APPLIED ECONOMICS

INSTRUCTOR: JOAN MAE A. VILLEGAS

CHAPTER 2
Application of Supply and Demand Analysis
Price
- Price is the monetary value of a unit of commodity
- From the point of view of consumers, price is a payment for the purchase of a commodity whose value reflects the
satisfaction or utility derived from the consumption of a good or service
- From the point of view of producers, price is the revenue earned for a commodity sold whose value reflects the cost of
producing a unit of good or service
What is a Demand Curve?
- A schedule of the willingness and capacity of a consumer to buy a commodity at alternative prices at a given point in time
ceteris paribus (other things constant)
- The only factor that influences the level of demand or consumption is the price of the commodity itself
- Refer to graph 2.1 in the book
Other Factors Affecting the Demand of a Commodity
Income
– a higher level of income will give a person a higher capacity to consume and vice versa
Prices of Other Commodities
– If the other good is a substitute, the increase in the price of the substitute good may increase the demand for the
commodity at hand and vice versa
– If the other good is a complementary good, a decrease in its price will have a positive impact on the demand of the
good at hand and vice versa
Expectation
– If you believe that the price of gasoline will increase tomorrow, there is a tendency for consumers to increase their
consumption today
Taste
– Shaped by cultural values, peer pressure or the power of advertising
Market
– Population and demographic changes
Why is the Demand Curve Downward Sloping?
Substitution Effect
– Decision of a consumer to substitute an expensive good with cheaper goods when there is a price change
Income Effect
– An increase in purchasing power will enable the customer to buy more of the good and vice versa
Principle of Diminishing Marginal Utility
This implies that the additional satisfaction (utility) provided by an additional commodity consumed is lower than the additional
satisfaction given by the previous level of consumption of the commodity. The optimal demand for a commodity is attained when
its price is equal to the marginal utility derived from the last unit consumed
Changes in Demand Curve
• Movement along the demand curve
Change in quantity demand resulting from the change in the price of the commodity. As the price of a commodity
decreases, the movement along the curve will lead to an increase in the quantity demand and vice versa
• Shifts in demand curve
Changes in demand curve cased by any of the other factors beside the price of the commodity. A positive effect will
shift the demand curve to the right (increase in the demand for a commodity). A negative effect will shift the
demand curve to the left (decrease in the demand for the commodity)
What is a Supply Curve?
A schedule showing a direct or positive relationship between the price of the commodity and the level of output that the seller
is willing to supply at a given point in time ceteris paribus. As the price of the commodity increases, there will be more
sellers that will be willing to supply the good
Other Factors Affecting Supply of a Commodity
• Price of Production Inputs
The production of any commodity will require the use of 2 major inputs – intermediate inputs or raw materials and factor
inputs (land, labor, capital and entrepreneurship). When the price of production inputs increases, there will be an increase
in the cost of production and sellers will be reluctant to maintain their previous level of supply
• Taxes
– An increase in sales tax, real estate tax and other business taxes can increase the cost of supplying a commodity
which will in turn discourage sellers from increasing their supply
• Technology
– Labor-intensive technology is used if the cost of labor is relatively cheap; Capital-intensive technology is used if
wages are high
– Improvements in technology can lower production cost and encourage firms to supply more
• Expectation
 – If there is an expectation that the price of rice will increase next season, this will encourage farmers to plant more
rice now in anticipation of higher price in the future. This expectation can also discourage rice dealers to sell rice
currently and some of them will keep a higher inventory of rice currently so they can sell it in the future with higher
returns.
Why is the Supply Curve Upward Sloping?
Variations in the unit cost of production
• Producer • Cost of Production

• A • 5 per unit
• B • 7 per unit
• C • 10 per unit
• D • 13 per unit
• E • 15 per unit
- Who can supply the good, if the market price is 6?; if the market price is 16?
- The previously ineffective producers at lower prices have become more efficient and competitive as the price of the
commodity increases
Principle of Diminishing Marginal Productivity & Increasing Marginal Costs
A fixed factor input (capital, land) is mixed with a variable factor input (labor), the employment of additional labor will increase
the total production but at a decreasing rate. As the firm employs additional variable inputs, it also increases its total cost of
production. Since each additional variable input is less productive than the previous ones, they become costlier to employ (increasing
marginal costs with the increase in output production)
• Profit – difference between total revenue and total costs
• Maximum Profit – attained when the difference between total revenue and total costs is the widest or marginal revenue is
equal to marginal costs (marginal profit is zero)
– As long as marginal profit is positive, there is motivation to increase production as this will increase profit
Changes in the Supply Curve
• Movement along the supply curve
Change in the price of the commodity. An increase in the price of the commodity will increase the quantity supplied as
shown by movement northeast along the supply curve and vice versa
• Shift in the supply curve
– Changes in other factors affecting supply except the price of the commodity
– A positive effect will shift the supply curve to the right (increase in the supply of a commodity)
– A negative effect will shift the supply curve to the left (decrease in the supply of the commodity)
Determination of the Prices of Commodities
• Equilibrium Price
– When buyers and sellers transact in the market and they agree on the price of the commodity and the amount to be
sold and bought
• Disequilibrium
– Cases when there are disagreements among buyers and sellers on the price and quantity (excess demand and excess
supply)
Other Applications of Supply and Demand Analysis
Applications in the Labor Market
– Those buying labor services are the firms and firms will hire laborers if the monetary value of the labor productivity
(marginal benefit) is equal to the wage rate (marginal cost). The laborers are the ones supplying the labor services
and to them, the wage rate is the opportunity cost of leisure
• Minimum Wage as Price Floor
– If the equilibrium price in graph 2.17 is considered too low by the laborers, they may demand the government to
impose a minimum wage
• Application in the Foreign Exchange Market
– Demand for USD is influenced by demand for imports. At higher USD price, imports becomes expensive and our
demand for USD decreases. Supply of USD is based on the inflows of USD brought by exports and remittances. At
higher USD price, it motivates exporters and Filipinos to work overseas
• Labor Migration and the OFWs
– Supply of OFWs increases when foreign wage rate increases or when the exchange rate increases even if the foreign
wage rate does not change. Demand for OFWs increases when foreign wage rate decreases. Even at lower foreign
wage rate, there will be more OFWs willing to go abroad because the peso value of their foreign wage is still high
with the depreciated peso.
• Determination of Rent
– Rent refers to the price of using land in the process of production. Supply curve of land is vertical because land is
fixed and cannot be increased with increase in rent or price of land.
– Low demand of land Do = idle.
– High demand of land D1 = agriculture.
– Very high demand of land D2 = business,
 – high rises and condominiums.
– Co = cost of putting land in productive use
Contemporary Economic Issues Facing the Filipino Entrepreneur
• There are 4 types of Market Structures based on the Market Power of the actors in any transaction
• Market Power
– The ability of any actor or group of actors in the market to significantly influence the price in the market and the
quantity to be produced and sold
– Aim of every actor is to enhance its market power
Perfect Competition
A market structure where no single seller or buyer has power to determine the price and the level of output in the market. Large
number of buyers and sellers
Suppliers sell similar or undifferentiated products
• Free entry and exit
• Mobility of resources
• Perfect information
• Ideal market structure since it leads to an efficient use of resources
Monopoly
• A market structure characterized by a single seller in the market
• Exact opposite of a perfect competition
• Enormous market power
• Unique product
• Huge profit (limiting production and setting higher price)
• Restrictions to entry (scale barriers and legal barriers)
• If there is only a single buyer, the market is known as a monopsony
Oligopoly
• A market structure characterized by few sellers producing similar and differentiated products
• Imperfect competition (there is competition among the few sellers, but it is imperfect since the excess profit is only reduced
but not eliminated)
• Interaction of these few sellers:
– Independent actions – mimics a competitive market
– Collusion – forming a cartel and monopolizing the market
– Since collusion is not allowed here, firms opt to react to their fellow firms decisions or follow the industry leader
Monopolistic Competition
• This market structure has the elements of both competitive and monopolistic markets
• Imperfect competition
• Competitive (numerous sellers and buyers that can freely enter and exit the market)
• Monopolistic (product although similar, can be differentiated through advertising and packaging, which leads to brand
loyalty)
Market Structures an Implications for Entrepreneurs
• If you have limited resources and productive capacity…
• The firm may enter the perfectly competitive market, but the ability to expand and find a niche is very limited
• Thus, a monopolistically competitive market is better, although the firm must be cautious of potential rivals
• Difficult in entering the monopolistic and oligopolistic market
Investment and Interest Rate
• External funds can be sourced from the capital market
– Demand curve for funds shows and indirect relationship between interest rate and the amount being borrowed
– Supply of funds (savings) is positively related with the interest rate
– If the price of capital is high, it may discourage potential entrepreneurs to engage in business and existing
entrepreneurs may postpone their expansion and investment plans, and vice versa
Rentals and the Cost of Business Operations
• It may not be wise for a small and beginning enterprise with limited resources to locate its office in high-end commercial
districts because rental rates can eat up a huge part of its revenues
• BUT there are several benefits of having an office in those areas
– Gives legitimacy and prestige
– Savings – attracting a lot of customers, accessible to workers and near to clients and service providers
– Commercial districts are well planned and designed for business with their good infrastructure and adequate support
services
Minimum Wage
• Example of floor price that prevents the market to seek its equilibrium condition because of a government policy
• For labor intensive industries, minimum wage can discourage firms to hire additional workers, since the wage rate has
become prohibitive.
• As a result, some of these firms locate their manufacturing plants in regions or countries where labor is relatively inexpensive
Taxes
• Taxes can increase the cost of business operations and can threaten the profitability of business enterprises at their initial
stage of operations
 • In order to attract pioneer, foreign and local firms to establish their presence in the country, governments can give tax
incentives
Synthesis
• Every commodity has a price. The price is a monetary value of a unit of commodity. For consumers, it reflects the value of
satisfaction on the good consumed. For producers, it reflects the costs of producing a unit of commodity.
• This price is determined by the interaction of demand and supply. Equilibrium price is the agreed price consumers are willing
to purchase and producers are willing to sell the same quantity of the commodity.
• Every commodity has a price. The price is a monetary value of a unit of commodity. For consumers, it reflects the value of
satisfaction on the good consumed. For producers, it reflects the costs of producing a unit of commodity.
• This price is determined by the interaction of demand and supply. Equilibrium price is the agreed price consumers are willing
to purchase and producers are willing to sell the same quantity of the commodity.

ACTIVITY 1
1. What have u understand about the Application of Supply and Demand Analysis?

CHAPTER 3
Industry and Environment Analysis: Business Opportunities Identification

Economic Analysis of Profit Maximization

• Market Concentration
– Refers to the number of sellers and buyers in the market
– The more concentrated the market means the lesser producers are there in the industry
– Monopoly: one seller (most concentrated with huge market power)
– Oligopoly: few sellers (lesser degree of market concentration but with significant market power)
– Perfect Competition: many sellers (diluted market concentration with no market power)
• Barriers to Entry
– Refers to inherent features of the industry and various means devised in the market to prevent the entry of potential
players and competitors
– Scale barriers: requirements for large production plants for a feasible operation in the industry (huge amounts of
capital and resources)
– Legal Barriers: proprietary rights and their corresponding legal protection extended to existing market players in the
production and distribution of a product or service
• Barriers to Entry (cont.)
– Monopoly: scale and legal barriers; government barriers
– Oligopoly and Monopolistic Competition: some scale barriers or contestable market
– Perfect competition: no barrier to entry
• Product Differentiation
– Refers to the ability of a business firm to create a market niche through several means of varying its products and
services
– Monopoly: highly differentiated product
– Oligopoly and Monopolistic Competition: some degree of product differentiation
– Perfect Competition: homogenous good
• Limited Information
– Refers to the unevenness in the distribution of information among actors in the market
– When market actors are not evenly informed, those with more information can have market power
– Monopoly: very limited information
– Oligopoly and Monopolistic Competition: limited information
– Perfect Competition: perfect information
• Market Power
– Monopoly: high market power
– Oligopoly and Monopolistic Competition: limited market power
– Perfect Competition: no market power
Porter’s Five Forces of Competitive Position
• Developed by Michael Porter (1979) as an alternative perspective on profitability analysis and on the attractiveness of an
industry for business ventures. The stronger the forces of competition bearing on the industry, the lower its profitability and
the less attractive the industry for business enterprises
• Competition Among Existing Firms in the Industry
• Monopoly: absence of competition (high profit)
• Oligopoly: forces of competition depends on the behavior and interactions of few firms in the industry
• Cooperate: forces of competition are mitigated (high profit)
• Independent actions: strong competition (low profit)
• Competition Among Existing Firms in the Industry (cont.)
• Monopolistic Competition: ability to differentiate products can temper the forces of competition; but there
are many sellers, so heightened competition (moderate/low profit)
 • Perfect Competition: very intense competition (very low profit)
• Bargaining Power of Customers
• Utility maximizing buyers prefer lower price to enhance their level of satisfaction
• Monopsony: sole buyer has huge bargaining power on the sellers in the industry
• In order to free the dependence of a business enterprise and the industry on a single or relatively few buyers:
• Diversification: diversify the buyers of the product
• Differentiated Products: divide its product lines
• Bargaining Power of Suppliers
• If an industry sources its raw materials from a single or few suppliers, these suppliers can have strong forces in the
industry that may lower the industry’s profitability
• In order to weaken the bargaining power of suppliers, the industry can adjust by:
• Diversifying its sources of raw materials
• Form a subsidiary firm
• Bargaining Power of Suppliers (cont.)
• Suppliers of factor inputs can exert bargaining power on the business enterprise and on the industry (labor unions)
• In order to weaken the bargaining power of labor unions, the industry can adjust by:
• Subcontracting through a number of manpower services firms
• In weakening the market power of the suppliers of capital, many large companies integrate banks in their
conglomerate, thus bargaining power is diminished
• Threats of Potential Entrants
• Scale and legal barriers can reduce the competitive forces, but what if potential entrants have resources to overcome
barriers
• How to deal with these potential entrants:
• Engage in research and development to improve their products and to segment the market through product
differentiation
• For firms with excess capacity, allow the potential competitors to enter then expand production and lower
the price
• Threats of Substitute Goods
• Usually industries that exhibit high rate of profitability are the ones challenged by the emergence of substitute goods
• Cross elasticity of demand: responsiveness of the demand for a substitute good due to a change in the price of the
product produced in the industry
• As the differentiation from the substitute goods widens and the cross elasticity of demand declines, the competitive
force of substitute goods is mitigated
Environmental Scanning in Industry Analysis
• There is a need to also consider the indirect impacts of factors and forces that were not considered in the previous two
analyses
• National Economy
• A rapidly growing economy will have positive effects
• A lethargic economy will have negative effects
• Global Economy
• Crises in other countries can affect the national economy in a bad way
• Government Policies and Regulation
• Can be beneficial to businesses when it promotes economic growth and employment
• But can be unfavorable to businesses when dealing with regulations and taxes
• Technological Developments
• Have intensified competition within the industry
• Companies that are slow to adapt or fail to adapt to these rapid developments are bound to exit from the industry
• Demographic Changes
• Population is the market base for industries and changes in the structure of the population has an impact on
businesses
• People are also the source of firms’ laborers, professional and technical expertise, savers, investors and entrpreneurs
• Social Changes
• Modifications in family structure and other social changes have an impact on consumer behavior and tastes
• Changes in the Natural Environment
• Extreme fluctuations in the natural environment can have adverse effects on the production of certain sectors and
may even temporarily impair the purchasing power of some consumers
SWOT Analysis
• Strengths, Weaknesses, Opportunities and Threats. Focuses on strengths and opportunities that can enhance the profitability
of an industry as a measure of benefit. Identifies the weaknesses and threats that may contribute in increasing the costs of the
industry that make it less attractive for business ventures
• Strengths
• Internal characteristics of firms or industry that can contribute directly to the profitability of firms and the industry
• Weaknesses
• Internal characteristics of firms or industry that mitigate the profitability of firms and the industry
• Opportunities
 • Positive impacts of various external environments on the profitability of an industry
• Unlike strengths, these are only potential, indirect and prospective (firms have no direct control)
• Threats
• Undesirable impacts of external factors on the profitability of the industry
• Unlike weaknesses, these are only potential, indirect and prospective (firms have no direct control)
• SWOT Analysis and the Business Climate
• The business climate is shaped by the interactions between various sets of internal factors and external factors
manifesting as SWOT
• Macroeconomic policies are government actions meant to stabilize and promote economic growth
• Government regulations are a set of rules meant to address market distortions to promote public welfare
• Institutional support refers to government assistance that can make a favorable business climate
Synthesis
• There are several perspectives that can be used in analyzing the firm’s profitability and identifying business opportunities
(profit maximization, Porter’s five competitive forces, environmental scanning and SWOT analysis)
• There are limitations in each perspective
• There are three major sectors of the Philippine economy: agriculture, industry and services
• There are numerous industries in each economic sector that potential entrepreneurs can pursue
• The perspectives discussed can give insights on what business opportunities have promise for implementation

ACTIVITY 2
1. What have you understand about the Industry and Environment Analysis: Business Opportunities Identification?