CHAPTER 1
INTRODUCTION
At the end of this semester, the students must be able to:
1) value the importance of economics not just as a discipline but also as an
instinctiveness way of addressing the basic scarcity issues and
2) understanding the concepts of agrarian reform and taxation in response to its issues
and concerns.
The main goal of this chapter is to provide us an overview to the concept of economics
that will help us strengthen our working knowledge of the subject. Included in the discussions
are the brief history of economics, scope and method of economics, economic problems that
underlie with the scarcity of resources and behavioral choice of the society, and structures of the
economy; all of these will assist us in dealing with the succeeding chapters.
Economics – the study of how individuals and societies choose to use the scarce resources that
nature and previous generations have provided. It is a behavioral science. In large
measure, it is the study on how people make choices. The choices that people make,
when added up, translate into societal choices.
Why Study Economics?
1.
2.
3.
4.
To
To
To
To
learn a way of thinking
understand society
understand global affairs
be an informed voter.
Brief History of Economics
A. Primitive Economics
The basic needs of primitive man, particularly food, were provided through the
exploitation of the natural environment. This marked the hunting and fishing stage.
During the stage of pastoralism, man learned to domesticate animals. They wandered
from place to place bringing with them their animals as primary source of food, the
development of agricultural stage. They built communities and learned to make use of
the land resources by planting their own crops. The economic activity soon became quite
complex when communities grew into states and kingdoms. As civilization developed,
interstate commercial activities were defined by trade barter.
B. Early Western Civilization’s Concept of Economics
Aristotle and Plato in ancient Greece wrote about problems of wealth,
property, and trade. Both were prejudiced against commerce, feeling that to live by trade
was undesirable. The Romans borrowed their economic ideas from the Greeks and
showed the same contempt for trade. During the Middle Ages, the economic ideas of the
Roman Catholic Church were expressed in the Canon Law, which condemned usury
(taking of interest from loans), and regarded commerce as inferior to agriculture.
C. Birth of Mercantilism
From the 15th to the 18th century, Europe experienced radical changes brought
about by a new trend in the economic activity of the people. Of the great significance
was the surge of the Industrial Revolution that gave prosperity to the continent. This
economic upliftment changed the outlook and life in Europe. Mercantilism is a theory of
political economy that holds that the wealth of a country consists of its quantity of gold
and silver and that the importation of precious metals and the exportation of goods
should be encouraged and controlled by the state. A reaction against mercantilism came
from a group of physiocrats who emerged during the second half of the eighteenth
century. Physiocracy had its beginnings in France and its founder was Francois
Quesnay, a doctor at the royal court of King Louis XV. His major work, the Tableau
Economique, was an attempt to trace the income flows through the economy, a crude
anticipation of the 20th century national income accounting. The physiocrats were against
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free trade and laissez-faire and strongly advocated a single direct tax to be levied on
land.
D. Birth of Economics as a Science
Adam Smith considered by then as the “founder of economics”. The birth of
economics as a separate subject of the study, independent of politics and philosophy,
may be traced to the year 1776, when Adam Smith published his An Inquiry into the
Nature and Causes of the Wealth of Nations. The book was an attack on the protectionist
doctrines of the mercantilists. It presented a brief outline of “free trade”, a step to the
idea of free enterprise and free market economy. Also, Smith’s book opened up new
economic concepts such as the theory of international trade, and the primitive theory of
money.
Thomas Robert Malthus wrote An Essay on the Principle of Population (1798)
that stressed the law of diminishing returns. He predicted that a natural depletion of
resources (referring to raw materials) will eventually occur due to the rate of increase in
population. According to him, the only way for a reversal in the geometric increase in
population and its eventual balance with food supply was the occurrence of severe
natural calamities, disease and wars.
In 1817, David Ricardo made a follow-up of Malthus’ theory and a critical
commentary on Smith’s The Wealth of Nations. His work, Principles of Political Economy
and Taxation gave a new twist to the science of political economy. Ricardo invented the
concept of an “economic model”. In his “law of comparative costs”, Ricardo showed that
the benefits of trade are determined by comparative costs within each country, rather
than by a comparison of costs between countries.
In 1848, John Stuart Mill restated Ricardian thought in his Principles of Political
Economy. However, after 1870, most economists turned their backs on the rage of
problems that had concerned Ricardo and concentrated on the theory of the relations
between goods and prices and began to re-examine the foundations of the theory of
value.
The last of the classical economists was Karl Marx. His book, Das Kapital
(1867), introduced a different economic theory that focused not on the real but on the
teachings of Smith and Ricardo. Marx worked out all the logical implications of this theory
and added to it the “theory of surplus value”. He believed that human alone is of value
and constitutes the sole source of profits.
E. The Marginal Revolution
This began in the 1870s and was essentially the work of three men: William
Stanley Jevons, an Englishman; Anton Menger, an Austian; and Leon Walras, a
Frenchman. The contribution of these three economists was their replacement of the
labor theory of value by the marginal utility theory of value. The English school led by
Alfred Marshall sought reconciliation with the doctrines of the classical economists.
Classical economics concentrated on the supply side of the market and marginal utility
theory dealt with the demand side but stressed the idea that prices are determined by
both the supply and demand sides.
F. Neo-classical Economics
The roots of macroeconomic thought was developed during the Great Depression
happened in US on 1930s by a British economists, John Maynard Keynes. The heart of
Keynesianism consists of an analysis of the determinants of effective expenditures,
investment and government expenditures, each of which is independently determined.
Keynes attempted to show that the level of effective demand so determined may well
exceed or fall short of the physical capacity to produce goods and services and that there
is no automatic tendency bringing the two into line with one another.
Branches of Economics
1. Microeconomics – the branch of economics that examines the functioning of individual
industries and the behavior of individual decision making units, that is, business firms
and households.
2. Macroeconomics – the branch of economics that examines the economic behavior of
aggregate income, employment, output and so on – on a national scale.
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Examples of Microeconomic Concerns
1. Production or output of individual industries and businesses.
Ex: how much steel?
2. Price of individual goods and services
Ex: price of medical care
3. Distribution of income and wealth
Ex: wages in the auto industry
4. Employment by individual businesses and industries
Ex: number of employees in a firm
Examples of Macroeconomic Concerns
1. National production or output
Ex: Gross Domestic Product (GDP) and Growth of output
2. Aggregate Price Level
Ex: Consumer’s and producer’s prices
3. National income
Ex: total wages and salaries
4. Employment and unemployment in the economy
Ex: total number of jobs and unemployment rate.
Diversity of Economics
-
Individual economists focus their research and study in many diverse areas.
Others focus on international economics or growth in less developed countries.
Some are concerned with economic history or the history of economic thought.
Still others study the economics of cities (urban economics) or the relationship
between economics and law.
Some economics specialized in developing new theories, while others spend their
time testing the theories of others.
Some economists hope to expand the frontiers of knowledge, while others are more
interested in applying what is already known to the formulation of public policies.
Methods of Economics
1. Positive Economics – an approach to economics that seeks to understand behavior
and the operation of system without making judgments.
Examples:
What determines the wage rate for unskilled workers?
What would happen if we abolished corporate income tax?
Types of Positive Economics
a. Descriptive Economics – the compilation of data that describe phenomena
and facts.
Example: data coming from the Philippine Statistics Authority
b. Economic Theory – a statement or set of related statements about cause and
effect action and reaction.
Example: The law of demand, stated by Alfred Marshal in 1890
2. Normative Economics – an approach to economics that analyses outcomes of
economic behavior, evaluates them as good or bad, and may prescribe courses of action.
Examples:
Should the government be involved in regulating the price of gasoline?
Should the income tax be changed to reduce or increase the burden on
upper-income families?
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Economic Goals
Every system invented by man presupposes some goals. These include economic
systems which seek to achieve the following goals:
1. Economic growth – what is desired by society is higher standard of living which is
translated into the production of more and better quality goods and services.
2. Full employment – there must be jobs for those who are willing and able to work.
3. Economic efficiency – this is a goal that requires using resources to derive the
maximum benefit of society
4. Price level stability – the economy should be able to avoid great fluctuations in the
general level of prices
5. Economic freedom – a high degree of freedom to choose what economic activity to
undertake should be afforded the various sectors consisting of executives, workers, and
consumers.
6. An equitable distribution of income – the economy must not be made up of certain
group that is so poor and destitute while other groups wallow in great luxury.
7. Economic security – there should be enough provision for those who are not able to
earn minimal income like aged, the chronically ill, the disable.
8. Balance of trade – a balance of trade that is reasonable must be maintained.
Economics as Related to other Social Sciences
In the early definition of economics, we classified economics as a social science because
it deals with the study of life of people and how they deal with others as a member of the
society. There are some social sciences that are related to economics because they study the
social life of human beings but differ in methods of analysis and objectives. We now enumerate
five social sciences that are most related to economics.
1. Anthropology – is the branch of science that studies the biological, psychological,
social and cultural aspects of human life.
2. Political Science – the word political comes from the Greek word polis which
means “city” or “state” and science comes from the Latin word scire which means “to
know”. Hence, political science is a systematic study of the state and government.
3. Sociology – comes from the Greek word socius and logus which together mean
“study of the society or study of groups or partners”.
4. Psychology – is derived from the Greek words psyche which means “soul” and
logus which means “study”. Psychology is defined as the scientific study of the
behavior and living organisms with special attention to human behavior.
5. History – is a social science that focuses on the study of past events.
The Economic Problem: Scarcity and Choice
-
Human wants are unlimited but resources are not. Limited or scarce, resources force
individuals and societies to choose.
The central concern of any economy, no matter how simple or complex is to
transform resources into useful form in accordance with those choices. This
transformation is what we called “production”.
Resources or Inputs – these are provided by nature or previous generations that can be used
directly or indirectly to satisfy human wants – Land, Labor, Capital and
Entrepreneur. Some resources are the product of nature: land, wildlife, minerals,
timber, energy, even the rain, and the wind. There are things that have been produced
by previous generations, such as buildings and equipment. These things are called
“capital”. “Human resources” are those labor, skills, and knowledge are also an
important part of a nation’s resources. Entrepreneur is the name given to a person (or
persons) responsible for operating a firm and making the decisions about what to do and
how to do. They are combining the other three factors of production to create some
products or services to sell. They hope for profit, but take risk loss or bankruptcy.
Producers – those people or groups of people, whether private or public, who transform
resources into usable products or inputs. Private manufacturing firms purchase resources
and produce products for the market. Government also produces outputs like natural
defense, the justice system, and police and fire protection. Individual households often
produce products for themselves; like land and structure of a house to produce housing
services.
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Scarcity, Choice and Opportunity Cost
There are 3 basic economic concepts that are important to understand: scarcity,
choice, and opportunity cost.
-
All society must answer THREE BASIC QUESTIONS:
1. What will be produced?
2. How much will it be produced?
3. Who will get what is produced?
-
In order to produce the producers must allocate the resources that are available.
These resources inputs are transform into usable products or outputs (like tables,
chairs or plywood)
These new products of outputs are distributed to households.
ECONOMIC SYSTEMS
1. Command Economy (Communism) – an economy in which a central authority or
agency draws up a plan that establishes what will be produced and when, sets
production goals, and makes rules for distribution.
Example: Russian Federation (USSR), Poland and China
2. Laissez-Faire Economy (Capitalism) – literally from the French “allow (them) to do”.
An economy in which individual people and firms pursue their own self-interests without
any central direction or regulation.
Market – the institution through which buyers and sellers interact and engage in
exchange.
a. Consumer Sovereignty – the idea that consumers ultimately dictate what will be
produced (or not produced) by choosing what to purchase (and what not to
purchase).
b. Individual Production Decisions: Free Enterprise – proponents of free market
systems argue that free enterprise leads to more efficient production and better
response to diverse and changing consumer preferences. If a producer produces
inefficiently, competitors will come along, fight for the business, and eventually take
it away. Thus, in a free market economy, competition forces producers to use
efficient techniques of production. It is competition, then, that ultimate dictates how
outputs are produced.
c.
Distribution of Output – in a free market system, it determines a decentralized
way. The amount that any one household gets depends on its income and wealth.
Income – is the amount that a household earns each year. It comes in a
number of forms: wages, salaries, interest, and the like.
Wealth – is the amount that households have accumulated out of past
income through saving or inheritance.
d. Price Theory – prices of inputs (land, labor and capital) determine how much costs
of producing a product. Many of the independent decisions made in a market
economy involve the weighing of prices and costs, so it is not surprising that much of
the economic theory focuses on the factors that influence and determine prices.
That’s why microeconomic theory is often simple called price theory.
Price – is the amount that a product sells for per unit. It reflects what
society is willing to pay.
3. Mixed System (Socialism) – mixture of command and laissez-faire economies.
Command and laissez-faire economies do not exist in the world because all real systems
are in some “mixed”. This system can be seen with the tension between the advantages
of free, unregulated markets and the need for government involvement in the economy
because free market systems are not perfect. First, they do not always produce what
people want at lowest cost so they are inefficiencies. Second, rewards some groups may
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be unevenly distributed, and some groups may be left out. Third, periods of
unemployment and inflation persist with some regularity.
Input and Output Markets: The Circular Flow
1. Firm – an organization that transforms resources (inputs) into products (outputs). Firms
are the primary producing units in a market economy.
2. Households – the consuming units in an economy.
Product or Output Markets – the markets in which goods and services are exchanged.
Input or Factor Markets – the markets in which the resources used to produce products are
exchanged.
MARKET ARENAS
1. Labor Market – the input/factor market in which households supply work for wages to
firms that demand labor.
2. Capital Market – the input/factor market in which households supply their savings, for
interest or for claims to future profits, to firms that demand funds in order to but capital
goods.
3. Land Market – the input/factor market in which households supply land or other real
property in exchange for rent.
Factors of Production – the inputs into the production process. It has three key factors: land,
labor and capital.
THE CIRCULAR FLOW
Output (Product)
Markets
SUPPLY
DEMAND
Goods
Services
FIRMS
HOUSEHOLDS
Supply in Output Markets
Demand in Input Markets
Demand in Output Markets
Supply in Input Markets
Input (Factor) Markets
DEMAND
Labor (wages)
Capital (interest)
Land (rent)
Entrepreneur (profit)
SUPPLY
Figure 1.1. The Circular Flow of Economic Activity
The Figure 1.1 shows the circular flow of economic activity among the two sectors: firms
and households, hence the name circular flow diagram. Goods and services flow in clockwise
direction. Labor services supplied by households flow to firms, and goods and services produced
by firms flow to households. Money (not pictured in the diagram) flows counterclockwise
direction. Payments for goods and services flow from households to firms, and payment for labor
services flows from firms to households.
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Production Possibility Frontier
The Production Possibility Frontier (PPF) – a graph that shows all combinations of goods
and services that can be produced if all of society’s resources are used efficiently.
A
Capital goods
E
G
800
D
550
C
B
0
1100
1300
Consumer goods
Figure 1.2. The PPF of Capital and Consumer Goods
Capital goods
Figure 1.2 shows the PPF of two goods: capital and consumer goods. On the Y-axis it
measures the quantity of capital goods produced, and on the X-axis, the quantity of consumer
goods. All points below and to the left of the curve represents combinations of capital and
consumer goods that are possible for the society given the resources available and existing
technology. Points above and to the right of the curve (such as point G) represent combinations
that cannot be reached.
If an economy were to end up at point A on the graph, it would be producing no
consumer goods at all and all resources would be used for the production of capital goods. If an
economy were to end up at point B, it would be devoting all of its resources to the production of
consumer goods and none of its resources to the formation of capital.
Points that are actually on the PPF can be thought of as points of both full resource
employment and production efficiency. However, points that lie within the PPF but not on the
frontier represent either unemployment of resources or production inefficiency (at point C). An
economy producing at point C can be produce more capital and consumer goods by moving to
point D. This is possible only if resources were initially not fully employed or not being used
efficiently.
In Figure 1.3 shows a shift in the PPF. A shift of PPF occurs either with an increase in the
available productive factors or with an improvement in the production technology. This is
depicted by an outward shift in the PPF. More capital and consumer goods could now be
produced as compared to before. However, even with the new frontier, the inevitability of tradeoff and the increasing opportunity cost of producing any good still remain as essential features.
Consumer goods
Figure 1.3. A shift in the PPF
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Negative Slope and Opportunity Cost
-
Points that lie on the PPF represents points of full resource employment and
production efficiency but society can choose only one point on the curve. In
producing more capital goods, the production of consumer goods can be reduced
because a society’s choices are constrained by available resources and existing
technology. The opportunity cost of the additional capital is the foregone
production of consumer goods.
-
The fact that scarcity exist is illustrated by the negative slope of the PPF. In moving
from point D to point E, in Figure 2, capital production increases by 800 – 500 = 250
units (a positive change), but that increase in capital can be achieved only by shifting
resources out of the production of the consumer goods. Thus, in moving from point
D to point E, consumer good production decreases by 1100 – 1350 = - 200 units (a
negative change). The slope of the curve, the ratio of the change in capital goods to
the change in consumer goods, is negative.
Slope
=
-
=
Y2 - Y 1
X2 - X 1
=
800 - 550
1100 - 1300
=
250
-200
=
- 1.25
The value of the slope of a society’s PPF is called the Marginal Rate of
Transformation (MRT).
REFERENCES:
Case, K. ,R. Fair and S.M. Oster. 2009. Principles of Economics. 9th Edition. Pearson Education,
Inc.
Gabay, B.G., R.M. Remotin, Jr., E.M. Uy and A.D. Pizarro-Uy. 2012. Economics Concepts and
Principles (with Agrarian Reform and Taxation). 2nd Edition. Rex Book Store, Inc.
Manapat, C., R. Olaguer, and F. Pedrosa. 2011. Economics, Taxation, and Agrarian Reform. 1 st
Edition. C and E Publishing, Inc.
Mankiw, N. 2009. Economics Principles. Cengage Learning Asia.
Medina, R.G. 2003. Principles of Economics. Rex Book Store, Inc.
Silon, E., R. Bernardo, M. Quilloy. 2009. Manual for economics with Work Exercises. 1st Edition.
Rex Book Store, Inc.
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Exercise No.1
INTRODUCTION
Name: _________________________
Yr/Crs/Sec: _____________________
Date: ____________________
Score: ___________________
TRUE OR FALSE
Instruction: Write the word TRUE if the given statement is correct and FALSE, if otherwise.
Write your answers on the space provided before the number.
_______________1. Human wants are limited and the resources are available.
_______________2. Firms demand goods and services from the households.
_______________3. The payment for capital is interest.
_______________4. Macroeconomics is the study of economy as a whole.
_______________5. Laissez-faire means no central direction or regulation coming from the
government.
IDENTIFICATION
Instruction: Identify which of the following is normative and which is positive statement. Write
the word cons if the statement is normative and the word pros if the statement is positive on
the space provided before the number.
___________1.
___________2.
___________3.
___________4.
___________5.
___________6.
___________7.
___________8.
___________9.
__________10.
Information Bill is one of the keys to solve graft and corruption.
Educational books are good tools for learning.
Peace and order situation is an issue in Mindanao.
The government should provide the economic and social services of the
Philippines.
Furniture and fixtures are luxuries for poor individuals.
The farmer should pay no taxes.
The imposition of minimum wage across the regions will result to an excess in
labor supply in general.
Fresh graduates who wanted to apply for jobs have less chance to hire on the
spot.
The Reproductive Health (RH) Bill is a key to reduce the population rate in the
country.
Fare hikes should not be imposed in public utility vehicles.
PROBLEM SOLVING
Instruction: Answer the following problems.
1. The following is a production possibilities table for Good X and Good Y.
Good
X
Y
A
0
35
B
3
33
Production Alternatives
C
D
6
8
27
17
E
10
0
a. Plot the production possibility frontier of the above-data with Good X in the
horizontal axis and Good Y on the vertical axis.
b. What do the points on the curve indicate?
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