PRINCIPLES OF ECONOMICS

ECONOMICS: STUDY
OF CHOICE
 THE ECONOMY
• "invisible hands" or market forces as introduced by Adam
Smith, the father of modern economics
• Economics is a social science that examines people's
choices available for them. It is the study of activities of
market forces.
• Market forces makes the goods available for consumers in
one place.
• Elements : Producers, Traders, Government and
Consumers
 THE ECONOMY
• SELECTION: scarcity, choice and opportunity cost
• SCARCITY means limited resources
• FUNDAMENTAL ECONOMIC QUESTIONS : (1) what should be
produced? (2) how should goods/services be produced? (3) for
whom should goods/services be produced?
• Every CHOICE has an OPPORTUNITY COST, and OPPORTUNITY
COST affects the CHOICES of the people.
• OPPORTUNITY COST of any CHOICE is the value of the best
alternative that had to be released in exchange of making
CHOICES.
 ECONOMIC WAY OF THINKING
• Economists give special emphasis to the role of
OPPORTUNITY COST in their analysis of any
choices.
• Economists assumed that individuals make
CHOICES to best serve their SELF-INTEREST.
• Economists focused on the effects of SMALL
CHANGES (choice at a margin) maximizing
individuals decision
 AREAS OF ECONOMIC ANALYSIS
• MICROECONOMICS - the branch of economics that focuses
on the choices made by individual decision-making units in
the economy (consumers and firms), including impact of their
choices on individual markets.
• MACROECONOMICS - the branch of economics that focuses
on the impact of choices on the total or aggregate level of
economic activity. (MACRO CONCERNS:"Inflation"- measure
of the rate of change in the average price for the entire
economy; "Unemployment" represent the aggregate of all
labor markets
 ECONOMIST'S TOOL KIT
• Economists examine relationships between
VARIABLES (changes in value)
• Economists used SCIENTIFIC METHOD (systematic
set of procedures through which knowledge is
created)
• In scientific method, HYPOTHESES are suggested and
tested, if then generally accepted, it becomes a
THEORY, if then, universally tested and accepted, it
becomes a LAW.
 MODELS IN ECONOMICS
• A MODEL is a set of simplifying assumptions about some
aspects of the real world.
• Economists often use graphs to represent economic models.
These models help us generate hypotheses about the real world.
• Two problems inherent in tests of hypotheses in economics are:
all-other-things-unchanged, and the fallacy of false cause
• Positive statements are factual and can be tested. Normative
statements are value judgments that cannot be tested. Most of
the disagreements among economists stem from differences in
values.
CONFRONTING SCARCITY:
CHOICES IN PRODUCTION
 PRODUCTION
• The process of producing goods and services available
for sale in the market. The value or satisfaction that
people derive from the goods and services they
consume or pursue is called UTILITY. Ultimately, the
economy's factors of production create UTILITY and
serve the INTERESTS of the people.
• FACTORS: land, labor, capital and enterprise
(responsible for the production of economy)
 FACTORS OF PRODUCTION
• LAND- political boundaries which can be used
for agriculture, residential, commercial purposes
• URBAN land is costly than RURAL land due to
the presence of vertical (bldg) and horizontal
(road) developments
• PROBLEM: conversion of land-use, fair market
value, alienable disposable land
 FACTORS OF PRODUCTION
• LABOR FORCE or human capital (18-65 y/o) is a
subset of total population in a country that has skills,
training, or experience that can be used in production.
• SALARY earners are those with fixed employment and
benefits (Full or part timers)
• WAGE earners are those with fixed tenure of
employment and not entitled to privileges.
• PROBLEM: unemployment, underemployment
 FACTORS OF PRODUCTION
• CAPITAL : savings, bank deposits and interests,
shares of stocks (financial capital) , office buildings,
machineries and tools, raw materials or natural
resources (physical capital)
• The more savings, the more available resources for
investment
• PROBLEM: when savings retained longer in banks
at lower fixed interest rates beaten by inflation
 FACTORS OF PRODUCTION
• ENTERPRISE : coordinates activities of the other three factors
namely, land, labor and capital. The ENTREPRENEUR is a person
who operates the ENTERPRISE. It used the TECHNOLOGY which
is the knowledge applied to the production of goods and
services. Both ENTREPRENEUR and TECHNOLOGY are the keys
in utilization of an economy's factor of production.
• The ENTREPRENEUR pays rent for land, wages to labor, and
interest to borrowed capital, and the surplus it earns above cost
is called PROFIT.
• Innovative vs imitative entrepreneur.
THE PRODUCTION POSSIBILITIES CURVE
• It is a graphical presentation of the alternative
combinations of goods and services an economy can
produce.
• Competitive Advantage happens when opportunity costs
is lower than any other.
• Law of Increasing Opportunity Costs holds that as an
economy moves along its production curve in producing
more goods, the opportunity costs of additional units of
that good will increase.
THE PRODUCTION POSSIBILITIES CURVE
• The downward slope of the production
possibilities curve is an implication of scarcity.
• The bowed-out shape of the production
possibilities curve results from allocating
resources based on comparative advantage.
Such an allocation implies that the law of
increasing opportunity cost will hold.
EFFICIENT AND INEFFICIENT PRODUCTION
• EFFICIENT production happens when an
economy is operating on its production
possibilities curve
• INEFFICIENT production happens when an
economy operating inside its production
possibilities curve. It could be producing
more goods without using additional labor,
capital, or natural resources.
 SPECIALIZATION
• It implies that economy is producing
goods and services has a comparative
advantage.
• The ideas of comparative advantage and
specialization suggest that restrictions on
international trade are likely to reduce
production of goods and services.
APPLICATION OF PRODUCTION POSSIBILITIES MODEL

• One of the most important implications

of the concepts of comparative
advantage and the production
possibilities curve relates to international
trade. If nations specialize, they will rely
on each other. They will sell the goods in
which they specialize and purchase other
goods from other nations.
 ECONOMIC GROWTH
• It is the process through which an economy
achieved outward shift in its production
possibilities curve (that outward shift is an increase
in physical quantity or quality of factors of
production available to an economy or a
technological gain will allow the economy to
produce more goods and services.
• Policies to encourage growth involve postponing
consumption to increase capital and human capital.
SOURCES OF ECONOMIC GROWTH
• Any increase in the quantity or
quality of the factors of
production available to the
economy or improvement in
technology contributes to
economic growth.
CLASSIFYING ECONOMIC SYSTEMS
• Market Capitalist Economy, known as "free enterprise",
resources are generally owned by private individuals
who have power to make decisions about their use.
• Command Socialist Economy, the government is the
primary owner of the capital and natural resouces and
has broad power to allocate the use of factors of
production.
• Mixed economies combine elements of market capitalist
and of command socialist economic systems.
DEMAND AND SUPPLY
 PRICE AND THE DEMAND CURVE
• The quantity demanded of a good or service is the
quantity buyers are willing and able to buy at a particular
price during a particular period , all other things
unchanged (ceteris paribus).
• A demand schedule is a table that shows the quantities
of a good or service demanded at different prices during
a particular period, all other things unchanged.
• A movement along the demand curve that results from a
change of price is called change in quantity demanded.
 PRICE AND THE DEMAND CURVE
• The law of demand holds that, for
virtually all goods and services, a higher
price leads to reduction of quantity
demanded and a lower price leads to
increase in quantity demanded.
• A shift in the demand curve is called a
change in demand.
 PRICE AND THE DEMAND CURVE
• A variable that can change the quantity of a good or
service demanded at each price is called a demand
shifter.
• In general, if a reduction in the prices of one good
increases the demand for another, the two goods
are called complements.
• If a reduction in the price of one good reduces the
demand for another, the two goods are called
substitute.
 PRICE AND THE DEMAND CURVE
• A good for which demand
increases when income increases
is called a normal good.
• A good for which demand
decreases when income increases
is called an inferior good
 PRICE AND THE SUPPLY CURVE
• The quantity supplied of a good or service is
the quantity sellers are willing to sell at a
particular price during a particular period, all
other things unchanged.
• A supply schedule is a table that shows
quantities supplied at different prices during
a particular period, all others things
unchanged.
 PRICE AND THE SUPPLY CURVE
• A supply curve is a graphical representation of a
supply schedule.
• A change in quantity supplied is a movement in
supply curve cause by a change in price.
• A variable that can change the quantity of a good or
service supplied at each price is called a supply
shifter. (eg. prices of factors of production, returns
from alternative activities, technology, seller
expectations, natural events, number of sellers
DETERMINATION OF PRICE AND QUANTITY
• The equilibrium price in any market is
the price at which quantity demanded
equals quantity quantity supplied.
• The equilibrium quantity is the
quantity demanded and supplied at
the equilibrium price
DETERMINATION OF PRICE AND QUANTITY
• Surplus is the amount by which the
quantity supplied exceeds the
quantity demanded at a current price.
• Shortage is the amount by which the
quantity demanded exceeds the
quantity supplied at the current price.
 THE CIRCULAR FLOW MODEL
• It provides a look at how market
works and how they are related to
each other. It shows flows of
spending and income through the
economy.
 PRICING
• Water vs Gold
• The price is not dependent on use
or purpose , it is determined by
the operation of the forces of
demand and supply.
 PRICING
• high demand, low supply, high
price
• low demand, high supply, low
price
APPLICATION OF DEMAND AND SUPPLY
• Technological change, which caused the supply curve for
computing power to shift to the right, is the main
reason for a rapid increase in equilibrium quantity and
decrease in equilibrium price of personal computers.
• The increase in fuel prices was driven by increase in
demand through out the world. Prices fell markedly as
world economic growth subsided. High fuel prices
increase cost of production, shifting supply curves to
the left. This tended to push prices up and output down
APPLICATION OF DEMAND AND SUPPLY
• Demand and supply determine prices of shares of stocks. The
equilibrium price of a share of stock strikes a balance between
those who think the stock is worth more and those who think it is
worth less than the current price.
• If a company's profits are expected to increase , the demand curve
for its stock shifts to the right and the supply curve shifts to the left,
causing equilibrium price to rise. The opposite would occur if a
company's profits were expected to decrease.
• Other factors that influence the price of corporate stock include
demographic and income changes and overall health of thr economy
APPLICATION OF DEMAND AND SUPPLY
• Price floors create surpluses by fixing the price
above the equilibrium price. At the price set by the
floor, the quantity supplied exceeds the quantity
demanded.
• In agriculture, price floors have created persistent
surpluses of a wide range of agricultural
commodities. Govt typically purchase the amount
of the surplus or impose production restrictions in
an attempt to reduce the surplus.
APPLICATION OF DEMAND AND SUPPLY
• Price ceilings create shortages by setting the price below
the equilibrium. At the ceiling price, the quantity
demanded exceeds the quantity supplied.
• Rent controls are an example of a price ceiling, and thus
they create shortages of rental housing.
• It is sometimes the case that rent controls create
"backdoor" arrangements, ranging from requirements that
tenant rent items that they do not want to outright bribes,
that result in rents higher than would exist in the absence
of the ceiling.
APPLICATION OF DEMAND AND SUPPLY
• The rising share of the output devoted to health
care represents a rising opportunity costs. More
spending on health care means less spending on
other goods and services.
• The model of demand and supply can be used to
show the effect of third-party payers (health
insurers) on total spending. With the third-party
payers, the quantity of services consumed rises, qs
does spending.