Microeconomics

Bachelor of Public Administration

Ten Principles and the Everyday Application of Economics

Most people have a general idea of what Economics is. They live with it; they practice it.
Some will even be able to define it. Economics is concerned with the production, distribution,
and use of material goods and services. Adam Smith, the recognized father of Economics, stated
that Economics is “an inquiry into the nature and causes of the wealth of the nations.”

Review on the Basic Terminologies in Economics

It is essential that you, as a student, be familiar with the terms that we will be using in
this study. A knowledge of such terms shall facilitate your understanding of economic analysis.

 Economics is a field of knowledge concerned with managing scarce resources to satisfy

unlimited wants and needs.
 Scarcity refers to the limitation of resources (i.e., land, labor, capital, and
entrepreneurship) to be allocated properly to all sectors of the economy.
 Sectors of Economy. Individual sectors, Business sectors, Government sectors,
International Organization (Asian Development Bank, United Nations, etc.)
 A Good is anything which yields satisfaction to someone. It is anything used to satisfy a
person’s needs and wants. Goods may be tangible when they are in the form of material
goods or commodities. They may also be intangible in the form of services.
 Tangible Goods are in a form of material goods and commodities such as books, shoes,
medicines.
 Intangible Goods are in the form of services such as intangible services rendered by a
doctor, or a teacher, or painter.

Both are all used in the satisfaction of human wants and needs.

 Consumer Goods are goods which yield satisfaction directly, just like softdrinks and
food.
 Capital Goods are goods used in the production of other goods and services. Example,
buildings, machinery, and equipment.

 Essential Goods are goods used to satisfy basic needs of man such as food, shelter, and
medicine.
 Luxury Goods are goods that man can live without, but are used to contribute to his
comfort and well-being. Perfume, chocolates, and expensive cars are luxury items that
are purchased only by those who can afford.
  Economic Good is a good which is both useful and scarce. It has a value attached to it
and a price has to be paid for its use.
 Free Good is a good that is so abundant that there is enough of it to satisfy everyone’s
needs without anybody paying for it. Air is free, but air from the electric fan is an
economic good.

Goods are created by means of production. It may involve the physical transformation of
a commodity such as the conversion of leather into shoes.

 Manufacturing or industry is a type of production that takes place in a factory.

 Agriculture production is a type of production which takes place in a farm such as
planting and harvesting of rice, corn, coconuts, and sugar.

Even exploration of oil, mineral, and precious metals is production.

All these activities are carried out to provide goods and services for use in the satisfaction
of man’s wants and needs.

 Economic Resources. The things which are needed to carry on the production of goods
and services are called economic resources or factors of production. These resources are
land, labor, capital, and entrepreneur. They are the basic resources because they
constitute the basic needs in production.

 Inputs refer to the commodities or services used to produce the good or the service.
Existing technology is used to combine these different inputs. Inputs consist of land,
labor, and capital.

 Outputs refer to useful goods and services resulting from the production process. These
are goods that are either consumed like shoes, or used in further production like
machines.

The Need to Choose

Scarcity is the reason why people economize. Scarcity refers to the limitations that exist
in obtaining all the goods and services that people want. It gives rise to economic problems and it
is the reason why man has to make a choice. If all goods were as free as air, there would be no
need to economize. Because of scarcity, any society must confront three fundamental and
interdependent economic problems.

1. What to produce and how much? This is a decision on what goods and services to
produce and their quantities. This would depend on what is needed, what is wanted, and
what has to be produced.
 2. How shall goods be produced? This is a decision of what resources are to be used in
production, by whom the goods will be produced, the technological manner in which
production will take place. A country with an abundant labor supply would be expected
to use a larger amount of that resources in its production of goods and services.

3. For whom shall goods be produced? This question is now on the problem of distribution.
Who will benefit from the production of goods and services? How much of total
production will each consumer get? Will the goods be bought by the rich or by the poor?

Unlimited Human Wants and the Economic Problem

Individually, personal objectives are concentrated in getting what one desires. The
problem is nobody can have everything. Even if one works an entire lifetime, he/she will never
earn enough to buy everything that he/she wants. For instance, a young adult, after buying
his/her first dream car and dressing it up, will eventually think of buying a new one. As fast as
he/she acquires a new car, his/her tastes and preferences change.

Needs consist of the products and services that an individual cannot live without based on
his/her existing lifestyle. For example, a middle class-family living in the city spends its budget
on food, school uniforms, work attire, car gasoline, allowances, and payments for rent and
utilities. As the family's income increases, it is possible that its needs will change.

Wants refers to products and services that a person can do without regardless of his/her
lifestyle. Specifically, they include items that have base models. For example, a cellular phone in
its basic form is a device that can make and receive calls wirelessly. Regardless of the user, this
is the purpose of a cellular phone. However, additional features or parts such as camera, music
player, and video recorder are integrated in the latest models. If the objective is communication,
then a basic cellular phone can be classified as a "need." As other features are desired, then the
cellular phone becomes a "want."

The distinction between needs and wants, however, is not strictly fixed. The wants of
today may become the needs of tomorrow. Cellular phones with various features are fast
becoming a need rather than a want because of the convenience and utility that technology
provides.

It is also important to understand that each person has different needs and wants which
keep on changing. There is always something new that will come out in the market.
Economics and Philosophy

Adam Smith (1776) wrote the famous An Inquiry into the Nature and Causes of the
Wealth of Nations and separated economics from philosophy as a source of knowledge. He
explained that society is based on the interdependence of all people regardless of what they do.
The underlying interconnection lies on the movement of goods and services in relation to the
needs and wants of people. This means that each individual has needs and wants to fulfill, which
are the ultimate reason for working.

Basic Assumption of Economics

Economics is able to predict actions of people based on rationality. Rationality is defined

as the decision-making process of an individual that is consistent and results in a logical outcome
most beneficial to the person. To illustrate further, the rationality test may be considered. For
example, if a person prefers mango over banana and banana over guava, then it follows that
he/she prefers mango over guava. Economics assume that individuals make decisions rationally,
and thus, it is able to predict certain behavioral outcomes.

Economic Resources or Factors of Production

Land covers all natural resources that exist without man's intervention. It encompasses all
things derived from the forces of nature such as air, water, forests, vegetation, and other forms
beneath the earth's surface, like minerals. These resources are irreproducible. The payment for
land is called rent.

Labor refers to human inputs such as manpower skills that are used in transforming
resources into different products that answer people's needs. Payments for labor are called wages
and salaries.

Capital is the man-made factor of production used to create another product. Examples
are machinery and equipment used by manufacturing companies. The payment for capital is
interest. Money, buildings, raw materials,

Entrepreneurship integrates land, labor, and capital to create new products. An

entrepreneur is a person who innovates and reinvents an old product by creating a new one. A
person who sells baskets will find it difficult to find a proper market for the product. However,
he/she can innovate and repackage the basket with grocery items, not to sell the grocery items
alone, but to sell the whole bundle as one merchandise. In this way, the basket of grocery items
can be sold as a different item with proper packaging.
 The scarcity of these four factors of production does not mean people cannot produce
much; rather, wants or desires are only relative to the availability of these resources. The finite
nature of land, labor, capital, and entrepreneurship consequently makes the existence of shortage,
on top of the unlimited human wants and needs, a universal and perpetual phenomenon.

Alternative Definition of Economics in the 21st Century

As the modern economy is being driven by technology and innovation, economics needs
to have a dedicated system or organization that implements the matching of resources and human
wants and needs. Recognizing that economic decisions are due to incentives, choices, and a
functioning set of rules to make things work, maintaining equilibrium relies heavily on the flow
of information.

To illustrate this point, the way of managing traffic rules violations may be examined.
Traffic congestion is an outcome of the limited number of and heavy demand for wide roads. It is
also caused by vehicular traffic violations. Most traffic rules punish non-compliance. The reverse
of punishment is providing incentives, a possible type of which is giving discounts to vehicle
registration for those without violation in a year. However, the efficiency of the rules is only as
good as its consistent implementation, adherence to standard operating procedures, and the
availability of information to all concerned.

Ten Principles of Economics

Gregory Mankiw (2004) observed and elucidated the different principles of economics.
They are as follows:

1. People face trade-offs. Each time a person makes a decision, he/she also makes a trade-
off. An example is a choice between buying a favorite band's concert ticket and
purchasing a new gadget. Only one can be selected over the other. Another is a family's
decision on where to allocate a month's salary. Will they spend it on food first then buy
durable goods after, or pay first the monthly car or house amortization and spend the rest
for food items? It is always important to know what item is prioritized or forgone.

To get one thing, we usually have to give up something else.

Ex. Leisure time vs. work

2. The cost of something is what one gives up to get it. This principle is about comparing
the costs of several alternatives or choices. Although it might seem easy to identify costs,
the dilemma is identifying the implicit ones. Opportunity cost is the value of the second
best choice. When resources are limited or scarce, consumers are compelled to decide
 how to manage them efficiently and determine how much of their wants and needs will
be satisfied. Hence, when a particular need is pursued, all other alternatives are forgone.

Opportunity cost is the second best alternative foregone.

Ex. The opportunity cost of going to college is the money you could have earned if you
used that time to work.

Effective – producing quality output

Efficient – producing quality output, with less resources

3. Rational people think at the margin. Marginal approach is about incremental changes or
differences in small amounts. Decisions should be made by comparing marginal costs
(MC) and marginal benefits. For example, if MC is 100 from Q1-Q2 and MC = 25 from
Q6-Q7, what quantity should be produced? Surely, the answer is where MC is 25 from
Q6-Q7.

Marginal changes are small, incremental changes to an existing plan of action.

Example, Deciding to produce one more pencil or not.

People will only take action of the marginal benefit exceed the marginal cost.

4. People respond to incentives. One reason for workers' low productivity is poor
attendance. To correct this problem, a particular firm can give a health bonus. The
incentive given can be a one month's worth of salary bonus for a year's perfect
attendance. After a year, workers may even insist on working during holidays. Another
example is a cable firm that gives discounts on subscribers who pay on time. The
company can even go further by giving a one-month service free of charge for every
eleven months of advance payment. After these incentives, collectors will hardly get
delayed monthly payments.

Incentive is something that causes a person to act. Because people use cost and benefit
analysis, they also respond to incentives.

Example, higher taxes on cigarettes to prevent smoking.

5. Trade can make everyone better off. If there are two countries producing goods A and B
with different levels of efficiency, is it better to let these countries continue
manufacturing both goods or make one country produce good A and the other good B
 and trade the excess with the other country that does not produce the good respectively?
A trade-off between participants usually gets a bigger output with less input.

Trade allows countries to specialize according to their comparative advantages and to

enjoy a greater variety of goods and services.

No man is an island

Comparative advantage is an economy’s ability to produce a particular good or service

at a lower opportunity cost than its trading partners.
A comparative advantage gives a company the ability to sell goods and services at a
lower price than its competitors and realize stronger sales margins.

6. Markets are usually a good way to organize economic activity. There was a particular
time in the economic history where the central planners in a command economic system
used to decide the allocation of a country's economic resources. This centralized system
proved to be instrumental in boosting one's output. Most nations turned into a market
system where the decisions on allocating resources are dependent on households and
firms. It is better for them to determine such because central planners do not know
anything about price adjustments due to buyer's relative tastes and preferences, or price
changes due to consumer speculations. For these reasons, communism failed in its raison
d'être which is the society's well-being. In fact, nations were able to achieve such well-
being using a market economic system, where there is an existence of an “invisible hand”
that places everything correctly to achieve equilibrium.

“Laissez-faire” – free market

Market economic system

Adam Smith made the observation that when households and firms interact in markets
guided by the invisible hand, they will produce the most surpluses for the economy.

Invisible hand – metaphor describing the unintended greater social benefits and public
good brought about by individuals acting in their own self-interest.
- Unseen forces that move the free market economy

7. Governments can sometimes improve market outcomes. Although the "invisible hand”
seems to put everything in place, the existence of the government is still necessary to
enforce laws and ensure that the mechanisms of the market work systematically.

Subsidy –
Fiscal policies – government policies in kaperahan
 Monetary policies – Banko Sentral

Markets failures occur when the market fails to allocate resources efficiently.
Governments can step in and intervene in order to promote efficiency and equity.

8. A country's standard of living depends on its ability to produce goods and services.
Why do Filipinos seek greener pastures and work abroad? Is it because they don't have
opportunities in the Philippines? Comparing the goods and services produced by
Philippines with those of the United States or Japan, it can be noticed that the outputs
directly correlate with the standard of living in the countries. Filipinos seek greener
pastures because they need to improve their standard of living instantly. To improve the
quality of their life, they need to work overseas.

Luxury Items – high standard of living

Essential goods – middle class standard

The more goods and services produced in a country, the higher the standard of living.
As people consume a larger quantity of goods and services, their standard of living will
increase.

9. Prices rise when the government prints too much money. In the later chapters, it will be
explained why an increase in money supply without an increase in the nation's output
leads to inflation. For instance, if the total output of the economy is 1 kg of fish for P100
and the government increases money supply by P50, the price of the same output of 1 kg
of fish changes to P150.

When too much money is floating in the economy, there will be higher demand for goods
and services. This will cause firms to increase their price in the long run causing
inflation.

Inflation – increase of prices for goods and commodities

Supply and demand

10. Societies face a short-run trade-off between inflation and unemployment. The increase
in money supply in the short run fuels the economy to increase spending, prompting
firms to increase output and raise prices. This, in turn, leads to an increase in employment
and a decrease in unemployment.

In the short run, when prices increase, suppliers will want to increase their production of
goods and services. In order to achieve this, they will need to hire more workers to
 produce those goods and services. More hiring means lower unemployment while there
is still inflation. However, this is not the case in the long-run.

The Tools in Economics

Economics is a positive science that means it deals with what it is. This is in contrast to
normative economics which deals with what should be. Economics is, therefore, a study that
attempts to explain how an economy operates. To be able to understand and explain economic
events and economic theories, you must learn how to use the basic tools of Economics.

Firstly, you must learn how to apply logic in order for you to reason out properly and to
draw conclusions. Secondly, the use of mathematics will enable you to conceptualize and
quantify economic principles. Thirdly, you use statistics to describe quantitatively human
behaviors and to serve as empirical evidence in the testing of hypothesis.

These tools equip the economists and you to approach the subject in a scientific manner.
This scientific approach can be outlined in the following stages:

1. Observation – an analyst should be able to recognize conditions, behaviors, and events in

the environment. By simply looking around, he shall be able to obtain information
necessary to analyze an economic principle.
2. Definitions and assumptions – The analyst should describe the specific uses of the study
and the peripheral conditions which affect the economic behaviors which are being
studied.
3. Deductions – These are hypotheses or theories presented for empirical validation. They
are temporary conclusions made based on one’s observations and are still subject to the
presentation of evidence.
4. Empirical Testing – Deductions have to be tested as to their validity and correctness. The
presentation of the empirical evidence will be the basis of rejecting or accepting a
hypothesis. The evidence gathered consists of statistics which is used to verify one’s
guesses. In the Philippines, important government agencies serve as major sources of
statistics: the Philippine Statistics Authority (PSA); National Economic Development
Authority (NEDA) the Central Bank, and even the municipal and city halls.

Macroeconomics and Microeconomics

Macroeconomics is the division of Economics that deals with aggregates. It presents

pictures of totals: income, output, employment, spending, and price level. It studies the economy
as a whole.
 Microeconomics is the division of Economics that studies the economy in parts. It is a
study of the price system, the individual consumer, the individual firm. It deals with this
questions: What determines the breakdown of national income aggregates into various types of
goods and services?

Macroeconomics and microeconomics are equally important. One cannot study the whole
without studying the parts. Neither can one break down aggregates into components without
knowing what the aggregates are and what components they are made of. The big picture is
made up of parts. Understanding the picture as a whole is just as vital as understanding the parts.

Programs and policies

1. Keep the prices stable;

2. Limit unemployment; and
3. Keep the economy flowing.