite from his youth. He would become the leading figure in economics
at Cambridge at a time when Cambridge became the leading center of economic study in the
world.

Friedrich August von Hayek (1899-1992)

Friedich August von Hayek, often referred to as F.A. Hayek, was the foil to Keynes' early rise to
prominence. This Austrian-born economist who later settled in Britain had a distinguished
career. He earned two doctorates, one in law and the other in political science. He was made a
member of the Order of the Companions of Honour by Queen Elizabeth II at the urging of
Margaret Thatcher, the first person to receive the Hanns Martin Schleyer Prize, a recipient of
the U.S. Presidential Medal of Freedom under George Bush, and a winner of the Nobel Prize.
Hayek was especially known for his contribution to our knowledge of changing prices and their
ramifications. According to Hayek, changes in prices provide information which then allow
individuals to adjust their expenditures.

Milton Friedman (1912-2006)

Friedman defended the free market and is considered the leading figure behind the Chicago
School of Economics. He received the John Bates Clark Medal honoring economists under the
age of 40, and won the 1976 Nobel Prize in Economics. When Friedman entered economics,
Keynesianism dominated the intellectual milieu. But slowly Friedman chipped away at the
intellectual orthodoxy. His coauthored volume, Income from Independent Professional Practice,
argued that government licensing for doctors artificially raised the price of medicine.
Lawrence Robert Klein (1920-2013)
Lawrence Robert Klein is one of the best examples of a mathematical approach to the
field. Born in Omaha, Nebraska, this MIT trained economist dedicated his career to
developing new macroeconometric computer models. He created this metric for economies
of all macroeconomic sizes, ranging from the national, to the regional, to the world. Unlike
so many economists who spend half their time telling you why their predictions did not pan
out, Klein's work gained notoriety from a series of early successes.
CHAPTER 9
PRINCIPLES, TOOLS AND TECHNIQUES
A business is just a small portion of an industry. It is an undertaking by a person or group
of persons who are partners, or of stockholders who own a juridical entity. An industry, on the
other hand, is the aggregation of the different businesses engaged in the same line of
undertaking.

BUSINESS ORGANIZATION
A business organization describes how businesses are structured and how their structure
helps them meet their goals. In general, businesses are designed to focus on either generating
profit or improving society. When a business focuses on generating profits, it is known as a for-
profit organization. When an organization focuses on improving the social good through the arts,
education, health care, or some other area, it is known as a non-profit (or not-for-profit)
organization and is not typically referred to as a business.

Sole proprietorship
A sole proprietorship is the simplest and most common structure chosen to start a
business. It is an unincorporated business owned and run by one individual with no
distinction between the business and you, the owner. You are entitled to all profits and
are responsible for all your business’s debts, losses and liabilities.
Advantages of a Sole Proprietorship
 Easy and inexpensive to form
 Complete control
 Have maximum privacy
 Easy tax preparation
Disadvantages of a Proprietorship
 Unlimited personal liability
 Hard to raise money
 Heavy burden
 The life of the business is limited

Partnership
By the contract of partnership, two or more persons bind themselves to contribute
money, property or industry to a common fund, with the intention of dividing the profit
among themselves.
Advantages of a Partnership
 Less formal with fewer legal obligations
 Easy to get started
 Sharing the burden
 Access to knowledge, skills, experience and contacts
 Better decision-making
 More partners, more capital

Disadvantages of a Partnership
 Unlimited liability
  Potential for differences and conflict
 Slower, more difficult decision making
 Limits on business development

Corporation
A corporation is an artificial being created by operation of law, having the right of
succession and the powers, attributes, and properties expressly authorized by law or
incidental to its existence.
Advantages of Corporation
 Owners have limited liability. 
 It can exist with continuity. 
 Shares of ownership are transferable. 
 It attracts more investors. 
Disadvantages of Corporation
 Incorporation is costly. 
 Corporations are highly regulated. 
 Limited liability may discourage creditors. 
 It may result to double taxation. 
 It is not easy to dissolve. 

Cooperative
A cooperative (also known as co-operative, co-op, or coop) is "an association of
persons united voluntarily to meet their common economic, social, and cultural needs and
aspirations through a jointly-owned enterprise". It is also an entity of organized people
with similar needs to provide themselves with goods and services or to jointly use
available resources to improve their income.
Advantages of Corporation
 There are equal voting rights for members
 The structure encourages member contribution and shared responsibility
 There is no limit in number of members
Disadvantages of Corporation
 Members have equal voting rights regardless of investment
 Less operational control

SCALE OF BUSINESSES
It is important to study the classification of businesses as to the size base on the worth of
business assets. For small business, total assets are from Php 1,500,001 to Php 15,000,000.
Medium business has total assets from Php 15,000,001 to Php 60,000,000. Any business with the
assets in excess of Php 60,000,000 is considered large scale.

Small Scale Business

Small scale business means an enterprise or corporation which is characterized by
the low initial investment, a small number of employees and low sales volume as
compared to regular sized business or corporation. It is generally privately owned and
mostly sole trader kind of business. One can choose these small business ideas from the
 short listed items. These small scale industries ideas are suitable to any one irrespective
of education. 
Example: Lawn care and landscape design – it is much larger in scope than a gardener. Here, you
can design the landscaping and types of plants to be planted. Many bungalow/ resort/
vacation house owners need such kind of services.

Medium Scale Business

Medium scale business is often the awkward middle child of its industry – too
large to get the discounts and services afforded to small businesses and too small to have
the weight and prestige granted to large enterprises.
Example: A company in the Record Production and Distribution industry (512250) requires more
than 250 employees to be a medium-sized company, while a magazine publisher in the
Periodical Publishers industry (511120) needs more than 1,000 employees.

Large Scale Business

Large Scale business which require huge infrastructure and manpower with an
influx of capital assets are. They provide an impetus to the industrialization of the
country; usually produce capital and basic goods and they are capable of generating funds
for the research and development of new technologies. Due to the large scale of
operations, they have the potential to lower the cost of goods. Further, they create
opportunities for small-scale and cottage industries to evolve and flourish. Also, the
employment opportunities created by large scale industries are huge.

SWOT Analysis
Swot Analysis is an organized list of your business’s greatest strengths,
weaknesses, opportunities, and threats. The primary objective of a SWOT analysis is to
help organizations develop a full awareness of all the factors involved in making a
business decision. This method was created in the 1960s by Albert Humphrey of the
Stanford Research Institute, during a study conducted to identify why corporate planning
consistently failed. 
Strengths and weaknesses are internal to the company. You can change them
over time. Opportunities and threats are external. They are out there in the market,
happening whether you like it or not.

Strengths (internal, positive factors)

Strengths describe the positive attributes, tangible and intangible, internal to your
organization. They are within your control.

Weaknesses (internal, negative factors)

Weaknesses are aspects of your business that detract from the value you offer or place you
at a competitive disadvantage.

Internal factors
1. Financial resources (funding, sources of income and investment opportunities)
2. Physical resources (location, facilities and equipment)
3. Human resources (employees, volunteers and target audiences)
 4. Access to natural resources, trademarks, patents and copyrights
5. Current processes (employee programs, department hierarchies and software systems)

Opportunities  (external, positive factors)

Opportunities are external attractive factors that represent reasons your business is likely to
prosper.

Threats (external, negative factors)

Threats include external factors beyond your control that could place your strategy, or the
business itself, at risk.

External factor
1. Market trends (new products, technology advancements and shifts in audience needs)
2. Economic trends (local, national and international financial trends)
3. Funding (donations, legislature and other sources)
4. Demographics
5. Relationships with suppliers and partners
6. Political, environmental and economic regulations

Example:
Alibaba  (BABA) is a company that provides the technology infrastructure and marketing
reach to help merchants, brands, and other businesses leverage the power of new technology for
efficient transactions between parties. Alibaba achieved the status of becoming the largest
retailer and e-commerce company in the world.

Strengths
One of Alibaba's largest strengths is their wide business diversity. The company runs
multiple websites and businesses, which spreads revenue over a large number and variety of
customer sources. This includes consumer to consumer, business to consumer, and business to
business services. Alibaba's e-commerce business is diversified among multiple websites and
wide product selections. The company established themselves as the largest retail business
globally. Alibaba has a strong research & development [R&D] program. 

Weaknesses
Alibaba has some weaknesses that are the nature of their business and others that can be
improved upon. The business requires large capital investments for expansion. The company's e-
commerce business is flooded with a large amount of sellers. Alibaba is a China-based
company. 

Opportunities
Alibaba has various options and strategies to grow the business for the long-term.
Continued expansion globally: Alibaba established themselves well in China and Asia. Expand
the cloud business: Alibaba has a successful growing cloud business.  Strategic acquisitions can
help Alibaba expand on top of their organic growth. 
Threats
Increased competition is an ongoing threat.  Unfavorable tariffs or trade policies could make
doing business with other countries more expensive.

Porter's Five Forces of Competitive Position Analysis

It is a model that identifies and analyzes five competitive forces that shape every industry
and identify an industry's structure to determine corporate strategy. The Five Forces model is
named after Harvard Business School professor, Michael E. Porter. Porter's model can be applied
to any segment of the economy to understand the level of competition within the industry and
enhance a company's long-term profitability.
Porter's Five Forces of Competitive Position Analysis can help:
 understand your industry of interest
 identify attractive vs less attractive industries/markets
 identify opportunities and risks
 how profits within an industry will be distributed
 extrapolate industry trends & anticipate changing trends
Porter's Five Forces is considered a macro tool in business analytics – it looks at the
industry's economy as whole, while a SWOT analysis is a micro analytical tool, focusing on a
specific company's data and analysis.

Porter's five forces are:

1. Competitive Rivalry
How many rivals do you have? Who are they, and how does the quality of their products and
services compare with yours? The first of the five forces refers to the number of competitors and
their ability to undercut a company. The larger the number of competitors, along with the
number of equivalent products and services they offer, the lesser the power of a company.

2. Threat of New Entrants

How easy is it to get a foothold in your industry or market? How much would it cost, and how
tightly is your sector regulated? A company's power is also affected by the force of new entrants
into its market. The less time and money it costs for a competitor to enter a company's market
and be an effective competitor, the more an established company's position could be significantly
weakened.

The six sources of barriers to entry

 Economies of scale – In many manufacturing industries, products can only be offered
cheaply because the cost of production per unit decreases as you produce larger volumes.
 Product differentiation – In a mature industry, there will be a wide array of variants
available already around core products.
 Capital requirements – Some industries simply require a huge amount of money to get
started.
 Cost disadvantages independent of size – There are often other costs to consider which
can be very difficult to get around. An example of this might be patents and proprietary
technology. Microsoft hold so many patents that it would always be difficult for another
company to try to offer the same products as them. You would need to, as Apple have
done, approach the space differently from a strategic perspective.
  Access to distribution channels – If competitors have exclusive agreements with the key
buying locations of your consumers, then you’ll find it very difficult to reach your
consumers.
 Government policy – In certain industries, it may be necessary to tender for government
contracts, or to spend highly on a whole department of people who can ensure regulatory
alignment – knowledge and a position on the experience curve which competitors already
have.

3. Bargaining Power of Suppliers

How many potential suppliers do you have? How unique is the product or service that
they provide, and how expensive would it be to switch from one supplier to another?
This addresses how easily suppliers can drive up the cost of inputs. It is affected by the number
of suppliers of key inputs of a good or service, how unique these inputs are, and how much it
would cost a company to switch to another supplier. The fewer suppliers to an industry, the more
a company would depend on a supplier.

4. Bargaining Power of Customers

How many buyers are there, and how big are their orders? How much would it cost them
to switch from your products and services to those of a rival? Are your buyers strong enough to
dictate terms to you? It is affected by how many buyers or customers a company has, how
significant each customer is, and how much it would cost a company to find new customers or
markets for its output. A smaller and more powerful client base means that each customer has
more power to negotiate for lower prices and better deals. A company that has many, smaller,
independent customers will have an easier time charging higher prices to increase profitability.

5. Threat of substitute products or services

This refers to the likelihood of your customers finding a different way of doing what you
do. Companies that produce goods or services for which there are no close substitutes will have
more power to increase prices and lock in favorable terms. When close substitutes are available,
customers will have the option to forgo buying a company's product, and a company's power can
be weakened.

How to resolve these 5 forces:

1. Playing to your strengths
2. Vertical integration
3. Being ahead of the curve
CHAPTER 10
INDUSTRY ANALYSIS

PORTER’S FIVE FORCES OF COMPETITION FRAMEWORK

The most widely used framework for analyzing competition within industries was
developed by Michael Porter of Harvard Business School. Porter’s five forces of competition
framework views the profitability of an industry as determined by five sources of competitive
pressure. These five forces of competition include three sources o “horizontal” competition:
competition from substitutes, competition from entrants, and competition from established rivals;
and two sources of “vertical” competition: the power of supplier and the power of buyers.

Competition from Substitute

The price that customers are willing to pay for a product depends, in part, on the
availability of substitute products. The absence of close substitutes or a product, as in the case
of gasoline or cigarettes, means that consumers are comparatively insensitive to price (demand
is inelastic with respect to price). The existence of close substitutes mean that customers will
switch to substitutes in response to price increases for the product (demand is elastic with
respect to price). The internet has provided a new source of substitute competition that has
proved devastating for the number off established industries. Travel agencies, newspapers, and
telecommunication providers have all suffered severe competition from internet-based
substitute.
The extent to which substitutes depress prices and profits depends on the propensity of
buyers to substitute between alternatives. This, in turn, depends on their price-performance
characteristics. The more complex a product a product and more differentiated are buyer’s
preferences, the lower the extent of substitution by customers based on price differences.

FIGURE 1. Porter’s five forces of competition framework

Threat of Entry
If an industry earns a return on capital in excess of its cost of capital, it will attract entry
from new firms and firms diversifying from each other industries. If entry is unrestricted,
profitability will fall towards its competitive level. Threat of entry rather than actual entry may be
sufficient to ensure that established firms constrain their prices to the competitive level. An
industry where no barriers to entry or exit exist in contestable: prices and profits tend toward the
competitive level, regardless of the number of firms within the industry. Contestability depends
on he no sunk costs, an industry is vulnerable to “hit and run” entry whenever established firms
raise their prices above the competitive level.
In most industries, however, new entrants cannot enter on equal terms with those of
established firms. A barrier to entry is any disadvantage that new entrants face relative to
established firms. The size of this disadvantage determines the height of a barrier to entry. Th
principal sources of barriers to entry are as follows.

Capital Requirements. The capital costs of becoming established in an industry can be so large
as to discourage all but the largest companies. The duopoly of Boeing and Airbus is large
passenger jets is protected by the huge investments needed to develop, build and service big
jet planes. In other industries, entry costs can be modest. Intense competition in the market for
smartphone apps reflects the low cost of developing most applications. Across the service
sector, start-up costs tend to be low; the start-up cost for a franchised pizza outlet starts at
$118,500 for Domino’s and $129,910 for Papa John’s production facilities or technology or
research or marketing, cost efficiency require amortizing these indivisible costs over a large
volume of output. The problem for new entrants is that they typically enter with a low market
share and, hence, are forced to accept high unit costs. A major source of scale economies is
new product development costs.

Absolute Cost Advantage. Established firms may have a unit cost advantage over entrants,
irrespective of scale. Absolute cost advantages often result from the ownership of low-cost
sources of raw materials. Absolute cost advantages may also result from economies of learning.
Intel’s dominance of the market for advanced microprocessors arises in part from the efficiency
benefits it derives from its wealth of experience.

Product Differentiation. In an industry where products are differentiated, established firms

possess the advantages of brand recognition and customer loyalty. Products with very high
levels of brand loyalty include cosmetics, disposable diapers, coffee, toothpaste and pet food.
New entrants to such markets must spend disproportionately heavily on advertising and
promotion to establish brand awareness.

Access to Channels of Distribution. For many new suppliers of consumer goods, the principal
barrier to entry is gaining distribution. Limited capacity within distribution channel (e.g., shelf
space), risk aversion by retailers, and the fixed costs associated with carrying an additional
product result in retailers being reluctant to carry a new manufacturer’s product. An important
competitive impact of the internet has been allowing new businesses to circumvent barriers to
distribution.

Governmental and Legal Barriers. Some economists claim that the only truly effective barriers to
entry are those created by government. In taxicabs, banking, telecommunications and
broadcasting, entry usually requires a license from a public authority. Today, patents copyrights,
and trademarks, protect the creators of intellectual property from imitators. Regulatory
requirements and environmental and safety standards often put new entrants at a disadvantage
in comparison with established firms because compliance costs tend to weigh more heavily on
newcomers.

Retaliation. Barriers to entry also depend on the entrant’s expectations as to possible retaliation
by established firms. Retaliation against new entrant may take the form of aggressive price-
cutting, increased advertising, sales promotion, or litigation. To avoid retaliation by incumbents,
new entrants may initiate small-scale entry into marginal market segments.

The effectiveness of Barriers to Entry. Industries protected by high entry barriers tend to earn
above above-average rates of profit. Capital requirements and advertising appear to be
particularly effective impediments to entry. The effectiveness of barriers to entry depends on the
resources and capabilities that potential entrants possess. Barriers that are effective against
new companies may be ineffective against established firms that are diversifying from other
industries.

Rivalry between Established Competitors

In most industries, the major determinant of the overall state of competition and the
general state of competition and the general level of profitability is rivalry among the firms within
the industry. In some industries, firms compete aggressively-sometimes to the extent that prices
are pushed below the level of cost and industry- wide losses are incurred. In other industries,
price competition is muted, and rivalry focuses on advertising, innovation, and other non-price-
dimensions. The intensity of competition between established firms is he result of interactions
between six factors.

Concentration. Seller concentration refers to the number and size distribution of firms competing
within a market. It is commonly measured by the concentration ratio: the combined market
share of the leading producers. Where a market compromises a small group of leading
companies (an oligopoly), price competition may be restrained, either by outright collusion, or
more commonly, by “parallelism” of pricing decisions. Thus, in the market dominated by two
companies, prices tend to be similar and competition focuses on advertising, promotion, and
product development.

Diversity of Competitors. The ability of rival firms to avid price competition in favor of collusive
pricing practices depends on how similar they are in their origins, objectives, costs, and
strategies.

Product Differentiation. The more similar the offerings among rival firms, the more willing are
customers to switch between them and the greater is the inducement for firms to cut prices to
boost sales. Where the products of the rival firms are virtually indistinguishable, the product is a
commodity and price are the sole basis for competition. By contrast, in industries where
products are highly differentiated (Perfumes, pharmaceuticals, restaurants, management
consulting services), competition tends to focus on quality, brand promotion, and customer
service rather than price.

Excess Capacity and Exit Barriers. The key is the balance between demand and capacity.
Unused capacity encourages firms to offer price cuts to attract new business. Excess capacity
maybe cyclical (e.g., the boom-bust cycle in the semiconductor industry); it may also be part of
structural problem resulting from over investment and declining demand. Barriers to exit are
cost associated with capacity leaving an industry. Where resources are durable and specialized,
and where employees are entitled to job protection barriers to exit maybe substantial.

Cost Conditions: Scale Economics and the Ratio of Fixed to Variable Cost. The key factor is
cost structure. Where fixed cost is higher to variable cost. The incredible volatility of bulk
shipping rates reflects the fact that almost all the cost of operating bulk carriers is fixed.

Bargaining Power of Supplier

 It is the mirror image of the bargaining power of buyers and refers to the pressure that
suppliers can put on companies by raising their prices, lowering their quality, or reducing the
availability of their products. This framework is a standard part of business strategy.
Types of Suppliers
Depending on the industry, there are various types of suppliers. A list of suppliers includes:

Manufacturers and Vendors: Sells products to distributors, wholesalers, and retailers.

Distributors and Wholesalers: Purchases goods in medium/high quantity for sale to retailers
or local distributors.
Independent Suppliers / Independent Craftspeople: Sells unique products directly to retailers
or agents.
Importers and Exporters: Purchase products from manufacturers in one country and export to
a distributor in a different country.
Drop shippers: Suppliers of products for different kinds of companies.

Bargaining Power of Buyers

The firms in an industry compete in two types of markets: in the markets for inputs and
the markets for outputs. In input market firms purchase raw materials, components, services,
and labor. In the markets for outputs, firms sell their goods and services to customers (who may
be distributors, consumers, or other manufacturers). The ability of buyer to drive down the
prices they pay depends upon two factors: their price sensitivity and their bargaining power
relative to the firms within the industry.

Buyers’ Price Sensitivity

 The greater the importance of an item as a proportion of total cost, the more sensitive
buyers will be about the price they pay.
 The less differentiated the products of the supplying industry, the more willing the buyer
is to switch suppliers based on price.
 The more intense the competition among buyers, the greater their eagerness for price
reductions from their sellers.
 The more critical an industry’s product to the quality of the buyer’s product or service,
the less sensitive are buyers to the prices they are changed.
Relative Bargaining Power
 Size and concentration of buyers relative to suppliers. The smaller the number of buyers
and the bigger their purchases, the greater the cost of losing one. Empirical studies
show that buyer concentration lowers prices and profits in the supplying industry.
 Buyers’ information. The better-informed buyers are about suppliers and their prices and
costs, the better they can bargain. Keeping customers ignorant of relative prices is an
effective constraint on their buying power. But knowing prices is of little value if the
quality of the product is unknown.
 Capacity for vertical integration. In refusing to deal with the other party, the alternative to
finding another supplier or buyer is to do it yourself. Large retail chains introduce their
own label brands to compare with those of their suppliers.
CHAPTER 11
Introduction to the Circular Flow of Economic Activity:

The all pervasive economic problem is that of scarcity which is solved by three institutions (or decision-
making agents) of an economy. They are households (or individuals), firms and government. They are
actively engaged in three economic activities of production, consumption and exchange of goods and
services. These decision-makers act and react in such a manner that all economic activities move in a
circular flow.

First, we discuss their nature and role in decision-making.

Household
 Households are consumers. They may be single-individuals or group of consumers taking a joint
decision regarding consumption. They may also be families. Their ultimate aim is to satisfy the
wants of their members with their limited budgets. Households are the owners of factors of
production—land, labor, capital and entrepreneurial ability. They sell the services of these
factors and receive income in return in the form of rent, wages, and interest and profit
respectively.

Firm
 The term firm is used interchangeably with the term producer in economics. The decision to
manufacture goods and services is taken by a firm. For this purpose, it employs factors of
production and makes payments to their owners. Just as household’s consumer goods and
services to satisfy their wants, similarly firms produce goods and services to make a profit. The
term ‘firm’ includes joint stock companies like DCM, TISCO etc., public enterprises like IOC, STC,
etc., partnership concerns, cooperative societies, and even small and big trading shops which do
not manufacture the commodities they sell.

Government
 The government plays a key role in all types of economic systems—capitalist, socialist and
mixed. In a capitalist economy, the government does not interfere. It simply establishes and
protects property rights. It sets standards for weights and measures, and the monetary system.
  In a socialist economy, the role of the government is very extensive. It owns and regulates the
entire production and consumption processes of the economy, and fixes prices of goods and
services. In a mixed economy, the government strengthens the market system. It removes its
defects by regulating the activities of the private sector and by providing incentives to it. The
government also uses resources to produce goods and services itself which are sold to
households and firms. These decision-making agents take economic decisions to produce goods
and services and to exchange them in order to consume them for satisfying the wants of the
whole economy. Production, consumption and exchange are the three main activities of the
economy. Consumption and production are flows which operate simultaneously and are
interrelated and interdependent. Production leads to consumption and consumption
necessitates production.
 In other words, production is a means (beginning) and consumption is the end of all economic
activities. Both production and consumption, in turn, depend upon exchange. Thus these two
flows are interrelated and interdependent through exchange.

 In a simplified economy with only two types of economic agents, households or consumers and
business firms, Consumers and firms are linked through the product market where goods and
services are sold. They are also linked through the factor market where the factors of production
are sold and bought.

Consumers and firms have a dual role, and exchange with one another in two distinct ways:

(1) Consumers or households own all the factors of production, that is, land, labor, capital and
entrepreneurship, which are also called productive resources. They sell them to firms for producing
goods and services.

(2) In a modem economy, exchange takes place through financial flows which move in the reverse
direction to the “real” flows. The purchase of goods and services in the product market by consumers is
their consumption expenditure which becomes the revenue of the firms The expenditure of firms in
buying productive resources in the factor market from the consumers becomes the incomes of
households,

So far we have been working on the circular flow of a two-sector model of an economy. To this we add
the government sector so as to make it a three-sector closed model of circular flow of economic activity.
For this, we add taxes and government purchases (or expenditure) in our presentation.

Taxes are outflows from the circular flow and government purchases are inflows into the circular flow.
First, take the circular flow between the household sector and the government sector. Taxes in the form
of personal income tax and commodity taxes paid by the household sector are outflows (or leakages)
from the circular flow. But the government purchases the services of the households, makes transfer
payments in the form of old age pensions, unemployment relief, sickness benefit, etc., and also spends
on them to provide certain social services like education, health, housing, water, parks and other
facilities.

All such expenditures by the government are inflows (injections) into the circular flow. Next take the
circular flow between the business sector and the government sector. All types of taxes paid by the
business sector to the government are leakages from the circular flow.

On the other hand, the government purchases all its requirements of goods of all types from the
business sector, gives subsidies and makes transfer payments to firms in order to encourage their
production. These government expenditures are injections into the circular flow.

Now we take the household, business and government sectors together to show their inflows and
outflows in the circular flow. As already noted, taxes are a leakage from the circular flow. They tend to
reduce consumption and saving of the household sector. Reduced consumption, in turn, reduces the
sales and incomes of the firms.

Taxes on business firms tend to reduce their investment and production. The government offsets these
leakages by making purchases from the business sector and buying services of the household sector
equal to the amount of taxes. Thus inflows (injections) equal outflows (leakages) in the circular flow.

Taxes flow out of the household and business sectors and go to the government. The government
purchases goods from firms and also factors of production from households. Thus government
purchases of goods and services are an injection in the circular flow and taxes are leakages in the
circular flow. If government purchase exceeds net taxes then the government will incur a deficit equal to
the difference between the two, i.e., government expenditure and taxes. The government finances its
deficit by borrowing from the capital market which receives funds from the household sector in the
form of saving.

On the other hand, if net taxes exceed government purchases the government will have a budget
surplus. In this case, the government reduces the public debt and supplies funds to the capital market
which are received by the business sector.

So far the circular flow has been shown in the case of a closed economy. But the actual economy is an
open one where foreign trade plays an important role. Exports are an injection or inflows into the
circular flow of money. On the other hand, imports are leakages from the circular flow.

Take the inflows and outflows of the household, business and government sectors in relation to the
foreign sector. The household sector buys goods imported from abroad and makes payment for them
which is a leakage from the circular flow of money. The householders’ ma receives transfer payments
from the foreign sector for the services rendered by them in foreign countries.

On the other hand, the business sector exports goods to foreign countries and its receipts are an
injection in the circular flow or money. Similarly, there are many services rendered by business firms to
foreign countries such as shipping, insurance, banking, etc. for which they receive payments from
abroad.
They also receive royalties, interests, dividends, profits, etc. for investments made in foreign countries.
On the other hand, the business sector makes payments to the foreign sector for imports о capital
goods, machinery, raw materials, consumer goods, and services from abroad. These are the leakages
from the circular flow of money. Like the business sector, modern governments also export and import
goods and services, and lend to and borrow from foreign countries. For all exports of goods, the
government receives payments from abroad.

Similarly, the government receives payments from foreigners when they visit the country as tourists and
for receiving education, etc., and also when the government provides shipping, insurance and banking
services to foreigners through the state-owned agencies.

It also receives royalties, interests, dividends, etc. for investments made abroad. These are injections
into the circular flow of money. On the other hand, the leakages are payments made to foreigners for
the purchase of goods and services. Further, imports, exports and transfer payments have been shown
to arise from the three domestic sectors—the household, the business and the government. These
outflows and inflows as through the foreign sector which is also called the “Balance of Payments
Sectors”.
CHAPTER 12

Lesson 3.6 The Economy’s Producing Sectors

Three Economic sectors of the economy

1. Primary sector (Agriculture)
2. Secondary sector (Industrial)
3. Tertiary sector (Service)

Primary sector is the sector of an economy making direct use of natural resources. This includes
agriculture, forestry and fishing, mining, and extraction of oil and gas.

The primary sector of the economy extracts or harvests products from the earth. The primary sector
includes the production of raw material and basic foods. Activities associated with the primary sector
include agriculture (both subsistence and commercial), mining, forestry, farming, grazing, hunting and
gathering, fishing, and quarrying. The packaging and processing of the raw material associated with this
sector is also considered to be part of this sector.

Secondary sector of the economy or industrial sector includes those economic sectors that create a
processed, tangible product: production and construction.

This sector generally takes the output of the primary sector and manufactures finished goods. These
products are then either exported or sold to domestic consumers and to places where they are suitable
for use by other businesses. This sector is often divided into light industry and heavy industry. Many of
these industries consume large quantities of energy and require factories and machinery to convert the
raw materials into goods and products. They also produce waste materials and waste heat that may
pose environmental problems or cause pollution.

Tertiary sector of the economy is the service industry. This sector provides services to the general
population and to businesses. Activities associated with this sector include retail and wholesale sales,
transportation and distribution, entertainment (movies, television, radio, music, theater, etc.),
restaurants, clerical services, media, tourism, insurance, banking, healthcare, and law.
Competitiveness and Efficiency
In an increasingly market-driven global economy, a national economy needs to be competitive to
develop and prosper. Competitiveness means the ability of a country to compete effectively in global
markets.

Moreover, economic efficiency is when all goods and factors of production in an economy are
distributed or allocated to their most valuable uses and waste is eliminated or minimized.

Agriculture and Fishery

This refers to cultivation of crops through soils and other medium growing of trees, raising of livestock,
poultry, or fish which includes harvesting, processing and marketing of product of farm activities and
practices.

Manufacturing
Manufacturing is derived from the Latin word manufactus, which means, made by hand. In modern
context it involves making products from raw material by using various processes, by making use of
hand tools, machinery or even computers. It is therefore a study of the processes required to make parts
and to assemble them in machines.

Manufacturing is the backbone of any industrialized nation. Manufacturing and technical staff in
industry must know the various manufacturing processes, materials being processed, tools and
equipment for manufacturing different components or products with optimal process plan using proper
precautions and specified safety rules to avoid accidents.

Trade and Transport

Trade is the exchange of goods and services across regions and national borders, it was considered
important in improving welfare of the people even before the birth of economics as organized science in
1776. The mercantilist philosophy maintained that the way for a nation to be rich and powerful was to
export more than to import. The Philippines is one of the world’s oldest open economies, which traded
goods even prior to its discovery by the western world. For more than a century however, it experienced
widening gap between exports and imports which causes trade deficit. This means that the country is
not trading at its potential, which may be due to its institutional and infrastructures rigidities or the
rigidities of its trading partner.
International Trade
International trade has an important share in GDP in different countries. Various companies from
different countries are looking for new growth opportunities beyond their home country borders. Due to
international trade, important sectors of the economies can be stimulated, such as transport and
Information and Communication Technology (ICT) sectors.

Thus, international trade can be important for business, due to profits growth prospects, reduced
dependence on known markets, business expansion, etc. The increase of international trade over the
years has been a result of the globalization process. Thus, both consumers and companies can now
choose from a wider range of products and services.

Also, globalization refers to the interdependence between countries arising from the integration of
different aspects of the economy, such as trade. International trade can stimulate economic growth of
countries that are now so interconnected. Currently, globalization cannot be ignored by businesses, due
to the opportunities offered by foreign markets.

Tourism
The Philippines is a sovereign island country in Southeast Asia situated in the western Pacific Ocean. It is
composed of 7,107 islands with vast 2 features of tropical rainforests, mountains, beaches, coral reefs,
and diverse range of flora and fauna. These generate tourism which becomes the major economic
contributor in the Philippine economy.

Tourism is an economic activity, which is the largest and dynamically developing sector in the country.
Tourism generate demands from many different industries, gives market power to those who have been
able to join different goods and services in a package and thus offer inclusive tours (IT) to potential
consumers (Ledesma, et al.,1999). According to the Department of Tourism/DOT (2011), tourism is one
of the three largest industries in the Philippines.

The tourism industry is mainly a consumer of inputs and producer of final goods, hence, its impact on
the output is relatively higher. Also, its interdependence with other industries proves that other sectors
do benefit from the tourism sector (Yu, 2012).

Small Business Opportunities

Since the 1980s, small business owners and entrepreneurs have been receiving greater recognition as
drivers of economic growth. Recently, several studies (Forsman 2011; McKeever, Anderson, and Jack
2014) have reported that long-term economic growth and prosperity require participation from
entrepreneurs. Both experts and governmental authorities opt for fostering entrepreneurship as ‘an
appropriate mechanism to face the impacts of the economic crisis’ (GEM 2014, 100).

Over the last two decades, extensive literature on the importance of small businesses in the economy
has consistently shown that the creation of new businesses drives economic prosperity. As well as
playing a crucial role in increasing the competition of emerging sectors, new small businesses are critical
for economic growth and innovative capacity in many regions. Job creation, economic growth and
poverty reduction are usually the main political interests in entrepreneurship (Battilana and Casciaro
2012; Willis 2011).

Entrepreneurship is thus a driving force within the economy, particularly because of entrepreneurs’
innovative nature. (Fuellhart and Glasmeier 2003; Maxwell and Stone 2004). Small businesses transform
and develop communities. Entrepreneurs create ways to connect resources and growth across cultures,
policy contexts, economic conditions and political situations that differ from a region to another.
(Carrasco-Monteagudo and Buendía-Martínez 2013).
CHAPTER 13
The Theory of Consumer Behavior

● Consumer behavior or consumer buying behavior are all the aspects that affect

consumers’ search, selection, and purchase of products. We can use the term for
the purchases of services too. Consumer behavior also includes the post-purchase
stage. Consumer behavior is an area of research within the business field of
‘marketing.
● To understand consumer behavior, companies need to know why customers bought
something and what pushed them to buy. They also need to know what trends are
developing in society.

Concept of Consumer Behavior

It is believed that consumers make their purchases on the basis of small number of
selective chosen pieces of information. Markets resolve every activity around the
ultimate consumers and focuses on:

> Who buy the products?

> How do they buy the product?

> Where do they buy them?

> How often do they buy them?

> When do they buy them?

> Why do they buy them?

> How often do they use them?

Four Types of Consumer Behavior

1. Routine shopping. The shopper buys without having to do much research, there is
low involvement, and usually at low cost. For example, the thought behind what to buy
in our weekly supermarket shopping is relatively simple.

2. Limited decision making. The buyer occasionally purchases the product after
somebody recommended it. They do a little research, i.e., it is not as time-consuming as
buying an expensive product.

For example, when a woman wants to dye her hair, she may ask friends for a reliable
option. Put simply; she only needs to check a few options.
3. Extensive decision making. People spend much longer deciding when they are
considering an expensive product. Consumers spend time carrying out research and
comparing multiple products. They check product ratings and also ask friends or sales
professionals.

The process takes longer to complete. For example, when buying a TV, people spend a
long time going to different shops and comparing products.

Deciding what house to buy may take weeks or even months.

4. Impulse buying. The customer had not planned to buy. When I am waiting at the
checkout in a supermarket, I might suddenly buy some chewing gum. It is an impulse
buy because I had not planned to purchase gum.

Supermarkets know that consumers are impulsive, especially when it comes to

chocolates, candy, and gum. Consequently, they place those products near the
checkout.

As a consumer, individual encompasses many different behaviors such as

collecting, nurturing, cleaning, preparing, displaying, storing, wearing, sharing,
evaluating, and serving.

To have a wide and clear view of the behavioral aspect, meaning of consumer,
customer and buyer are bifurcated and their meaning are as follows:

● Customer - Individual who is the ultimate user of the goods/services and purchases
the same from particular organization or shop. A customer is not always a consumer
thus; all the buyers or consumers are not buyers.
● Buyer - One who purchases the product is called the buyer. Buyer may not be the
ultimate user.
● Consumer - The end user of goods/services is known as consumer. The consumer
may or may not be the buyer or customer. Latent purchase behavior is referred
here.

The Utility Function

In economics, utility function is an important concept that measures preferences over

a set of goods and services. Utility represents the satisfaction that consumers receive
for choosing and consuming a product or service.
Understanding Utility Function

In economics, the utility function measures the welfare or satisfaction of a consumer as

a function of consumption of real goods such as food or clothing. Utility function is
widely used in the rational choice theory to analyze human behavior.

When economists measure the preferences of consumers, it's referred to ordinal utility.
In other words, the order in which consumers choose one product over another can
establish that consumers assign a higher value to the first product. Ordinal utility
measures how consumers rank one product versus another.

KEY TAKEAWAYS

● In economics, utility function is an important concept that measures preferences

over a set of goods and services.
● Utility represents the satisfaction that consumers receive for choosing and
consuming a product or service.
● Economists track consumer choices to ascertain the utility of one product versus
another and assign a numerical value to that utility.
● Company executives research consumers' utility to guide the company's
advertising, sales, and new product offerings.

Significance of Consumer Behavior in Business

1. To design production policies-

This is the first importance of consumer behaviour and it means that all the production

policies have designed taking into consideration the consumer preference so that
product can be successful in the market.

In every business, the main motive is to enhance the production and as well as sales of
the company and to do all these, any company or business has to win the trust of its
customers and studying about their tastes, likings, and preferences.

2. Know the effect of price on buying-

This is the second consumer behaviour importance and it means that consumer

behavior can help in understanding the effect of price on buying. Whenever the price is
moderate on cheap more and more customer will buy the product.

After the time of production, there comes a time in which the company has to decide
what the price of our product will be because it helps to divide the categories of the
customer and also helps to attain more sales.
3. Exploit the market opportunities-

This is the third importance or significance of consumer behaviour and it means that the

change in consumer preference can be a good opportunity for the mark to bring
something which cannot as a revaluation in the market. For Example– When palm pops
introduced in the market, it was successful due to the stylish and sleek design.

4. Design marketing mix-

This is the fourth importance of consumer behaviour and it means that consumer

behavior is very much vital in designing and approaching marketing mix to be chosen
(product, price, place, and promotion).

The product should be valuable, the price should be moderate, place distribution should
be intensive and an appropriate. Promotion mechanism should be there.

5. Implement STP Strategies-

This is the fifth importance of consumer behaviour and it means that the segmentation,

targeting, and positioning strategies are implemented by understanding the behaviour of
consumers towards the various brands.

The products are targeted grouping the customers having common taste and
preference and finally positioned in the market. Thus, building a positive image of the
product of a company related to the competitors and as well as help to beat them also.

6. Helps in understanding diversified preferences-

This is the sixth importance of consumer behaviour and it means that the consumer

preferences are diversified in nature and their keep on changing over a particular period
of time. Nowadays consumers are more value conscious and they want to extract the
maximum benefits from a particular product of a brand.

7. Understanding of various roles played by consumers-

This is the seventh importance and it means that there are various roles played by the
consumers in the consumer decision-making process. These roles are initiators,
influencers, decider, users, buyers, and gatekeeper. The steps of the consumer
decision-making process can be described are as follows:-

● Need Recognition,
● Information Search,
● Evaluation of Alternatives,
● Purchase Decisions,
● Post Purchase Behaviour.

8. Results in customers satisfaction-

This is the eighth importance of consumer behaviour and it means when the designed

product is matching the expectations of the customer than they result in customer
satisfaction. In case the product is exceeding the expectations of the customer then its
result in customer delight.

In an organization, there are various departments like purchase, personnel, finance,

production, marketing and all departments have a motive to satisfy the customer needs
and wants.

The Production Theory

● The Theory of Production explains the principles by which a business firm decides
how much of each commodity that it sells (its “outputs” or “products”) it will produce.
And how much of each kind of labor, raw material, fixed capital goods, etc., that it
employs (its “inputs” or “factors of production”) it will use.

● Economics, models, and theories are not dynamic; they are fixed to a period. So,
economists base their models on the short run, medium run or long run. The
difference in these time frames is the ability to change the factors of production.

Factors of production are the resources people use to produce goods and services;
they are the building blocks of the economy. Economists divide the factors of production
into four categories: land, labor, capital, and entrepreneurship.

● The Short-Run is the period in which at least one factor of production is considered
fixed. Usually, capital is considered constant in the short-run.

● In the Long-Run, all factors of production are variable, while in the very long-run all
factors of production are variable and research and development is possible.

Significance of Production Theory in Business

The theory of production is at the heart of business economics. That is why, its
importance is great.

Firstly, cost theory is a derived theory—it is derived from the production theory. Cost
has great relevance in the determination of price of a commodity
Secondly, the theory of production may be used in the determination of rewards of an
input. The basis of input demand theory is indeed the theory of production.

To the economists, a production function is something more. A production function

shows costs for using inputs and revenues for output sold. As the production function is
given in the form of a table showing physical combinations of different inputs to obtain
certain unit of output, it is not within the domain of economics.

Economists are concerned not with the physical combinations but with the costs,
revenue, output behaviour in response to changes in inputs used, etc. Whenever there
is a change in input usage in a production process, the output changes
 CHAPTER 14
A labor market is the place where workers and employees interact with each other. In the labour
market, employers compete to hire the best, and the workers compete for the best satisfying
job.

A labor market in an economy functions with demand and supply of labour. In this market,
labour demand is the firm's demand for labour and supply is the worker's supply of labour. The
supply and demand of labour in the market is influenced by changes in the bargaining power.

The Philippines is among Asia’s premier labor markets. The country houses a large and growing
young population with a median age of 23.

Currently, about 44.1 million people out of the 70.9 million – aged 15 years and above – are in
the labor force. Such high labor productivity is greatly attributed to the Philippines’ high literacy
rate which stands at around 96.6 percent. Furthermore, the country produces over 600,000
graduates each year, enriching the professional pool. With such a highly skilled and productive
workforce, along with a robust supply of business process outsourcing services, and sound
economic fundamentals, Philippines has become one of the most attractive destinations for
businesses expanding to Southeast Asia.  

Factors That Influence the Labour Market

 Supply and demand: How many people are trained for an occupation? How many jobs
are there?
 Language abilities: Do you need to be bilingual for this kind of work?
 Seasonal fluctuations: Is this work more in demand at certain times of year (e.g.
landscaping)?
 Population: Is the demand for this work increasing or decreasing based on population
patterns?
 Economy: How do economic factors influence job prospects?
 Technological advances: Has the field been impacted by recent changes in technology
(e.g. online shopping)?
 Skills and abilities: What skills and abilities are essential to this kind of work?

Employment structure

The Philippines has a traditional employment structure with services being the largest employer,
followed by agriculture, and industry being the smallest.

The Philippines Statistics Authority (PSA) data also shows 61.2 percent, of the total employed
persons, were salaried, 27.6 percent were self-employed, while 3.5 percent were employers in
own family-operated farms or businesses, and 7.7 percent were unpaid family workers.
Philippine Wage Situation:

The Philippines’s labor market provides an attractive prospect for investors given the large
working-age population and growing pool of skilled labor. However, the country’s minimum
wages are higher and labor regulations are more stringent than many other countries in Asia –
increasing costs for investors.’

Wage rate varies in every region and is set by tripartite regional wage boards located in each
province. The following Minimum Daily wages are from that source, as of 2020.

Daily Rate Region

P500-537 NCR

P340-350 CAR

P282-340 RB-I

P345-370 RB-II

P304-420 RB-III

P303-400 RB-IVA

P294-320 RB-IVB

P310 RB-V

P310-395 RB-VI

P351-404 RB-VII
P285-315 RB-VIII

P303-316 RB-IX

P331-365 RB-X

P381-396 RB-XI

P305-326 RB-XII

P320 CARAGA

P290-325 BARMM

Labor Migration

Labor migration refers to migration for the main purpose of employment. Labor
migrants often work in the informal sector and are usually exposed to abuses
resulting from xenophobia and racism. They lack legal protection and insufficient
information about their rights makes them vulnerable to exploitation and abuse
from recruiters, employers, and authorities.
In response to the abuses that most labor migrants had experienced. The
government subsequently developed a number of institutions, laws, and policies
aimed at enhancing the protection of OFWs and their families, spurred on by
civil-society advocacy. This dual approach of facilitation and protection
contributed to making the Philippines a major source country of workers and
talent for the global labor market, while also providing protection to OFWs.

One of those developed institution is the OWWA. The Overseas Workers Welfare

Administration (OWWA) is an attached agency of the Department of Labor and
Employment (DOLE) and a membership institution. It protects and promotes the welfare
of Overseas Filipino Workers (OFWs) and their dependents.

Figure 1. Annual Deployment of Overseas Filipino Workers (OFWs), 1975-2015

Source: Philippine Overseas Employment Administration (POEA), “Compendium of OFW
Statistics,” accessed July 6, 2017, 

Figure 2. Deployment of Land-Based OFWs by Region, 2015

Source: POEA, “Compendium of OFW Statistics.”

In the Philippines, a deeply rooted and pervasive culture of migration has made
moving abroad common, acceptable—even desirable—as an option or strategy
for a better life. For decades, sizeable numbers of Filipinos have left home in
search of permanent settlement or temporary work overseas. The reason behind
labor migration is the lack of opportunity in employment in the Philippines.
Statistics have shown that as years are passing, labor migration is also
increasing in numbers. The number of Overseas Filipino Workers (OFWs) who
worked abroad during the period April to September 2018 was estimated at 2.3
million. Overseas Contract Workers (OCWs) with existing work contract
comprised 96.2 percent of the total OFWs during the period April to September
2018.The rest (3.8%) worked overseas without contract.