Economic

Foundation of
Financial
Management
ACC08

Topical Objectives

Review relevant microeconomic concepts;

Review relevant macroeconomic concepts;

and

Identify the Green regulations affecting doing

business.

Microeconomics: Elasticity

a concept related to the equilibrium between

demand and supply

measures the dependency between demand

and supply and the impact of changes in
either on the equilibrium price level.

Microeconomics: Price Elasticity

of Demand

Price elasticity of demand is calculated as

Microeconomics: Price Elasticity

of Demand

Perfect Elasticity:

Elastic:

Microeconomics: Price Elasticity

of Demand

Unit Elasticity:

Inelastic:

Microeconomics: Price Elasticity

of Demand

Perfectly Inelastic
Elasticity:

Microeconomics: Price Elasticity

of Demand - Examples
For

each sample, determine elasticity as

Perfectly Elastic, Elastic, Unit Elasticity
Inelastic, Perfectly inelastic

Microeconomics: Price Elasticity

of Demand Example 1

Rich Asians buy into upwardly mobile Manila's luxury

condominiums

Yield-hungry investors from Malaysia to Japan now buy

Philippine condominium space in bulk, rotating money from
favorites Hong Kong and Singapore as the authorities there
have acted to cool real estate prices, property managers
and consultants said.

"There has never been this strong foreign interest in the

Philippines," said David Young, Philippines managing director
with consultancy and brokerage Colliers International.

Microeconomics: Price Elasticity

of Demand - Examples

Rich Asians buy into upwardly mobile Manila's luxury

condominiums (continuation)

Typically, 40 % of space in newer condominiums is owned by

foreigners, the maximum they are allowed. Foreigners
cannot own land in the Philippines, but they are allowed to
hold condominium titles as long as 60 % of the
development's total floor area is owned by Filipinos.

Asians usually buy apartments worth as much as $550,000

per unit, CPG managing director Robbie Antonio said.

Microeconomics: Price Elasticity

of Demand - Examples

Rich Asians buy into upwardly mobile Manila's luxury

condominiums (continuation)

Brokers also noted rising interest in office space on bets that

commercial leasing prices will skyrocket as more foreign firms
outsource in the country.

The action remains concentrated in Manila, brokers said, although

it is slowly spilling over into "new wave cities" in central and
southern Philippines, which host business process outsourcing
firms.

Top property developers use globally-known luxury brands to

attract overseas demand.

Microeconomics: Price Elasticity

of Demand - Examples

Rich Asians buy into upwardly mobile Manila's

luxury condominiums (continuation)

Other than Armani, CPG has tapped Versace and

American socialite Paris Hilton to design interiors.
"Brand associations have attracted interest from
foreign nationals," Antonio said.

For their part, Megaworld's Go said the company is

offering in-house brokerage services to help in leasing
apartments.

Microeconomics: Price Elasticity

of Demand Example

The surge in overseas pre-sales also keeps top property

firms awash with cash to fund projects and fatten their
land bank.

Jones Lang's Leechiu said top developers brush off

private equity and sovereign wealth funds seeking
discounts as they foresee sustained strong demand from
retail buyers.

"If they ask for too much discount we won't agree. We

don't need the money," Go said. ***

Reuters. (2014, July 3). Rich Asians buy into upwardly mobile Manila's luxury condominiums. Retrieved
July 6, 2014, from Yahoo! Finance: https://finance.yahoo.com/news/rich-asians-buy-upwardly-mobile052903760.html;_ylt=AwrSbmsDSLlTHVIATCRXNyoA;_ylu=X3oDMTEzbm5lbnJjBHNlYwNzcgRwb3MDMQ
Rjb2xvA2dxMQR2dGlkA1ZJUDQ3M18x

Microeconomics: Price Elasticity

of Demand Examples

Microeconomics: Expenditures
and Price Elasticity

Microeconomics: Factors
influencing elasticity
Close

substitutes increase elasticity.

Luxuries

tend to be more elastic than

necessities.

Elasticity

increases when the proportion of

income spent on a product is high.

Elasticity

increases over time.

Microeconomics: Cross elasticity

of Demand
measures

the responsiveness of the quantity

demanded of one product to the change in
price of another product.
If Cross
Elasticity Is:

The Products
Are:

Positive
Negative

Substitutes
Complements

Microeconomics: Income
elasticity of Demand
measures

the responsiveness of the demand

for a product to changes in income.

If Income

Positive and greater

than 1.0

Positive and less

than 1.0

Negative

The Product Is:

Normal and income

elastic

Normal and income

inelastic

Inferior

As Income
Rises:

The amount of
income spent and %
of income spent on
the product rise

The amount of
income spent rises
but the % of income
spent on the product
falls

The amount of
income spent and
% of income spent
on the product fall

Elasticity Is:

Microeconomics: Price elasticity

of Supply
measures

the responsiveness of the quantity

supplied of a product to a change in its price
More Elastic
Supply

Product is easy to produce

with many different, common
types of resources

Less Elastic
Supply

Product is hard to produce and

requires very specific, scarce
resources

Microeconomics: Examples of
factors affecting increase
(decrease) demand for goods

Microeconomics: Examples of
factors affecting increase
(decrease) supply for goods

Microeconomics: Example of
factors affecting increase
(decrease)
supply
for
goods
Discussion Questions:
Predict what may happen to the usage by the riding
public of the MRT? Of the Bus?
Do you think the MRT/LRT fare hike is good?

MRT,

LRT fares may go up in AugustAbaya

By Miguel R. Camus |Philippine Daily Inquirer
12:26 am | Friday, June 21st, 2013

Read more: http://business.inquirer.net/128269/mrt-lrt-fares-may-go-up-inaugust-abaya#ixzz36mF0nFX7

Microeconomics: Example of
factors affecting increase
Read more: http://business.inquirer.net/128269/mrt-lrt-fares-may-go-up-in-august(decrease)
abaya#ixzz36mF0nFX7 supply for goods

This

means fares, which were last adjusted in the early

2000s, will increase by P5 in 2013 while the second P5
increase will kick in next year.

The

announcement of the fare increases comes amid

severe criticism of the LRT-MRT operationscoaches
with passengers woefully packed like sardines most
times of the day and long queues to the stations during
rush hours.

Microeconomics: Example of
factors affecting increase
Read more: http://business.inquirer.net/128269/mrt-lrt-fares-may-go-up-in(decrease)
supply for goods
august-abaya#ixzz36mF0nFX7

For example, MRT 3 was designed to serve 350,000

passengers per day, but some 600,000 people cram the
system daily.

A 1.3-kilometer stretch of the line on north Edsafrom

Muoz to Trinomahas yet to be connected, three years
into the Aquino administration.

Critics say that no mass transportation system anywhere in

the world makes money, quite apart from Hong Kong.

Microeconomics: Example of
factors affecting increase
Read more: http://business.inquirer.net/128269/mrt-lrt-fares-may-go-up-in(decrease)
supply for goods
august-abaya#ixzz36mF0nFX7

Even with the fare increase, the LRT lines and MRT 3 come
out cheaper than rates charged by bus operators, which
are pegged at P40 per passenger, Abaya said.

The current fare at MRT, which runs through Edsa, Metro

Manilas main highway, is pegged at a maximum of P15
per passenger. For LRT 1, passengers are charged up to
P20 each for a single journey; for LRT 2, the rate is
pegged at P15.

Microeconomics: Example of
factors affecting increase
Read more: http://business.inquirer.net/128269/mrt-lrt-fares-may-go-up(decrease)
supply for goods
in-august-abaya#ixzz36mF0nFX7

Unlike other agencies under the DOTC, the LRTA is

unique, as it does not have a regulating body when it
comes to setting fares.

For the MRT 3 alone, Abaya said the government was

spending P60 to transport one passenger from end to
end, well above the current ticket price. This translates
to about P7 billion to P9 billion in subsidies every year.

Microeconomics: Example of
factors affecting increase
Read more: http://business.inquirer.net/128269/mrt-lrt-fares-may-go-up-in(decrease)
supply for goods
august-abaya#ixzz36mF0nFX7

To address overcrowding, the DOTC is evaluating a proposal

by a Chinese manufacturer as part of its plan to acquire 48
new train cars to expand MRT 3s capacity.

Complete delivery will happen on May 2016, he said.

MRT 3 currently has a fleet of 73 train cars, serving

passengers at 3-minute intervals. The DOTC said the
addition of new cars will cut the waiting time to 2.5-minute
intervals. ***

Marginal Benefit vs. Marginal Cost

Marginal Benefit Benefit that an individual gets from

consuming an additional unit of good or service. However
each additional unit consumed results in smaller marginal
benefit and results in diminishing returns.
The demand curve represents the marginal benefit
product to consumers.

curve of the

Marginal Cost Cost of producing an additional unit of output;

also referred to as opportunity cost.

The supply curve represents the marginal cost curve

of the producers.

Marginal Benefit vs. Marginal Cost

Example 1

Read more: http://newsinfo.inquirer.net/617323/sc-ruling-on-dap-checks-balances-democracywork#ixzz36mhRVdfo

Follow us: @inquirerdotnet on Twitter | inquirerdotnet on Facebook

The Supreme Court last Tuesday struck down the DAP, including a circular
allowing the release of savings from the executive department to
agencies and projects outside the national budget approved by Congress.

The executive department pooled savings under the DAP, a stimulus

program introduced in 2011, and allotted these for projects to speed up
government spending and boost economic growth.

Marginal Benefit vs. Marginal Cost

Example 2

The selling price is P100

The variable cost per unit is P40 (of which is P5,
marketing costs)
The total fixed manufacturing cost is P5,000.
The total fixed administrative costs is P2,200.

Requirements:

Compute for the break-even units

If there are 150 units, how much is the increase in net income

Consumer Surplus & Producer

Surplus
Consumer Surplus is the difference
between total value consumers place
on a good produced less the amount
paid

Producer Surplus is the difference

between the price received for each
good produced and the opportunity
cost of producing the good.

The difference between the lowest available price for a good

and the highest price is the producer surplus

Price Takers & Searchers

Price Taker
Price takers must take the market
price in selling their product,
because each price takers output
is small relative to total market
Price searchers have a downward
sloping demand curve for their
product. The amount they are
able to sell is inversely related to
the price they charge

Market
Characteristics
All firms are
producing an
identical product
A large number of
firms exist in the
market
Each firm supplies
only a very small
portion of total
amount supplied to
the market
No barriers limit
the entry or exit of
firms in the market

Market Structures
Perfect
Competition

Monopolistic
Competition

Oligopoly

Monopoly

# of Sellers and
Buyers

Many

Many

A Few Sellers

One Seller

Sellers
Products

Identical

Slight
Differences

No Close
Substitutes

No Close
Substitutes

Barriers to entry

None

None

High

Insurmountable

Economies of
Scale

Low

Low

Often High

Often High

Competition
Between
Sellers

High

High

High or Low

None

Other

Buyers have
perfect
knowledge of
product and

Sellers are
independent
but have
incentive to

Macroeconomic Concept

Macroeconomic concepts that have an impact on

all firms in the same environment, be it a
country, a group of related countries, or a
particular industry.

Topics covered concepts about the business

cycle, and how to forecast changes in the
business cycle and the impact on, among other
things, price levels and profitability.

Macroeconomic Concept: Business

Cycle

Moderating the Business Cycle

Policies can be used to moderate the business cycle:

Status of the
Economy

Appropriat Using Fiscal Using

e Action:
Policy
Monetary
Policy:

Recession:
GDP < Potential

Stimulus
AD

G T
Deficit

Contractio
n
AD

G T
Deficit

Excess
unemployment

Boom:
GDP > Potential
Rising real
wages

Moderating the Business Cycle

(continued)
The

actions can be:

oDiscretionary actions require a policy
change. Example:
Increase government spending on roads
Raise income tax rates

Moderating the Business Cycle

(continued)
oAutomatic

actions require no policy

change and occur with changes in the
level of economic activity. Examples:
Income

taxes are based on progressive rates

so total taxes fall at an accelerating rate with
declining economic activity
Needs-based spending such as
unemployment insurance automatically
increases with rising unemployment

Moderating the Business Cycle

(continued)
Discretionary
oRecognition
oLaw-making
oImpact

policy is hampered by lags:

Macroeconomics: Inflation

The Rate of Inflation is calculated as:

Inflation = Last years price index - This years price

index

* 100

rate

Last years price index

Inflation is an increase in the general

level of prices.

Inflation and Interest Rates

rnom = Real rate + E(inf)
Supply set by BSP
Demand is a function of
interest rate

Change in inflation
expectations directly
changes nominal rates

Investment demand for capital

Savings supply
Real interest rate is independent
of inflation rate

Nominal interest rates reflect both an expectation of inflation and a real rate of interest

Inflation and Interest Rates

(continued)

Unexpected inflation redistributes income among economic

groups.
If inflation is higher than expected:
Interest
Benefits
Causes

rates will have been set too low

borrowers at the expense of lenders

borrowers to regret they did not borrow more and

lenders to regret they did not lend less

Inflation and Interest Rates

(continued)
If inflation is lower than expected:
Interest
Benefits
Causes

rates will have been set too high

lenders at the expense of borrowers

lenders to regret they did not lend more and

borrowers to regret they did not borrow less

Two Types of Inflation

Demand-Pull Inflation starts with an increase in AD. Typical causes
of the increase include an increase in the money supply, government
spending, or exports. Assuming the economy is already at full
employment:
The increase in AD will increase GDP Real and the price level
But rising costs will decrease SRAS leading to another increase in
the price level and decrease in GDP Real
Net result is a one time round of price increases and no change in
GDPReal

However if the money supply continues to grow excessively and

fuel AD, the demand-pull inflation process can continue

Two Types of Inflation

(continued)
Cost-Push
Inflation starts with an increase in costs. Typical
causes of the increase include a rise in the money wage rate
or raw material prices
Rising

costs reduce the SRAS curve and the initial effect is

to increase prices and decrease GDP Real
This fall below GDPPotential could precipitate government
stimulation which will increase AD leading to another
increase in prices and an increase back to GDP Potential
Net result is a one time round of price increases and no
change in GDPReal

Output in the Short Run

In the short run:
Some inputs (such as labor and raw materials) are variable but others (such as
property, plant and equipment) are not.
Output can benefit by the specialization of labor.
All inputs are subject to the Law of Diminishing Returns.

Expected Relationships in the

Short-Run

AFC: Falls as output rises and fixed cost is spread.

AVC and MC:
First, fall with specialization
Then, rise with Law of Diminishing Returns
MC: When rising it will intersect the minimum points on AVC and
ATC.

Expected Relationships in the

Short-Run

Costs in the Long Run (continued)

In the long run all costs are variable and the firm can alter the size of its
plant to meet higher or lower product demand.

If expanding plant size leads to more efficiency and specialization, the

minimum point on the SRATC curve will be lower.
If expanding the plant size leads to less efficiency and specialization, the
minimum point on the SRATC curve will be higher.
These minimum points become the firms LRATC curve (which can be
upward, flat, or even downward sloping).

The minimum point on the LRATC curve is the firms minimum efficient scale.

Costs in the Long Run

In the short run some costs are fixed and the firm will maximize profits by
operating at the minimum point on its SRATC curve.

The aggregate demand curve (AD) measures the amount of total, real consumption
expenditures (goods and services) demanded at various price levels
AD = Y = C+I+G + (XM) = GDPReal

AD curves downward slope is caused by the:

Wealth Effect: Rising inflation (GDP

Deflator ) causes financial assets to lose
value. All other things equal, this leads to
increased savings and decreased current
spending

Substitution Effect: Rising prices and

inflation increase nominal interest rates,
which reduces borrowing to fund current
consumer and investment spending

A change in AD curve is due to a factor other than price:

Aggregate supply is the quantity of goods, services supplied (GDP Real).

It is a function of aggregate production which depends on:

Quantity of Labor (L)

Quantity of Capital (K)

Level of Technology (T)

At any one point in time the level of technology and quantity

of capital are fixed, but the quantity of labor is variable. This
produces a vertical long-run aggregate supply and an upward
sloping short-run aggregate supply curve.

Potential GDP increases over time with increases in the:

Full employment
quantity of labor
Capital (human and
physical)
Level of Technology

Increases in factor costs decrease the SRAS curve:

Does not affect real factors of

production and Potential GDP

Rising production costs decreases

SRAS (higher price for any
quantity of output)

Assuming all other prices rise at

the same rate, the economy

Classical View: The economy is self regulating back to full

employment
Wages and prices adjust fully and quickly to eliminate
shortages and surpluses to restore economic efficiency and
full employment
Taxes and government intervention are potential
disruption to the market signals necessary for fully functioning
competitive markets
Technology is the prime driver in increasing aggregate
demand and supply over time

Keynesian View: The economy is inherently unstable and does

not return to a long-run equilibrium (potential GDP) without
government intervention
Expectation are the primary determinant of AD and expectations
are the subject to excesses of optimism and pessimism (leading
to inflation and recession)
SRAS does not quickly adjust because wages, in particular, are
sticky in the downward direction
Government intervention to dampen or stimulate the economy is
needed to maintain output at potential GDP

Monetarist View: The economy is self regulating back to full

employment as long as the money supply grows at an
appropriate, stable pace
The quantity of money fuels aggregate demand
Recessions are caused by bad monetary policy
The wage rate is sticky which delays economic recoveries
when coming from recession
Taxes and government intervention are a potential disruption
to the market signals necessary to make competitive markets
work

MONEY
Money is a means of payment to settle a debt for a current or prior
purchase. It has three functions:
Medium of exchange for goods or services
Credit cards are not money, they just delay the debt
Checks are not money. They move funds (money) from one account to
another
Checking account balances are money!
Store of value that can be held and exchanged for goods in the future
Unit of account that allows relative prices to be quoted in a standard unit

The Supply and Demand for Money

The

supply of money is fixed at any point in time by the Fed (hence, the
vertical supply curve)
The price of money is the interest rate
Surplus of money leads
market participants to invest
Equilibrium Price

Shortage
leads to
selling of
investments

The Supply and Demand for

Money (continued)

The demand for money is affected by four major

factors:
o The level of interest rates cause movement on the
demand curve and is inversely related to demand:
Higher rates create an incentive to invest
instead of holding money
Higher rates are associated with higher inflation,
which causes money to lose value

The Supply and Demand for

Money (continued)
o The

General Price Level:

Quantity of nominal money demanded is directly
related to the price level
Quantity of real dollars demanded is independent of
the price level
o Real GDP: demand for money is directly related to real
income
o Financial Innovation has generally led to greater liquidity
and decreased demand for narrowly defined money

Two Categories:
Renewable resources are replenished by nature
Nonrenewable resources are used up in production

Renewable Resources:
Total supply is fixed and inelastic
Any one purchaser can obtain more by paying a higher price
Non-Renewable Resources
Total supply (both known and expected to be recovered supply) is
fixed, known, and perfectly elastic
Total demand (current and all future demand) determine future price
Current price is the PV of future price causing the current price to rise
over time at the rate of interest rates (Hotelling Principle)
Lack of perfect knowledge of future supply, demand, and interest rate
can lead to surprise changes in price today.

The materials balances model

Kneese, Ayresand DArge (1970) (Thomas, 2010) (Figure 1.0)

Environmental Policies

The Philippine Experience

P.D. 1151 Philippine Environmental Policy (1977)
Renewable Energy Act (2008)
In December of 2008, then President Gloria M.
Arroyo signed into law the Republic Act 9513
Renewable Energy (RE) Act of 2008-an act
promoting the development, utilization, and
commercialization of renewable energy
resources and for other purposes.

The Philippine Experience

Its targets were, for the Philippines, (Perez,
2009):
to be the No.1 geothermal producer in the world
to be the No.1 wind power producer in the
Southeast Asia
to double its hydro capacity by 2013
to expand contribution of biomass, solar, and
ocean energy by 250 MW

The Philippine Experience

The Philippines has an abounding potential for

generating energy from renewable resources
(Perez, 2009):
Geothermal resource: 1,200 MW
Wind: 700 MW
Solar: no potential estimate which depends on solar
panels put up (but currently the largest solar
manufacturing hub in Southeast Asia producing 400 MW)
Hydro: 1,784 MW from 888 sites
Biomass (bagasse): 235 MMBFOE

The Philippine Experience

Amidst the so-called abundance of this Philippine

potential for renewable energy, about 50% of its
power generation still comes from non-renewable
sources (i.e. coal (26%) and oil (23%))
(Department of Trade and Industry, 2009). DTI
has forecasted that with growing industrial
demand, the country will still require 4,000 to
4,350 MW for sustainability (Department of Trade
and Industry, 2009). ***