MODULE 2

Part 1- Economic Problems and Theories

Recapitulation

When economic decisions are made by individuals and families, the analysis falls under the
field of microeconomics while if done on the aggregate, say a national government, then we
are concerned with the field of Macroeconomics. When made in conjunction with other
governments, International Economics.

Always remember, however, that whatever economic decisions made at any level mutually
impact all levels of economic analysis. Take for example the decision to quarantine an
entire community is a decision made by the national government but whose impact is felt
not only on the national but also local level.

The Structure of an Economic System

For a better understanding of the dynamics of a microeconomic entity, we have to identify

the different sectors that make up our economy. Looking at a simplistic model of an
economy, there are two basic players, the household and the business sector.
Figure 1. The Circular Flow of Economic Activity
Goods and Services

Factor Payments

Business Firm
Household
Rent
Land
Salaries and Wages
Labor
Interest
Capital
Profit
Entrepreneur

Consumption Expenditure

Factors of Production
Under normal circumstances, it is from the household where all production factors emanate.
These are used in the production of goods and services sold to the household sector. The
business firm pays for the production factors used in the form of rent for land, salaries and
wages for labor, interest for capital and profit for the entrepreneur. In return, the household
pays for the goods and services they use in the form of consumption expenditures.

Such is the dynamic interaction of both sectors. A disruption in any part may affect the
operation of both. Example is when laborers fail to report for work because of the lack of
transport, factories stop operating, no operation, no wages, no purchases, the economy
stops altogether.

It is in this kind of a scenario that a third player enters – the government. It comes in to
moderate activities within an economy, assistance when necessary for there are goods and
services whose cost is so high that neither the business nor the household sector can
provide. The government provides for social goods and services like roads, bridges,
hospitals, schools and other institutions where they source their income from taxes paid by
their citizens.

In each level, however, are alternative decision choices faced by individuals, business firms
and government all in their desire to improve their individual welfare in a microeconomy or
collective welfare, in a macroeconomy.

Economic Theory & Price Theory

Economic Theory. When economic decision makers are confronted with a problem, they
look for causes in order to come up with a solution. A family head earns income by driving
a tricycle. With the advent of the Covid 19 pandemic, quarantines and lockdowns became
commonplace and he finds himself out of work, unemployed. The cause is simple – he is
prohibited from plying his trade because of the viral problem. This is what is called an
economic theory in its simplistic sense.

An economic theory is made up of statements that predict the relationship between

economic variables. In this case, the problem is his absence of income- the theory – it is
caused by his being prohibited in the streets to take on passengers. Now if he wants to
solve the problem of his absence of income, he has to look for other sources which will not
require the usage of his tricycle for hire. He decides to cook food items sold via online
portal which he delivers. An economic problem giving rise to an economic theory and a
consequent solution to the problem.

On a higher plane and a broader perspective, national decision makers look for solutions to
the problem of widespread poverty. In search of explanation, a plausible explanation is
seen in the unbridled, rapid increase in population. Provided with this theory, one approach
to solving the problem is population control.

Among the different forms of economic theory, of particular interest in managerial

economics is price theory. Why? For the reason that we are, as consumers, affected by
the movement in the prices of goods and services. Knowing why prices change or not
change and what may cause the change will give us the facility to properly react to any
fluctuation in the prices of commodities we either produce or consume.

Price Theory is made up of statements that predict the relationships between variables
relating to how prices are determined. It is concerned primarily with the market activities
of individual economic units such as the consumers, resource owners, and business firms.

If you are a consumer, with price theory, you get to understand why the prices of a
commodity are such so you can come out with an informed decision on when you are going
to buy. If you are a business owner, knowing the dynamics of price theory gives you the
opportunity to make rational decisions relative to the following basic economic problems.

1. What to produce – the types of goods society desires

2. How much to produce – the quantity of each good
3. How to produce – the technique of production, labor or capital intensive, and
4. For whom to produce – the market to which you are going to sell the product.

Now do the following(Learning Tasks):

1. Explain how an economic theory relates to price theory. Which is the bigger
concept? Cite examples.
2. Differentiate and give an example each of the three levels of economic analysis.
Use examples different from those given in this and the previous module.
3. Considering the available resources in your own locality(municipality and/or
barangay), relate a concrete application of your response to the four basic economic
problems.
 4. Is the government necessary for the proper functioning of an economic system?
Why/not?
5. Should the current quarantine status of Cagayan be liberalized? Made more strict?
Maintain current status? Why? How will your decision impact the microeconomic
functioning of the economy? Its macroeconomic functioning? Will your decision
have any bearing on the economic relations of the Philippines with other countries?
How?

Final Instruction for this learning package: All learning outputs must be in on or before
March 13, 2021. Send your output to my email address: mstanjr@csu.edu.ph , and not
through our GC page.