chapter 1 eco3

8/3/2019 Chapter 1 eco3

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Introduction to Economic Theory


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Terms to Remembers Economics Basic Needs Luxury Goods Economic Resources

Land Labor Entrepreneur Capital Theory Market Wants

Variable Macroeconomics

Microeconomics

Normative Economics

Positive economics

Empirical validation

Economic System

Free enterprise system

Right to private property

Function


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Different definitions of economics:

Economics studies how prices of land, laborand capital are determined, and how theseprices are used to allocate scarce resources.

Economics looks into the behavior of financialmarket and how they allocated capital to therest of the economy.


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Economics looks into the distribution of income andinto ways of helping the poor without causing harmto the countrys economic performance.

Economics looks into the impact on growth ofgovernment spending, taxes and budget deficits.


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Economics examines the movements in incomeand employment during the different stages ofthe business cycle with the goal of developinggovernment policies that will improveeconomic growth.

Economics looks at trade patterns amongnations and analyzes the impact of tradebarriers.


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Economics examines growth indeveloping countries and suggests waysto encourage the efficient use of

resources.


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Economic activity:

Mans economic activityconsists of efforts to satisfy

human wants with the use ofgoods and services.


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3 elements are involved in this objectiveof satisfaction:

1. Human wants

2. Use of Resources

3. Technique of production


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Human wants Human wants wants are unlimited. This vary from

the needs for survival (basic needs).

CLOTHES FOOD SHELTER


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Human Wants Man is also subject to created wants (caused by advertising).


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Use ofResources

The basic economicresources of a nationconsist of: Land

Labor Capital

Entrepreneurship


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These are availablein limited amounts,

which is why manhas to learn how toallocate themproperly tomaximize the

number of wantsthat can be satisfied.

Resources

Land

Labor

Capital

Business


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The economyshould pay theowners of thesebasic factors ofproduction for theuse of theirresources such asrent for the land,wage or salary forlabor, interest for

capital and profitforentrepreneurship.


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CONSUMPTION

Household is the basic consuming unit inthe economy.

Since human wants are unlimited, it

maximizes its satisfaction through properallocation or mix of expenditures within thecontext of budget limitations.


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Allowance per week is 500

Budget:

Transportation 100

Food

250Soft drinks 50

Others - 100

Allowance per week is 500

Budget:

Transportation 100

Food 125

Soft drinks 30Others - 100

T-shirt - 145

The student

forgoes foodand drinks for

shirt


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Opportunity cost

Value of foregone alternative ofa specific resource


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Business firm the economysproducing unit to satisfy human wantswith goods and services.

They hire employees and use resourcesto operate and provide goods andservices.


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Hire employees

Use resources

Pay for the use

of resources

Resourceowners

PROFIT


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SOME ECONOMIC PROBLEM:

1. Unemployment

2. Economic Instability

3. Low levels of growth and development4. Unequal income distribution

5. Determination of the countrys type ofeconomic system.


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Unemployment this is a problem because it leads to idle

resources. This means that income is foregone inresources which would generate earnings to theowners if used.


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Economic Instability

makes it difficult for producers to make accurateforecasts on demand and consumption levels,causing fluctuations in production and supply ofgoods and services, which further leads to

surpluses or shortages.


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Low levels of Growth and Development

makes it difficult for underdeveloped anddeveloping nations to rise from their low levels ofincome.


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Unequal Income Distribution

this concentrates the wealth of thenation in the hands of the few.


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Determination of the countrys type of economic system

this is vital to any nation because this determineshow goods will be produced, the quantities to bemade, and how these goods and services shall bedistributed.


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ECONOMIC ANALYSIS AND ECONOMICPOLICY

Economic analysis the process of directing economic relationships by

examining economic behavior and events, anddetermining the causal relationships among the

data and activities observed.


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Tools in Economics:

1. Logic

2. Statistics

3. Mathematics


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Logic first tool of economics. Used in establishing

relationships among different variable to drawconclusion from particular to general or fromgeneral to particular.


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Statistics used to quantitatively describe economic

behavior and therefore serves as basis forhypothesis testing. Hypothesis becomes a theorywhen empirically validated.


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Mathematics enables the analyst to conceptualize and quantify

a hypothesis for empirical validation.


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Purpose of economic analysis:

It is an aid in understanding how economyoperates because it explains how economicvariables are related to one another.

It permits prediction of the results of changes in

economic variables

It serves as basis for policy formulation.


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Economic Policy

This consists of interventions or courses of actiontaken by the government or other privateinstitutions to manipulate the results of economicactivity.


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The economic policy adopted by the governmentmay be monetary, fiscal or trade for the purposeof achieving economic welfare.


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Methodology:

One must use economic theory to make a usefuland systematic study of economic activity.


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Economic theory consists of causal relationshipsamong the important facts or variables thatsurrounded and permeate economic activity.

Theories are based on premises or postulates

(conditions that are taken as given).


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The construction of economic theory:

1. Specification and definition of its postulates.

Ex. In economics, theory may be build based onconsumer behavior.


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2. The observation of facts concerning the activityabout which we want to theorize.

Ex. Looking at the exchanges of groceries betweensupermarket and consumers: What facts are

relevant and what facts can be disregarded?


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3. The application of the rules of logic to the observedfacts.

This attempts to establish causal relationship among thefacts and to eliminate as many irrelevant andinsignificant facts as possible.

Reasons could be deductive (general to particular) orinductive (particular to general).

Reasons will help reach tentative statements called

hypotheses.


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4. Testing hypotheses thoroughly after itsformulation.

Testing it is crucial to determine the extent of its

validity. Some hypothesis will not stand repeatedtesting and therefore should be rejected.


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Others may be modified and tested.

Hypotheses that hold up to most of the time in mostof the circumstances, to which they are relevant

may be referred to as principles


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Theories should not be regarded as absolute truthas the testing process is never ending. Economictheories continue to evolve and grow.


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Functions of Economic Theory:

To explain the nature of economic activity

To predict what will happen in the economy asfacts change.


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Differentiation of how the theory is used

1. Positive Economics

2. Normative Economics


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1. Positive Economics Supposed to be completely objective

Limited to the cause and effect relationships ofeconomic activity


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1. Normative Economics Concerned with what ought to be

Value judgments must necessarily be made

Ex. Economic policy making conscious intervention ineconomic activity with the intent of altering the course thatit will take.

PRICE THEORY AND ECONOMIC


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PRICE THEORY AND ECONOMICTHEORY

The 2 Basic Analytical Tool Kit in Economics are:

Price theory

microeconomics

Economic theory

macroeconomics


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Microeconomics

It is primarily concerned with the marketactivities on individual economic units such asconsumers, resource owners, and business firms.


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Microeconomics is concerned with:

1. the flow of goods and services from business firms toconsumers

2. the composition of the flow

3. the process of establishing relative prices of thecomponent parts of the flow

4. the flow of resources from resource owners to businessfirms

5. the evaluation of resources

6. the allocation of resources among alternative uses


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Macroeconomics

Treats the economic system as a whole ratherthan treating the individual economic units ofwhich it is composed.


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The value of overall flow of goods (net nationalproduct) and the value of the overall flow ofresources (national income) receive the focus ofattention.


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Macroeconomics Deals with:

Price index and general price level

Concentrates on cause of change in aggregatemoney flows, the aggregate movement of goodsand services


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The general employment level resources Concerned about the nature of economic growth

The conditions necessary for the expansion ofproductive capacity and national income time


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Price theory Microeconomics

This is abstract because it does not and cannotencompass all the economic date of the realworld.


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The function of the theory is to single out the

most relevant data and to build an overallconceptual framework of the price system in

operation from those.


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It concentrates on data and principles that are

most important in motivating most economicunits. Eliminating less important data, certain

contact with reality is lost but we gainunderstanding on the overall operation of theeconomy.


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Characteristics of Microeconomics

1. Microeconomics looks at the decisions ofindividual units (household, producers andfirms).

Ex. How efficiently is our resources used?


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2. Microeconomics looks at how prices aredetermined.

Ex. Should a monopolist increase his price?


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3. Microeconomics is concerned with socialwelfare.

Ex. Is it prudent to build a new bridge or to buy

additional arms for the army.


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4. Microeconomics has a limited focus. Itis just a part of the economicsdiscipline.


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5. Microeconomics develops skills:

Microeconomics helps you develop your logicalreasoning.

Microeconomics will help you develop skills inconstruction and use of models.


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Microeconomics employs optimizing techniquesthat are useful for making decisions in variety ofsituations.

Its concepts are applicable to personal resourceallocation decisions (career choice and financialinvestments).


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ECONOMIC MODELS

Microeconomics makes extensive use ofmodeling, comparative static and mathematics.


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Economic models are composed of a series of:

Assumptions or given

Statement of implications


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Supply and demand One of the best known economic model. This is an

example of comparative static analysis (acomparison of two different economic outcomes

Wikipedia.com).


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Supply and demand relationships can beexpressed in 3 ways:

1. Verbal or logical

2. Mathematical3. Graphical


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Verbal:

Supply is a schedule of prices and quantities thata supplier would be willing to offer for sale ateach price period of time.


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As suppliers, they would be encouraged to sellmore at higher prices and would sell less at lowerprices. This is because higher prices, if otherthings are held constant, means higher profits.


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Therefore, higher prices offered for sale aredirectly related.


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Mathematical:

The law of supply can be expressed in anequation:

Qs=500

This means that if the price for commodity isPhp 1, quantity supplied would be Php 500.00(Php 1 x 500 = Php 500.00.


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Graphical:

Price Qty.Supplied

1 102 20

3 304 405 50


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A common feature of models is that they focusonly on the fundamental elements of an object orprocess. In the example, supply is analyzed basedon varying prices. But supply could also be

affected by other factors.


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Models that consistently predict a broad range ofreal-world phenomena are classified as theories.But not all models are theories. The test of thetheory is the consistency of its predictions.

3 types of models in


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3 types of models inMicroeconomics:

1. Models that explain resource allocation orchoice decisions of individual household,producers and firms.


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2. Models that explain how prices and quantitiesexchanged are determined in various types ofmarket structures.


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3. Models that examine the market economy as aninterrelated system (general equilibriummodel).

COMPARATIVE STATICS AND DYNAMIC


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COMPARATIVE STATICS AND DYNAMICANALYSIS

Comparative statics focuses on the shift ofequilibrium positions for an individual decisionunit, a market or an economic system.


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Equilibrium refers to a state in which there isbalance of internal forces and no tendency for thesituation to change unless outside forcesintervene.

A system in such an equilibrium may also betermed static.


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Ex. A commodity reaches equilibrium at price Php20. If demand will go up because of increase inpopulation or extensive advertising effort, pricewould go up to Php 22. Comparative analysis isapplicable here because of the shift in equilibrium.


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Dynamic analysis focuses on the pattern andrate of change for some variable between pointsin time.


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Ex. There is dynamic analysis if the model will statethat the price of commodity would increase in aweeks time.


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PARTIAL VS. GENERAL EQUILIBRIUM

Partial Equilibrium Analysis

This compares equilibrium changes for one decision

unit or one market, independent of related changesin the economic system.


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It assumes that, for the purpose of analysis, other

factors will remain the same (ceteris paribus).


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General Equilibrium Analysis

This recognizes the interdependence of all decisionunits and all markets in the economic system. All

variables are allowed to adjust in response to theinitial change.


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Here, demand will not only depend on one variable

like price. It will also depend on several otherfactors like income, population, advertising,promotion and the like.


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OVERVIEW OF ECONOMY

The Circular Flow ofEconomic Activity:

Basic activities:

Production

Consumption Employment

Income generation

Household-consuming unit

Firm producing

unit

Circular Flow of


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Circular Flow ofEconomic Activity


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The consumers pay for the goods and servicesprovided by the business firms. The businessfirms/producers on the other hand, pays theconsumers/resource owners for labor, land or

capital used for the operation of their business.

Economic issues that a nation should


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Economic issues that a nation shouldaddress:

1. What to produce?

2. How much to produce?

3. How to produce?

4. For whom to produce?


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What to produce?

The country should identify the type of goodsthat the society or the nation desires.


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Since the resources are limited, no economy isable to produce all the product that the people inthe nation desires.


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This is why a country should identify the goodsthat are most useful for the country.


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How much to produce?

This would refer to the quantity of each good thatwill have to compose the total output. How muchof the decided products to be produced will be

produced.


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How to produce?

This refers to the technique of production and themanner of combining resources to come up withdesired output.


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This involves the materials to be used. Will theprocess involve more labor or more machinery?


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For whom to produce?

This refers to the market of the producers. Whowill buy the products? Will the goods andservices be sold to high income groups or to

poorer buyers, to women or men?


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Types of Economic System:

1. Traditional

2. Command

3. Market Systems


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Traditional Economic System

Production decisions are made according tocustoms and traditions.

Example: A farmer engaged in the production ofrice does exactly what his father did when heplanted rice 20 years ago.


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Such system does not allow progress to beintroduced in the production techniques. This isnormally practiced in underdeveloped regions,especially in areas where transportation and

communication are nonexistent.


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Command economies:

The answers to the economic problems aredictated by the government through the head ofthe nation or a group of men designated by the

head to make decisions.


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The government owns and controls the factors ofproduction.

The system works on the principle that the

interests of the society should prevail over that ofthe individuals.


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Here, the consumers freedom of choice arecurtailed and this does not enable him toparticipate in the decision-making process.Individual preferences are not considered at all.

M k


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Market system:

This deals with economic problems byconsidering consumers choices. The indicatorsare consumers demand in the market, reflected

in the prices of goods and services.


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The market serves as signals to the producers

about what goods to produce and how much ofthese goods should be produced.

THE MARKET SYSTEM AND THE


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ENTERPRISE

Market system is best described as characterizedby free enterprise where individuals enjoy theright of private property.


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It places high value on individual freedom andallows self-interest to be the motivating force.

Under the free enterprise, individuals are allowedd f h f ll


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to do any of the following:

Purchase goods and services of his choice withinthe limits of his income.

Offer for sale his economic resources in exchangefor financial remuneration.

Establish a business enterprise of his choice for theproduction and sale of a desired product.


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The market economy is an economy whereindividuals exercise free enterprise.

THE MIXED ECONOMY


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THE MIXED ECONOMY

It is seldom that an economic system exists in itspure form. While the US exercises marketeconomy, there is a form of government

regulation and control.


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China is known to exercises command economy

but it may have adopted other economic systemsin certain occasions.


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Philippines adopts the 3 types of economic system:

1. Traditional a system used in isolated barrios2. Command although Filipinos exercise the

market system, they are also influenced bygovernment decisions, regulations and laws.

3. Market Filipinos exercise the different activitiesunder the free enterprise system.

chapter 1 eco3

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