1 Nature Of Economics.ppt

BASIC ECONOMICS Nature of Economics

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Topics • Fundamental Economic Terms and Concepts • Economic Activity and Resources • Types of Economic Systems • Macroeconomics and Microeconomics • National Development Goals

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Fundamental Economic Terms and Concepts • Economics can be traced to the time when Adam Smith published his path-breaking book, “The Wealth of Nations" in 1776. • Since that time, the study of economics has undergone rapid changes.

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What is ECONOMICS? • 1. Economics is the study of wealth. • 2. Economics is the study of how human beings go about the business of organizing consumption and production activities. • 3. Economics is the study of how to improve society and make human civilization possible.  4

What is ECONOMICS? • 4. Economics is the study of people in their ordinary life, earning and enjoying a living. • 5. Economics is the study of how people choose to use scarce or limited productive resources to produce various commodities and distribute these goods to various members of society for their consumption. • 6. Economics is the science that allocates scarce resources to satisfy human wants. 5

• Of the definitions mentioned above, the last definition summarizes what economics is. • Economics, first of all, is a science. • It, is highly related to other academic disciplines. History, sociology, psychology, anthropology, political science are all ,social sciences whose studies overlap with those of economics. 6

• Economics also draws from mathematics and statistics. • Economics is concerned with the wise allocation of scarce resources. • We have economic problems simply because resources are scarce. 7

• Economics is also concerned with the satisfaction of human wants which are often, unlimited. • Economic problems exist because resources are scarce while human wants are unlimited.

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The Importance of Economics

• To have a working knowledge of economics is to understand a very important part of human life. • We go through life concerned with earning a living, earning money and what money can buy. • Thus, an understanding of economics is an understanding of life's principal preoccupation. 9

• A working knowledge of economics would make the students and the citizens economically literate. • A big part of the news and the contents of the newspapers are concerned with the economic decisions of business and the government. 10

• If people make no effort to understand economic issues and do not make intelligent position about them, they surrender all power to those who claim to understand.

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• To illustrate, among the more pressing economic issues we face right now are: – Poverty – our debt problem – import liberalization

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Poverty Line • According to a World Bank study, the proportion of Filipinos living below the poverty line increased from 66 perrcent in 1965 to 77 percent in 1983. • Ironically, the highest incidence of poverty was among the country's food producers - the farmers. 13

• In 1985, a nationwide survey conducted by the National Economic Development Authority (NEDA), the Food and Nutrition Research Institute (FNRI) and the National Census and Statistics Office (NCSO) shows that 59.3 percent of Filipino families lived below the poverty line set at P2,376 monthly for a family of six. 14

• The NSO analysis of its family income and expenditures survey implies that the economic situation of Filipino families from 1991 to 1994 did improve.

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• In 1991, poverty incidence was placed at 39.9% of total families. • In 1994, per capita poverty threshold of P8,885 declined from 39.9% in 1991 to 35.5% in 1994.

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ISSUES : The Financial Crisis in Asia

• As early as the first quarter of 1997, a number of tell-tale events were evident prior to the outbreak of a regional financial crisis. • In Korea, corporate debt problems were evident with the failure of two chaebols (Hanbo and Sammi). • In Thailand, Somprasong, a major land developer, defaulted on foreign debt repayments as concerns continued to brew over the financial health of Finance One, a leading finance company. 17

• Thailand, where the crisis broke out in full force, experienced exchange market pressures and intense speculative activities in May and June and the Bangkok SET index trended down steadily through most of the second quarter.

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• In the Philippines, tell-tale signs manifested as early as February when the stock market went through a series of consolidations due to unfavorable developments (poor corporate earnings, anticipated increase in the US Fed Fund rates, etc.) that precipitated a series of speculative attacks on the peso and a surge in the average daily turnover of foreign exchange transactions in the Philippine Dealing System (PDS) beyond normal levels. 19

• After several weeks of speculative attacks, the Bank of Thailand announced on July 2 its decision to shift to a managed float of the baht and called on the International Monetary Fund for technical assistance.

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• The announcement caused several regional currencies to experience pressure ,prompting regional authorities of affected countries to take remedial actions. • In Manila, the Bangko Sentral ng Pilipinas (BSP) was forced to intensify dollar sales and raise its key policy rates to stave off the speculative attacks on the peso. 21

• As effectiveness of this policy stance diminished, the BSP allowed the peso to float freely against US dollar on 11 July. • On the same day in Indonesia, Bank Indonesia widened its intervention In Malaysia, the defense of the ringgit abandoned on 14 July. 22

• Pushed by the pressure, the rupiah was allowed to float begging on 14 August. • In the middle of the quarter, the crisis was stabilized partially and contained Southeast Asia amid continued mounting market pressure in Korea where another major chaebol , Kia Motors, suffered from financial distress. 23

• Likewise, intense speculative attacks were experienced by Hongkong in mid-August. • On 20 August, an IMF led financial support package of $17.2 billion was extended to Thailand.

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ISSUES : Deregulation • Despite the traffic, living in southern Metro Manila has its upside. • One of them is gassing up along Sucat Road in Paranaque, where two new players in the petroleum industry, Unioil and Total, are competing with the so-called Big Three- Petron, Caltex and Shell. 25

• From Caltex, I shifted to Unioil last year because of slightly cheaper prices and cleaner restrooms. • Earlier this year, I shifted to Total because its restroom is air conditioned, always perfumed and with ample supply of toilet paper. Its prices were the same as Unioil's. 26

• Yesterday, when I gassed up again at Total, I checked the pump prices along Sucat Road. • Caltex was selling premium gasoline at P13.16 per liter, unleaded at P12.75 and diesel at P8.71. • Over at Petron, the prices were P13.18, P12.78 and P8.71, respectively. • Shell's were P13.18, P12.78 and P8.71 for the same products. 27

• Compare these with Total's P13.10, P12;73 and P8.71 and Unioil's' P13.10, P12.75 and P8.69. • Not much difference there.

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• Curious, I checked the pump prices across town, in Manila Port Area, where the new oil players have no presence . • The Caltex station near the Manila Hotel was selling premium at P13.34, unleaded at P12.98 and diesel at P9.33. • Prices at the Petron station near the Manila Cathedral wereP13.25, P12.91 and P9.34. 29

• The only reason I can think of for this significant discrepancy in the pump prices of the same company's gas stations is competition. • And this was made possible by deregulation of the oil industry.

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• Its easy to paint the Big Three as national ogres. • Are they engaged in cartelized pricing? • I don't have the inside tract on this, but I see it the capitalist way; if there are two convenience stores near each other, selling the same product, with similar come-ons, the main consideration of an ordinary consumer is the price. 31

• This is why the Big Three's prices are almost the same. • And this is why on Sucat Road, they have been forced to bring down their prices to keep up with the new competition.

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• More often, he will have to deliver the bad news; that despite the oil companies' heavy subsidy, a fuel price increase is inevitable. • Every oil price hike will bring protesters marching to Malacanang. • Is this what the government wants? 33

• Since the oil industry was deregulated, about 35 new players have come in, although none is engaged in petroleum refinery like Petron, Shell and Caltex. • If we go back to regulation, we will keep out these new players who are posing stiff competition to the Big Three.

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• Now the government is making noises about reversing the trend. • President Erap should keep in mind that in a regulated environment, he can look good or pogi only if he's announcing a fuel price reduction.

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• Deregulation divorced oil pricing from politics.

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Basic Terms in Economics • Good – is anything which yields satisfaction to someone. – It is anything used to satisfy a person's wants and desires. – Goods may be tangible when they are in the form of material goods or commodities. – They may also be intangible in the form of services. – Tangible goods like shoes, books and umbrellas, and intangible services like those rendered by the doctor, the teacher, or the painter, are all used in the satisfaction of human wants and needs. 37

• Consumer Goods – classified according to use. Goods which – softdrinks and food are called consumers goods.

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• Capitalized Goods • Goods used in the production of other goods and services • Examples of these are buildings, machinery, and equipment.

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• Essential Goods – Goods may also be essentials, if they are used to satisfy the basic needs of man such as food, shelter, and medicine.

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• Luxury goods – are those goods man may do without, but are used to contribute to his comfort and well being. – Perfume, chocolates and expensive cars are luxury items that are purchased only by those who can afford.

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• Economic goods – is a good which is both useful and scarce. – It has a value attached to it and a price has to be paid for its use.

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• Free Goods – If a good is so abundant that there is enough of it to satisfy everyone's needs without anybody paying for it, that good free. – Air is free, but air from the electric fan is an economic good.

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• Manufacturing or Industry Goods – Goods created by means of production. – It may involve the physical transformation of a commodity such as the conversion of leather into shoes.

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• Agricultural Production Goods – Production may also take place in the farm. – Planting and harvesting of rice, corn, coconuts and sugar are agricultural production. – Even exploration for oil, minerals and precious metals is production. – All these activities are carried out to provide goods and services for use in the satisfaction of man's wants and needs. 45

Economic Resources • The things which are needed to carry on the production of goods and services are called economic resources or factors of production. • These resources are land, labor, capital, and entrepreneur. • They are the basic resources because they constitute the basic needs in production. • They are the most basic tools used in the production of goods and services. 46

• Land – Strictly speaking, it refers to all natural resources, which are given by and found in nature, and are, therefore, not man made. – This term includes the soil, rivers, forests, and mineral deposits. – Land is an economic good because it is scarce and a price has to be paid for it. – Thus, people who own land and offer it to others for their use, earn an income called rent. The less the. supply of land available for man's use, the higher is the rent that has to be paid for it. 47

• Labor – It is any form of human effort exerted in the production of goods and services. – Labor covers a wide range of skills, abilities, and characteristics. It includes factory workers who are engaged in manual work. – It also includes the accountant, economist, nurse, typist, and other numerous people who leave their homes in the morning to be in time for their 8-hour work. 48

– The supply of labor in a country is dependent on its population and on the percentage of this population that is willing to join the labor force. – Naturally, a country with a high population growth rate is expected to come up with a bigger labor supply. – Still, its number of workers will depend on factors like the age distribution of the population, the age at which young people finish school and start work and the age at which people retire. 49

– The labor supply is also highly dependent on the people's social and cultural practices. – Are women workers discriminated against? – Are married girls liberated enough to work despite marriage, instead of being plain housewives?

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– The country’s supply of labor is also affected by the migratory tendencies of its population and by the influx of workers from other countries. – While we lose hundreds of workers yearly to Saudi Arabia, Libya, the USA and other higher paying countries, our labor supply is also expanded by the foreigners who come here and get employed in jobs which otherwise should be held by Filipinos. 51

– Since labor supply is not available in any amount at a zero prize, anybody who expends his efforts in the production of goods and services earns an income. – Wages, which are the return on the use of labor, include salaries, commissions, tips, and other forms of remuneration.

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• Capital – Capital refers to man-made goods used in the production of goods and services. – Capital does not only include money, it also includes buildings, machinery, raw materials, and other physical necessities for use in production. – A nation's capital is dependent on its level of savings. 53

– Savings refer to the part of a person's income which is not spent on consumption. – It therefore involves a sacrifice because consumption has to be given up for one to save. – Capital is therefore an economic good and the owner of capital earns income for its use. – This income is called interest. – Thus, if you bring your money to the bank for deposit, it earns interest because you are actually lending capital to the bank. 54

• Entrepreneur – Oftentimes, the entrepreneur is not presented as a separate factor of production, but is classified as part of labor. – However, the entrepreneur does a special type of work and is, therefore, not ordinary labor. – He is the person who combines the other economic resources for use in the production of goods and services. 55

– He decides on the combination of land, labor and capital to be used in production. – Since not everybody has the managerial and organizational ability to be an entrepreneur, entrepreneurship is an economic good that commands a price. – This price is the income earned by the entrepreneur and is called profit. It is the amount that is left behind after all allocations to the other economic resources have been made. 56

The Need to Choose • Scarcity is the reason why people economize. • Scarcity refers to the limitations that exist in obtaining all the goods and services that people want. • It gives rise to economic problems and it is the reason why man has to make a choice. 57

• If all goods were as free as air, there would be no need to economize. • Because of scarcity, any society must confront 3 fundamental and interdependent economic problems:

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• 1. What to produce and how much? – This is a decision on what goods and services to produce and their quantities. – This would depend oh what is needed, what is wanted and what has to be produced.

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• 2. How shall goods be produced? – This is decision of what resources are to be used in production, by whom the goods will be produced, the technological manner in which production will take place. – A country with an abundant labor supply would be expected to use a larger amount of that resource in its production of goods and services.   60

• 3. For whom shall goods be produced?  – This question is now on the problem of distribution. – Who will benefit from the production of goods and services? – How much of total production will each consumer get? – Will the goods be bought by the rich or by the poor? 61

• These three questions are basic to all economies. • However, the manners in which these economies answer the problems differ. • The country's economic organization has a lot to do with how the decisions to these fundamental problems are arrived at. • In the same manner, the way a nation answers the problems determines the type of econo• mic system it adopts. 62

Types of Economic Systems • 1. The Traditional Economy – This is basically a subsistence economy. – A family produces everything that it consumes. – Decisions on what, how, and for whom to produce are made by referring to the traditional manner of doing things. – Production is carried on in the methods used by the forefathers, and is therefore very primitive. – This type of economic system is very backward since it does not allow for change. 63

• 2. The Command Economy – In this type of economy, the means of production are owned by the government. – Its decisions are arrived at by planners or government men who dictate what, how, and for whom to produce.

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• 3. The Market Economy – The basic characteristic of this economy is that resources are privately owned and decisions are made by the people themselves. – Since every consumer arrives at his own decision, the system is coordinated through an interlocking network of market and f prices. – The system depends on prices set by the conditions of demand and supply.

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– Competition is supreme; there is consumer sovereignty, and the price of the good is the guiding factor for producers to know what and how much to produce.

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• It is in the goods market that the prices of goods and services are determined. • If there is a strong demand on the part of the consumers for rice, this will be reflected in the peso votes, which are the amount of money they are willing to spend on rice. 67

• Producers respond by obtaining land, labor, and capital from the resource market for use in the production of rice. • The supply of rice in the market will also determine the price at which rice will be sold in the goods market.

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• In the resource market, the prices of the resources: the rent, salaries, and interest, will depend on the amount made available by the resource owners as well as the amount of these resources that the producers will be. willing to hire.

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• The Mixed Economy – It is seldom that an economic system exists in pure form. – The United States economy is predominantly market, but it cannot be denied that there exists some form of government control. – The Union of Soviet Socialist Republic can best be described as command since its decisions are planned by the government, however, the price system is also used, even if only minimally. . 70

– The Philippine economy is a mixed economy since it applies a mixture of the 3 forms of decision-making. – However, it is more market-oriented rather than command or traditional.

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• Opportunity Cost – When one makes a choice, there is always an alternative that has to be given up. – A producer who decides to produce shoes, gives up other goods that could be produced with the same resources. – A student who buys a book with his limited allowance, gives up the chance of eating out or watching a movie. 72

– An M.A. graduate who decides to teach, gives up the salary he would have earned had he worked in a big firm like San Miguel Corporation. – The values of these alternatives given up are referred to as opportunity costs. – When we make a decision to buy Good A, we are in effect, making the decision not to buy Good B. 73

– Let us study a graphical presentation of this concept. – Let us say that you as a student, have a weekly food allowance of sixty pesos. You decide this week to spend it on a combination of cokes and chicken sandwiches. – In the school canteen, a chicken sandwich cost P6.00 and a coke P2.00, giving you the following alternatives: 74

– The values of these alternatives given up are referred to as opportunity costs. When we make a decision to buy Good A, we are in effect, making the decision not to buy Good B. – Presenting the graphical representation of the concept:

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Let us say that you as a student, have a weekly food allowance ofp300.00. You decide this week to spend it on a combination of cokes and chicken sandwiches. In the school canteen, a chicken sandwich cost P30.00 and a coke P10.00, giving you the

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All possible combinations:

•The connection of possible combinations is the consumption possibilities line. •This is a downward sloping line that reflects the inverse relationship between the consumption of cokes and the consumption of sandwiches. •Let us say that your original choice is a combination of 15 cokes and 5 sandwiches. •However, within the week, you decide to eat one more sandwich. You will have to give up 3 cokes to do so. Your new choice will be 12 cokes and 6 sandwiches and your opportunity cost is the value of the 3 cokes you have to give up. 77

• Let us now take the case of a laborer who spends 8 hours of his 24hourday for sleep. The remaining 16 hours he can divide between work and leisure. • The following table shows his possible combinations of work and leisure time. 78

If the worker goes to work for 8 hours day, this gives him a leisure time of 8 hours. On a day that he is asked to go on overtime work of 2 hours he will have to give up 2 hours of his leisure time. 79

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• Let us now look at the side of the producer. • Given a fixed amount of a resource, he has the choice of what goods to produce with that limitation. • Supposing a fixed amount of resource can be used for food production or for the construction of houses. • Let us show the alternative combinations on the next graph. 81

The combinations of food and houses are shown in. the production possibilities curve or production frontier. We can see that if all the resources were devoted to food production, a maximum of 1,000 units of food would be produced. If on the other hand, all –Other combinations can be obtained at any resources were devoted, to the construction of houses, a other point along the curve. maximum of 10 houses will –For example, on point C on the graph, output would consist of 500 units of food and be built.

7 houses. –Point D on the graph, although a feasible point, since it is within the curve, is not a desirable combination since it would be a production of output that is less than what is the maximum feasible output.

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• If an economy operates exactly on the frontier, it is in a condition of full employment since it uses up all the available resources to produce the maximum possible output. • Point D is a condition below full employment and is characterized by idle capacity since not all available resources are used up. 83

• The production possibilities curve is a downward sloping curve that is concave to the point of origin. • The negative slope reflects the inverse relationship between production of houses and food. • However, as we move along the curve, we give up larger amounts of food for each additional house produced. 84

• The transfer of resource in the production of a good where it is more productive, to the production of another good where it is less productive would produce an overall drop in .output.

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• Supposing the economy originally operates at point C on the curve. • Then a growing demand for food necessitates a change to point F on the graph. • This means the economy has to give up 1 house to increase food production to 600 units. • This amount of housing that is given up is another example of the concept of opportunity cost. 86

• When economic policies are formulated, the opportunity cost has to be considered. • The implications of what has to be given up have to be studied and priorities have to be set. • Less urgent needs are given up for the more important ones, in view of the limitations existing in the economy. 87

Tools of Economics • Economics is a positive science that means it deals with what is. • This is in contrast to normative economics which deals with what should be. • Economics is, therefore, a study that attempts to explain how an economy operates. 88

• To be able to understand and explain economic events and economic theories, the student of economics must learn how to use the basic tools of Economics. • Firstly, he has to learn how to apply logic in order to enable him to reason out properly and to draw conclusions. 89

• Secondly, the use of mathematics will enable him to conceptualize and quantify economic principles. • Thirdly, he uses statistics to describe quantitatively human behaviors and to serve as empirical evidence in the testing of hypothesis.

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• These tools equip the economist or even the student of Economics to approach the subject in a scientific manner. • This scientific approach can be outlined. in the following stages:

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• 1. Observation – An analyst should be able to recognize conditions, behaviors and events in the environment. – By simply looking around, he shall be able to obtain information necessary to analyze an economic principle.

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• 2. Definitions and Assumptions – The analyst should describe the specific uses of the study and the peripheral conditions which affect the economic behaviours which are being studies.

• 3. Deductions – These are hypotheses or theories presented for empirical validation. – They are temporary conclusions made, based on one's observations and are still subject to the presentation of evidence. 93

• 4. Empirical Testing – Deductions have to be tested as to their validity and correctness. – The presentation of the empirical evidence will be the basis of rejecting or accepting a hypothesis. – The evidence gathered consists of statistics which is used to verify one's guesses. 94

– In the Philippines, important government agencies serve as major sources of statistics: • the National Census and Statistics Office (NCSO), • the National Economic Development Authority (NEDA), • the Central Bank • and even the municipios and the city halls.

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Macroeconomics and Microeconomics • Macroeconomics is the division of Economics that deals with aggregates. • It presents pictures of totals: income, output, employment, spending and price level. • It studies the economy as a whole.

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• Microeconomics is the division of Economics that studies the economy inputs. • It is a study of the price system, the individual consumer, the individual firm. • It deals with the following questions: – what determines the relative prices of goods?; – what determines the breakdown of national income aggregates into various types of goods and services? 97

• Macroeconomics and Microeconomics are equally important. • One cannot study the whole without studying the parts. • Neither can one break down aggregates into components without knowing what the aggregates are and what components they are made of. 98

• The big picture is made up of parts. • Understanding the picture as a whole is just as vital as understanding the parts.

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