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Lesson 1
Revisiting Economics as a Social Science
Overview:
Economics is broad ranging discipline that uses a variety of techniques and approaches to
address important social question.Because of the great complexity of human behaviour,
economists are forced to abstract from many details, to make generalizations that they know
are not quite true and to organize what knowledge they have in terms of some theoretical
structure in our economy.
Other well-known schools or trends of thougt referring to a particular style of
eofconomics practiced at and disseminated from well-defined groups of academicians that have
become known world-wide came up also with their own economics structure.
Specific Objectives
At the end of the lesson,learners will be able to:
1.Defines economics;
2.Determine the importance of economics; and
3. Describe the nature of economics.
What is Economics?
Economics may appear to be study of complicated tables and charts, statistic and number
but more specially, it is the study of what constitutes rational human behaviour in the endeavor
to fulfil needs and wants.
Economics has been defined in many ways. It comes from the Greek word “oikonomia”
meaning “household management.” Some of these definitions are as follows:
1. According to Fajardo, economics is the proper allocation and efficient use of available
resources for the maximum satisfaction of human wants.
2. Samuelson states that economics is the study of how societies use scare resources to
produce valuable commodities and distribute them among different people.
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3. Economics according to Nordhaus, is the science of choice. It studies how people
choose to use scarce resources or limited productive resources (labor, equipment,
technical,knowledge ) to produce various commodities and to distribute these
commodities for consumption.
4. Sicat defined economics as scientific study which deals with how individuals and
society in general make choices.
5. Webster defined economics as a branch of knowledge that deals with the production,
distribution and consumption of goods and service.
6. Castillo viewed economics as the study of how man could best allocate and utilize the
scare resources of society to satisfy his unlimited want.
To sum it up, economics covers all kind of topics but at the core, it is devoted to
understanding how society allocates its scare resources. Any country has limited resources. Since
resources. Any country has limited resources. Since resources are generally scare and human
wants these resources are not freely available. At the very core, economics lies the fact of
scarcity. Goods are limited, while wants seem infinite. Because resources are service, how
different commodities are produced and priced and who gets to consume the goods that society
produce.
Importance of Economics
Many individuals have no clear understanding of what economics is. They don’t even
know how it works and how it affects their lives. People just don’t mind what economics can give
to them.
Actually, every individual cannot isolate himself from economics. This is brought about by
the mere fact that his physical existence in this world depends upon economics. People cannot
live without production and consumption almost always, human activities involve economics. For
instance, earning money, buying goods and services, depositing and withdrawing money in the
banks, these are all economics activities.
Clearly, a good knowledge of economics offers many favorable possibilities. It guides us
how to make a living, how to use our money wisely. How to run our business, how to distribute
properly our available scarce resources, and how appropriate economic decision and
implementation, life for everyone most likely better.
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Furthermore, economics is important in order to understand problem facing the citizen
and the family; to help government promote growth and improve the quality of life while
avoiding depression and inflation and to analyze fascinating patterns of social behaviour.
Because economic is vital for sound decision making by individuals and nation.
The Nature of Economics
Economics is a Science. A Science is a body of systematic knowledge built upon by
conscious effort. Like any other science, its laws and principle are arrived at only after a long
series of observation and experimentations. An explanation of a certain event called a theory. A
theory may become a successful theory if its prediction are confirmed by actual by actual
observations and must gain universal acceptance. Economics thus, concerned with accurate
appraisal of facts and events about our material life.
Economics is classified as a social science because it deals with study of man’s life and
how he lives with other men. Economics is concerned with human beings and his behavior.
Obviously, it is interdependent with other sciences like: Psychology, the science of the mind;
History, the science that records and explain past events; Sociology, the science of government;
Geography, the science that determines the main resources of a region. Likewise, religion is
related to Economics. Religious tradition and belief can discourage or encourage economic
development.
Economics, as a social science, is the study of the relation between people during the
production, distribution and consumption of wealth in human society. In other words, economics
is the study of the relationship established in the production and consumption of goods and the
transfer of wealth to produce and obtain those goods among people. Economics explains how
people interact within markets to get what they want or accomplish certain goals. Since
economics is government behave in particular ways. A study of economics can describe all time
laborers devote to work and leisure, the outcome of investing in industries or financial product,
the effect of taxes on a population, and why businesses succeed or fail.
Of the social sciences, Economics has more advantages as a scientific discipline for two
major reason:
1. Economic motives of human being may be more regular and therefore persistent.
They can be more predictable.
2. There is more factual information in the formation of alternative economic
theories.
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Considering the nature of economics, it is not advisable to solve an economic problem with
economic solution alone. Our economic problems are not purely economic in nature. These are
also created by non-economic factors like culture, education social, and political.
Macroeconomics and Microeconomics
Macroeconomics
deals with the economic behavior of the whole economy or its aggregates
such as goverment, business and household. An aggregate is composed of
individual units. The operation of the various aggregate and their
interrrelationship is analayzed to provide a profile of the economy as a
whole.
Macroeconomics is concerned with the discussion of topics like gross
national product, level of total expeditures, etc. It is also known as
employment and income analysis.
Microeconomics
deals with the economic behavior of individual units such as the consumer,
firms, and the owners of the factors of production. Such specific economic
units constitute a very small segment of the whole economy. Their
activities are presented and discussed in details. For example, the priceof
rice, the number of workers of a certain firm,the income of Mr. Sajise, the
expendintures of PLDT,etc. Microeconomics also known as the Price
Theory.
Micro and macroeconomics are intertwined so as economists gain understanding of certain
phenomena, they can help nations and individuals make more-informed
decisions when allocating resources. Theh system by which nation allocate
their resources can be placed on a spectrum where the command
economy is on the one end and market economy is on other. The market
economy advocates forces withina competitive market,which constitute.
“Invisible hand” to determine how resources should be allocated. The command
economic system relies on the goverment to decide how the country’s resources would best be
allocated. In both system, however,scarcity and unlimimited wants force goverment and
individuals to decide how best to manage resources and allocate them in the most efficient way
possible.However,there are always limits to what the economy and goverment can do.
However,what is true in Microeconomics may not be true in Macroeconomics. For example, a
vegetable farmer gets better harvest. This means more income for him,if all vegetable farmers
have increased their harvest; it is not favorable for them. Because,more supply reduces the price
of vegetables.
Division of Economics
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Economics has five major division. These divison are as follow:
1.Production -this refers to the process of producing or creating goods needed by the
household to satisfy their needs. The factors of production are called
inputs and the goods and service that have been created are called outputs
of production.
2. Distribution -This refer to the marketing of goods and services to different economic
outlets for allocation to individual consumer. In monetary terms, this is the
allocation of income among person or household.
3. Exchange
- This is a process of transferring goods and service to a person or person
in return for something. At present, the medium of exchange our money.
This means with goods and services.
4. Consumption –This refer to proper utilization of economic goods. However, goods and
service could not be utilized unless you pay for it. Hence, we can also say
that consumption is spending money for goods and services in order to
yield direct satisfaction.
5. Public Finance – This pertains to the activities of the government regarding taxation,
borrowings, and expenditures. It deals with the efficient use and fair
distribution of public resources in order to achieve maximum social
benefits. This means, government programs and projects which are funded
by taxes and loans are properly implemented and managed to generate
maximum and optimum benefits for all members of society.
Tools of Economics
Most economists are engaged in analyzing the present economic situation of the
country. Most of these economists use different scientific approaches and
utilize different tools to be able to formulate theories and principles.
Some of the major tools used by these economists are the following:
1. Logic – It is a science that deals with sound thinking and reasoning. In the
process of reasoning, facts and proofs should be presented; otherwise, such
reasoning will be clouded by an iota of doubt. With the wise application of
logic, one may be able to arrive at a conclusion.
2. Mathematics – It is a science that deals with numbers and their operations.
Actually, economics is the most quantifiable discipline among social science.
It can quantify population, income, national product aggregate number of
firms, etc. Beside, mathematical conclusion. Mathematics comes hand in
hand with economics in arriving at a conclusion.
3. Statistic – It is a branch of mathematics engage with analysis and
interpretation of numerical data. It deals with the process of collecting
tabulating and analyzing data to test the validity of a certain hypothesis.
These are facts collected and arranged in an orderly way for study. Through
statistic, one may be able to reject or accept an assumption made on a
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certain phenomenon. Statistic for example, help economics calculate a
nation’s GDP or allows them to better configure a manufacturing process to
reduce costs. Statistical tools include regression and correlation analysis and
calculation of probabilities.
The Economic Resources
Our economic resources are also known as factors of production or inputs.There are a
five major factors of production, which are utilized in our economy. These are land, labor, capital
entrepreneurs, and foreign exchange.
1. Land
2. Labor
-These resources consist of free gift of nature which includes all natural
resources above,on and below the ground such as soil, rivers, lake, oceans,
forest, mountains, mineral resources and climate. Land is considered economic
Land is considered economic resources because it has a price attached to it.
One cannot utilize this natural resource without paying for it ussually in the form
of rent or lease.
Land is usually a limited resource for many economies. Although some natural
resources,such as timber,food and animals are renewable, the physical land is
usually a fixed resource.Nations must carefully use their land resource by
creating a mix of natural and industrial uses. Using land for industrial purposes
allows nations to improve the production processes for turning natural resources
into consumer goods.
-This is also termed as human resources. Labor refers to all human efforts, be it
Mental or physical,that help to produce want satisfying goods and services.Labor
is an indespensable factor in the production of goods and services. In return, he
earns an income in the form of wages and/or salaries.
Labor represent the human capital available to transform raw or national
resources into consumer goods. Human capital includes all able –bodied
individuals capable of woking in the nation’s economy and providing various
service to other individuals or business. This factor of production is a flexible
resource as workers can be allocated to different areas of the economy for
producing consumer goods or service. Human capital can also be improved
through training or educating workers to complete technical functions or business
tasks when working with other economic resource.
3. Capital
-Capital has two economic definitions as a factor of production. Capital
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can represent represent the monetary resources companies use to
purchase natural resources, land and other capital goods. Monetary
resource flow through a nation’s economy as individuals buy and sell
resources to individuals and business. Capital also represent the major
physical assets individuals and companies use when producing goods or
services. These assets include buildings, production facilities, equipment,
vehicles and other similar items. Individuals may create their own capital
production resources, purchase them from another individual or business
or lease them for a specific amount of time from individual or other
business. Income derived from capital is called interest.
4. Entrepreneurs
- This is a French word meaning enterpriser. An entrepreneur is the
organizer and coordinator of the other factors of production land,
labor, and capital. An entrepreneur is one who engaged in economic
undertakings and provides society with goods and services it needs.
5. Foreign Exchange -This refers to the dollar and dollar reserves that the economy has
foreign exchange is part of economics resources because we need
foreign currency, particularly dollars for international trading and
buying of raw materials from other countries. Dollars is international
medium of currency used engaging business with foreign countries.
Activity 1.1
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Video clip: Answer the following question through a video clip!
1. Define Economics in your own words.
2. It is said that economics is related to other disciplines in the social science.
.Why?
3. Collect at least five issues (news clipping) pertaining to Philippine economy.
Discuss how these issues affect you as a student and as an individual.
4. State the significance of your news.
5. What advantages does economics have over the other social science that
study human behavior? What does it have in common with other social
science? Elaborate
6. It is said that we cannot solve economic problems by making economic
solutions alone. If this is so, why or why not?
Activity 1.2
1. Identify some of the problems of the country. Do the identified problems
have something to do with economics? Support your answer.
2. What are the uses of logic, mathematics and statistic in the study of
economics? Explain in a short essay.
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Lesson 2
Economics as an Applied
Science
Overview
A pure science furnishes tools and applied science works with these
tools. Similarly, Economics as pure as science, formulates various laws and
applied economics applies them in practice in solving various problems.
Before economics has been treated as pure as positive science. But recently,
applied economics assume greater importance. As pure science and applied
science go hand-in-hand, so Economics is also pure as applied science. The
scope means the limits or boundaries of economics. According to Adam
Smith and A.C. Piguo, Economics studies the causes of material wealth. They
gave a very narrow scope to the study of economics by limiting it only to
those activities relating to wealth. According to Prof. Marshall,
“Economics is a study of economic activities of a man. It is only concerned with
the wealth-getting and wealth-using activities of a man,”
Specific Objectives
At the end of lesson, the learners will be able to:
1. Discuss why economic is applied science;
2. Explain the basic economics problems; and
3. Understand how applied economics work.
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Applied Economics
The term ‘applied economics’ is believed to have started being use nearly 00
years ago, in the writings of French economist and businessman Jean-Baptise Say
(1967-1832) and British political economist, philosopher and servant John Stuart
Mill (1806-1873)
Say wrote about applying the general principles of political economy. In
1848, Mill used the term in his works Principles of Political Economy with Some of Their
Applications to Social Philosophy.
Applied Economics is the study of economics in relation to real world situation,
as opposed to the theory of economics. It is the application of economics principles
and theories to real situations, and trying to predict with the outcomes might be.
Put simply, applied economics is the study of observing how theories works in
practice. Applied economics may be practiced at microeconomic (the whole,
aggregate economy) or microeconomic (analyzing individual consumers and
companies) levels.
Applying economics to the status of the economy of a country, households
or company helps eliminate all attempts to dress up a situation so that it will seem
better or worse than it really is.
Only with applied economics can a true and complete picture of an economic
situation or theory emerge, so that decision-makers can choose what to do in order
to move in the right direction from a current position.
Applied economics deals on the application of economics theories and
principles to real world situation with the desired aim of predicting potential
outcomes. The use of applied economics is designed to analytically review potential
outcomes without the “fanfare” associated with explanations that are backed by
numbers. Applied economics can involve the use of econometrics and case studies.
Because economics relies on the interpretation of historical events in its
theories, applied economics can lead to “to do” lists of the steps that can be taken
to ensure stability in real world events. Although applied economics uses economic
theories and principle, it is itself not a field of economics, such as neoclassical
economics or the Austrian school.
Essentially, it is the application of basic assumptions of economics to real-world
situation, both isolated and interrelated with sets of current circumstances. Thus,
applied economics involved economists taking generally accepted theory and
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applying those theories to something that is happening in the real world, with an
eye toward determining what can reasonably can be expected to happen next.
Applied Economics Application
Applying economic theories to current economic conditions can be
extremely helpful for three key reasons.
First, applying economics to the status of the economy of a company, a
household or a country helps to sweep aside all attempts to dress up the situation
so that it will appear to be worse or better than it actually is. From this perspective,
applied economics is a powerful tool that enables the true and complete picture to
emerge, so that it becomes possible to decide what to do and where to go from the
current position.
Second, applied economics acts as a mechanism to determine what steps
reasonably be taken to improve the current economic situation. Each element that
is relevant to the contemporary mode of operation of the entity – including the
purchase and sales of good and services, the usage of raw materials and division of
labor with the entity of – come into play. Examining each aspect of the current
economic condition will often yield sound ideas on ways to maintain aspects that
are working at a reasonable of efficiency and strengthen areas where the
performance is weak.
Last, applied economics can teach valuable lessons on how to avoid the
recurrence of negative situation, or at least minimize the impact. Applied
economics is all about the application of theory to real-life situations, so the
process can help develop an understanding of why a condition took place. This
includes reviewing what steps was taken to improve or correct similar situations
and how those strategies can be employed to keep the economy flowing in a
direction that will preclude a repeat of the undesired situation.
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What is econometrics?
Econometrics is the application of statistical and mathematical theories to
economics for the purpose of testing hypotheses and forecasting future trends.
Econometrics take economic models and tests them through statistical trials. The
result are then compared and contrasted against real-life example.
Econometric can be subdivided into two major categories: theoretical and
applied. Econometrics uses tools such as frequency distributions, probability and
probability distributions, statistical inference, simple and multiple regression
analysis, simultaneous equations model and time series methods. An example of a
real-life application of econometrics would be to study the hypothesis that as a person’s income
increases, spending increases.
Basic Economic Problems
In today’s world, it is commonly believed that scarcity is the root cause of all
economic problems. But this important aspect was neglected by Alfred Marshall. In
1932, Lionel Robbins offered a new definition, the scarcity definition which was
accepted by most economists and no one has challenged the definition then.
In reality, we see that the means of or sources available for satisfying
unlimited human wants are scarce compared to their demand. Scarcity of means
for satisfying various needs in the central problem of our economic life it is scarcity
that creates the need to make a choice. The scarcity and choice go hand in hand.
All problems like poverty, unemployment, inflation, balance of payments, slow
growth, etc. that a modern economy faces originate from the scarcity of sources.
Had resources been available in abundance, had everybody got enough food and
shelter, there would not had been any economic problem and, thus, no need to
study economics as a subject.
However the truth is that the scarcity of resources exists. The problem
existed in all periods. People belonging to the stone age experienced variety of
problems. Modern people also face the problem of scarcity. And the future
generation cannot be made free from the problem of scarcity. In all societies and
time periods choices have to be made to overcome the problem of scarcity. When
we talk about the society’s economic problem, we refer to the overall problem of
the scarcity resources. Irrespective of the economic system or its nature and stage
of the development, scarcity of resources forces people to make certain crucial
choices if we go to the capitalist and affluent countries of Europe or the post
socialist countries or the less developed mixed economies like India and the
Philippines we find problems of scarcity and choices.
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Scarcity refers to the tension between our limited resources and our
unlimited wants and needs. For an individual, resources include time, money, and
skill. For a country, limited resources include natural resources, capital, labor, force
and technology. Scarcity is the fundamental economic problem of having humans
who have wants and needs in a world of limited resources. It state that society has
insufficient productive resources to fulfill all human wants and needs. Alternatively,
scarcity implies that not all of society’s goal can be pursued at the same time; tradeoffs are made of one good against others.
Because all our resources are limited in comparison to all our wants and
need, individuals and nation have to make decisions regarding what goods and
services they can buy and which ones they must forgo. For example, if you choose
to buy one DVD as opposed to two videotapes, you must give up owning a second
movie of inferior technology in exchange for the better quality of the one DVD. Of
course each individual’s and nation’s values are different, but people and nations,
each having different levels of (scarce) resources, for some of their values only
because they must deal with the problem of scarcity.
So because of scarcity, people and economies must make decisions over how
to allocate their resources. Economics, in turn, aims to study why we make these
decisions and how we allocate resources most efficiently.
Because the scarcity of resources, every economic system is faced with the
following problem:
1. What to produce? - First of all, the system must determine the desires of the
people. Goods and services to produced are based on the needs of the
consumers. However, there are some factors that should be taken into
consideration in producing the goods and services the individuals need. These
are. There are:
1.1. Availability of resources;
1.2. Physical Environment
1.3. Customs and traditions of the people
2. How to produce? – Equally important is the system’s task of selecting the proper
combination of economic resources in producing the right amount of output.
Through several combinations of resources, goods are produced. A clear
knowledge of manipulating the different factors of production helps a lot in
coming up with the desired output. However, the quality of output must come
first before quantity.
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3. For whom shall goods and services be produced? – The last question has something to
do with the problem of distribution. Once the goods are produced, how shall
they be distributed?
Economist are often interested in what determines how a nation’s total
income is distributed among various groups. They are also interested in
knowing how the existing pattern of income distribution can be changed
through government policies.
- The first three questions fall within the scope of microeconomics.
Microeconomics concerns the allocation of resources and distribution of
income as they are affected by the workings of the price system and by
some government policies.
- In addition, one can point two other problems connected with resources
allocation and economic growth. Thus, altogether there are five closely
interrelated problems that are faced by every economic society.
4. Are the country’s resources being utilized, or some of them are lying idle and unemployed? –
When resources are scarce, it is not in the rightness of things to keep some of
the available resources idle. Yet in free market economies, such waste does
often occur in problem of unemployment. And if resources are not fully utilized,
the productive system is said to be inefficient. The consequence: the national
income is sub-optimal, actual GNP is much below and maximum or potential
GNP attainable with existing resources and technology.
5. Is the economy’s capacity to produce goods growing or remaining the same overtime? – This
is essentially a dynamic problem, the problem of growth with cycles. To achieve
a growth in productive capacity is a universal objective. This makes possible
arise in living standard if the rate of population growth is not very high. And
government all over the world are now busy exploring the possibilities a
satisfactory growth rate.
Problems 4 and 5 fall with what is called Macroeconomics. Macroeconomics
is the study of determination of economic aggregates such as total output,
total employment and the price level.
Note: Items number 4 and 5 are best explained by the Production Possibility
Frontier of PPF, which is discussed in lesson 3, p.28.
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Name:
Activity 1.4
If you are the economic planner, how can you resolve unemployment? List down
your options
Activity 1.5
What are the three central problems of an economy? Do you have any solution
for these?
Activity 1.6
Cut some news clippings that have something to do with economics. Identify the
problems presented and try to solve the problem.
Activity 1.7
In your own opinion, are the countries resources being utilized? Why?
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Name:
Test Yourself 1.2
Multiple choice: Choose the letter of the correct answer and right it down
on the space provided for in each item:
1. Once the goods are produced, how shall they be distributed?
a. What to produce?
b. How to produce?
c. For whom to produce?
d. How much to produce?
2. Goods and services to be produce are based on the needs of the
consumers:
a. What to produce?
b. How to produce?
c. For whom to produce?
d. How much to produce?
3. It is the study of economics in relation to real world situations as
opposed to theory of economics:
a. Economics
b. Applied economics
c. Pure economics
d. Macroeconomics
4. Scarcity means:
a. Infinite resources
b. Definite resources
c. Finite resources
d. Unlimited resources
5. Applied economics as a mechanism to:
a. Sweep aside all attempts to dress up the situation so that it will
appear to be worse or better than it actually is
b. Determine what steps can reasonably be taken to improve the
current economic situation
c. Avoid the recurrence of a negative situation, or atleast minimize
the impact
d. All of the above
6. It is the system’s task of selecting the proper combination of
economic resources in producing the right amount of output:
a. What to produce?
b. How to produce?
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c. For whom to produce?
d. How much to produce?
7. This has something to do with needs of the consumers:
a. What to produce?
b. How to produce?
c. For whom to produce?
d. How much to produce?
8. Because of scarcity, people and economic must make decisions over
how to:
a. Allocate resources
b. Import resources
c. Export resources
d. Stagnation of resources
9. The use of applied economics is designed to:
a. Analytically review potential outcomes
b. Apply statistical and mathematical theories
c. Increase production
d. Validate economic theories
10.This has something to do with the problem of distribution:
a. What to produce?
b. How to produce?
c. For whom to produce?
d. How much to produce?
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Lesson 3
The Economic System
Overview
The role of the price system in solving society’s economic problem was first
brought into focus by Adam Smith, the Father of Economics. He used the term
invisible hand which refers to the free functioning of the price system in a free
enterprise economy under competitive conditions. However, in a modern economy,
there is neither free enterprise nor perfect competition. So, the price system has to
be modified to solve society’s economic problem.
The three problems mentioned in Lesson 2 are the same everywhere. Only
the nature of solution differs. One may opt for the planning system and the other,
the price system. With the collapse of socialism clearly indicates that the price
system perhaps is the best way of solving society’s problem.
Specific Objectives
At the end of the lesson, the learners will be able to:
1. Explain how applied economics can be used to solve economic
problem;
2. Analyze the solution to the economic probems;
3. Discuss the Production Possibility Frontier; and
4. Know the operation of Opportunity Cost.
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The Economic System
There are four commonly used economic systems that helps
solve the basic economic problems. These are:
Traditional Economy
The earlier method of allocating resources consisted of traditional patterns.
Hence, the forces of tradition answered the fundamental questions. In an economy
bounded by traditional or customs, young people followed the footsteps of their
ancestors in the choices of occupation. What to produce, how to produce and for
whom to produce, all were govern by past behaviour patterns. As a result, there
was little change in the pattern of production, in the composition of the output and
in the techniques of production. Thus, all production questions were answered by
prevailing traditions of an economy. However, such static environment does not
exist today.
In traditional economy, everything is mostly based on what is popular,
production respond on what is in demand from the people. An example of this
would be in the prehistoric times where farmers grazed animals and produced
food. Enough food would be produced for the people living in the area. A farmer
would produced the food for the people and the farmer would get something in
return.
In some part of the Philippines, this type of economic system still permeates.
Some families or tribes are self-sufficient. They produce goods and services only for
their own consumption. If ever there are surpluses in their goods, they resort to
barter, the method of exchange of goods which is of value.
The Market Economy
The exchange and trading of goods and services is what takes place in a
market economy. This is a form of a free market hence also being known as “free
market economy”. In a market economy, what to produce is determined by what
the people demand. For example, in a city with no roads, cars would not need to
be produced or traded due to the fact that there is no demand for them. In term
of how to produce, a market economy is the complete opposite of planned
economy where the government decides what to produce and in what quantities
to produce, a market economy is produced for people in exchange in goods or
services. An example would be an individual purchasing an automobile due to
their need of transportation; money would need to be exchange for the product.
In a market economy, there is something known as the “invisible hand” which
represent the supply and demand market force. This defines what is produced, in
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what quantity and at what price. One example of a country, which actually
includes more market economy traits than Western Europe countries.
Transaction in this market occur when both buyer and seller agree on the
price of a given good or service. Government intervention is minimal and confines
itself more on regulation.
People are free to engage in business if they so decide. However, they have
to face some risks and consequences in a competitive market. The success of your
business largely depend on the demand for the product you are selling and at the
same time, the price of the good.
Planned Economy
A planned economy is the complete opposite of a market economy. A market
economy is towards production being based on the supply and demand, or the
“invisible hand”, a planned economy is mostly government controlled with the
government deciding everything. In a planned economy, the government decides
what gets produced, at what quantity and what price. Planned and market
economies blend together in mixed economies. In this case, the government would
have some input in such economic problem; however, the rest of the activities will
be driven by the decision of the buyers and seller. No country has a completely free
economy in strict sense, meaning that there will always be some government
involve, however we label the market economies with the fact that the government
intervening is very minimal. Two countries, which are known as one of the example
of, planned, or command economy would be China as well as former USSR. Despite
the fact that there are many counties todays switching from such an economy to
mixed or free economies, other nation including North Korea and Cube still
embrace this economy in such economic problem including what to produce, how
to produce and for whom to produce.
Mixed Economy
In a mixed economy, both capitalism and socialist economies are found. This
economy is basically a mix of a rather free economy such as a market combined
with a planned economy as well as avoiding the issues with capitalism and socialist
economies. Most countries have a mixed economy including the United States of
America, the Philippines, as well as Cuba. It was mentioned earlier that the United
States embraces a market economy and Cuba goes by the planned economy,
however, it much be taken into consideration that no country strictly uses one
economy. Fox example, if a country had a strict market economy there would be
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no taxes, environmental laws, government owned businesses and other aspects
of the nature.
Adam Smith and the Invisible Hand
Adam Smith (1723-1790) who is recognized as the founder of Classical
School, constructed an explanation on how social behaviour is regulated. Like
Aristotle, Smith’s view of economics was shape by the world he observed. Smith
saw a world where each person sought his own self-interest but was constrained
by morality, market, and government. Smith developed an analysis of the moral
system through his book entitled, “The theory of Moral Sentiment” in 1759 and on
economics, the “Wealth of the Nation” in 1776.
One of the main points of The Wealth of Nation is that the free market, while
appearing chaotic and unrestrained, is actually guide to produce the right amount
and variety of good by a so-called “invisible hand,” an image that Smith had
previously employed in Theory of Moral Sentiments, but which has its original use
in his essay, “The History of Astronomy”. If a product shortage occurs, for instance,
its price rises, creating a profit margin that creates an incentive for others to enter
the market, the increased competition among manufactures and increased supply
would lower the price of the product to its production cost, the “natural price”.
Even as profits are zeroed out at the “natural price” there would be incentives to
produce goods and services, as all cost of production, including compensation for
the owner’s labor, are also built into the price of market; if they were above a zero
profit, producers would drop out of the believed that while human motives are
often selfishness and greed, the competition in the free market would tend to
benefit society as a whole by keeping prices low, while still building in an incentive
for a wide variety of goods and services. Nevertheless, he was wary of businessmen
and argued against the formation of monopolies.
Production Possibility Frontier (PPF)
Under the field of macroeconomics, the production possibility frontier (PPF)
represents the point at which an economy is most efficiently producing its goods
and services, and therefore allocating its resources in the best way possible. If the
economy is not producing quantities indicated by the PPF, resource are being
managed inefficiently, and there are limits to production , so an economy, to
achieve efficiency, must decide what combination of goods and services can be
produced.
Let’s turn to the chart below.
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Imagine an economy that can produce only and rice. According to the
PPF, points A, B and C- all appearing on the curve-represent the most efficient use
of resources by the economy. Point X represents an inefficient use of resources.
While point Y represent goals that the economy cannot attain with its present levels
of resources.
As we can see, in order for this economy to produce more copra, it must give
up some of its resource used to produce rice (point A). If the economy started
producing more rice (represented by points B and C), it would have to divert
resources form making copra and consequently from point A to B, the economy will
have to decrease in rice output. However, if the economy moved from B to C, copra
output would be significantly for the economy, and the nation must decide how to
achieve the PPF and which combination to use. If more copra is in demand, the cost
of increasing its output is proportional to the cost of decreasing rice production.
Point X means that the country’s resources, the country is not producing
enough rice or copra. Point Y, as mentioned above, represents an output level that
is currently unreachable by this economy. Any point inside the curve, (X) indicate
that some resources are unemployed or not used in the best possible way.
Productive Efficiency occurs when society cannot increase the output of one good
without cutting back on another good. An efficient economy is on its PPF.
When the PPF shifts out, we know there is growth in an economy.
Alternatively, when the PPF shifts inwards, it indicates that the economy is
shrinking as a result of a decline in its most efficient allocation of resource and
optimal production capability. A shrinking economy could ‘be a result of a decrease
in supplies or a deficiency in technology.
An economy can be producing on the PPF curve only in theory. In reality
economies constantly struggle to reach an optimal production capacity. And
because scarcity force an economy to forgo one choice for another, the slope of
the PPF will always be negative: if production in product A increases, production in
product B will have to decrease accordingly.
Unemployed Resources and Inefficiency
Eve casual observers of modern life known the society has unemployed
resources in the form of idle worker, idle factories, unutilized minerals and raw
materials, idle land, unused brain etc. Such an economy is not on its PPF, but well
inside it. This is represented by point X, where the society is producing only 2 units
of rice and 6 units of copra. Some resources are unemployed. By utilizing them, we
can move from point X to point B, thereby producing more rice and more copra,
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and living for its citizens. An economy inside the PPF is inefficient. That is, it is not
using its resources to the maximum.
Business cycle depression,strikes,agitation,internal and external fighting,
natural calamities etc. will further push the economy inside peace for a developing
country, in the beginning itself.
Importance of PPF
In addition to explaining efficiency, PPF can help introduce many of the most
basic concepts of economics.
1. It illustrates the definition of economics as the science of choosing what
goods to produce.
2. PPF provides a rigorous definition of scarcity. It show the outer limit of
producible goods dictated by the law of scarcity. Scarcity is a reflection of the
limitation on our living standards imposed by the PPF.
3. PPF can also illustrate the three basic problem of economic life-what, how
and for whom.
4. PPF can also illustrate the general point that we always choosing among
limited opportunities.
As a result of increasing inputs of capital and labor and improving technology, the
PPF shifts out. A nation can have more of all goods as its economy grows. Poor
countries must devote, most of their resource to food production, while rich
countries can afford more luxuries as productive potential increases.
Opportunity Cost
Opportunity cost is the value of what is foregone in order to have something
else. This value is unique or each individual. You may, for instance, forgo ice cream
in order to have an extra helping of mashed potatoes. For you, the mashed
potatoes have a greater value than dessert. But you can always change your mind
in the future because there may be some instances when the mashed potatoes are
not just attractive as ice cream. The opportunity cost of an individual’s decisions is
determine by his or her needs, wants, time and resources (income).
This is important to the PFF because a country will decide how to best
allocate its resources according to its opportunity cos. Therefore, the previous
wine/cotton example shows that if the country chooses to produce more wine than
cotton, the opportunity cost is equivalent to the cost of giving up the required
cotton production.
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Let’s look at another example to demonstrate how opportunity cost ensures
that an individual will buy the least expensive of two similar goods when given the
choice. For example, some of an individual has a choice between two telephone
services. If he or she were buy the most expensive service, that individual may have
to reduce the number of times he or she goes to the movies each month. Giving up
these opportunities to go the movies may be a cost that is too high for this person,
leading him or her to choose the less expensive service.
Remember that opportunity cost is different for each individual and nation.
Thus, what is valued more than something else will vary among people and
countries when decisions are made about how to allocate resources.
Activity 1.8
Based on the discussions regarding the different economic systems which is
the best system for our country? Why?
Activity 1.9
If you are an economist, how can you solve the problem of scarcity using the
opportunity cost model? Identify first some scarce resources and make us of these
as your model.
Activity 1.10
As a student, in what way can you help solve the problem of scarcity. Support
your answer.
Activity 1.11
What is the production possibility frontier? How does PFF help solve scarcity
in our economy? Explain your answer.
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Test yourself 1.3
Multiple choice: Choose the letter of the correct answer and write it down
the space provide for in each item
1. It is the value of what is foregone in order to have something else:
a. Production Possibility Frontier
b. Invisible hand
c. Opportunity cost
d. Payment
2. PPF is under the field of:
a. Production
b. Scarcity
c. Distribution
d. Exchange
3. The PFF is under the field of :
a. Economics
b. Applied Economics
c. Microeconomics
d. Macroeconomics
4. Scarcity means:
a. Infinite resources
b. Finite resources
c. Definite resources
d. Unlimited resources
5. An example of a country having of an mixed economy:
a. USA
b. Philippines
c. Cuba
d. Al of the above
6. A government controlled economy:
a. Traditional economy
b. Mixed economy
c. Free market economy
d. Planned economy
7. Opposite of market economy:
a. Planned economy
b. Traditional economy
c. Mixed economy
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d. All of the above
8. The earlier method of allocating resources consisted of out- moded
patterns :
a. Traditional economy
b. Mixed economy
c. Market economy
d. Planned economy
9. The exchange of trading of goods and services is what takes place
in a:
a. Traditional economy
b. Planned economy
c. Market economy
d. Mixed economy
10.The economic system that makes the use of the invisible hand:
a. Traditional economy
b. Planned economy
c. Market economy
d. Mixed economy
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