THE NATURE AND IMPORTANCE OF ECONOMICS What is Economics? The Nature of Economic Choice The Fundamental Economic Problem Types of Economic Systems The Economic Resources Economic Goals %. Divisions of Economics i. « Scanned with CamScannerTURE AND THEM RTANCE OF IMF’ ECONOMICS sate the lives of individuals j, Ls activities perm farmer chooses tO Brow Econ e ; ing an econom; aspect. js making Mic ery 85P' 88 obits or losses. When a sion that may-result ine" education course gecision T= di ate chooses toeny0” decision that wil high school gra ie he is also making @ eth 1 al rather than Sci te vancial capability. Since there is always a affect his future ly of tomatoes and teachers, the oe a earl he! farmer and the future teacher wi] econ always be at risk. Ns i very person makes economic decisions, major or minor, throughout their lives. As only a few become onomically well-off, it may be safely presumed that they are the only ones who made the right economic decisions. ‘this statement is true, then that alone would be sufficient Teason to study economics. ae Economics; however, should not be the concern of individuals only, butalso of Organizations and institutions including the government. ili smnment - When the Philippine government decides to: ves to Stabilize th of the base the value of the peso, for ere = ofan economic motive, When oing aan MBineering rather than nthe basis of some | uae with é RiThe above-cited statements now lead us to inquire on the nature of economics and its various aspects. The subsequent chapters will be an attempt to answer the said questions. WHAT IS ECONOMICS? Various writers have given us their share of the definitions of economics. Some of these definitions are presented below: © Walstad and Bingham define economics as “a social science concerned with using scarce resources to obtain the maximum satisfaction of the unlimited material wants of society.”! Samuelson and Nordhaus define economics as “the study of how societies use scarce resources to produce valuable commodities and distribute them among different people.” Economics, according to Collin, is “the study of iA production, distribution, selling, and use of goods and services.”3 To McConnell and Brue, economics is “a social science concerned with using scarce resources to obtain the maximum satisfaction of the unlimited material wants of society. * Parkin and Bade’s definition refer to economics as “the @ study of how people use their limited Tesourges to try to satisfy unlimited wants.”5 What the Definitions Indicate wie the teader may have noticed, the definitions point two important factors: scarce resources and unlimited wants of people. They represent two opposing realities, ie., Rsourees are just not enough to satisfy people since + wants are -unlimited and resources are limited. Since this is so, the Scanned with me cannerSoncern will now be focused on how these resources ‘eivantl as they are) will be used to satisfy wants to the highest egree possible. The definitions forwarded by the above-cited economists agree on all the three aspects: scarce resources, unlimited wants, and maximum satisfaction. What Scarcity Means, Scarcity refers to the condition wherein most things that people want are available only in limited supply. These things, called economic goods, are generally scarce and must somehow be rationed, whether by price or by some other means. What is an Economic Good? An economic good is anything, either a physical commodity or a service, which Yields utility and which could command a price if bought or sold in the market Examples of economic goods are books, bicycles, residential lot, and medical care. What Unlimited Wants Mean. Wants refer to “a Person’s desires or preferences for specific ways of satisfying abasic need.” Thus, to Satisfy an unsatisfied need, a Person agency. Acompany needs fully trained emplo: ees and want: to hire the services of a training firm, sh wi _-THE NATURE OF ECONOMIC CHOICE ~™ Scarcity ma be defi : d desires and the Ps an ie lance between our 'Y Poor and ri Tich to satisfy all the wants Scanned with CamScannerOpportunity Cost In deciding which want to satisfy, the decision-makers must reckon with opportunities that will be lost when a particular choice is made. When we want to have more ofa good or service, we are actually sacrificing something in exchange. The concept of opportunity cost now comes under consideration. Opportunity cost may be defined as “the cost of choosing to use resources for one purpose measured by the sacrifice of the next best alternative for using those resources.”” For example, if a farmer chooses to send his child to college rather than expanding his farm’s output by 100%, his opportunity cost is the additional output of the farm. Ifa erson is considering sleeping rather than choosing the next best alternative, i.e., meeting a friend, then the opportunity cost of sleeping is meeting a friend. THE FUNDAMENTAL ECONOMIC PROBLEM The basic economic problem may be derived from the above-cited definitions and discussions. Since resources are not sufficient to satisfy the unlimited wants of people, decisions must be made with the said constraints in mind. ‘As such, the following questions must be considered: 1. What goods and services must be produced and in what quantities? How shall these goods and services be produced? ° For whom shall these goods and services be produced? . Decisions on What and How Much to Produce Human society must come up with answers to the following questions: Which goods or services must be ods o1 produced? O the many possibilities, shall we produce rice or ek Scanned with CamScannerini tity of : : a limited quant today? If we decide on rice, shall it be @ Te te many es ta high-quality rice or low-quality rice Sar Gots Mie rRhaghat goods like bread or ane pe Ria ahadting bike equipment? Shall we pro! _ setntions or many vegetable farms i d Decisions on How Goods and Services Shall Be Produce Society must also make decisions on how as pare ae, services shall be produced. Who shall pane t “ ee resources and technology must be used? Who wi = and who will be clerks? Will the educational eee cenaiet of government schools alone or a combination of pul e a private schools? What types of organizations shall ee goods and services? Will they be privately-owned or publicly- owned? Decisions on How the Goods and Services Shall Be Distributed The society must also resolve the issue of who shall consume the goods and services produced. Who benefits from the results of economic activities? How shall the goods be distributed? Shall we have a society of a few rich people and many poor people? Shall we have high-salaried managers and low-salaried workers or vice versa? TYPES OF ECONOMIC SYSTEMS The distribution of goods and i i Partly on the availability of Tesources, Shela ee aoe Prevalent in a given Society, Distribution shall 7 dene Partly on the objectives of the economic system | See preee (5 Adapted. At this point, i becomes important ts a discussion of the various economic ena ‘ Economic Systems are Classified ag foll — capitalism ( OWS: communism sot mired economies, meet ts S Scanned with CamScannerCapitalism Capitalism is an economic system mainly characterized by private individuals owning and operating the majority of businesses that produce goods and services, The decisions on what goods and services are produced, how they are produced, and how they are distributed are determined by competition and consumer demand. Forms of Capitalism. The economic system of capitalism consists of two forms: pure capitalism and modified capitalism. Pure capitalism is characterized by the following: 1, All economic decisions are made without government intervention; 2. Competition serves to determine the goods and services needed by society; 3. Competition will determine who will survive in the marketplace. Under the modified capitalism, the government intervenes and regulates business toa certain extent. me Rights of Capitalism. Capitalism is vested with basic tights which are as follows: 1. Private property - People have the right to own property, and their heirs have the right of inheritance. These rights motivate individuals to work and save money to buy property. - 2. Profits - People have the right to earn profits and dispose them as they wish. 3. Business decisions - People have the tight to engage in business and determine how their business will operate. 4. Choice - People have the freedom to chi a 1oose what perpen to undertake, where to establish their residences, what products and services to buy, etc.ism «on the government Communi stem ogc 8 which ze Pak pete ote tion’s resources.”"” It 3s ve The rights of ee oy the opposite of CEE eat business ey Rich are private property, Hf : communism. enact choices are not allowed un - Di AgaNce The decision on what goods and aie aiaamiited how they will be produced, and how they W# People have eadasaed by central government when It is no choice of jobs as this is dictated by he aerial and who the government which decides who will {ean own and will be soldiers, and only the governmen’ operate businesses. Socialism Under socialism, the government owns and operates the basic industries like telecommunications, water service, postal service, transport, banking and selected manufacturing businesses. Private individuals are allowed, however, to own and operate small businesses. The government determines what goods and services to:produce, how to produce, and how they are distributed. Those-not-produced by the government are provided by private individuals depending on consumer demand and Tesource availability. j Mixed Economies Amixed economy is one that has than one economic syst F enterprises. elements from more tem, It contains both private and state ig “nomic system and “mix” these wi another system. This came about as a result of oo ‘© Produce the required results, © - Scanned a anscaninerTHE ECONOMIC RESOURCES The aim of any economic system is to produce the required output of goods and services. To be able to do so, the following resources are requried:" 1. land 2. labor 3. capital 4. entrepreneurial ability _ Land Itis one of the factors of production which include land used for agricultural or industrial purposes as well as natural resources taken from above or below the soil. Natural resources consist of energy resources like fossil fuel and geothermal emissions, non-energy resources like gold, diamond, and limestone, air and water, and many others. Labor Labor refers to that basic factor of production which are productive services embodied in human physical effort, skill, intellectual powers, and others. It consists of human time spent in production like driving buses, feeding cattle, singing in night clubs, acting in movies, or repairing household appliances. Capital The third basic factor of production which is capital tefers to durable goods produced in order to produce other goods. It consists of buildings, plant and machinery, roads, computers, ships, electric guitars, tennis balls, etc: Entrepreneurial Ability Land, labor, and capital will remain as they are until Someone taps them to produce the required goods and services. Actual production needs the ability of an entrepreneur to decide on and implement the ri ht combination of the first three factors of production. me Scanned with CamScanner| The entrepreneur per 1. 2. ~ ECONOMIC GOALS ~ {\ forms the following functions: ini lab ; es production by combining land labor, Be oral to make goods and servi be i, ia makes business Pele Pe ane pres et i e es to produc goods or servic them; He bears the risk suffer the consequi the same light, he must reap if he succeeds." fs i i cts, new He innovates by introducing new Pro’ ucts, technology, and new ways of organizing business. ; : baie ret ie f his business decisions. s ence of losses if he fails, but in the profits as a reward MAM Every system invented by man presupposes some goals. These include economic systems which seek to achieve the following goals:"* Lun A. Y 4 Economic growth - What is desired by society is a higher standard of living which is translated into the production of more and better quality goods and services. Fullemployment - There must be jobs for those who are willing and able to work. Economic efficiency ~ This is a goal that requi mas ae to derive the maximum benefit for rhe €conomy should be able Hen tions in the general level of i free om. : choose wha . ~Ahigh degree of : b teconomic activity fe freed 0 e afforded the vari tind om. : executives, worker. shoul ,6. Anequitable distribution of income -The economy must not be made up of a certain group that is so poor and destitute while other groups wallow in great luxury. 7. Economic security - There should be enough provision for those who are not able to earn minimal income like the aged, the chronically ill, the disabled, etc. 8. Balance of trade - A balance of trade that is reasonable must be maintained. DIVISIONS OF ECONOMICS Economic theory is conventionally divided into the following: 1. microeconomics, and 2. macroeconomics. Microeconomics Microeconomics is concerned with “the behavior and activities of specific economic units — individuals, households, firms, industries, and resource owners.” Examples are the determination of the price of a single product, or the behavior of a single consumer or business firm. The central concept in microeconomics is the market. Are a Macroeconomics Macroeconomics is that division of economics that deals with “the behavior of the economy as a whole with respect to output, income, thé price level, foreign trade, unemployment, and other aggregate economic variables.”"° It views all consumers as a unit, i.e., the consumer sector, all businesses as an aggregate unit, i.e., the business sector, and all the various government agencies as a unit, i.e., the ernmental sector. The purp r ation explain and predict th cl economies. Scanned with CamScannerJUMMAR' , ple find ty : : a subject leh a Et of our cant ics 15 a5 wevel, ; a oe sions, ie for every WFO economy. boring. Econ pay eis must be a very importay, decisions we MaKe, subject learn. ’ f i itions of economics oe i. Various defini Two common import i ate by various authors: urces and unlimite wants. The : a eran the problem of scarcity, task of economics is to address P The fundamental economic problem is to make ices to produce, how they isi hat goods and services Skies i for whom they shall be produced, x tal economic problem wil] Deciding on the fundamen| : differ in approach depending on the type of economic system of which there are four types: capitalism, communism, Economic resources are needed to produce the required output. The resources consist of land, labor, capital, and entrepreneurial ability. : Economic goals provide a Sense of direction to any tall expire rae Boals are economic growth, eaten freedom, snsitabie di Ss level stability, = : fe is: _ . economic security, balance othe ution of income, Economic theory ; . ; i Ty is Subdiyi . categories; mi vided ne nes Microecono, ics and Ra 0 two broad Seal with havi ‘Toeconomics.Terms To Remember Economics Socialism Scarcity Mixed economies Economic good Economic resources Unlimited want Economic goods Opportunity cost Microeconomics Capitalism Macroeconomics Communism Review Questions 1. Why is the study of economics an important exercise? 2. What does scarcity mean? Give examples of opportunity costs. In what ways are capitalism and communism different? 5. Why is the entrepreneur an important economic resource? 6. What economic goals do you think are pursued in the Philippines? 7. What is the distinction between microeconomics and macroeconomics? ENDNOTES 1William B. Walstad and Robert C. Bingham, Study Guide to Microeconomics, 12" ed. (New York: McGraw-Hill, Inc., 1993) p. 308. 2Paul A. Samuelson and William B. Nordhaus, Economics, 14" ed. (New York:McGra iB Scanned with CamScannerTHE CIRCULAR FLOW OF ECONOMIC ACTIVITY Stock and Flow Concepts The Circular Flow of Goods, Services, and Income The Production Process The Flow of Goods Among Producing Firms Goods and Income Flow Among Households and Various Types of Producers Income Flow The Concept of Equilibrium The Effect of Savings and Investments Flow in a Market with Government and Foreign Countries SS Scanned with CamScannerCULAR FLoy Cire ECONOMIc ACTIVITY _. activities undertaken in ,, sic activities , ) There are two x consumption. The firms perfor, y: production hile households underta,, a ion W the production function consumption. eed the economic resource; ple to produce, firms nee?” nic res app me labor, and capital. The individual, cnr holds own these resources and they comprisi: house! i brane the als with the services of these resources. When the economic resources are used in the production ; of goodsand services, employment of these resources occurs. i Aprice is paid to resource owners whenever these resources I are used in production. Rents paid to the landowner, interest i to the capitalist, and wage to labor. The goods and services produced by these firms are consumed by households. gull see steticn between households and firms K ‘arcing production, consumption, employment, and eo income generation results to the circular a i ‘oods and i Setvices in the economy, P ‘e y Ss "g AND FLOW CONCEPTS Tief discussj d ide a better ot the stock and flow concepts wil! ivity, “standing of the circular flow of a > = * ™m Scanned with CamScannerStock refers to the measure of quantity at a point of time. It is art accumulation of a commodity like gasoline in a fuel tank. Wealth as of December 31, 2001 is a stock. Flow refers to the measure of movement of quantity over a period of time. The movement of water from upstream to downstream is a flow. Income represents money earned per year and is also a flow. Other examples of the flow concept are as follows: 1. saving money at a particular rate like P'1,000 per month or 12,000 per year; 2. consumption at a certain rate like 100,000 per year." THE CIRCULAR FLOW OF GOODS, SERVICES, AND INCOME The basic aspects of the economy which include production and consumption are subject to the stock and flow concepts which are circular in nature. As presented in figure 1, the activity performers (firms and households) are engaged in a cycle of exchanges. The Production Process The process of producing goods and services involves households and firms in a circular flow. As shown in Figure 1, the economic resources of land, labor, and capital are provided by the households and used by the producing firms. These firms, in turn, produce goods and services which are delivered to households for consumption. The Flow of Goods Among Producing Firms Within the circular flow of the production process is another flow which happens among different types of business firms. This flow involves raw materials, intermediate goods, and final goods. POW Scanned with CamScanner(Organizers and Users of Economic Resources) HOUSEHOLDS (Resource Ownes) | GOODS & SERVICES | | (Output) | | Raw materials are goods which are still unprocessed | like wood, sand, and iron ore. Intermediate goods are partially processed and still need further processing before they can be finally consumed. Examples of intermediate | goods are steel bars used for construction, flour used in } making breads and cakes, and microchips used in manufacturing electronic appliances. Final goods are peveesed ops that are ready for final consumption like | & x P a candies, and ready-to-wear clothing. [intent BRMEDIA = von pRODUCERS payment 202c R= PRO! j oo deme payment —_— final a goods payment Income Flow When money is spent by households for consumption and by firms for production, a circular flow of income is re eendinne of one unit becomes the income o! Income ‘e 1 rena f¥0 distinct circular flows as follows: edi tan ims and As shown in Figure 4 labor, and capital are bough ease 22, the services of land: juction. As a result, money j canned with CamScannerhouseholds buy the goods and services produced by the firms. Money is paid by the households to the firms. This last action completes the circular flow of income among households and firms. As illustrated in Figure 5, on page 22, purchases are made between firms. The output of raw materials firms are sold to intermediate goods firms, which, in turn, sell their output to final goods firms. The final goods are sold to households for consumption. These purchases result to a circular flow of money from buyer to seller. The Concept of Equilibrium The economy will be in equilibrium if the amount received by firms from households is equal to the amount received by households from firms. Disequilibrium happens when either households or firms do not spend all their incomes. If households, for one reason or another, reduce their purchases, firms will receive a reduced amount of income resulting to their inability to maintain current levels of purchases from households. When firms actually reduce their purchases of economic resources, some laborers will lose their jobs, and some land and physical capital will become idle. The result is a corresponding reduction in the income of households. The Effect of Savings and Investments If the total output of firms are purchased by the households and the total economic resources are bought by firms, there is equilibrium in the market. In reality, however, households allocate a part of their incomes for future use like providing money for old age. Asa result, disequilibrium happens because firms are hard-pressed to dispose all their output? The circular flow will tend to contract. To prevent this from happening, some other means for disposing the ‘ unsold portion of the output must be tapped. 5‘ Scanned with CamScannerFigure 4 oF INCOME BETWEE, ae omtou FDS AND FIRMS OME FLOW obs interests, rents) INCOME FLOW (purchase of goods and services) Figure 5 THE CIRCULAR FLOW OF INCOME BETWEEN Finns <—— | NTERMEDL IEDIATE Income flow for purchase of raw materials GOODS FIRMS Income flow for purchase of intermediate goods . a FINAL GooDs FIRMS, en “tiga HOUSEHOLDS fh. _._ RIN Z canned with CamScannerFigure 6 THE EFFECT OF REDUCTION OF PURCHASES REDUCED INCOME (as a result of reduced purchases of economic resources) REDUCED INCOME (asa result of reduced purchases of goods and services) Figure 7 THE CIRCULAR FLOW OF GOODS AND INCOME IN A SIMPLE ECONOMY WITH SAVINGS & INVESTMENT 4 capital goods rent, wi fund foods ins, ‘payments Sepa lifer ‘ Lakh HOM, savingsal isposing unsold output: F; Investment isa way of “pyil services for the pu * ectnttopeintegetyetets l *, f e: tated e 5 of increase oney now to e penditures f., ital outlay in the ts capita hep f households are matched }, the saving: of firms, disequilibrium is nepatey yeiplt ‘come Will tend to normalize. naMarket with Government and ae Countrie, i philippines, there are tw In an economy like the # two important sectors that interact with the Brasstolds and firms, the government an The governme! pinctions Ai the economic resources of land, labor, and capital from households. Land is used by the government to Jomate its building and faciliti .Jaborishired to fill up various itions in the different government agencies; capital is borrowed to produce the necessary facilities and services. Payments in the form of wages, rents, and interests are remitted to the households by the government. Government money, however, is spent not only in buying the economic resources from households but also the goods and services produced by firms. Payments are also remitted to these firms. The goods and services purchased by the government come in a wide variety of forms: from office supplies '° pare equipment, and from consultancy to janitorial Households purchase goods and services from other cui ier ume le ES ee ae payments are sent to the Local firms sell goods and services li , ' roducts i i like agricultura P to foreign countries. Payments are Be Ried to the Jocal firms by foreign buyers. Figure 8 illustr I y canned with amScannerFigure 8 THE CIRCULAR FLOW OF GOODS AND INCOME OF HOUSEHOLDS AND FIRMS WITH THE GOVERNMENT AND FOREIGN COUNTRIES wor { capital 3 payments for “gle ‘and services inert 47 tr HOMO ERM Summary Firms produce goods and services by using the economic resources of land, labor, and capital which are provided by households. When goods and services are delivered to households for consumption, payments are remitted to the firms. Money payments are also received by the households when the economic resources they own are used by firms. The payment made by one party becomes the income of the other party. OE goods and services, and payments follov | Scanned with CamScanner=U Bae ae . and slow me ric activity: Stock is 4, of 20” nile flow 16 is the Movement ., sto’ 10 the circular odity, tion of com period accum ven P commodl over a8 covers the production PLOces, the circula income ae petween households in red od ie and eX exchanges between n firms, 0 e) firms ids, the g° and investm mnie Saki savingsand investnens, Terms To Remember Stock Circular Flow Goods & Income Flow Government Foreign Countries Investment Flow Households Equilibrium Firms Savings Review Questions 1, Whyis production and consumption important in discussing the circular flow of economic activity? 2. What prices are paid for the use of the economic » resources? 3. eek lala w may the ci: : Taine ular flow of goods and income be exp) 5. What two dis " income? tinct flows may be classified with _ 6 What hay P| neat happens to the a when either adBAS |, ELEMENTS q, DEMAND AN) SUPPL, - The Market , How a Market Functions " Market Demand NonPrice Determinants of Demand Effects of Changes in NonPrice Determinants of Demand Market SupplyBASIC ELEMENTS OF DEMAND AND SUPPLY The fundamental economic problem calls for making definite decisions on what goods to produce, how they shall be produced, and for whom they shall be produced. To address the problem, the market is used as the principal mechanism. THE MARKET ‘A market exists when “buyers wishing to exchange money fora good or service are in contact with sellers wishing to exchange goods or services for money.”” Itis where people are left alone to make their tre ions. It is the forces of demand and supply interact. The meeting of these two opposing forces paves the way to providing answers to what goods to produce, how they shall be produced, and for whom they shall be produced. These happens because it is through the market where “buyers make known their decisions to buy or not to buy and on what terms, and sellers make known their willingness and lity to sell or not to sell and on what terms.”? How a Market Functions _ Markets are strictly made up of buyers and sellers. The actions and decisions of buyers constitute demand for a product or service, while the sellers’ decisions and actions constitute supply. Scanned with CamScanner