Economics 101

Definition of economics
• the study of how individuals and societies use
limited resources to satisfy unlimited wants.
 Fundamental economic problem
• scarcity.
• individuals and societies must choose among
available alternatives.
 Individual’s Economizing Problem
• Economizing Problem is the need to make
choices because economic wants exceed
economic means
• Limited Income
• Unlimited Wants
• Budget Line
 Society’s Economizing Problem
• Scarce resources
• Resource categories
– Land
– Labor
– Capital
– Entrepreneurial Ability
 Economic resources
• land
– natural resources, the “free gifts of nature”
• labor
– the contribution of human beings
• capital
– plant and equipment
– this differs from “financial capital”
• entrepreneurial ability
 Resource payments

Economic Resource Resource

payment
land rent
labor wages
capital interest
entrepreneurial ability profit
Positive and normative economics

• positive economics
– attempt to describe how the economy
functions
– relies on testable hypotheses
• normative economics
– relies on value judgments to evaluate or
recommend alternative policies.
 Economic methodology

• scientific method
– observe a phenomenon,
– make simplifying assumptions and formulate
a hypothesis,
– generate predictions, and
– test the hypothesis.
Microeconomics vs. macroeconomics

• microeconomics - the study of individual

economic agents and individual markets
• macroeconomics - the study of economic
aggregates
 Algebra and graphical analysis
• direct relationship
Direct relationship
Inverse relationship
Opportunity costs
 Scarcity
• Economics is the study of how individuals
and economies deal with the
fundamental problem of scarcity.
• As a result of scarcity, individuals and
societies must make choices among
competing alternatives.
 Opportunity Cost
• The opportunity cost of any alternative is defined as
the cost of not selecting the "next-best" alternative.
 Example
• The opportunity cost of college attendance
includes:
– the cost of tuition, books, and supplies, and
– foregone income (this is usually the largest cost
associated with college attendance)

• What about room and board?

 Marginal analysis

• Marginal benefit = additional benefit

resulting from a one-unit increase in the
level of an activity

• Marginal cost = additional cost

associated with one-unit increase in the
level of an activity
 Net benefit
• Individuals are not expected to maximize
benefit; nor are they expected to minimize
costs.

• Individuals are assumed to attempt to

maximize the level of net benefit (total benefit
minus total cost) from any activity in which
they are engaged.
 Marginal analysis
• MB > MC → expand the activity
• MB < MC → contract the activity
• optimal level of activity: MB = MC (Net
benefit is maximized at this point)
 Production possibilities curve
• Assumptions:
– A fixed quantity and quality of available resources
– A fixed level of technology
– Efficient production (i.e., no unemployment and
no underemployment)
 PRODUCTION POSSIBILITIES
What if we could only produce ...
10,000 Robots
 PRODUCTION POSSIBILITIES
What if we could only produce ...

10,000 Robots

or

400,000 Pizzas

using all our resources?

 PRODUCTION POSSIBILITIES
What if we could only produce ...

10,000 Robots

or

400,000 Pizzas

using all our resources?

 PRODUCTION POSSIBILITIES
What if we could only produce ...

10,000 Robots
or
400,000 Pizzas

To get some pizza, we must

give up some robots!
for example....
PRODUCTION POSSIBILITIES
PIZZA 0 1 2 3 4
(in hundred thousands)

ROBOTS 10 9 7 4 0
(in thousands)
PRODUCTION POSSIBILITIES
PIZZA 0 1 2 3 4
(in hundred thousands)

ROBOTS 10 9 7 4 0
(in thousands)

Production Possibilities

12
robots (thousands)

10
8
6
4
2
0
0 1 2 3 4 5
pizza (hundred thousands)
PRODUCTION POSSIBILITIES
PIZZA 0 1 2 3 4
(in hundred thousands)

ROBOTS 10 9 7 4 0
(in thousands)
Production Possibilities

12
robots (thousands)
10
8
6
4
2
0
0 1 2 3 4 5
pizza (hundred thousands)
PRODUCTION POSSIBILITIES
PIZZA 0 1 2 3 4
(in hundred thousands)

ROBOTS 10 9 7 4 0
(in thousands)
Production Possibilities

12
robots (thousands)
10
8
6
4
2
0
0 1 2 3 4 5
pizza (hundred thousands)
PRODUCTION POSSIBILITIES
PIZZA 0 1 2 3 4
(in hundred thousands)

ROBOTS 10 9 7 4 0
(in thousands)
Production Possibilities

12
robots (thousands)
10
8
6
4
2
0
0 1 2 3 4 5
pizza (hundred thousands)
PRODUCTION POSSIBILITIES
PIZZA 0 1 2 3 4
(in hundred thousands)

ROBOTS 10 9 7 4 0
(in thousands)
Production Possibilities

12
robots (thousands)
10
8
6
4
2
0
0 1 2 3 4 5
pizza (hundred thousands)
PRODUCTION POSSIBILITIES
PIZZA 0 1 2 3 4
(in hundred thousands)

ROBOTS 10 9 7 4 0
(in thousands)
Production Possibilities

12
robots (thousands)
10
8
6
4
2
0
0 1 2 3 4 5
pizza (hundred thousands)
 PRODUCTION POSSIBILITIES
PIZZA 0 1 2 3 4
(in hundred thousands)

ROBOTS 10 9 7 4 0
(in thousands)
Production Possibilities

12
robots (thousands)
10
PRODUCTION 8

POSSIBILITIES 6
4
CURVE 2
0
0 1 2 3 4 5
pizza (hundred thousands)
PRODUCTION POSSIBILITIES
Figure 2-1
Q Unattainable
A B
10
C
9 Robots (thousands) W
Robots (thousands)

8
7 D
6 Attainable and
5 attainable efficient
4 but
3 inefficient
2
1 E
Q
1 2 3 4 5 6 7 8
Pizzas (hundred thousands)
 Production Possibilities
• the production possibilities curve (frontier)
marks the boundary between attainable &
unattainable production levels
• points on the curve are attainable & efficient
• points above the curve are unattainable
• points below the curve are attainable &
inefficient
 Law of diminishing returns
• Law of diminishing returns: output will
ultimately increase by progressively smaller
amounts when the use of a variable input
increases while other inputs are held constant.
Demand and Supply
 Markets
• In a market economy, the price of a good is
determined by the interaction of demand and
supply
A market is a group of buyers and sellers of a
particular good or service.
The terms supply and demand refer to the
behavior of people . . . as they interact with one
another in markets.
And Economics, especially Microeconomics is
about how supply and demand interact in
markets.
 Demand
• A relationship between price and quantity
demanded in a given time period, ceteris
paribus.
Demand schedule
Demand curve
 Law of demand
• An inverse relationship exists between the
price of a good and the quantity demanded in
a given time period, ceteris paribus.
• Reasons:
– substitution effect
– income effect
 Ceteris paribus
• Ceteris paribus is a Latin phrase that means
all variables other than the ones being studied
are assumed to be constant. Literally, ceteris
paribus means “other things being equal.”
• The demand curve slopes downward because,
ceteris paribus, lower prices imply a greater quantity
demanded!
 Change in quantity demanded vs.
change in demand

Change in quantity demanded Change in demand

Change in Quantity Demanded
versus Change in Demand

Change in Quantity Demanded

Movement along the demand curve.
Caused by a change in the price of
the product.
Change in Quantity Demanded
versus Change in Demand

Change in Demand
A shift in the demand curve, either to
the left or right.
Caused by a change in a
determinant other than the price.
 Market demand curve

• Market demand is the horizontal summation of

individual consumer demand curves
 Determinants of demand
• tastes and preferences
• prices of related goods and services
• income
• number of consumers
• expectations of future prices and income
 Tastes and preferences

• Effect of fads:
 Prices of related goods
• substitute goods – an increase in the price of
one results in an increase in the demand for
the other.
• complementary goods – an increase in the
price of one results in a decrease in the
demand for the other.
Change in the price of a substitute
good

• Price of coffee rises:

 Change in the price of a
complementary good

• Price of DVDs rises:

Income and demand: normal goods

• A good is a normal good if an increase in income

results in an increase in the demand for the good.
 Income and demand: inferior goods

• A good is an inferior good if an increase in income

results in a reduction in the demand for the good.
Demand and the Number of buyers

• An increase in the number of buyers results in an

increase in demand.
 Expectations
• A higher expected future price will increase
current demand.
• A lower expected future price will decrease
current demand.
• A higher expected future income will increase
the demand for all normal goods.
• A lower expected future income will reduce
the demand for all normal goods.
 Supply

• the relationship that exists between the price of a

good and the quantity supplied in a given time
period, ceteris paribus.
Supply schedule
 Law of supply
• A direct relationship exists between the price
of a good and the quantity supplied in a given
time period, ceteris paribus.
Reason for law of supply

• The law of supply is the result of

the law of increasing cost.
– As the quantity of a good
produced rises, the marginal
opportunity cost rises.
– Sellers will only produce and
sell an additional unit of a
good if the price rises above
the marginal opportunity cost
of producing the additional
unit.
Change in supply vs. change in quantity
supplied
Change in supply Change in quantity supplied
 Individual firm and market supply
curves

• The market supply curve is the horizontal

summation of the supply curves of individual
firms. (This is equivalent to the relationship
between individual and market demand
curves.)
 Determinants of supply
• the price of resources,
• technology and productivity,
• the expectations of producers,
• the number of producers, and
• the prices of related goods and services
– note that this involves a relationship in
production, not in consumption
 Price of resources

• As the price of a resource rises, profitability

declines, leading to a reduction in the quantity
supplied at any price.
Technological improvements

• Technological improvements (and any changes

that raise the productivity of labor) lower
production costs and increase profitability.
 Expectations and supply
• An increase in the expected future price
of a good or service results in a reduction
in current supply.
Increase in Number of sellers
 Prices of other goods
• Firms produce and sell more than one commodity.
• Firms respond to the relative profitability of the
different items that they sell.
• The supply decision for a particular good is affected
not only by the good’s own price but also by the
prices of other goods and services the firm may
produce.
The Market System
 Economic System
• A particular set of institutional
arrangements and coordinating
mechanism to respond to the
economizing problem.
 Command System
• Socialism or communism
• Government owns most property
resources and economic decision making
occurs through a central economic plan
• Central Panning Board
 Characteristics of the Market System
• Private property
• Freedom of enterprise and choice
• Self-interest
• Competition
• Markets and prices
• Technology and capital goods
• Specialization
• Use of money
• Active, but limited, Government
 Five fundamental questions:
• What will be produced?
• How will it be produced?
• For whom will it be produced?
• How will the system accommodate
change?
• How will the system promote progress?
 What?
• In the words of Adam Smith:
– It is not from the benevolence of the butcher, the
brewer, or the baker that we expect our dinner, but
from their regard to their self-interest. (Adam
Smith, Wealth of Nations, Book I, Chapter I)
– Invisible hand
 How?
• In a market economy:
– profit maximization requires least-cost production
(holding quantity and quality constant).
– new technology is introduced only if it lowers total
cost.
– sellers of a resource have an incentive to supply
the resource to its most highly valued use.
 For whom?
• In a market economy, both output and resource
(factor) markets determine who receives which
goods.
• Distribution of income (wages, interest, rent, and
profit) is determined in the resource market.
– Individuals who own more highly valued resources receive
higher incomes.
• The allocation of goods and services is determined in
the output market (given the distribution of income).
 Government and the three
fundamental questions
• Government influences the responses to each of the
three fundamental questions. Examples:
– What?
• government spending
• product safety and consumer protection laws
– How?
• safety regulations
• minimum wage laws
• environmental protection
– For whom?
• tax structure
• welfare programs
 Households
• A household consists of one or more
individuals sharing living quarters
 Firms
• Types of firms
– Sole proprietorship
– Partnership
– Corporation
– Hybrid corporations/companies
 International sector
• The international sector has been expanding
as a share of output in the Philippines. Both
imports and exports have been rising.
• A trade deficit occurs when imports exceed
exports
• A trade surplus occurs when exports exceed
imports
Circular flow
Circular flow
Circular flow w/financial
intermediaries
Circular flow w/ financial intermediaries and
the foreign sector