Applied Economics - Lesson 2

WEEK 2 TO 4 Lesson 2
TABLE OF CONTENTS
APPLIED ECONOMICS
UNIT 2: APPLICATION OF SUPPLY AND DEMAND

ANALYSIS
LESSON 1: ANALYSIS OF DEMAND AND SUPPLY

LESSON 2: DETERMINATION OF PRICES OF COMMODITIES
LESSON 3: CONTEMPORARY ECONOMIC ISSUES FACING THE
FILIPINO ENTREPRENEUR
TABLE OF CONTENTS............................................................................................................. i
GRADE LEVEL STANDARD ...............................................................................................iii
UNIT 2 .......................................................................................................................................... 1
LESSON 1: ANALYSIS OF SUPPLY AND DEMAND ............................................................... 1
LESSON 2: DETERMINATION OF PRICES OFCOMMODITIES........................................... 1
LESSON 3: CONTEMPORARY ECONOMIC ISSUES .............................................................. 1
FACING THE FILIPINO ENTREPRENEUR ................................................................................ 1
INTRODUCTION ...................................................................................................................... 1
DEVELOPMENT ........................................................................................................................ 3
ASSIMILATION/ASSESMENT ......................................................................................... 42
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REFLECTION ........................................................................................................................... 43
The things I learned from the lesson: .................................................................. 43
...................................................................................................................................................... 43
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QUARTER
GRADE LEVEL STANDARD: This course deals with the basic principles of applied
economics and its application to contemporary economic issues facing the Filipino
entrepreneur such as prices of commodities, minimum wage, rent and taxes. It covers an
analysis of industries for identification of potential business opportunities. The main output
of the course is the preparation of a socioeconomic impact study of a business venture.
Content Standards: Learning Competencies:
The learner will be able to examine the

The learners demonstrate an
utility and application of applied
understanding of economics as an
economics to solve economic issues and
applied science and its utility in addressing
problems.
problems of the country.
Performance Standards:
The learners will be able analyze and

propose solution/s to the economic
problem using the principles of applied
economics
Values Integration:
1. Interaction
2. Communication
3. Engagement
4. Respect
5. Community involvement and service towards Nation-building
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Performance Task: Goal – the learner will be able to

The learner will determine market structure
Role – the learner will conduct a
1. Collate information about a
company in the Philippines. Based research and brief proposing measures
on its market power, determine the
to encourage small entrepreneurs
market structure it can be
categorized in. Audience – co-learners
Situation – learner will present to the class
2. Given your knowledge on market
structures and start up issues, write a Product – any
policy brief proposing measures on
Standard – Assess the performance task
how to encourage more small
entrepreneurs. using the following criteria:
Essay content - 60%
Group Effort – 20%
Class Presentation (Reporting) – 20%
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UNIT 2
LESSON 1: ANALYSIS OF SUPPLY AND DEMAND

LESSON 2: DETERMINATION OF PRICES OFCOMMODITIES
LESSON 3: CONTEMPORARY ECONOMIC ISSUES
FACING THE FILIPINO ENTREPRENEUR
INTRODUCTION
The framework developed has shown its usefulness in understanding various contemporary
social, economic and business issues. The analysis of supply and demand, which is a
simplified version of the analysis of benefits and costs, will be developed. This simple model
of demand and supply analysis is also a persuasive tool in understanding economic and
business realities, issues and problems.
The economic problem of scarcity which has been widely articulated in last chapter calls
for an allocation mechanism in light of limited resources and expanding human want. A
popular mechanism for allocation being utilized by many economies today is the market
system. The market system is based on the interactions of buyers and sellers of a commodity
to determine the price and level of output of a good or service. The market system is a
powerful tool for allocation because the changes in price from market transactions create
incentives and disincentives on buyers and sellers to address disparities between demand
and supply. The instruments of allocation is the market price which is determined by the
interactions of the buyers and sellers in any market. These interactions of the market players
are summarized in the analysis of demand and supply
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Specific Learning Objectives
1. The learner will be able to analyze the determinants of supply and demand and
the ways in which changes in these determinants affect equilibrium price and
output; in particular, to make the distinction between movements along the
curves and shifts in the curves.
2. The learner will be able to consider the impact of government policies, such as
price floors and ceilings, excise taxes, tariffs and quotas on the free-market price
and quantity exchanged
3. The learner will be able to understand the concepts of consumer surplus and
producer surplus should also be introduced.
Key Understandings
1. A demand curve is a schedule of the willingness and capacity of a consumer

to buy a commodity at alternative prices at a given point in time other things
held constant.
2. There are two major categories in the changes in the supply curve –
movement along the supply curve and shifts in the supply curve.
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Essential Questions
1. What are the economic reasons why the demand curve is downward sloping?
2. What are the economic reasons why the supply curve is upward sloping?
DEVELOPMENT
LESSON 1: ANALYSIS OF DEMAND AND SUPPLY

The demand curve is a schedule that shows the level of consumption at alternative prices
at a given point in time. The demand curve of a commodity summarizes the benefits
derive by the consumers from the purchase of a good or service. On the other hand, the
supply curve shows the amount of output producers are willing to sell at alternative prices
at a given point in time. The supply curve incorporates the sacrifices and costs incurred
by the seller in producing a commodity.
To the buyer the price is his payment for the purchase of a commodity. His willingness to
purchase the commodity at the market price implies that the additional satisfaction he
derives from the consumption of the commodity is equivalent to the market price.
Similarly, when the supplier accepts the price as payment for the sale of a commodity it
implies that the price can compensate for the additional costs incurred in producing a
unit of a commodity. Thus, the price agreed upon in the market is indicator of marginal
benefits to the buyers and at the same time marginal costs to sellers.
We will analyze the elements of the two major components of the demand and supply
analysis.
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What is a Demand Curve?
The first major actor in a market is the consumer whose primary objective is to purchase
a commodity because it can give him/her benefits. His/ Her inclination to purchase is
indicated by the demand curve.
A demand curve is a schedule of the willingness and capacity of a consumer to buy a

commodity at alternative prices at a given point in time other things held constant. In the
construction of the demand curve it is important to consider not only the willingness to
buy but also the capacity to buy. Everyone wants or willing to buy a good but not all is
able to buy because some do not have the capacity to buy the good. The demand
curve is derived from the demand for a commodity since it only reflects the relationship
between quantity demand and the price of the commodity. When we say other things
held constant or ceteris paribus, the other factors that may affect the demand for the
commodity are not changing. The only factor that influences the level of demand or
consumption is the price of the commodity itself.
Graph 2.1 shows the indirect relationship between price of the commodity and the
quantity in a demand curve. At the horizontal axis we put the quantity demand and on
the vertical axis, the price of the commodity. Along the demand curve D at price P 1 the
quantity demand is denoted by Q1. If the price increased to P2 the quantity is reduced to
Q2. Thus, a negatively sloped demand curve D implies an indirect relationship between
price of the commodity and quantity demand.
Other Factors Affecting the Demand of a Commodity
To be more realistic in our discussion on the demand for a commodity, there is a need to
consider other factors aside from its own price that may influence individuals in the
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purchase of a commodity. At this pint is may be instructive to identity and discuss these
other factors that may affect the demand for a commodity aside from the price of the
commodity.
Income
As indicated in the concept of demand, it is the willingness and capacity of a consumer

to buy a commodity at alternative prices. Although the willingness may be influenced by
the price of the commodity as well the taste for the commodity, the capacity to
purchase on the other hand is influenced by the income of the consumer. A higher level
of income will give him higher capacity to consume while a lower income will give him
limited purchasing power. As a result, we observe that richer families have higher levels
of consumption while poorer families have lower and limited consumption basket.
Prices of Other Commodities
Aside from the price of the commodity being sold, the demand for a good or service
may also be influenced by prices of other goods or services. Although the prices of many
commodities may have an effect on the demand of a particular good, the influence of
related goods is more pronounced. For example, 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. Thus, when the price of beef increase, the demand for chicken will increase
since beef and chicken may be considered as substitute goods. On the other hand, if
the other good is a complementary good, a decrease in its price will impact positively
on the demand of the good being investigated. For instance, when the price of bread
decrease the demand for butter may increase since butter and bread may be
considered as complementary goods.
Expectation
In addition to the price of the commodity, the expectation or prospect on what is going
to happen to the price can influence the demand for the commodity. For example, if
you believe that the price of gasoline will increase tomorrow, there is a tendency for
consumer to increase their consumption today. Similarly if there is a prospect that the
price of US dollar will decline tomorrow, people will postpone their purchase of US dollar.
They will buy US dollar the following day when its price is expected to be lower.
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Taste
Taste or preference is another important factor that may influence the demand for a
commodity. The formation of taste is influenced by several factors. Some of them can be
shaped by cultural values, other through peer pressure or the power of advertising. For
example, on the celebration of New Year’s Eve, it is customary for families to have round
fruits at their plate to attract good luck. This tradition which was influenced by Chinese
Filipinos has increased the demand for fruits during this season. On the other hand,
advertising that shows that cigarette is bad for your health has to some extent decreased
the demand for cigarette.
Market
The size and characteristic of the market can also influence the demand for a
commodity. An increasing population can contribute to the expansion of existing
markets for various commodities. A lower birth rate, on the other hand, coupled with an
ageing population may alter the composition of demand by shifting the demand toward
the needs of the elderly and away from goods and services that target the youth.
Why is the Demand Curve Downward Sloping?
The demand curve focuses on the relationship between the quantity demand and the
price of the commodity at a given point in time other things held constant. The demand
curve shows a negative relationship between the price of the goods and the quantity
demand. Specifically, as the price of a commodity declines, the quantity demand
increase and when the price increase, the quantity demand declines. It may be
interesting to explore the reasons behind why the relationship between price and
quantity demand is inverse or why the demand curve is downward sloping.
Substitution and Income Effects
The inverse or negative relationship between the price of the commodity and the
quantity demand shown in the demand curve can be explained through the substitution
effect and income effect of a price change. The substitution effect describes the
decision of a consumer to substitute an expensive good with cheaper goods when there
is a price change. Thus, as the price of the mangoes increases, the consumer will make
a choice of consuming cheaper papayas and bananas to substitute for mangoes which
have become more expensive. As a consequence of the substitution effect, there will be
a decrease in the consumption of mangoes as the price of mangoes as the price of
mangoes increase.
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In the same manner, as the price of mobile phones decrease, the consumer will perceive
that the other commodities have become relatively expensive. Accordingly, the
consumer will substitute mobile phone for commodities that have become relatively
more expensive. Thus, the consumer will purchase more mobile phones and less of the
other goods. In both examples, the inverse or indirect relationship between the price and
demand of the good has been shown through the substitution effect.
On the other hand, income effect refers to the modification of the consumption of a
commodity due to the change in the purchasing power of the consumer resulting from
a price change. An increase in the purchasing power will enable the consumer to buy
more of the good while a reduction in purchasing power will reduce its capacity to
purchase. We know that an increase in the price of a good will reduce the purchasing
power of the consumer’s income while a decrease in price will increase the consumer’s
ability to purchase.
Suppose a consumer has an income of PHP 500 while the price of mangoes is set at PHP
20 per piece. He can buy up to 25 pieces of mangoes from his given income. However,
if the price of mangoes increases to PHP 25 per piece, he can only buy up to 20 pieces.
Thus, an increase in the price of the good will reduce quantity demand because the
capacity of the consumer to purchase is reduced with a price increase. This confirms the
negative relationship between the price of the commodity and quantity demand.
On the other hand, if the consumer has PHP 20,000 and the price of the mobile phone is
set at PHP 5,000 per unit, the consumer can purchase up to 4 units of mobile phones. If
the price of mobile phones decreases to PHP 2,000 per unit, the same income of the
consumer can buy up to 19 units of mobile phones. The illustration has shown that a
decline in price will result in increase in quantity demand because the purchasing power
of the consumers’ income has expanded and he can buy more of the commodity whose
price has declined. This again confirms the inverse or indirect relationship between the
price of the commodity and the quantity demand.
Principle of Diminishing Marginal Utility
A more interesting but theoretical explanation on the downward sloping demand curve
is derived from the principle of diminishing marginal utility. According this major economic
principle as a buyer continues to consume a good his total satisfaction or utility increases;
however, the additional or marginal satisfaction decrease as a buyer consumes an
additional unit of good. This reduction in marginal satisfaction is attributed to the fact that
consumers can have a feeling of satisfaction when they continuously increase the
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consumption of a particular commodity. Diminishing marginal utility implies that the

additional satisfaction provided by an additional commodity consumed is lower than the
additional satisfaction given by the previous level of consumption of the commodity.
In a market economy, consumption of a commodity implies that you need to purchase

the good or service. Although there is satisfaction or utility derived from the consumption
of a good, there is also a cost or reduction in satisfaction because you have to pay in
buying this good. As much as possible a rational consumer will behave in such a way that
his/her net total satisfaction will be maximized. It can be proven that the optimal demand
for a commodity is attained when its price is equal to the marginal utility derived from the
last unit consumed.
Given this optimal condition, as long as the marginal utility is higher than the marginal
cost or the price of the commodity, the net marginal satisfaction is positive and the total
net satisfaction can still be increased by increasing the consumption of the commodity.
With the additional consumption, the equality of marginal utility and the price will be
reached since additional consumption will have a lower marginal utility. With the equality
of marginal utility and marginal cost or the price being reached, the net marginal
satisfaction is zero. This means that net total satisfaction no can longer be increased since
the maximum level of the net satisfaction has already been attained.
For example, if the price of the good is PHP 8 per unit and the monetary value of marginal
utility of a certain level of consumption is PHP 10, that level of consumption is lower than
the optimal since the marginal benefit is still higher than the marginal cost. This means
that the net total satisfaction can still be increased since the net marginal satisfaction of
PHP 2 is positive. The optimal level of consumption can be reached by increasing
consumption whose marginal utility will decline until it reaches PHP 8 which is now equal
to the price of the commodity.
Having explained the condition for maximum level of net satisfaction, a rational
consumer will always equate the price of the commodity with its marginal utility to obtain
its optimal level of consumption. Since continual consumption of a commodity is faced
with diminishing marginal utility, the price of the commodity has to be decreased to
achieve the objective of maximum net satisfaction. This behavior of consumer implies
that he is faced with downward sloping demand curve. This means that the price of the
commodity has to be lowered if you want to continue your consumption to attain the
goal of maximum satisfaction. Thus, the marginal utility curve reflects the demand curve
since the price has to be equated to marginal utility to attain maximum consumption.
Thus, the demand curve is a schedule showing the inverse relationship between price
and the level of optimal consumption.
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Changes in Demand Curve
There are several factors that may affect the demand for a commodity. As a
consequence, changes in these factors can alter the demand curve depending on their
impact on the demand for a commodity. There are two major categories of changes in
demand curve – movement along the demand curve and shift in the demand curve.
Movement along the demand curve refers to the change in quantity demand resulting
from the change in the price of the commodity. Thus, as the price of the commodity
decreases, the movement along the curve will lead to an increase in the quantity
demand of the commodity. Similarly, an increase in the price will result in the decrease in
quantity demand as shown in the movement along the demand curve.
Graph 2.2 shows a movement along the demand curve when a change in the price of
a commodity results in a change in quantity demand. At price P1 the coordinate a along
the demand curve D will give us the quantity demand which denoted by Q1. If the price
decrease to P2 (coordinate b along the demand curve) quantity demand increases to
Q2. Thus, as the price of the commodity decrease the amount of quantity demand
increases as shown by the movement of along demand curve D from point a to pint b.
Shifts in demand curve, on the other hand, are changes in demand curve caused by any
of the other factors beside the price of the commodity. Taste, price of other goods,
income and other factors may affect the demand of a commodity positively or
negatively. A positive effect will shift the demand curve to the right. This means that in
each price point there is an increase in the demand for a commodity. On the other hand,
a negative impact of these other factors on the demand for a commodity will shift the
demand curve to the left implying a decrease in the demand for the commodity in each
point.
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The positive or negative impacts of these other factors do not alter the negative
relationship between the price of the commodity and the quantity demand. An increase
in income will shift the downward sloping demand curve to the right since it increases the
level of quantity demand at all alternative prices. On the other hand, the risk of being
poisoned by eating shellfish contaminated during red tide season can shift the
downward sloping demand curve for shellfish to the left as it decreases the level of
quantity demand at all alternative prices.
Graph 2.3 illustrates a shift in the demand curve brought about by an increase in the
price of a substitute good. At price P1, the coordinate a along the initial curve D, will give
us the quantity demand which is denoted by Q1. With the increase in the price of the
substitute good, quantity demand will increase to Q11 at price P1 as consumers substitute
a relatively expensive commodity with a relatively cheaper commodity. We will label this
change as coordinate m (Q11, P1).
In the same light if the price decrease to P2 coordinate b along the demand curve D1 will
give us the increase in quantity demand at Q2. The same price P2 quantity demand will
further increase to Q22 with the increase in the price of the substitute good. We will label
this change as coordinate n (Q22, P2). Thus, when we connect coordinates m and n, we
have constructed a new demand curve D2. Thus, the demand curve shifted to the right
from D1 to D2 as a consequence of the increase in the price of a substitute good.
What is a Supply Curve?
The second major actor in a market is the supplier whose primary purpose in selling is to
maximize profit. This inclination to sell is summarized in the shape of the supply curve.
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The supply curve is defined as a schedule showing a direct or positive relationship

between the price of a commodity and level of output that the seller is willing to supply
at a given point in time other things held constant. This direct relationship means that as
the price of the commodity increase there will be more sellers that will be induced to
supply the good. In the same light, as the price of the commodity decreases, there will
be lesser sellers that are willing to supply the good in the market.
Graph 2.4 shows a direct relationship between the price of the commodity and quantity
supplied in the supply curve S. Along this supply curve, at the initial price of P1, quantity
supplied is given by Q1. As the price of the commodity increases to P2, quantity supplied
is increased to Q2. Thus, the supply curve shows a positive relationship between the price
of the commodity and the amount supplied.
Other Factors Affecting Supply of a Commodity
Aside from the price of the commodity, there are other things that may influence the
sellers to supply the commodity. At this point we will discuss and analyze how various
factors or reasons can influence the sellers to sell the commodity.
Price of Production Inputs
The production of any commodity will require the use of two major inputs – intermediate
inputs or raw materials and factor inputs. Intermediate inputs refer to materials including
raw materials that are still going to be processed or transformed into higher level of
outputs. On the other hand, factor inputs are the processing or transforming inputs. Some
examples of factor inputs are labor, capital, land and entrepreneurship. These factors
inputs are the ones adding value to the raw materials through the process of production.
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When the price of these production inputs increases, there will be an increase in the cost
of production at every level of production. With the cost of production increased at given
price level sellers will be reluctant to maintain their previous level of supply. This in turn will
reduce the quantity supplied at alternative prices. On the other hand, if the cost of
capital as indicated by interest rate has been lowered, this may encourage sellers to
produce more because the cost of one of its factor inputs has become inexpensive.
Taxes
Business establishments are required to pay a number of taxes to various levels of

government. Since it is a monetary expense on the part of the firms, the payment of taxes
can be considered as part of cost of production. Although, taxes are not factor inputs
nor raw materials they are still considered part of the cost of operating a business. Thus,
an increase in sales tax, real estate tax and other business taxes can increase the costs
of supplying a commodity. This in turn may discourage the sellers to increase their supply
of the commodity in the market.
Technology
The manner in which various factors inputs process the raw materials is done through the
use of technology. Some firms may use labor-intensive technology if the cost of labor is
relatively cheap. On the other hand, firms may use capital-intensive technology if wages
are very cheap. Improvements in technology used by some firms can lower their
production costs and can make these firms more competitive. A lower cost may
encourage these firms to supply more of the commodity since they can sell it at reduced
price.
Expectation
The expectation or anticipation on what is going to happen on the price of the

commodity can also influence the amount supplied in the market. If there is an
expectation that the price of the rice will increase next season, this may encourage
farmers to plant more rice now in anticipation of the higher price in the near future. This
expectation of higher price next season can also discourage rice dealer to sell rice
currently. Some of them will keep a higher inventory of rice currently so they can sell it in
the future with higher returns.
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Why is the Supply Curve Upward Sloping?
The supply curve shows a positive or direct relationship between the price of the
commodity and the quantity supplied in the market. The main motivation to supply goods
is to gain profit which is based on the costs of production of a firm and the price of the
commodity. There are several interpretations on the reasons why suppliers respond
positively with price changes.
Variation is the Unit Cost of Production
The simplest reason for the direct relationship between price and quantity supplied is due
to variation of the costs of production among producers. Let take an example of five
producers A, B, C, D and W with different unit costs of production. Producer A is the most
efficient with the least cost of PHP 5 per unit cost. Producer B had PHP 7 unit cost,
producer C has PHP 10 unit cost, while producer D incurs PHP 13 per unit. Lastly, producer
E is the most inefficient with PHP 15 unit cost.
Suppose the market price is set at PHP 6 per unit; at this price only producer A can supply
the good in the market while the rest of the producers are inefficient or not competitive.
On the other hand if the price is increased and set at PHP 12 per unit, the number of
producers that can supply the market has also increased. Procedures A, B and C can
now supply the market. Because of the price increase, formerly inefficient producers B
and C have become competitive since their unit cost of production are now lower than
the current market price. Producers D and E remain uncompetitive at the current prince.
Meanwhile, as the price increases to PHP 16 per unit, the number of producers is also
increased to five. All of them are competitive and earning some profit at the current price
because their unit costs are lower than the current market price.
In the above example, we have shown that there is a direct relationship between the
price and the number of procedures and quantity supplied. The previously inefficient
producers at lower prices have become efficient and competitive as the price of the
commodity increases.
Principle of Diminishing Marginal Productivity and Increasing Marginal Costs
A more theoretical explanation developed by economists is based on the increasing

marginal cost of production. According to this perspective, as the production of a good
increase not only does its total cost increases but the additional or marginal cost
increases as well. This means that the additional cost of an additional unit of production
is higher than the previous unit of production. This increase in marginal cost is due to the
principle of diminishing marginal productivity of resources. According to this principle, as
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a fixed factor input, capital or land, is mixed with a variable factor input, labor, the
employment of additional laborers will increase total production but will increase it at a
decreasing rate. This means that although total production is increasing, the additional
or marginal contribution of the additional labor to total production is declining. This is
because the productivity of the variable input is constrained by a fixed input, capital or
land.
As the firm employs additional variable inputs to increase its production, its total cost of
production will likewise increase. Total costs will not only increase but it will increase
rapidly because the additional variable factor inputs are becoming less and less
productive. Since these variable inputs are becoming less productive than the previous
ones, it implies that they are becoming costlier to employ. This is the implication of
increasing marginal costs with the increase in production out output.
As mentioned earlier, the main motivation for firms in producing goods and services is to
earn profit. A rational firm usually targets reaching maximum profit in its production. Profit
is the difference between total revenue and total cost. Maximum profit is attained when
the difference between total revenue and total costs is the widest. It can be proven that
maximum profit is attained when marginal revenue or price is equal to marginal costs.
If the price of a commodity or the marginal revenue is higher than marginal cost, the
marginal profit is positive. This implies that the total profit can still be increased by
increasing production. This is because the additional revenue brought about the
additional production is higher than the additional cost which results in a positive
contribution to total profit. On the other hand, if the price of a good or the marginal
revenue or the marginal revenue is lower than marginal cost, the marginal profit is
negative. This implies that total profit will decline with additional production. Thus, as long
as the marginal profit is positive, there is a motivation to increase production because this
will increase profit. When marginal profit reaches zero, the firm has attained the maximum
level of profit. This means that when marginal profit is zero, price or marginal revenue is
equal to marginal cost.
Since the marginal cost curve of the firm is increasing with the level of production, a firm
will follow the direction of its marginal cost when supplying a commodity in the market.
Thus, for the firm to increase its production, the price must be increased to match an
increasing marginal cost. This is required for the firm to attain its goal of maximum profit.
Thus, marginal cost curve which has a positive inclination becomes the supply curve of
the firm.
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Changes in the Supply Curve
There are two major categories in the changes in the supply curve – movement along
the supply curve and shifts in the supply curve. These changes are influenced by the
changes in the factors affecting the supply of a commodity.
The movement along the supply curve is brought about by changes in the price of the
commodity. An increase in price will increase the quantity supplied as shown by
movement towards northeast along the supply curve. On the other hand, a decrease in
the price of the commodity will cause a decrease in quantity supplied as shown by the
movement toward the southwest along the supply curve.
Graph 2.5 shows the movement along the supply curve brought about by an increase in
the price of the commodity. A price P1, coordinate g along the supply curve S will give
us the quantity supply which id denoted by Q1. If the price increases to P2, coordinate h
along the supply curve will give us the increased quantity at Q2. Thus , as the price of the
commodity increase the amount of quantity supplied increases as well as shown by the
movement of along supply curve S from point g to point h.
The shift in the supply curve, on the other hand, is caused by changes in the other factors
affecting supply except the price of the commodity. For example, in increase in the
minimum wage can increase the cost of production and will shift the supply curve to the
left. As the supply curve shifts to the left, the supply will declined since all possible
quantities to be supplied decreases at all alternative prices. Similarly, an imposition of an
additional business tax by the government will likewise lower the supply as the supply
curve shifts to the left.
On the other hand, a bountiful harvest can shift the supply curve to the right. At
alternative prices the firm can now produce and supply at highest level of output. In both
examples, the initial positive and direct relationship between the price of the commodity
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and the quantity supplied is maintained. However, the positive or negative effects of the
other factors on the supply are illustrated by shifting the supply curve to the right or to left,
respectively.
Graph 2.6 shows the shift in the supply curve brought about by an imposition of additional
sales tax per unit of output. At price P1, the coordinate c along the initial supply curve S1
will give us the quantity supply which is denoted by Q1. With the imposition of an
additional sales tax which increases the cost of production, quantity supplied decreases
to Q11 at price P1. We will label this changes as coordinate f (Q11, P1).
In the same light if the price decrease to P2 coordinate b along the supply curve S1 will
give us the decrease in quantity supply at Q2. The same price P2, quantity supplied will
further decrease to Q22 with the imposition of a tax. We will label this change as
coordinate g (Q22, P2). Thus, if we connect coordinates g and f, we form a new supply
curve S2. Thus, the supply curve has shifted to the left from S1 to S2 as their production costs
increase as a consequence of the imposition of an additional sales taxes.
LESSON 2: Determination of Prices of

Commodities
Equilibrium Price
When buyers and sellers transact in a market they agree on the price of the commodity
and the amount to be sold and bought. This agreed price is called the equilibrium price.
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In our demand and supply analysis this market agreement is shown by the intersection of
the demand curve with the supply curve. From a graphical perspective, the equilibrium
price implies that buyers and sellers are in agreement to buy and sell the same amount
of commodity at the equilibrium price. Since the equilibrium price is an agreed price it is
also a stable price since there no pressure from the buyers and sellers to alter the amount
they want to buy or sell.
Graphic 2.7 illustrates how the equilibrium condition is achieved using demand curve and
supply curve. With the price set at the vertical axis and the quantity placed at horizontal
axis, a download sloping demand curve D and an upward sloping supply curve S will
intersect at point e. point e is an equilibrium point because it sets the agreement between
the buyers and sellers. Consumers and sellers are in agreement on the price, PE, that the
commodity will be bought and sold. In addition, at this equilibrium price P E, consumers
are willing to buy QE. At the same time at price PE the sellers are willing to sell same
quantity QE.
However, there are cases when there are disagreements among buyers and sellers on
the price and quantity. In such cases disequilibrium situations can occur. An example of
a disequilibrium condition is when the amount buyers are willing to buy is not the same as
the amount the producers are willing to sell at a given price. Another example of a
disequilibrium situation is when at a given level of quantity, the price that buyers are
willing to purchase the commodity is different from the price producers are willing to sell.
This means the demand price is different from the supply price.
Because disequilibrium situations create differences in the amount of commodity being

bought and sold, the market price is not stable and can bring economic problems. If the
market is efficient, these differences create pressures through price changes to remove
the disequilibrium.
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For example, if the quantity demand is greater than quantity supplied, there is excess
demand at the prevailing price. Because of the excess demand, there will be
competition among buyers to have their wants served. They will complete for the limited
supply and this is done through a price increase. As the price of the commodity increases,
the quantity demand will decline and the quantity supplied will increase thus eliminating
the excess demand.
On the other hand, if the quantity demand is lower than quantity supplied, there is excess
supply at the prevailing price. Given this situation, there is motivation among suppliers to
remove this excess supply through price competition. Suppliers will complete to dispose
their excess supply by lowering their prices. A decrease in price will decrease quantity
supply and encourage consumers to increase quantity demand. These adjustments
coming from the suppliers and buyers will eliminate the excess supply.
The graphical representation of excess demand and excess supply is shown in Graph 2.8.
with the demand curve D and supply curve S determining the equilibrium price at PE and
equilibrium QE. This situation is stable since there is no pressure for change as both buyers
and sellers are in agreement of the price and quantity bought and sold. However, if the
price is set higher or lower than the equilibrium price, it will create problems in the market.
Suppose the price is set at PH which is higher than PE; this will result in a disequilibrium
situation described as excess supply. At this high price, the buyer will reduce their
demand to QDH from QE while suppliers will increase their quantity supply to QSH from QE.
The gap between quantity supply and quantity demand, QDH QSH is the amount of excess
supply.
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Suppose the price is set at PL which is lower than PE; this will result in a disequilibrium
situation described as excess demand. At this low price, the buyers will increase their
demand to QDL from QE while suppliers will decrease their quantity supply to QSL from QE.
The gap between quantity demand and quantity supply, QDL QSI is the amount of excess
demand.
Changes in Equilibrium Price and Output
The impact of changes in demand and in supply brought about by various factors on the
equilibrium price and quantity can be analyzed through price mechanism in the market
system. Through changes in the price, suppliers and consumers adjust to attain a new
equilibrium situation. These adjustments are very useful in understanding price changes
in some commodities.
Shift in the Demand Curve to the Right
We have discussed earlier the shifts in the demand curve. Let us apply this change on the
demand of a particular good. We can use this concept in explaining why the price of
fruits increases during the Christmas and New Year Holiday. An increase in income
received from bonuses and thirteenth month pay increases the purchasing power of the
consumers. This will shift the demand curve to the right. Similarly, a shift in the demand
curve to the right can be caused by a change in taste brought about by the need to
have fruits during the midnight supper on New Year eve.
Graph 2.9 illustrates the effects of a shift in the demand for fruits to the right brought about
by an increase in income. Given the shift of the demand from D0 to D1 brought about by
an increase in income with no shift in the supply curve remaining at S 0, the equilibrium
price will have to change. At the previous equilibrium price, P0 and the new demand
curve, there will be an excess demand amounting to e0B since the quantity supply has
not changed. To eliminate this excess demand, the consumers will compete for the
limited supply. This competition will put a pressure on the price to increase to P 1. With an
increase in price, the consumers will lower their quantity demand by AB. With this
adjustment by the consumers a portion of the excess demand has been eliminated. The
other component of the excess demand is removed by an increase in supply by e 0A
brought about by the increase in price. This shift in the demand curve is one of the
explanations why we observe an increase in price of fruits during the Christmas season.
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Shift in the Demand Curve to the Left
The decrease in the price of shellfish during red tide season is another application of these
changes in demand. We can explain this phenomenon through a shift in demand curve.
As consumers fear being poisoned by contaminated shellfish, they alter their taste for
shellfish and reduce their consumption at all alternative prices. This in effect will shift the
demand curve to the left brought about by this fear and a change in taste.
Graph 2.10 will assist us in understanding the effects of a shift in demand curve to the left.
With the supply curve not shifting and remaining at S0, the shift of the demand curve to
the left from D0 to D1 will in a new equilibrium using demand and supply analysis. At the
initial equilibrium price P0, there is an excess supply denoted by Me0 since the quantity
supply has not changed but the quantity demand has significantly been reduced. To
eliminate this excess supply the supplier will compete among each other by offering lower
prices. With the reduction in price to P1, some consumers will be enticed to consume
more which will reduce the excess supply by Ae0. On the other hand, a decrease in price
will discourage some suppliers to sell at a much reduced price. This reduced quantity
supplied amounting to AM will partially eliminate the excess supply. Thus, the excess
supply was eliminated by a reduction in supply, on the one hand and the increase in
demand, on the other hand, brought about y a price decrease. As a result, we observe
that the price of shellfish declines when a red tide alert is announced by the government.
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Shifts in the Supply Curve
After understanding the impact of the shifts in demand, let us analyze the applications of
shifts in the supply curve. As discussed in the previous section, there are several factors
other than its own price that may affect producers in supplying a commodity. Changes
in these factors can shifts the supply curve can also influence the changes in the
equilibrium price.
Shift of the Supply Curve to the Right
One application of this change in supply is the significant reduction of the price of mobile
phones in the past several years. There was a time that the price of mobile phones was
so prohibitive that only the rich can afford these electronic gadgets. Now, almost
everyone from all walks of life has a cell phone or two with them. What are the reasons
that brought about the expansion of this market? This can be explained by rapid
improvements in information technology that substantially lowered the cost of producing
mobile phones.
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Graph 2.11 will help in understanding the implications of a shift in the supply curve to the
right. The improvements in technology have shifted the supply curve to the right from S 0
to S1. This means that at the same level of alternative outputs, producers will now incur
much lower costs. Alternatively, at the same alternative prices, sellers can supply more
mobile phones. With the demand curve not shifting remaining at D0, a shift in the supply
cure to the right will cause an excess supply e0R at the prevailing initial equilibrium price
P0. This excess supply can be eliminated by the market mechanism though pre
competition among sellers. This will have a pressure for the price to decrease. With a
reduction in the price to P1, consumers are encouraged to buy more by e0N thus
eliminating partially the excess supply. The other portion of the excess supply NR is
eliminated by some high cost suppliers that become uncompetitive at a lower price. As
a consequence of these adjustments, we see more people with mobile phone since they
have acquired these gadgets at a much lower price.
Shifts in the Supply Curve to the Left
Have you observed the price of vegetables becoming very expensive immediately after
a strong typhoon that hit the country? This phenomenon can be formally explained
through supply and demand analysis using the shifts in supply.
Graph 2.12 will aid us in understanding the impacts of a shift in the supply curve to the
left. After a strong storm, many of the agricultural products are damaged, if not totally
destroyed, by strong winds and heavy rains. As such, the supply curve for vegetables will
shift to the left. That means that at alternative prices, there will be less sellers that will be
willing to supply because they may find if difficult securing the vegetables. Another way
of looking at it, at alternative outputs, the sellers will now incur higher costs because of
the struggle of securing the vegetables.
With a shift in the supply curve to the left from S0 to S1 and no change in the demand
curve remaining at D0, there will be excess demand amounting to Re0 at the initial
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equilibrium price P0. To eliminate this excess demand, consumers will have to compete
for the limited supply and this will put a pressure for the price to increase. The increase in
price to P1 will discourage consumption amounting to Ge0 that will partially eliminate the
excess demand. In addition, the price increase will encourage some sellers to supply
more amounting to RG that will partially remove the excess demand.
Simultaneous Changes in Demand and Supply
In the preceding sections, the applications of supply and demand analysis in

understanding current economic situations were made by limiting the changes to either
demand changes or supply changes. But to be more realistic, the changes in the
equilibrium price are usually caused by concurrent changes in the demand and supply.
This can be illustrated when both the demand curve and the supply curve are changing
at the same time.
Shift of the Demand Curve to the Right and Shift of the Supply Curve to the Right
(Equal Proportion)
Have you observed that the price of chicken remains stable during the Christmas season
despite the increase in demand brought about by increase in income and the need to
celebrate during the holidays? A possible explanation is the increase in supply as
producers of chicken anticipate the increase in demand during the holiday season. Since
the increase in demand is equally matched by an increase in supply, the price of chicken
does not change.
Graph 2.13 shows the shift in demand in chicken to the right is matched by a proportional
shift in the supply of chicken to the right. With the need to celebrate during the Christmas
season coupled with increased income of household with the receipt of their thirteenth
month salary and other bonuses, the demand for chicken increases. This will shift the
demand for chicken to the right from D0 to D1. If the supply of chicken is not changed
and remains at S0, this will create an excess demand e0e1 at the prevailing price P0.
However, this does not happen because suppliers have prepared for this expansion of
demand by increasing their supply of chicken during the Christmas season and the supply
of chicken shifts to the right to S1. In such a case the increase in the demand for chicken
is matched by an increase in the supply. As a result the price of chicken does not change
and goes back to P0.
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Shift of the Demand Curve to the Right and Shift of the Supply Curve to Left
(Unequal Proportion)
During times of major natural calamities, we often observe that prices of basic
commodities increase very fast. This is not caused by the reduction in the supply alone as
shown in Graph 2.12 but it can be accompanied by an increase in the demand of the
consumers as they expected the price of basic increase in the near future. Graph 2.14
will assist us in understanding the shifts in the supply to the left and a shift in the demand
to the right. Let us assume that the change in supply has a greater magnitude than the
change in demand.
At normal times, the price of the commodity is set at P0 which was determined by the
initial demand curve, D0 and initial supply curve S0. With a strong typhoon hitting the
region, the supply of the commodity is drastically reduced and the supply curve shifts to
S1. With no change in demand, the price will settle at a higher price P1. However, as
consumers expect the price of this basic commodity to increase in the future their current
demand curve shifts to the right at D1. With reduced supply and increased demand the
price further increases to P2.
This rapid increase in the price of the basic commodity from P0 to P2 during times of natural
calamities forces the government to impose price control measures and even rationing.
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Other Applications of Supply and Demand Analysis
The analysis of supply and demand is a simple yet powerful economic framework that
can be used in understanding contemporary issues facing the Philippine economy. In
the previous section, we used it in understanding seasonal increases in the price of goods,
the decline of prices of electronic gadgets, price decrease of shellfish during red tide
season and the rapid increases in the prices of basic commodities after a natural disaster.
In this section we will use the supply and demand framework in understanding the effects
of an imposition of price ceiling and price floor, as applied in the goods market, labor
market, factor markets and the market for foreign exchange.
Price Ceiling
In the previous section we have discussed the impact of an increase in demand and
decrease in the supply of commodity on the supply of a basic commodity after the
damage of a typhoon. As a measure to stabilize prices of basic commodities during these
unusual periods the government may impose a price control measures on basic
commodities. This means that the price cannot ho higher than the mandated price
ceiling.
Graph 2.15 will provide us with the effects of a price ceiling on the market for sugar. Before
the natural calamity, the interaction of the demand curve D0 and supply curve S0
determines of sugar at P0. After the calamity, the supply of the commodity is drastically
reduced and the supply curve shifts to S1. With no change in demand, the price will settle
at a higher price P1. However, as consumers expect the price of this basic commodity to
increase in the future their current demand increases and shifts their demand curve shifts
to the right to demand curve D1. With reduced supply and increased demand the price
further increases to P2.
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Since the new equilibrium price, P2 is significantly higher that the initial price P0 the
government may impose a price ceiling since new equilibrium price is too prohibitive.
Many consumers may not be able to afford to buy sugar at this price. With the imposition
of price ceiling, Pc which is lower than the P2, a disequilibrium situation can occur
described as excess demand. At this lower price, the buyers will increase their demand
to QDC from Q2 while supplier will reduce their quantity supply to QSC from Q2. The gap
between quantity demand and quantity supply QSC QDC (AB) is the amount of excess
demand. This excess demand cannot be removed through price increase because it is
not allowed by the price control measure. An alternative measure is for the government
to ration the limited supply of sugar to consumers.
Price Floor
Another government measure to arrest the price adjustment in the market is the
imposition of a price floor. This means that the government sets the price of a commodity
and it cannot go lower than the set price. The imposition of price floor measure is meant
to protect certain actors in the market. For example, to support tobacco planters in
achieving a reasonable income, the government may set a floor price of tobacco in the
market. Although this way favor the tobacco planters it may have some economic
consequences.
Graph 2.16 will assist us in understanding the economic effects of a price floor in the
tobacco industry. Without the price floor, the equilibrium price PE and quantity QE in the
tobacco market is determined by the intersection of the demand curve D and supply
curve S. at this price, tobacco farmers may find it too low to provide them with income
to have a decent living. Tobacco farmers may convince the government for support in
terms of an imposition of a price floor. If the government agrees it can set the price of
tobacco at PT which is higher than the equilibrium price PE.
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The imposition of a price floor means that the market price cannot be lower than P T. This
government measure, however, will result in a disequilibrium situation described as excess
supply. At this high price, the buyer will reduce their demand to QDT from QE while suppliers
will be encouraged to supply to QST from QE. The gap between quantity supply and
quantity demand, QDT QST is the amount of excess supply. This excess of supply or over
production is an indicator of inefficiency and waste.
Application in the Labor Market
The analysis of demand and supply can also be used in the determination of the wage
rate in the labor market. As in any market, the labor market is composed of those that
demand labor services, an indicated by the demand curve for labor and those that
supply labor services, as indicated by the supply curve of labor. These major actors in the
labor market are motivated by the changes in the price of labor which is indicated by
the wage rate.
Similar to other demand curve, the demand curve for labor is downward sloping. This
means that there is an indirect relationship between the wage rate and the quantity of
labor services that will bought in the market. Note that labor services are bought in the
labor market and not the laborers. The ones buying the labor services are firms that use
labor service as factor inputs in production. With the objective of maximizing their profits,
firms will equate marginal benefits with marginal cost as discussed in the previous
chapter. Thus, firms will hire laborers if the monetary value of the labor productivity
(marginal benefit) is equal to the wage rate (marginal cost). Since the value of marginal
productivity decrease based on the diminishing marginal productivity, firms will hire
additional laborer services if wage rate is decreased in order to maximize profit. Thus, the
demand for labor services is downward sloping. At a high wage rate, the demand for
labor is low while at the low wage rate the demand for labor is high.
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On the other hand, the supply of labor is also influenced by the wage rate. The laborers
are the ones supplying the labor services in the labor market. To them, the wage rate is
the opportunity cost of having leisure. It is assumed that individuals use their time by
choosing having leisure or devoting it to work. Given this, if the wage rate is very low, very
few laborers are willing to work since they would rather have leisure because the price of
leisure is very low. At this low wage rate, the foregone income of not working is very low.
On the other hand, if the wage rate is high, the demand for leisure decrease since the
opportunity cost of not working is very high. As they devote less time for leisure, they will
be willing to offer more time for work. Thus, we observe a positive relationship between
wage rate and the supply of labor services.
In Graph 2.17 we depict a market for labor services. The intersection of the demand for
labor DL and the supply of labor SL at point e will yield the equilibrium wage rate, WE and
the quantity of labor service bought and sold, LE.
Minimum Wage as Price Floor
If the equilibrium price at Graph 2.17 is considered too low by the laborers they may
demand the government to impose a price floor or a minimum wage. In Graph 2.18, we
show the effects of the imposition of the government of a floor price or minimum wage
WM higher than the equilibrium wage rate, WE. With this regulation, the reaction of the
firms is to demand less labor services, LDM as the value of marginal productivity of the last
worker LE is now lower than the minimum wage WM. Hiring additional workers beyond LDM
will mean the net returns to firms is negative implying that their profit may decline as a
consequence.
From the point of view of the suppliers of labor services, they may find the minimum wage
attractive and they offer more hours for work up to LSM. With demand for labor decreasing
while the supply of labor increasing with the minimum wage will result in an excess supply
of workers seeking work but cannot be hired because of the strict requirements of higher
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value of marginal products by the firms. This excess supply of labor services amounting to
LDM LSM ends up as unemployment workers.
Although the objective of the government in setting the minimum wage is to provide a
decent life for workers, this policy may be considered counter productive because it
creates unemployment workers.
Application in the Foreign Exchange Market
Another application of the demand supply analysis is the determination of the exchange
rate. The exchange rate is the price of a foreign currency. For example, the exchange
rate between Philippine peso and US dollar is PHP 45 per US dollar. This means that the
price of one US dollar is 45 Philippine pesos. This price of US Dollar or exchange rate (ER)
can be determined by the interaction of the demand of US dollars and the supply of US
dollars in the market for foreign exchange.
Graph 2.19 will assist us in the determination of the exchange rate in the foreign
exchange market. On the vertical axis we put the price of foreign exchange or exchange
rate, ER. On the horizontal axis we put the quantity of foreign exchange in this case, US
dollar, QUSD.
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The demand for US dollars in the Philippines is influenced primarily by its demand for
imports since the country needs US dollars to pay for our imports. Just like the demand
curve developed earlier, the demand for US dollars has an indirect relationship with the
exchange rate in this case the price of a US dollar. The higher price of a US dollar imports
become expensive. As imports become expensive our quantity demand for US dollars
decreases. This is denoted by the downward sloping demand curve, DUSD.
The supply of US dollars, on the other hand, is based on the inflows of US dollars into the
country brought by export receipts, remittances and capital inflows. The supply of US
dollars has a positive relationship with the exchange rate. As the exchange increases
from PHP 40 to PHP 50 per US dollar, it can motivate exporters to export more Filipinos to
Work overseas and send remittances. When the exchange rate decrease or the peso
appreciates form PHP 40 to PHP 30 per US dollar, there is a disincentive to export and for
workers to work overseas. Because of this, we have a positively sloping supply of US dollars
as indicated in SUSD.
The intersection of the demand curve for US dollars, DUSD and the supply curve of US
dollars, SUSD at point e will determine the equilibrium exchange rate ER E and the amount
of dollars bought and sold amounting to QE.
Labor Migration and the Overseas Filipino Workers (OFWs)
Currently, there are millions of Filipinos working abroad. The push and pull factors have
often been utilized to explain the temporary labor migration of Filipinos. However, the
demand and supply analysis can also be used to describe the phenomenon of Overseas
Filipino Workers (OFWs). Similar to the market for labor service in Graph 2.17, temporary
labor migration of Filipinos can be analyzed in terms of demand for OFWs and supply of
OFWs in the international labor market.
Graph 2.20 can help understand why many Filipino workers want to become OFWs even
at the low foreign wage and decreasing foreign wage rate. The supply of OFWs is
positively influenced by the foreign wage rate WF. As the foreign wage rate increase it
becomes more attractive for Filipinos to work abroad. This positive relationship is shown in
the supply of OFWs SLF1.
On the other hand, demand for OFWs is also influenced by the foreign wage rate. As
foreign wage rate decrease, foreign firms will demand more OFWs as they equate the
wage rate with the value of the marginal productivity of workers. This downward sloping
demand for OFWs is shown by DLF. The intersection between the supply curve of OFW, SLF1
with the demand curve for OFWs, DLF1 at e1 gives the equilibrium wage rate WE1 and
employment of OFWs at LE1.
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However, this supply of OFWs is also influenced by the exchange rate. The higher the
value of the US dollars in terms of Philippine peso, more Filipinos will be inclined to work
abroad. Suppose the exchange rate ER is PHP 40 per US dollar. A salary of USD 1,000 per
month abroad will translate into PHP 40,000 per month. However, if the ER is now PHP 50
per US dollar, the same salary of USD 1,000 can be exchanged for PHP 50,000.00. With the
increase in the ER, working abroad becomes attractive even if the wage rate abroad is
not changing.
Suppose the exchange rate increase or the peso depreciates, the supply curve of OFWs
shifts to the right to SLF2. With the demand curve not changing, a new equilibrium is set a
point e2 with a lower wage rate, WE2 and a higher employment of OWFs at LE2. Thus even
at a lower foreign wage rate, there will be more OFWs willing to go abroad because the
Philippine peso value of their reduced foreign wage is still high with a depreciated
Philippine peso. The demand of OFWs also increase because the foreign wage has
declined encouraging foreign firms to hire more Filipino workers.
Determination of Rent
Another application of the demand supply analysis is the determination of the rent which
is the price for a fixed factor input. Typically, rent refers to the price of using land, a fixed
input, in the process of production. You probably wonder why the price of land or rent in
the commercial districts of Makati, Taguig and Ortigas in Metro Manila are significantly
higher that the same are of agricultural lands in rural Samar or Bicol. In some remote areas
of the country some lands remain idle. The framework of demand and supply analysis
developed in this chapter can explain these differences in rent.
Consider the Graph 2.21 where the market for land is shown. The supply curve of land is
depicted by a vertical line S1 because land is fixed and cannot be increased with
increase in rent or the price of land. Since supply is not responsive to the change in price,
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the price of land or rental rate is determined by the demand for land alone. But before
we consider the impact of demand for land, we have to realize that there is a cost in
putting this fixed land into productive use. This is shown by C0. Thus the difference
between the price of land and the cost, will give us the pure rent realized by the owners
of the land. This difference can be considered as net surplus of owners by putting their
land into productive use.
Consider a very low demand for land as indicated by D0. The intersection of supply curve
S1 and demand curve D0 at point e0 will give us a very low price of land or rent, R0. Since
R0 is lower than the cost of putting land into productive use C0 the owner of the land are
getting negative net surplus or negative pure rent. In this case, there is no incentive for
landowners to use their land. Thus, the remains idle.
Consider a high demand for land as indicated by D1. The intersection of supply curve S1
and demand curve D1 at point e1 will give us a price of land or rent, R1 which is higher the
R0 and C0. Since R1 is relatively higher than C0, the owners of the land earn some positive
net surplus or some pure rent. Since the price of land is not as much, landowners may use
this land in productive activities that can afford to pay the modest price of land. In most
cases, this type of land can be used for agricultural production.
However, if the demand for land is very high as indicated by D2, its intersection with the
supply curve S1 at point e2 will set the equilibrium price of land or rent in this case at R2
which is significantly higher than R1 and substantially higher the C0. At this price of land,
the landowners are reaping huge pure rent. Since the price of land is very high, those
who will use it for business and other productive purposes must devise ways to recover
the huge cost of land use.
Because of the prohibitive price of land in commercial districts in highly urbanized cities
in Metro Manila, those who buy or acquire a lease on land in these area construct high
rises and condominium to recoup the cost of acquiring land. They sell the units at
prohibitive prices or charge high rental rates to their tenants to recover the hundreds of
million Philippines pesos spent in acquiring the land. It does not make good business or
economic sense to construct a two storey building in these commercial districts or use it
for agricultural production because such initiatives cannot recover the prohibitive cost of
the land.
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LESSON 3: CONTEMPORARY ECONOMIC ISSUES

FACING THE FILIPINO ENTREPRENEUR
Market Structures
The interaction of demand and supply with consequent determination of the price is set
in an environment called a market. More than a place or state where transactions are
made between sellers and buyers, what is more important in this setting is the power
being exercised by any of the actors in the market. Market power is defined as 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 or sold. The aim of every actor is to enhance its
market power in order to increase its profit for producers and satisfaction for the
consumers. The availability to have market power and enhance the interest of the actors
will depend on the structure of the market.
A Filipino who wants to engage in any business or become an entrepreneur should know
the characteristics of the market he is trying to enter. He should know whether the
structure of the market can provide him reasonable profit and environment for growth.
There are four major classification of market structures depending on the market power
of the actors in any transaction – perfect competition, monopoly, oligopoly and
monopolistic competition.
Perfect Competition
Perfect Competition is described as a market structure where no single seller or single

buyer has power to determine the price and the level of output in the market. Although
buyers and sellers compete, but since no one has market power, meaning they have
Page 33
equal influence, the price is entirely determined by the price mechanism in the market
system.
The reasons behind the absence of market structure are also the key characteristics of a
perfect competitive market. For one, there are numerous firms and buyers supplying and
buying the product. Because of the huge number of sellers and buyers, not a single one
can have a significant influence on the price and quantity in an equally huge market.
In addition, suppliers in a perfectly competitive market sell similar or undifferentiated

product or service. Since suppliers cannot differentiate their products from one another,
no one can develop brand loyalty on his/her product. A seller that increases his/her price
above the market price can end with no buyers since customers can shift to other sellers
that are producing the similar product and selling it at a lower market price. On the other
hand, a seller trying to attract more buyers by selling the product below the market price
can end up losing because its cost of production has increased while his/her selling price
has declined. Because of this no seller can benefit by deviating from the market price. In
effect, every seller is considered a price taker.
A competitive market also is characterized by free entry and free exit. This means that
there are no restrictions on the entry and exit of new players. This implies that if the industry
is profitable, new entrants are allowed to enter. As a consequence, any excess profit
earned by existing firms in the market is eliminated by the entry of new firms. On the other
hand, if there are losses in the industry, firms incurring losses are allowed to exit. With free
entry and free exit, only firms with normal profit will remain in the market.
Related to free exit and free entry is the characteristics of mobility of resources. This
assumption facilities the movement of resources to activities that will give higher returns
to actors. For example, if wages are high in one sector, mobility of resources permits the
movement of workers to this sector from a low wage sector or region.
The last characteristics of a perfect completion is perfect information. This means that
actors in the market are adequately equipped with information to make rational
decisions. An important assumption made is that information is symmetric. This means that
what is known to the buyers is likewise known to the sellers. Given this information
symmetry, buyers and sellers can make appropriate decisions. However, when
information is uneven or asymmetric, some actors can extract surplus at the expense of
the other actors. For example, the nondisclosure of sellers on the expiry date of their
products can put uninformed consumers at risk while sellers are cashing in on revenues
and reaping profits.
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With all these characteristics, not a single seller and buyer can influence the
determination of the price in the market. The constant competition among buyers and
sellers lead to an efficient production where they produce at the least cost. In addition,
since the price in a competitive market reflects marginal cost incurred by sellers and the
marginal utility received by the consumers, a perfectly competitive market is an ideal
market structure since it leads to an efficient use of resources.
Monopoly
Monopoly is a market structure characterized by a single seller in the market. If there is

only one buyer in the market, the market is called a monopoly. A monopoly is the exact
opposite of perfect competition. Because there is only seller or one buyer, this single seller
or single buyer has enormous market power. As a single seller, a monopolist can set a
lower output and a high price in the market that will maximize his profit. On the other
hand, as a single buyer a monopsonist can set a higher output and low price that give
him the highest level of utility or satisfaction.
The presence of the huge market power in a monopolistic market is due to the key
characteristics of the market. In a monopoly, there is only one seller and as such there is
no competition in the production of a highly differentiated product that the monopolist
alone can produce. The uniqueness of the product gives the monopolist market power
since consumers respond to his production decisions through price changes along the
consumer demand curve. The ability of the monopolist to differentiate a product gives
him market power because the product has its own market and corresponding demand
curve that reacts to price and output changes.
Because of the market power, a monopolist can extract huge profit in the market. This
huge profit is not easily eliminated because there are restrictions on the entry of potential
competitors. One of the market restrictions is the scale barriers. Usually monopolists are
found in highly capital intensive industries like the provision of utilities electricity, water and
gas.
You need enormous amount of money to buy the equipment and build the physical
structure of these industries. Usually companies that provide these public utilities are given
permission by the government to monopolize the market through the granting of a
franchise. With the franchise, these utilities become natural monopolies. A natural
monopoly is a company in an industry where it is not feasible and uneconomical to have
more than one producer because the huge physical capital requirements.
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Another entry barrier is a list of legal privileges given to owners of copyrights, trademarks
and other intellectual property rights. These property rights given an exclusive right to a
company to produce, use the design and trademark, process and distribute the good.
Aside from preventing the entry of potential competitors who may want to reap the
monopoly profits in the industry, these property rights also serve in differentiating the
product.
As mentioned earlier, the profit reaped by the monopolist is done by limiting production
and setting a higher price. With this limited production, the price of the product is greater
than the marginal cost. As a result, the monopolist becomes an inefficient producer since
it does not want to increase its production even if the marginal benefit derived from the
product is still higher than the marginal cost of production. Increasing production is not
an attractive option because it may lower its profits. Since there are no competitors in
the market, there is no incentive for the monopolist to be efficient in the use of resources.
However, the government can lower the market power of the monopolist by taxing its
huge profit or through limit pricing.
Oligopoly
Oligopoly, on the other hand, is a market structure characterized by few sellers producing
similar and differentiated products. Large scale cement and steel companies usually
have the characteristics of firms in an oligopolistic market. An oligopolistic market is
described as an imperfect competition since it has some elements of a competitive
market. Although there is competition among the few sellers in the market, their
competition is imperfect since the excess or abnormal profit in the industry is only reduced
but not totally eliminated. More than the competition among the few sellers, what is
significant in the determination of price and output in the industry is the way these few
sellers interact with one another. Since they are only few sellers they can ignore each
other or corporate or react with one another or follow the dominant company.
Ignoring one another or having independent actions can lead to price competition and
can result in drastic reduction in the profit of the companies. Their behavior in this case
mimics a competitive market. On the other hand, they can opt to monopolize the market
by cooperating with one another. They can collude with one anther in setting the price
that will yield the highest profit for the industry and distribute the industry output among
the few sellers. Although this option can enhance their market power, collusion or forming
a cartel is not legal in our country. In the international market, however, the formation of
Organization of the Petroleum Exporting Countries (OPEC), an oil cartel of big oil
producers has been effective in influencing the world price of crude oil for decades.
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Since collusion is not allowed, these few firms can also opt to react with one another by
setting their output that will maximize their profit based on the output decision of their
rival firms. In addition, they can also follow the behavior of the leader in the industry. The
more dominant firm will usually set the output that will maximize his profit. Once the output
is set, the price is likewise determined. Followers will take this price and adjust their output
accordingly.
Monopolistic Competition
Monopolistic Competition is another example of imperfect competition. This market

structure has the elements of both competitive and monopolistic markets. It is
competitive because it has numerous sellers and buyers in the market that can freely
enter and leave the market. However, it has a monopolistic element since the product
being sold in the market although similar can be differentiated by the seller through
various means of advertising and numerous ways of packaging. This product
differentiation is accepted by buyers as they patronized a particular brand. Such brand
loyalty in turn, provides some degree of market power to the sellers since their products
are faced with individual demand curve that are responsive to price and output
changes. Some of the products sold in a monopolistically competitive market are
shampoos, soaps, detergents and other household items.
Because of free entry and exit in the market, the excess profit is eliminated with the price
level equivalent to the average cost of production. However, even with this equality firms
in this market structure experience excess capacity as they set their production levels
below the output that gives the minimum cost of production. As a consequence of this
excess capacity monopolistically competitive firms are also inefficient in the use of
resources.
Market Structure and Implications for Entrepreneurs
An entrepreneur with limited resources and productive capacity may situate his business
in a perfectly competitive market. Entry is easy and for a small enterprise with limited
resources it can easily move into a market. But the firm will be faced with numerous
competitors, actual and potential that can limit the profitability of the firm. With profit
approximating the normal rate of return and difficulties in differentiating the product, the
ability to expand and find a niche in the market is very limited.
In the light of these limitations, a monopolistically competitive market can be explored.

In this case, the firm who can give the market a unique branding for its product can find
Page 37
a niche and expand its market share. However, the firm should always be conscious of
potential rivals who can easily enter the market.
Situating a small scale business in a monopolistic market may be difficult unless the firm is
able to produce a very unique product or service with no substitutes. Even if you can
produce this unique commodity the next challenge is to convince the public that it is
worth buying. It took several decades and a lot of advertising money before personal
computers became acceptable as household durables. A small firm with limited
resources may not have the money to spend to advertise the benefits and uniqueness of
his product.
Similarly, a small form with limited resources may find it difficult to enter an oligopolistic
market. The scale of business operations is too large that may prevent this small firm to
enter a very lucrative market.
Investment and Interest Rate
Beside knowing the market where he/she can establish his/her business, an entrepreneur
is also faced with various issues affecting the costs of operating a business enterprise. One
of the major costs in conducting a commercial organization is the interest payments on
borrowed funds.
In establishing a business, an entrepreneur will need funds to finance its initial operation
as well as the acquisition of tools, machinery and other capital equipment in building his
factory and physical plant. Because internal resources coming from the entrepreneur
and his business partners may not be sufficient to finance these investment needs, the
entrepreneur or his company may have to borrow externally.
External funds can be sourced from the capital market or the market for funds. In this
market the demand for funds is made by firms and other organizations that are deficient
in funds to finance their investment needs. The optimal amount of borrowing made by
firms is determined when the interest rate or price of capital funds is equal to the value of
the marginal productivity of capital. Since the value of marginal productivity of capital is
declining the demand curve for funds shows as indirect relationship between the interest
rate or price of capital funds and the amount being borrowed.
Meanwhile, the supply of funds comes from individual, corporations and other institutions
that have savings or excess funds from their income. Savings is influenced by the interest
rate which is the price of the present goods relative to future goods. If the interest rate is
high, present goods are expensive which discourages individual to consume currently.
Page 38
Instead of consuming now they save. On the other hand, if the interest rate is low, present
goods are cheap which encourages current consumption and discourages savings. Thus,
savings or the supply of funds is positively related with the interest rate.
The intersection of the demand curve for funds and the supply curve of funds determine
the equilibrium interest rate. If the price of capital is high, it may discourage potential
entrepreneurs to engage in business. In addition, existing entrepreneurs may postpone
their expansion and investment plans with high cost of capital.
However, the price of capital is also influenced by government policies in controlling

inflation. If the Bangko Sentral ng Pilipinas (BSP) foresees an inflationary pressure on the
prices of goods and services, the Monetary Board of BSP may adopt a tight monetary
policy by decreasing the money supply funds in circulation. This will shift the supply of
funds to the left as savings decreases at alternative interest rates. Thus, in controlling the
inflation rate, the tight monetary policy of the BSP can discourage business activities by
making the cost of capital more expensive. Therefore, the BSP must strike a balance of
stabilizing the domestic price and the price of funds.
Rentals and the Cost of Business Operations
We have discussed in the previous section how rent or the price of the use of land is
determined. We also explored the reasons why the rental office space in commercial
districts in Makati, Taguig and Ortigas in Matro Manila are very expensive. Since
companies spent hundreds of millions of pesos to buy or lease real estate in these
locations and disbursed probably billions of pesos to construct high rises or condominium,
they expect favorable returns on their investments. This can only be done by charging
very high rental rates in office spaces.
It may not be wise for a small and beginning enterprise with limited resources to locate
its office in these high-end commercial districts because rental rates can eat up a huge
part of its revenues. But these commercial districts still attract numerous business
establishments despite the high rental rate. Based on our benefit cost analysis, the
marginal benefits of locating in these areas is equal to the marginal cost.
There are several benefits of having an office in these commercial districts. First, it gives
legitimacy and prestige to the business enterprise. If a company can afford the high cost
of office space, it must be a genuine business venture supported with huge resources
and having favorable business revenues from its operations. Second, there are
economies or savings when business enterprises are located in one strategic place. Aside
from attracting a lot of customers and clients, the transaction cost may go down if the
Page 39
office is accessible to workers and near to the clients and service providers. Third, these
commercial districts are well planned and designed for business with their good
infrastructure and adequate support service. Because of these benefits, many local
government units as well as private real developers are developing strategic areas in their
localities into commercial districts.
Minimum Wage
The determination of the wage rate has also been discussed in an earlier section of this
chapter. A wage rate imposed by the government which is higher than the equilibrium
wage rate can have consequence on the labor market as well as on firms. A minimum
wage is an example of a floor price that prevents the market to seek its equilibrium
condition because of a government policy or legislation. For labor intensive industries, the
imposition of a floor price on the wage rate can discourage firms to hire additional
workers since the wage rate has become prohibitive. With labor services becoming more
expensive, the comparative advantage of these firms is compromised. As a result, some
of these firms locate their manufacturing plants in regions or countries where labor is
relatively inexpensive.
Taxes
Various levels of government units impose a number of taxes including business permits,
real estate taxes, sales taxes, value added taxes, income taxes and taxes on traded
goods and services. These taxes can increase the cost of business operations and can
threaten the profitability of business enterprise at their initial stage of operations.
The attract pioneer and foreign and local enterprises to establish their presence in the
country, the government has crafted a program of tax incentives to locate their business
in the country. Income tax holidays are given to firms so they can be more profitable at
their initial years since they are exempted from paying their income tax for a certain
period of time. To encourage them to build their physical plant and import modern
technology, pioneer firms are exempted in paying import taxes. Sometimes, hiring of
more workers can qualify for double deduction in the computation of the net income
which is subject to tax.
The government can also allow firms to the rapidly depreciate the value of their capital
equipment. Although depreciation is considered a cost of operation, it does not involve
a cash outlay on the part of the firm. Rapid depreciation can bring more cash to the firms
which they can use for further expansion and operation. In addition, it can also lower the
income tax liability of the company.
Page 40
WORDS TO REMEMBER
Ceteris Paribus Market Power

Collusion Monopolistic Competition
Exchange Rate Monopoly
Equilibrium Oligopoly
Expectation Perfect Competition
ENGAGEMENT
The learner will be able to compose a slogan after understanding the basic economic
problems confronting the development of the Philippines in the 21st century
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ASSIMILATION/ASSESMENT
I. Gather news articles on the price of basic commodities including rice, sugar and
chicken. Make a presentation on what is happening to their prices using demand
and supply analysis.
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REFLECTION
The things I learned from the lesson:
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Questions I want to ask from the lesson:
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Things I realized from the lesson:

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REFERENCES:
For additional information, refer to the following website:
Economics for A Progressive Philippines

Tereso S. Tullao Jr., PhD
Phoenix Publishing House, Inc.
927 Quezon City
Page 44

Applied Economics - Lesson 2

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Applied Economics - Lesson 2

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WEEK 2 TO 4 Lesson 2

UNIT 2: APPLICATION OF SUPPLY AND DEMAND

LESSON 1: ANALYSIS OF DEMAND AND SUPPLY

Content Standards: Learning Competencies:

The learner will be able to examine the

The learners will be able analyze and

Performance Task: Goal – the learner will be able to

LESSON 1: ANALYSIS OF SUPPLY AND DEMAND

Specific Learning Objectives

1. A demand curve is a schedule of the willingness and capacity of a consumer

LESSON 1: ANALYSIS OF DEMAND AND SUPPLY

What is a Demand Curve?

A demand curve is a schedule of the willingness and capacity of a consumer to buy a

Other Factors Affecting the Demand of a Commodity

As indicated in the concept of demand, it is the willingness and capacity of a consumer

Prices of Other Commodities

Why is the Demand Curve Downward Sloping?

Substitution and Income Effects

Principle of Diminishing Marginal Utility

consumption of a particular commodity. Diminishing marginal utility implies that the

In a market economy, consumption of a commodity implies that you need to purchase

Changes in Demand Curve

What is a Supply Curve?

The supply curve is defined as a schedule showing a direct or positive relationship

Other Factors Affecting Supply of a Commodity

Price of Production Inputs

Business establishments are required to pay a number of taxes to various levels of

The expectation or anticipation on what is going to happen on the price of the

Why is the Supply Curve Upward Sloping?

Variation is the Unit Cost of Production

Principle of Diminishing Marginal Productivity and Increasing Marginal Costs

A more theoretical explanation developed by economists is based on the increasing

Changes in the Supply Curve

LESSON 2: Determination of Prices of

Because disequilibrium situations create differences in the amount of commodity being

Changes in Equilibrium Price and Output

Shift in the Demand Curve to the Right

Shift in the Demand Curve to the Left

Shifts in the Supply Curve

Shift of the Supply Curve to the Right

Shifts in the Supply Curve to the Left

Simultaneous Changes in Demand and Supply

In the preceding sections, the applications of supply and demand analysis in

Other Applications of Supply and Demand Analysis

Application in the Labor Market

Minimum Wage as Price Floor

Application in the Foreign Exchange Market

Labor Migration and the Overseas Filipino Workers (OFWs)

LESSON 3: CONTEMPORARY ECONOMIC ISSUES

Perfect Competition is described as a market structure where no single seller or single

In addition, suppliers in a perfectly competitive market sell similar or undifferentiated

Monopoly is a market structure characterized by a single seller in the market. If there is

Monopolistic Competition is another example of imperfect competition. This market

Market Structure and Implications for Entrepreneurs

In the light of these limitations, a monopolistically competitive market can be explored.

Investment and Interest Rate

However, the price of capital is also influenced by government policies in controlling

Rentals and the Cost of Business Operations

Ceteris Paribus Market Power

Questions I want to ask from the lesson:

Things I realized from the lesson:

For additional information, refer to the following website:

Economics for A Progressive Philippines