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Reviewer FOR Basic Microeconomics ENJOY
Accountancy (University of Northern Philippines)
Studocu is not sponsored or endorsed by any college or university
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REVIEWER FOR BASIC MICROECONOMICS FINALS
BY: JOSHUA GAIL S. OANDASAN
CONSUMER BEHAVIOR: UTILITY APPROACH
A. The Concept of Utility
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Economics assumes rational consumer behavior which means individuals pursue selfinterest. They allocate their time and money to maximize their satisfaction. Again, this is
because of the problem of scarcity.
Given that a consumer has a fixed budget or income, how does he or she allocate this budget
among goods and services in order to obtain the most satisfaction?
Normally, a consumer weighs the cost and benefits before deciding. Thus, to understand the
theory of consumer behavior, it is essential to understand the concept of utility.
Utility:
o It is a technical term in Economics which means satisfaction or pleasure.
o It is a numerical score that represents the level of satisfaction that the consumer derives
from a particular market basket.
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A consumer prefers to obtain more utility from the goods and services he consumes rather
than less of it.
However, satisfaction, is not easy to measure in tangible and concrete terms, that is why
economists introduced the concept of util, an imaginary unit for measuring satisfaction.
B. Total and Marginal Utility
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Total utility (TU) - it is the total amount of satisfaction derived by a consumer from
consuming a particular good or service.
Marginal Utility (MU) – it is the extra or additional satisfaction or pleasure derived by an
individual when he consumes an additional unit of a good or service.
Formula in getting Marginal Utility:
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The total utility received from a good or service rises as more and more of the good or
service is consumed.
On the other hand, the marginal utility may rise at first, but eventually may fall. It may even
become negative if consuming further units of the good brings you dissatisfaction. For
example:
Have you ever eaten “too much” pizza? Many people have said, “I wish I hadn’t
eaten that last piece.” This means that it brought the consumer dissatisfaction or
negative utility.
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A hypothetical example is shown below:
C. Law of Diminishing Marginal Utility
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The Law of Diminishing Marginal Utility states that as a person consumes more and
more of a given commodity (the consumption of other commodities being held
constant), the marginal utility of the commodity eventually will tend to diminish.
This law implies that it is not possible for a consumer to consume unlimited units of the
same product without feeling a decreasing satisfaction or pleasure.
CONSUMER BEHAVIOR: INDIFFERENCE THEORY
A. Indifference Curve
 The Indifference Theory assumes that consumers could tell which of two combinations of
commodities they prefer without having to tell by how much they prefer it.
 Indifference Curve – it is a curve that shows different combinations of two goods which yield
the same level of satisfaction.
 The consumer is indifferent between the combinations indicated by any two points
on an indifference curve.
 The consumer can state his preferences by ranking the combination of goods
according to the utility or satisfaction received.
 Indifference curves are useful because they indicate the degree of substitution of
one good over another.
 For example, given the following combinations of commodities:
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Indifference Schedule Showing
Combinations of Two Goods (Mango and Avocado)
COMBINATION A COMBINATION B
1 mango
2 avocados
3 avocados
2 mangoes
A consumer can state his preferences as:
1. “I prefer combination A to combination B”, or
2. “I prefer combination B to combination A”, or
3. “I am indifferent between combination A and combination B”.
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Another example of indifference schedule and indifference curve:
Indifference Schedule Showing the Various
Combinations of Two Goods (Chicken and Beef)
COMBINATIONS CHICKEN (per kilo) BEEF (per kilo)
A
5
1
B
4
2
C
3
3
D
2
4
E
1
5
The points along the indifference curve correspond to the different combinations of
consumption of chicken and beef that yield the same level of their aggregate
satisfaction.
Between any point to another along the curve, an inverse relationship exists between
the commodity units, inasmuch as the satisfaction foregone by consuming less of one
is regained by consuming more of the other.
It is the equality between satisfaction gained and satisfaction foregone that holds the
total satisfaction level from both commodity items constant.
B. Marginal Rate of Substitution
 The ability of one good to substitute for another is an important scope of consumer
behavior. This concept is illustrated by the Marginal Rate of Substitution.
 Marginal Rate of Substitution:
 It indicates the rate at which a consumer would exchange units of one product for
additional units of another product.
 It is the amount of one commodity that a consumer would be willing to give up in
order to get one more unit of another commodity.
 For example, the MRS of chicken for beef is 2 at a particular point. This means the
consumer would give up 2 units of chicken to get 1 unit of beef and enjoy the same
level of satisfaction.
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MARKET STRUCTURES
A. Market and Market System
 Markets and prices are key characteristics of the market system. They provide the market
system its ability to coordinate millions of daily economic decisions.
 Market – it is the institution or mechanism where buyers and sellers exchange products
and services. Examples:
 A typical example of a market is a public market that is usually found in every
municipality. These places are filled with farmers bringing their harvests, retailers
displaying their products, and housewives carrying their baskets filled with meat,
fish, groceries, vegetables, and fruits. There are also tricycle drives, sales agents, and
market collectors. They interact with each other by exchanging goods and services
and their activities are the real lifeblood of the local economies.
 Some markets are more sophisticated like the shopping malls and the real estate
markets or are complicated like auction markets and stock exchanges.
 Markets also include systems where potential buyers are linked with potential sellers
like the online markets in the Internet.
 The coverage of markets may be local, national, or international.
 Markets may involve face-to-face contact between the seller and buyer or may be
impersonal where they may not see or know each other.
 Markets may also have one seller to many sellers, and one buyer to many buyers.
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 The Market System (also called Capitalist or Free-Enterprise System) depends on the
competition of economic units such as businesses and households. These economic units
are free to purse their own economic self-interests.
 For the market system to function efficiently, the buyers and sellers act independently
and are free to enter or leave markets. Competition diffuses economic power thereby
limiting the abuse of that power.
B. The Four Types of Market Structures
 In the previous lessons, the behavior of buyers when they decide what products to buy and
how much they would buy were discussed. Eto ung consumer behavior
 In this lesson, the supply side of the market is studied.
 The business decision on two major problems such as (1) what price to charge and (2) how
much to produce, depends on the character of the industry or the market structure in which
it is operating.
 Industry – it is a group of businesses or firms that produce the same product or service.
 Economists group industries according to four distinct market structures (arranged from
most intense to least intense or lack of competition):
1. Pure Competition
2. Monopolistic Competition
3. Oligopoly
4. Monopoly
 The main criteria in classifying markets are:
1. The number of firms in the industry.
2. The nature of the good produced or the service provided.
3. The conditions of entry or exit in the industry.
C. Pure Competition
 Example of pure competition:
 Production of most agricultural products.
 Pure Competition – involves a large number of sellers producing a standardized product.
 There are many small firms acting independently to produce a product. They are so
many and so small that they cannot influence the price of the product. They are
price takers.
 The consumers are indifferent to whether they buy from one firm or another. As
such, firms sell at a uniform price, otherwise, they will not be able to sell any of their
product.
 The entry or exit in a purely competitive industry is very easy because there are no
financial, legal, and technological obstacles. Usually, investments in purely
competitive firms are relatively small.
 Standardized or homogeneous products – means that the products of all firms are identical.
D. Monopolistic Competition
 Examples of establishments operating under monopolistic competition may include:
 Restaurants, Grocery stores, Palay buying stations.
 A number of firms produce toothpaste. However, the product of each firm differs
from its rival in various ways. When a consumer wants to buy a toothpaste, he
specifies the brand of toothpaste he wants. He does not go to the store and orders
toothpaste; he goes to the store and orders “Colgate” or “Closeup” or whatever
brand he wants.
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Monopolistic Competitive Industry – it is composed of many firms (from more than 20 to
less than 100) but is different from a purely competitive industry because the firms produce
differentiated products.
 The firms are small, and each firm produces a small percentage of the total demand
for the product.
 The firms act independently, and their large number prevents them to collude to
influence the price.
 However, the firms try to influence price by producing a different product from those
in the industry.
1. Product differentiation has several dimensions:
1. “Real” differences can exist through functional features, material,
and design which are important aspects of product differentiation.
2. “Imaginary” differences can exist through effective use of
advertising, packaging, trademarks, and brand names.
 For example, a smoker buys “Marlboro” cigarette because of
the image projected by this particular brand of cigarette.
2. There are other conditions where product differentiation exist:
 The location of the store.
 The reputation of the firm marketing the product.
 The courteousness of the sales staff.
 The availability of credit.
 And others.
3. Because of product differentiation, the producers spend significant amounts
of money for advertising and promotion to increase sales. The competition
centers not only on price but also on product quality, advertising, and sales
promotion.
4. These non-price competitive practices try to make price less of a factor in
consumer purchases.
 Entry or exit in a monopolistic competitive industry offer obstacles. Entry barriers
may include large capital investment compared with that required in pure
competition.
E. Oligopoly
 Examples of oligopolistic firms:
 Commercial banks
 Oil firms
 Electronic companies
 Car industry
 Cement industry
 Beer industry
 Oligopolists are not necessarily large firms. If only two groceries, for example, exist in
a town or a barrio, they are oligopolists, too.
 Oligopoly – involves a few firms producing either standardized product or differentiated
products.
 The main characteristics of oligopoly is that it is composed of a few firms dominated
by two to five large produces. When the four largest firms control 40 percent or
more of the total demand for the product, the industry is considered an oligopoly.
 The firms in oligopoly exert control over price. Each firm is a price maker.
 Aside from competing in terms of price, an oligopoly is characterized by strategic
behavior and mutual interdependence.
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Firms exhibit strategic behavior governed by self-interest like developing and
implementing price, quality, location, service, and advertising strategies
while considering the reactions of others.
 Firms are mutually interdependent because their price and sales strategies
are also dependent on the actions of their few competitors.
 The barriers to entry or exit in oligopoly are substantial. Large expenditure for
capital, ownership, and control of raw materials are some of the barriers.
Three oligopoly models are identified based on the pricing and output behavior of
oligopolistic industries:
1. Non-collusive Oligopoly – this type of oligopoly occurs when a firm reacts to a
competitor’s price change by matching the price change or ignoring the price
change.
2. Collusive Oligopoly – firms in an oligopoly collude by agreeing to fix prices, to divide
the market, or to restrict competition among them.
3. Price Leadership – practices evolve in this type of oligopoly when the dominant firm,
usually the largest or most efficient firm, initiates price changes, and automatically
all or almost all follow the leader.
F. Pure Monopoly
 Examples of pure monopoly:
 Government-owned or government-regulated public utility firms.
 Manila Electric Company (MERALCO) monopolizes the distribution of
electricity in the Metro Manila. Although candles and kerosene lights can be
used, they are considered imperfect or poor substitutes for electricity.
 Maynilad is also considered a Monopoly, it is the only company that supplies
water service in some parts of Metro Manila.
 Pure Monopoly – it is a market structure where there is only one firm producing a unique
product or service for which there are no close substitutes.
 A single firm is the sole producer in a pure monopoly thus the firm is the industry.
 The firm produces a unique product which does not have a close substitute.
 In general, the monopolist is not encouraged to differentiate its product.
 The single firm has considerable control over price. A monopolist is a price maker.
 The pure monopolist undertakes public relations advertisements in order to improve
its image.
 Entry or exit in pure monopoly is blocked. The factors that prohibit entry include the
following:
1. Patent and Licenses. Legal barriers to entry include patents and licenses.
 Patent – it is the exclusive right of an inventor to use or to allow
another to use his or her invention.
 License – it is a government permission to enter into a business.
2. Ownership or control of an essential resource. The right to private property
is the essence of this barrier. Ownership of a mineral deposit used in a
production process prevents others from exploiting the resource.
3. Natural Monopolies. These are industries in which technology is such that
only a single seller can achieve the lowest possible cost. The government has
allowed the existence of some of these but is regulated. Examples of
regulated monopolies are those providing electricity, telephone, and
transportation services.
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THE BUSINESS FIRM
G. The Firm
 Firm – it is an institution within which managers organize resources in an effort to produce
goods and services by the most efficient means possible.
 In a firm, workers are often organized in team production which enhances productivity by
detecting and preventing shirking. As a result of increased productivity, their income is
greater. The manager’s main function then is to maximize production efficiency for profits.
H. Forms of Business Organizations
1. Sole Proprietorship – it is a business owned by one individual.
 It is the most common form of business ownership.
 It is the easiest and simplest business enterprise to organize.
 Because few laws exist to regulate them, sole proprietorships have the advantage of
being easy to set up and to dissolve.
 The proprietor, as owner, maintain a direct control of his business and own all its
profits.
 On the downside, owners of proprietorships are personally responsible for all
business debts and, because they are constrained by the limits of their personal
financial resources, they may find it difficult to expand or increase their profits.
1.For those reasons, sole proprietorships tend to be small, primarily service
and retail business.
2. Partnership – it is an association of two or more persons who have agreed to combine their
labor, property, and skill, or some or all of them, for the purpose of engaging in lawful
business and sharing profits and losses between them.
 The parties forming such an association are known as partners.
 The partners may adopt a fictitious name or use a real family name for the
partnership they created.
 Partnerships may include every trade, occupation, and profession.
 In order to establish the terms of the business and to protect partners in the event of
disagreement or dissolution of the business, a partnership agreement is drawn up
with the assistance of a lawyer.
1.These agreements are contained in what is called “The Articles of
Partnership” that is submitted to the Securities and Exchange Commission
(SEC), prior to formal registration and recognition of the business.
2.Partners share in the profits according to the terms of their agreement.
 Kinds of Partner in a Partnership Business:
1.General Partner – he is active in the operation of the business and he is
liable for all business debts or claims.
 In small business with only two or three owners, all typically are
general partners.)
2.Limited Partner – he invests in the business, but he is not involved in its daily
operations and he is not liable for business debts or claims.
 It is usually a requirement that the business name of the firm having
limited partners be extended to include the characters “Ltd.” to
properly inform people, including creditors, that there are limited
partners.
 Partnerships, like sole proprietorships, are relatively easy to establish.
 Furthermore, partners can pool resources to fund expansion and can divide their
duties and responsibilities according to personal expertise and abilities.
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 For example, one partner may be very good at selling, while another has a
knack for maintaining good financial records.
 Like sole proprietorships, however, partnerships may entail substantial financial risks,
as all of the general partners are each personally liable for the entire amount of any
business debts.
 A partner acts as an agent of the firm in the conduct of its business.
 Normally, anybody among the partners can transact for and in behalf of the
partnership. The action of one partner automatically binds all other partners
in a transaction.
 A partner must, however, exercise the highest degree of good faith in all
dealings with the other partners, devote time and attention to the
partnership business, and must account to the other partners for any secret
profit made in the conduct of the partnership business.
 The liability of a partner for partnership debts is said to be unlimited, except when
the partner is a limited one.
 By agreement of the partners, a partnership may be dissolved or terminated, and the
terms of the partnership agreement modified at any time.
 Death or bankruptcy of a partner, the insanity or misconduct of a partner, and the
end of the period fixed for the duration of the partnership also operate to terminate
the partnership.
3. Corporation – it is a legal entity that exists as distinct from the individuals who control and
invest in it.
 Since a corporation exists as distinct from the individuals who control and invest in it,
it can continue indefinitely through complete changes of ownership, leadership, and
staffing.
 Current stockholders can sell their holdings to other individuals or, if they die, have
their assets transferred to heirs. This is possible because a corporation creates shares
of stock that are sold to investors.
 One strength of the corporate business structure is that stockholders have limited
liability, as opposed to unlimited liability of general partners in a partnership, so the
stockholders of a corporation cannot lose more than their initial investment.
 Corporations can more easily raise capital for business expansion than what sole
proprietorships and most partnerships can.
 Stockholders control a corporation through the election of a managing body, known
as Board of Directors. In a large corporation, stockholders collectively decide who
will oversee the operation of the enterprise.
 In turn, the Board of Directors chooses a president, who decides on the key company
personnel and helps formulate company strategy.
 Many corporations are highly successful business organizations, with profits far
exceeding those of many sole proprietorships and partnerships. However, they are
subject to more regulation.
 Corporations also traditionally have higher tax burdens than other kinds of
businesses.
 Also, the fees involved in creating and organizing a corporation can be
expensive.
 Corporations may be classified as non-profit corporations, profit corporations,
private corporations, and government owned and controlled corporations (GOCCs),
among other classifications.
 Corporations that are not government agencies are called private
corporations.
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Some private corporations are found and owned by an individual or a small
group of individuals. Typically, their stock is not for sale to the general
public. These companies are sometimes referred to as privately held.
 Other private corporations are owned by many individuals. The general
public can purchase their stock on a stock exchange. These companies are
sometimes referred to as publicly traded or publicly held.
Cooperatives – it is a business organization that advocates equality of rights and
privileges among all owners.
 Organizers of a cooperative often refer to their business as “collective” or
“co-op”, thus, the term cooperative.
 A cooperative is in effect, a corporation organized and controlled by its
members, who pool resources together to provide themselves and their
patrons with goods, services, or other benefits.
 It is a voluntary organization of people who have agreed to pool their
resources in order to establish an economic enterprise that will meet their
common needs.
 The business is democratically managed and controlled by the members and
the benefits are shared according to patronage and participation.
 A cooperative operates in accordance with universally accepted cooperative
principles. The Universally Accepted Cooperative Principles are as follows:
 Open and voluntary membership.
 Membership in a cooperative is voluntary and available to all
individuals regardless of their social, political, and racial or
religious background or belief.
 Democratic control.
 Cooperative members enjoy equal rights to vote and
participate in decisions concerning the cooperative without
regard to the amount of savings or number of their capital
share. This is otherwise known as one member, one vote.
 Limited interest on share capital.
 A fair rate of interest is paid on savings and deposit that is
within the capability of the cooperative. This is practiced so
that no person, especially those with money, can have
overwhelming equity in the cooperative, hence preventing
the domination of the cooperative’s affairs by wealthy
members at the expense of the poorer members and the
cooperative as a whole.
 Equitable distribution of net surplus.
 The surplus arising out of the operations of the cooperative
are distributed for cooperative development, common
services, and for interest on capital and patronage fund,
after reserving amounts for the General Reserve Fund,
Cooperative Education and Training Fund, and Land and
Building Fund (which is optional).
 Continuing cooperative education.
 Every cooperative makes provision for education and
training of cooperative members so as to have an up-to-date
knowledge about the principles, practices, and current
issues on cooperation.
 Cooperation among cooperatives.
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A cooperative should actively collaborate with other
cooperatives at all levels in order to:
o Establish harmonious relationships.
o Advocate policy changes.
o Facilitate better exchange of technology.
o Have better access to resources.
o Establish business linkages.
 Principle of subsidiary.
 Cooperatives may organize, regulate, and help themselves
with government assistance only if necessary.
Cooperative is already a popular form of business organization in the
Philippines.
May cooperatives provide cheaper goods and services to their members.
Although not primarily designated for profit, cooperatives are starting to be
run in a professional manner.
Cooperatives registered under the supervision of the Cooperative
Development Authority (CDA) may be classified according to their primary
purpose and service to their members. A cooperative may be a:
 marketing cooperative,
 credit cooperative,
 consumer cooperative,
 agricultural cooperative,
 multipurpose cooperative, or a
 housing cooperative.
THE PRODUCTION FUNCTION
A. Concepts of Production and Production Function
 Production – it is the transformation of inputs or factors of production into an output in the
form of goods and services. Inputs or factors of production include labor, capital, land (raw
materials, and entrepreneurial or managerial capabilities.
 The firm schedules its production to take place either in the short-run or long-run period.
 For example, if the firm decides to increase its production next month, the firm may not be
able to purchase additional amount of all inputs in such a short period of time.
 Fixed inputs such as land and machineries are costly to acquire in such a short
notice.
 Variable inputs such as labor and raw materials are easily increased or decreased in
quantity in the short run.
 In contrast, the long-run period allows the firm to vary all its inputs.
 Production Function:
 It shows the relationship between inputs and outputs.
 It identifies the input combinations that can produce a given output per time period.
B. Total Product, Average Product, and Marginal Product
 Total Physical Product – it is the quantity of output produced per time period given the
inputs.
 Average Physical Product of an Input – it is the total product divided by the amount of the
input used to produce an output.
 For example, 4 workers produce 400 units of shoes, so the average product of labor
is 100 units of shoes per worker.
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Marginal Physical Product of an Input – it is the change in the total product resulting from a
one-unit change in the amount of the input, holding the quantities of the other inputs
constant.
 For example, when the number of workers (labor) increased from 4 to 5 persons,
total product rises from 400 to 450 units. So, the marginal product of labor is 50
units of shoes.
The formulae for Average Product and Marginal Product are the following:
AP = TP/Q
T
P
Q
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= Total Product or Output
MP = TP/Q
Where:
= Quantity of Input Used
= Change
Total product
or output responds to increase in the
use of a variable input.
Law of Diminishing Marginal Returns – it states that as the amount of some input is
increased in equal amount, holding other inputs constant, the increase in output will
decrease beyond some point.
Since the firm can vary all inputs in the long run, there are three possibilities in the overall
scale of production:
1. If the amount of input is doubled and the output doubles, there is constant returns
to scale.
2. if the amount of input doubles and the output more than doubles, there is
increasing returns to scale.
3. If the amount of input doubles but the increase in output is less than proportion in
input use, there is decreasing returns to scale.
COST ANALYSIS
C. The Concept of Cost and its Various Types
 Any firm or producer of a good or service entails costs.
 Costs – these are the expenditures for the purchase of raw materials, wage and salaries of
employees, machineries and equipment, interest on loan, overhead costs and other items
used for production.
 Costs are not only monetary but also non-monetary.
 The Various Types of Costs:
 Explicit Costs (or Accounting Costs) – these are payments directly paid by the
producer based on receipts of purchases.
 Implicit Costs – those that involve the use of resources owned by the owner of the
business like his own labor to operate or manage the business.
 Implicit cost is difficult to value but it is a very important component of total
costs.
 Opportunity Cost – this is the value of a foregone alternative of a specific resource.
 Resources can be used to produce many things: corn can be used to produce
cornick, feeds for animals, cornstarch, cooking oil, biofuel, or many other
uses.
 Another example for opportunity cost: Earning value of a university ground
had it been used as a commercial center instead of an educational
institution.
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Economic Cost – this is the amount required to keep the resources in their present
use.
D. Measures of Costs
 The firm uses fixed and variable inputs hence, there are also fixed and variable costs.
 Fixed Costs (FC) – these are paid regardless of output.
 Variable Costs (VC) – these are paid as output changes in the short-run.
 Total Variable Cost (TVC) – this is the sum of all the variable costs.
 Total Costs (TC) – sum of the fixed costs and variable costs.
 Average Total Cost (ATC) – total cost divided by the total output.
 Marginal Cost (MC) – the change in total cost divided by the change in total output per given
period.
PROFIT MAXIMIZATION
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The Concepts of Profit and Profit Maximization
In the circular flow model, the firm is one of the major players in the economy.
The main objective of business firms is to maximize profit.
Profit – it is the total revenue that a firm receives from the sale of its product minus all costs,
explicit and implicit, in producing a product.
 Formula to get profit: Profit = Total Revenue – Total Cost
Profit Maximization – it requires that the firm must manage its internal operations efficiently
(prevent waste, encourage worker morale, choose efficient production processes, etc.) and make
decisions in the marketplace (buy the correct quantity of inputs and choose the optimal level of
output).
Profit Maximizing Firm – it is a firm whose primary goal is to maximize the difference between
total revenues and total costs.
ECONOMIC GROWTH AND DEVELOPMENT
I.
Growth vs. Development
 Economic growth and development are goals of all peoples and nations in the world.
 Economic growth is the sustained increase per capital real output of goods and services.
 The output of goods and services is measured in terms of the gross national product
of gross domestic product.
 Economic growth is usually expected to result from economic development.
 Economic development is a process of bringing about changes in the economic and social
structure of the economy.
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J.
Economic structural changes mean the modernization of techniques of production
designed to bring about increase in the output of goods and services.
Economic development can also mean the transition from peasant agriculture to
mechanized farming, the weaning away from dependence on endowments of
Mother Nature.
Moreover, economic development is the transformation from rural living to an urban
way of life.
Three Core Values of Development
1. Sustenance – the ability to meet basic needs.
2. Self-esteem – to be a person.
3. Freedom from Servitude – to be able to choose.
K. Three Objectives of Development
1. To increase the availability and widen the distribution of basic life-sustaining goods such as
food, shelter, health, and protection.
2. To raise levels of living, in addition to higher incomes, provision of more jobs, better
education and greater attention to cultural and humanistic values.
3. To expand the range of economic and social choices available to people and nations by
freeing them from servitude and dependence not only in relation to other people and nation
states, but also to the forces of ignorance and misery.
L. Characteristics of Advanced and Third World Countries
 There are differences between the advanced countries (or developed countries) and the
Third World countries (or developing countries).
 Below is a summary of the characteristics of Advanced and Third World Countries:
ADVANCED COUNTRIES
1. Sustained rise of output per head of
population
2. Increased population due to increasing
agricultural production
3. Sustained patterns of technological
progress
4. Sustained increase in net capital stock
5. Sustained rise in real wages
6. High rate of change in economic
structure and transformation in social
and other non-economic sectors
THIRD WORLD COUNTRIES
High birth rate
Subsistence agricultural economy
High illiteracy
Low per capita income
High rates of unemployment
Negative attitudes, values and
institutions
7. Poor health
8. Inefficient public administration
1.
2.
3.
4.
5.
6.
M. Theories of Development
The theories of development are based from the works of the following distinguished and
famous economists of all times:
1. Adam Smith and the Wealth of Nations
 That a country will grow economically if the people would accumulate capital via
domestic savings and gains from trade.
 “Invisible Hand” in the economy.
 Advocated minimal intervention by the government in production.
 The wealth of a nation is in its enterprise development, labor productivity and
capital formation.
2. David Ricardo and the Limits of Growth
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3.
4.
5.
6.
7.
8.
9.
10.
The economy will continue to grow for as long as people work on the land on
profitable basis so that profit for the entrepreneurs and wages for labor would result
in accumulated savings which in turn, can be used for capital formation.
Thomas Malthus and the Population Theory
 As population grows, food production can cope less and less with food requirement
of the society so that the quality of life will fall. No saving can be generated by the
masses because they will have subsistence wages.
John Maynard Keynes and the General Theory
 Holds that the economy can be stabilized and stirred up to grow by injecting income
into the economy which will in turn spur new productive efforts among enterprises.
 Pump priming.
Harrod-Domar Theory
 Growth is determined by the capital-output ratio and the marginal propensity to
save.
Schumpeter’s Theory of Technological Change
 Development of the business organization and the economy is dependent on the
chain of innovations that can be produced.
Balanced Growth Theory
 A country should balance the development of its agricultural, commercial and
industrial sectors so that is can avoid complications such as loss of the agricultural
base, through sudden shift to industrialization, slow growth through over-emphasis
of agricultural production and failure to find the markets to match the growth of
agriculture and industry.
Trickle Down Theory
 Development will trip down from the higher income groups to the masses so that
there is no need to plan for growth with redistribution.
Debt Trap Theory
 There is a limit to how much a country can borrow from other countries and the
international lending institutions.
 Beyond the limit, the burden will be so heavy that the repayment problem will be so
heavy and pervasive.
Import-Substitution Theory
 A country that wants to develop should manufacture or produce items that the
economy imports from other countries, otherwise, it shall remain as an importing
country with the consequent effect of promoting the growth of exporting countries.
N. Models of Development
1. Linear Stages of Growth Model
 Development is a series of stages through which all countries undergo, given the
right mix of savings, investment and foreign aid.
 Development is merely a matter of time and that countries follow the same historical
path trod by the industrialized nations.
 Stages of Economic Growth by W.W. Rostow
1.The traditional society.
2.The preconditions for take-off.
3.Take-off or self-sustaining growth.
4.Drive for maturity.
5.The age of high mass consumption.
2. Neo-Colonial Dependence Model
 Underdevelopment is due to a highly unequal internationalist capitalist system of
rich country-poor country relationship.
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The coexistence of rich and poor nations in an international system dominated by an
unequal power relationship between the center and the periphery makes
development efforts of poor countries difficult and sometimes even impossible.
3. False Paradigm Model
 Underdevelopment is due to faulty and inappropriate advices, provided by wellmeaning, but often uninformed, biased, and ethnocentric international “expert
advisers” from developed country assistance agencies and multinational donor
organizations.
 Experts offer sophisticated concepts, elegant theoretical structures and complex
econometric models of development that often lead to inappropriate or incorrect
policies.
4. Ideal Model
 Swedish Model – this model sets a lower limit for wealth and income.
 Argentinian Model – this model sets a lower and upper limit for wealth and income.
O. Dimensions of Development
1. Economic Development
 It is growth oriented and development is measured according to how much progress
is made in gross and per capita national product, national and per capita income and
similar economic indicators.
2. Social Development
 It considers people and their total development and improvements in the quality of
life as focus of development. Poverty eradication, social justice and equity, and
employment opportunities are the goals pursued by social development.
3. Political Development
 The maturity and stability of political institutions and systems.
4. Sustainable Development
 It balances the requirement for economic progress and the imperative to conserve
and safeguard the environment for future generations. Productivity remains a valid
goal but one that is consistent with the carrying capacities of nature.
5. Human Development
 It is the process of enlarging people’s choices. The strategies used to achieve human
development focus on providing opportunities and access to education, health
services and livelihood.
6. Sustainable Human Development
 A development paradigm that emphasizes total well-being of the people within the
context of an ecologically friendly and future-minded development activities.
 It is development that distributes the benefits of growth more equitably,
substantially satisfied human needs, and improves the quality of life.
P. Determinants of Development
 Economic development is not determined by economic factors (such as capital, technology
and market) alone.
 There are non-economic factors such as social structure, family system, cultural values,
political conditions, corruption in public administration, religion, population and geography
that affect economic development and they have greater influence than the economic ones.
Q. Some Problems of Philippine Economic Development
The Philippines as a developing country continue to face many problems in its attempt to achieve
economic development. Many economists, however, believe that the Philippine’s concern with
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respect economic development policy is mainly that of structural problems. These include the
following:
1. Saving and Investment.
 Typically, in developing countries, the question is not how much to save, but in what
form should people hold their money balances.
 The economy should endeavor to mobilize a certain level of savings necessary to
promote economic growth.
 However, the lack of knowledge of opportunity costs in various areas of investment
lead people to hold money balances idle in form (i.e. jewelry or in real estate) such
that these assets do not appreciate in value over time. Thus, this form of saving does
not generate production and employment.
2. Tax Structure.
 Tax collections in developing countries cannot really cope with government
expenditures.
 It is difficult for a developing country to rely on taxation alone to finance many
development programs.
 Some economic, socio-cultural and political factors explain why taxation cannot
really cope with public expenditures.
3. Agricultural Structure.
 In the Philippines, large land areas are owned by only a few.
 Farm operations make use of tenancy arrangements and absentee landlordism.
 Moreover, pricing of the produce is dominated by traders and millers.
 Other heartaches of small farmers include typhoons, floods, pestilence, draught ad
the market mechanism.
 Increasing agricultural output is a problem that arises out of a social system that
benefits only a few.
4. Education.
 The educational system of the Philippines has been influenced predominantly by
Spain and the United States.
 Some recurrent issues in education continue to be addressed by educational
planners and policy makers. These are issues on quality of education, literacy,
curriculum offering, mismatch between demand and supply for labor, job
opportunities and labor market information.
5. Population.
 Rapid population growth is one of the most pressing problems of developing
countries.
 The ideal ratio is this: if population growth rate is 3 percent, then production growth
rate should be more than 3 percent.
 Economists contend that too large a population proportion to support lowers the
standard of living.
 The need is not population control alone, but also a population program of human
settlement, that is, to involve the people in activities that contribute to productivity
to overcome the current problem of scarcity.
6. Business and Enterprise.
 Traditional characteristics of methods of production and organization are among the
structural faults of economic institutions in developing countries.
 Economic development requires integration of various stages by interlinking with
other supplier-firms, and not a self-contained process from the first to the final
stages of production.
ESSENTIALS OF TAXATION
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R. Taxation and Economic Development
 To accelerate the economic development of the Philippines, equitable distribution of income
and wealth has been given top priority in our national development program.
 While economic development involves the interaction of different factors, economic and
non-economic, as mentioned in the preceding lesson, social structure or the institutions of
the society is one of the more fundamental barriers to our economic development.
 The present institution of ownership of private properties in our country favors the elite. A
very big portion of the wealth and income of the society belongs to them, and only about
ten percent of such resources are owned by the 90 percent of the population.
 Taxation and agrarian reform program have been the key measures adopted by our
government as the key instruments of social control, to affect a more equitable distribution
of wealth among the people and achieve economic and social stability.
 Relying on the ability-to-pay concept, individuals and business firms in higher income levels
have been taxed at higher rates to provide revenues for income security and services that ate
shared in greater proportion by those in the lower income level.
S. Why Should We Study Taxation?
 Taxes are referred to as the lifeblood of the nation without which the State cannot exist and
perform its many and varied functions.
 In the Philippines, most of our people are not tax conscious. They must be made aware of
the need to pay to the Government the taxes imposed by law.
 One effective way of achieving this is to teach the young, even before they become
taxpayers, the reasons for and basic workings of taxation.
 To a lot of people, taxation means additional burden. This attitude should be discouraged. In
its place, the payment of taxes should be considered as the means by which a person shares
in the support of his Government so that the latter can perform its functions effectively.
 Taxes are the enforced proportional contributions from persons and property levied by the
law-making body of the State by virtue of its sovereignty for the support of the government
and all public needs.
 Taxation is the process or means by which the sovereign, through its law-making body, raises
income to defray the necessary expenses of government. It is the inherent power of the state
to demand enforced contributions for public purposes.
T. Basic Principles of a Sound Tax System
1. Fiscal Adequacy – this means that the sources of revenue should be sufficient to meet the
demands of public expenditure.
2. Equality or Theoretical Justice – this means that the tax burden should be appropriate to the
taxpayer’s ability to pay.
3. Administrative Feasibility – this means that the tax laws should be capable of convenient,
just, and effective administration.
U. Classification of Taxes
1. As to Subject Matter or Object:
i.
Personal, Poll, or Capitation Tax – tax imposed on individuals, whether citizens or
not, residing within a specified territory without regard to their property or the
occupation in which they may be engaged.
Example: community tax
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ii.
Property Tax – tax imposed on property, whether real (immovable) or personal
(movable) property, in proportion either to its value, or in accordance with some
other reasonable method of apportionment.
Example: real estate tax
iii.
Excise Tax – tax imposed upon the performance of an act, the enjoyment of a
privilege, or the engaging in an occupation.
Example: income tax, value-added tax, practically all business taxes
2. As to Who Bears the Burden:
i.
Direct Tax – tax demanded from the person who also shoulders the burden of the
tax; it cannot be shifted to another.
Example: corporate and individual income taxes, estate tax
ii.
Indirect Tax – tax demanded from one person in the expectation and intention that
he shall indemnify himself at the expense of another; it can be shifted to another.
Example: sales tax, amusement taxes, customs duties, specific taxes, occupation
taxes
3. As to Determination of Amount:
i.
Specific Tax – tax which is a fixed amount imposed by the head or number, or by
some standard of weight or measurement; it is imposed on certain specified articles
manufactured or produced in or imported into the Philippines.
Example: excise taxes on distilled wines, cigarettes, gasoline
ii.
Ad Valorem Tax – tax which is a fixed amount in proportion to the value of the
property being taxed.
Example: real estate tax, value-added tax, percentage taxes, excise taxes on
automobiles, non-essential goods like jewelry
4. As to Purpose:
i.
General, Fiscal, or Revenue Tax – tax imposed solely for the general purposes of the
government, that is, to raise revenue for governmental expenditures.
Example: income tax, sales tax, and almost all taxes
ii.
Special or Regulatory Tax – tax imposed for a special purpose, that is, to achieve
some social or economic ends irrespective of whether revenue is raised or not.
Example: protective tariffs on imports to protect local industries against
foreign competitors; taxes on alcoholic drinks
5. As to Scope (or Authority Imposing Tax)
i.
National Tax – tax imposed by the national government.
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Example: national internal revenue taxes, customs duties
ii.
Municipal or Local Tax – tax imposed by municipal or local governments to meet
their needs.
Example: real property tax, community tax
6. As to Graduation or Rate
i.
Proportional Tax – tax is based on a fixed percentage of the amount of the property,
receipts/income or other basis to be taxed.
Example: real property taxes, all percentage taxes
ii.
Progressive or Graduated Tax – tax whose rate increases as the tax base or bracket
increases.
Example: income tax, estate tax, donor’s tax
iii.
Regressive Tax – tax whose rate decreases as the tax base or bracket increases
V. Limitations on the Power of Taxation
1. Constitutional Limitations – limitations that are expressly found in the Constitution or
implied from its provisions. They are as follows:
a. Due Process of Law
 A taxpayer may not be deprived of his property for non-payment of taxes
without giving notice to him of his tax liability as well as of the sale at public
auction of such property to satisfy the taxes as this will amount to denial of
due process. Here, the giving of notice is part of the procedure that is
prescribed by law.
 A tax which is imposed for a private purpose or which is beyond the
jurisdiction of the government to levy and collect, likewise violates due
process of law. In this case, the law imposing such tax is void.
b. Equal Protection of the Laws
 This signifies that “all persons subject to legislation shall be treated alike
under like circumstances and conditions both in the privileges conferred and
liabilities imposed”.
 This doctrine does not require that persons or properties different in fact be
treated in law as though they were the same. What it prohibits is “class
legislation” which discriminates against some and favors others.
c. Rule of Uniformity and Equity in Taxation
 Uniformity in Taxation – this means that “all taxable articles or properties,
or other subjects like transactions, business, rights, of the same class shall be
taxed at the same rate.” Different articles may be taxed at different amounts
provided that the rate is uniform on the same class everywhere.
 Equity in Taxation – the apportionment of the tax burden among the
taxpayers be more or less just in the light of the taxpayer’s ability to shoulder
the burden.
d. No Imprisonment for Non-Payment of a Poll Tax
 This principle is based on the constitutional provision that “No person shall
be imprisoned for debt or non-payment of a poll tax”.
 Under Section 38(e), Article 6 of the Local Government Code (Chapter IV),
the only penalty for delinquency is the payment of surcharge; and this is not
prohibited by the Constitution. A person, however, is subject to
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imprisonment for violation other than non-payment of the community tax as
in falsification of the community certificate, and for non-payment of other
taxes if expressly provided by the pertinent law.
e. Non-Impairment of the Obligation of Contracts
 The obligation of contracts is impaired when its terms or conditions are
changed by law or by a party without consent of the other, thereby
weakening the position or rights of the latter.
 An example of impairment by law is when a tax exemption based on a
contract entered into by the government is revoked by the latter through a
later taxing statute.
f. Non-Infringement of Religious Freedom
 The constitutional provision is as follows: “No law shall be made respecting
an establishment of religion or prohibiting the free exercise thereof. The free
exercise and enjoyment of religious profession and worship without
discrimination or preference shall forever be allowed.”
g. No Appropriation for Religious Purposes
 This is based on the requirement that taxes can only be levied for a public
purpose the legislative body is without power to appropriate funds for a
private purpose.
h. Exemption of Religious, Charitable and Educational Entities, Non-Profit Cemeteries,
and Churches from Taxation
 This limitation is based on the following constitutional provision:
 Section 28 (3), Article VI, 1987 Constitution. “Charitable institutions,
educational entities and churches are exempted from tax for the use
of the property but not ownership. Thus, a property leased by the
owner to another who uses it is exclusively for charitable purposes is
exempt from property tax, but the owner is subject to income tax.
Personages or convents appurtenant thereto, mosque and nonprofit cemeteries, and all lands, buildings and improvements
actually, directly and exclusively used for religious, charitable or
educational purposes shall be exempt from taxation.”
 The exemption covers only property and not other taxes.”
i. Exemption of Non-Stock, Non-Profit Educational Institutions from Taxation
 Sec. 4 (3), Art. XIV, 1987 Constitution. “All revenues and assets of nonstock,
non-profit educational institutions used actually, directly, and exclusively for
educational purposes shall be exempt from taxes and duties.”
 Sec, 4, Art. XIV, 1987 Constitution. “Subject to conditions provided for by
law, all grants, endowments, donations, or contributions used actually,
directly and exclusively for educational purposes shall be exempt from tax.”
 The exemption covers income, property, donor's and donee's taxes and
customs duties.
j. Concurrence by a Majority of all Members of Congress for the Passage of a Law
Granting Tax Exemption
 This is intended to prevent the indiscriminate grant of tax exemption.
k. Authority of the President to Veto the Particular Item or Items in a Revenue or
Tariff Bill
l.
Non-Impairment of the Jurisdiction of the Supreme Court in Tax Cases
 "The Congress shall have the power to define, prescribe, and apportion the
jurisdiction of the various courts but may not deprive the Supreme Court of
its jurisdiction enumerated in Section 5 hereof." (Sec.2, Article VIII).
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
"The Supreme Court shall have the following powers: review, revise, reverse,
modify, or affirm final judgments and orders of lower courts in all cases
involving the legality of any tax, impost, assessment, or toll, or any penalty
imposed in relation thereto." (Secs, 1,5 (2b), Article VIII).
 Under the two provisions, the Congress cannot take away from the Supreme
Court the power given to it by the Constitution as the final arbiter of tax
cases.
2. Inherent Limitations – they are as follows:
i.
Requirement that Levy must be for a Public Purpose
 The term is synonymous with "governmental purpose". The proceeds of the
tax must be used for the support of the government, for some of the
recognized objects of government, or to promote the welfare of the
community.
ii.
Non-Delegation of the Legislative Power to Tax
 Only the law-making body of the government has the power to impose
taxes.
iii.
iv.
v.
Exemption from Taxation of Government Entities
 The government need not tax itself.
International Comity
 The property of a foreign state or government may not be taxed by another.
 This is based on the sovereign equality among states under international law
by virtue of which one state cannot exercise its sovereign powers over
another.
Territorial Jurisdiction
 Tax laws do not operate beyond a country's jurisdictional limits.
 Furthermore, property which is wholly and exclusively within the jurisdiction
of another state receives none of the protection in return for which a tax is
supposed to be imposed.
W. Tax Laws
 Tax laws in the Philippines cover national and local taxes.
 National Taxes – refer to national internal revenue taxes imposed and collected by the
national government through the Bureau of Internal Revenue (BIR).
 Local Taxes – refer to those imposed and collected by the local government.
 The basic source of Philippine tax law is the National Internal Revenue Law, which codifies all
tax provisions.
X. The Bureau of Internal Revenue (BIR)
 The BIR functions under the supervision and control of the Department of Finance (DOF).
 The BIR was created by Commonwealth Act No. 466, approved by the National Assembly on
June 15, 1939 made effective July 01, 1939.
 The mission of the BIR is to "collect taxes efficiently and effectively, for and at the least cost
to the government, through impartial and consistent enforcement of internal revenue laws,
and convenient and honest service to taxpayers.”
 BIR accounts for more than 60 percent of the national government's total revenues.
 The BIR carries the bulk of the burden of solving the country's budget deficit problem.
Y. Powers and Duties of the BIR
1. To assess and collect all national internal revenue taxes, fees and charges.
2. To enforce all forfeitures, penalties, and fines connected therewith.
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3. To execute judgments in all cases decided in its favor by the Court of Tax Appeals and
ordinary courts.
4. To give effect to and administer the supervisory and police power conferred upon it by law.
5. To recommend to the Secretary of Finance all needful rules and regulations for the effective
enforcement of the provisions of the national Internal Revenue code (Sec 244).
Z. Distinction Between Tax Evasion and Tax Avoidance
 Tax Evasion – it is the use by the taxpayer of illegal or fraudulent means to defeat or reduce
the payment of a tax.
 Tax evasion is escape from taxation accomplished by breaking the letter of the tax
law, like the deliberate omission to report a taxable income, or a taxable property,
under declaration of sales, over-statement of expenses, and backdating an important
document.
 It is punishable by law.
 Tax Avoidance – it is the use by the taxpayer of legally permissible means or methods in
order to avoid or reduce tax liability.
 It covers escape from taxation accomplished by legal means which may be contrary
to the intent of the sponsors of the tax law but nevertheless does not violate the
letter of the law.
 The term may include situations where a person refrains from engaging in some
activity or enjoying some privilege in order to avoid the incidental tax, or to lower his
tax bracket for a taxable year to avoid the higher rate of tax.
 A man may change the form of his property by putting his money into non-taxable
securities.
 It is not punishable by law.
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