Chapter 1: Introduction to Applied Economics

Terms to Remember

Economics Traditional Economy

Scarcity Command Economy

Social Science Market Economy

Macroeconomics Positive Economics

Microeconomics Normative Economics

Opportunity cost Gross National Product (GNP)

Economic Resources Gross Domestic Product (GDP)

Land Applied Economics

Labor Unemployment

Capital Poverty

Economic System Poverty Line

Everybody goes through a day faced with constraints or limitations: motorist complain of high gasoline prices, times when people
suffer due to shortage of chicken in the market, or insufficient allowance for a student who needs to buy books and school
supplies. People always complain about not having enough- not enough food on the table, not enough money to pay one’s
debts, or not enough income to meet all the family’s needs. This in effect, SCARCITY, that is, insufficiency of resources to meet
wants consumers and insufficiency of resources for producers that hamper enough production of goods and services.

Scarcity is the reason why people have to practice economics. Economics, as a study,is the social science that involves the use
of scarce resources to satisfy unlimited wants. Part of human behavior is the tendency of man to want to have as many goods
and services as he can. However, his ability to buy goods and services is limited by his income and purchasing power. It is
therefore in this context of man has to practice economics.

Well-known economist Alfred Marshall described economics as a study of mankind in the ordinary business of life. It examines part
of individual and social action that is most closely connected with the attainment and use of material requisites of well being.

Scarcity is a condition where there are insufficient resources to satisfy all the needs and wants of a population. Scarcity maybe
relative or absolute. Relative Scarcity is when a good is scarce compared to its demand. For example, coconuts are abundant in
the Philippines since the plant easily grows in our soil and climate. However, coconuts become scarce when the supply is not
sufficient to meet the needs of the people. Relative Scarce occurs not because good is scarce per se and is difficult to obtain but
because of the circumstance that surround the availability of the good. Bananas are abundant in the Philippines and are being
grown in a lot of regions around the country. But when a typhoon destroys banana plants and the farmer has no bananas to
harvest, then banana become relatively scarce.

On the other hand, Absolute Scarcity is when supply is limited. Oil is absolutely scarce in the country since we have no oils wells
from which we can source our petroleum needs, so we rely heavily on imports from oil - producing countries like Iran and other
Middle Eastern countries. Cherries are absolutely scarce in our country since we do not have the right climate to grow them and
we have to rely on imports for our supply of cherries. This explains why cherries are very expensive in the Philippines.

CHOICE AND DECISION-MAKING

Because of the presence of scarcity, there is a need for man to make decisions in choosing how to maximize the use of the
scarce resources to satisfy as many wants as possible. A homemaker who has a monthly budget needs to decide on how to
utilize it to pay the rent, to buy food, to pay the children’s tuition fees, and to but new clothes and shoes. If the budget is not
enough, then the homemaker has to give up some of these things. She needs to make a choice. If she decides not to buy new
shoes for her children at the start of the school year, then this is the choice she gave up.

Opportunity cost refers to the value of the best forgone alternative. When land is devoted exclusively to the cultivation of rice, we
give up an output of bananas or mangoes that we could have planted on that land area. A producer who decides to transform
all his leather to shoes, gives up the chance to produce bags with that leather. A school teacher who could have work in the
bank, gives up salary that she would earned as a bank employee. A manager who quits his job in order to take up master degree,
gives up his salary as a mananger. That salary is his opportunity cost. Without scarcity, a person does not need to make choices
since he/she can have everything he/she wants.
ECONOMIC RESOURCES

Economic resources, also known as factors of production, are the resources used to produce goods and services. These resources
are, by nature, limited and therefore command a payment becomes the income of the resource owner.

1. Land - soil and natural resources that are found in the nature and are not man-made. Owner of lands receive. Owners of lands
receive a payment know as rent.

2. Labor - physical and human effort exerted in production. It covers manual workers like construction workers, machine operators,
and production workers as well as professionals like nurses,lawyers and doctors. The term also includes jeepney drivers, farmers,
and fishermen. The income received by labors is referred to as wage.

3. Capital - man-made resources used in the production of goods and services, which include machineries and equipment. The
owner of capital earns an income called interest.

ECONOMICS AS A SOCIAL SCIENCE

Economics is a different science from biology and chemistry as these are physical sciences. Economics is a social science
because it studies human behavior just like psychology and Sociology. A social science is, broadly speaking the study of society
and how people behave and influence the world around them. As a social science, economic studies how individuals make
choices in allocating scarce resources to satisfy their unlimited wants.

MACROECONOMICS AND MICROECONOMICS

There are two branches of economics. These are macroeconomics and microeconomics.

MACROECONOMICS is a division of economics that is concerned with the overall performance of the entire economy. It studies
the economic system as a whole rather than individual economic units that make up the economy. It focuses on the overall flow
of goods and resources and studies that causes of change in the aggregate flow of money, the aggregate movement of goods
and services, and the general employment of resources. Macroeconomics is bout nature of economic growth, the expansion of
productive capacity, and the growth of national income.

MICROECONOMICS, on the other hand, is concerned with the behavior of individual entities such as the consumer, the producer,
and the resource owner. It is more concerned on how goods flow from the business firm to the consumer and how resources
move from the resource owner to the business firm. It is also concerned with the process of setting prices of goods that is also
known as Price Theory. Microeconomics studies the decisions affects the prices of goods in the market. Likewise, it examines
alternative methods of using resources in order to alleviate scarcity. It does not focus on aggregate level of production,
employment and income.

BASIC ECONOMIC PROBLEMS OF SOCIETY

All societies are faced with basic questions in the economy that have to be answered on order to cope with constraints and
limitations. These are:

1. what to produce and how much - society must decide what goods and services should be produced in the economy. Having
decided on the nature of goods that will be produced, the quantity of these goods should also be decided on.

2. how to produce - is a question on the production method that will be used to produce the goods and services. This refers to the
resource mix and technology that will be applied in production.

3. for whom to produce - is about the market for the goods. For whom will the goods and services produced? The young or the old,
the male or the female market, the low-income or the high income groups?

How these questions are answered depends on the nature of the economic system in place. The economic system is the means
by which society answers the basic economic problems.

ECONOMIC SYSTEMS
The economic system is the means through which society determines the answers to the basic economic problems mentioned. A
country may be under any of the following types or even combination of the three economic systems:

1. TRADITIONAL ECONOMY. Decisions are based on traditions and practices upheld over the years and passed on from
generation to generation. Methods are stagnant and therefore not progressive. Traditional societies exist in primitive and
backward civilizations.

2. COMMAND ECONOMY. This is the authoritative system wherein decision-making is centralized in the government or a planning
committee. Decision are imposed on the people who do not have a say in what goods are to be produced. This economy holds
true in dictorial, socialist, and communist nations.

3. MARKET ECONOMY. This is the most democratic form of economic system. Based on the workings of demand and supply,
decisions are made on what goods and services to produce. People’s preferences are reflected in the prices they are willing to
pay in the market and are therefore the basis of the producers’ decisions on what goods to produce.

WHY ECONOMICS IS IMPORTANT

Students mat ask, “why do we need to study economics?” to know how important the subject is, all they need to do is read the
front page of the newspaper to see that the most important news are economics in nature. Watch the news on TV and for sure,
economic news always presents important issues.

Economics will help the students understand why there is a need for everybody, inlcuding the government, to budget and
properly allocate the use of whatever resources are available. It will help one understand how to more rational decisions in
spending money, saving part it, and even investing some of it.

On the national level, economics will enable the students to take a look on how the economy operates and to decide for
themselves if the government officials and leaders are effective in trying to shape up the economy and formulate policies fro the
good of the nation.

SCIENTIFIC APPROACH IN THE EMPIRICAL TESTING OF AN ECONOMIC THEORY

Economics is a study that attempts to explain how an economy operates and how the consumer attempts to maximize his/her
wants within limited means. Using tools such as logic, mathematics, and statistics, the student needs to approach the empirical
testing of an economic theory in a scientific manner. This scientific approach involves the following steps:

1. State the propositions or conditions that are taken as given and do not need further investigation, as basic starting point of
investigation, as the basic starting point of investigation. These propositions will serve as the premises upon which the theory is
established.

2. Observe facts in connection with the activity that we want to theorize.

3. Apply the rules of logic to the observed facts to determine casual relationships between observed factors and to eliminate
facts that are unnecessary and irrelevant.

4. Establish a set of principles such that formulated hypotheses may be tested as to whether they are valid or not.

5. Use statistics and econometric as empirical proof in testing the hypotheses.

POSITIVE ECONOMICS VERSUS NORMATIVE ECONOMICS

Positive Economics deals with what is - things that are actually happening such as the current inflation rate,the number of
employed labor, and the level of the Gross National Product. Normative Economics, on the other hand, refers to what should be -
that which embodies the ideal rate of population growth or the most effective tax system. Positive economics is an overview of
what is happening in the economy that is possibly far from what is ideal. Normative Economics focuses on policy formulation that
will help to attain the ideal situation.

MEASURING THE ECONOMY

We always get to read in the newspaper how our economy has grown in the recent years. Before we go into the essence of
applied economics, it is beneficial that students get to learn first how the growth of economy is actually measured. The national
government is always happy to inform the people that the country’s Gross Domestic Product (GDP) has grown in rates, much
higher than in the previous administration.
 The government plans for a better economy from a perspective of what the economy has been. Shaping the economy’s
future is changing the past and the present perspectives extended to the future. In particular, looking ahead is grounded on past
and present performance and health of the economy. The heart of the economy is production whose values measures both
resource input and output of the people. The interplay of resources and outputs tells us how well the economy has performed.

COUNTING ALL THROUGH GNP

As the mirror of all products, Gross National Product (GNP) is the market value of final products, both sold and unsold, produced
by the resources of the economy in a given period. Market value is determined by supply and demand while the economy’s
resources are those belonging to Filipino citizens and corporations. Not all resources belonging to the economy are in the
economy, like the capital and entrepreneurship that brought SM mall to China. Conversely, not all resources in the country by
multinationals like Nestle and Procter and Gamble (P&G). in addition, the value of final products already includes the value of its
components from the lower from the lower production stages, double counts and overstates the value of economy’s production.
Likewise, the value of any product in a certain period should no longer be counted in succeeding periods to avoid double
counting and overstatement that can mislead decision-making.

GNP/GDP: EXPENDITURE APPROACH

One way to account GNP and classify its components is by end-use expenditure. Products are final when they have reached the
highest levels of processing in the economy for different uses in the given period they are household and individual consumption
(C), and the government expenditure on goods and services including labor (G) and exports (X). Products,