Applied Economics

MODULE
Module No. 1: Week 1: First Quarter
TOPIC: Basic Terms in Applied Economics

Learning Competency
Differentiate economics as social science and applied science in terms of nature and
scope.
Code: Code: ABM_AE12-Ia-d-1

Objectives
After reading this module, the learners will be able to understand:
1. Five Areas of Economics
2. Difference between Economics and Applied Economics
3. Three Major Types of Economic Systems
4. Scientific Methods in the Study of Economics
5. Five Economic Factors

Let’s Recall

MULTIPLE CHOICE. Choose the letter of the best answer.

1. It is the proper allocation and efficient use of available resources for the maximum
satisfaction of human wants.
a. Governance b. Economics c. Mathematics d. Sociology
2. It is an activity of earning money, buying goods and services or saving money in a bank.
a. Financial b. Motivational c. Normal d. Economic
3. Economics also classified as __________ science because it deals with the study of man’s
life and how it deals with other men.
a. social b. cultural c. political d. biological
4. An economic theory which is put in action.
a. Economic policy b. undefined economics c. Simplified economics d. Improved
economics
5. One of the basic economic problems is: What __________ to produce?
a. needs and priorities b. goods and services c. conduct and behavior d. clothing and
shelter
For numbers 6-10: Determine the effect of the following on money supply. Write A for
increases, B for decreases, and C for no change.
6. Central bank sells stock and bonds
7. Higher re-discount rate
8. Lower reserve requirement
9. No requirements for loans
10. Purchase of securities by the Central bank

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 Let’s Understand
Applied Economics Basics

Scope
People are confronted with innumerable wants from the cradle to the grave. If one want is satisfied,
other wants emerge in succession. To satisfy these wants people are engaged in different activities in
the society. But the means are limited in relation to unlimited wants. So people are constantly striving
to satisfy unlimited wants with limited means. The science of Economics has emerged as a discipline
to discuss how people are engaged in different activities to earn money and how do they endeavor to
satisfy unlimited wants with limited means. The knowledge of economics is indispensable to know
about how best to solve the manifold economic problems by the proper utilization of resources in the
society.
Applied economics is the application of economic theory. The subject matter of economics deals
with the analysis of economic problems of people in the society and the satisfaction of their wants.
Scope of applied economics is discussed below:
➢ As social science economics deals with the economic activities of human being. One person day
to day money earning and money spending activities constitute the subject matter of economics.
For example, parents’ affection and nursing service for their children are not the subject matter of
economics.
➢ Resources are needed to satisfy people’s wants. So, the availability of resources and their use are
important subject matter of economics. Adam Smith has termed economics as the “Science of
Wealth”.
➢ People’s wants are unlimited. But the resources to satisfy the wants are scarce. Economics
discusses how men can get the maximum satisfaction by using the scarce means to satisfy wants on
the basis of priority. So, as subject matter of economics, the scarcity or resources is considered
very important.
➢ People’s wants are related to production, exchange, distribution and consumption. Again, currency,
banking system, public finance, trade etc. is also parts of economic activities. Economics discuss
these issues also. Besides, how economic development of the country is achieved through the
means of economic planning is also included in the subject matter of economics.
Overview
Applying economic theories to current economic conditions can be extremely helpful for three key
reasons.
First, applying economics to the status of the economy of a company, a household or a country helps
to sweep aside all attempts to dress up the situation so that it will appear to be worse or better than it
actually is. From this perspective, applied economics is a powerful tool that enables the true and
complete picture to emerge, so that it becomes possible to decide what to do and where to go from the
current position.
Second, applied economics acts as a mechanism to determine what steps can reasonably be taken to
improve the current economic situation. Each element that is relevant to the contemporary mode of
operation of the entity including the purchase and sale of goods and services, the usage of raw materials
and the division of labor within the entity come into play. Examining each aspect of the current
economic condition will often yield sound ideas on ways to maintain aspects that are working at a
reasonable rate of efficiency and strengthen areas where the performance is weak.
Last, applied economics can teach valuable lessons on how to avoid the recurrence of a negative
situation, or at least minimize the impact. Applied economics is all about the application of theory to
real-life situations, so the process can help develop an understanding of why a condition took place.
This includes reviewing what steps were taken to improve or correct similar situations and how those
strategies can be employed to keep the economy flowing in a direction that will preclude a repeat of the
undesired situation.
Introduction to Applied Economics

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The application of economic theories and principles to real world situations with the desired aim of
predicting potential outcomes. The use of applied economics is designed to analytically review
potential outcomes without the “noise” associated with explanations that are backed by numbers.
Applied economics can involve the use of econometrics and case studies.
Basic Terms in Applied Economics
➢ Five Areas of Economics
Economics is a social science which analyzes the production, consumption and distribution of goods
and services. Attempts to explain how economies and economic agents work, and applies models in
order to analyze primarily business finance, and government. However, the models derived through
economics may be applied to many other things such as crime, law, politics and education. While there
are endless subtopics of economics, there are five main areas which will be a factor in the analysis of
any subtopic.
1. Microeconomics – the most essential in understanding the economy as a system. The prefix “micro-
“ refers to small-scale interaction and refers to households as firms interacting in the market for
consumption of goods. Some of the most vital topics in the study of microeconomics are markets,
efficiency, supply and demand, opportunity cost, game theory and market failure.
2. Macroeconomics – unlike microeconomics, examines the economy as a whole. The prefix “macro-
“ refers to large-scale interactions. Some topics included in macroeconomics are inflation, GDP
(gross domestic product), pricing, savings and investment, market growth, development,
unemployment and competition.
3. International Economics – analyzes the flow of goods and services between nations. Concerned
with international banking, monetary exchange rates, tariffs and the effects of different economic
and governmental systems.
4. Theory – Economic theory is the field in which the models are derived and applied to current
problems. The goal of economists in developing theories is that they require less information and
lead to more accurate results. In microeconomics, many theories include supply and demand,
opportunity costs, marginality and game theory. In macroeconomics, theories include money
supply, monetary theory of inflation and the quantity theory of money.
5. History – Economic history is the field which focuses on economic theories and writings of the
past. Many decisions of today are made based on the theories and ideas of former economists and
scholars such as Adam Smith, Karl Marx and John Maynard Keynes.
➢ Difference between Economics and Applied Economics
There are three basic categories of economics:
1. Positive Economics – the study of criteria of what is. Positive economists research economic
phenomena that exist and create theories to explain why these phenomena exist. It is a pure, abstract
science and is not very popular with contemporary economists, because economists are under
pressure to research things that have relevance to the policy. All positive economic statements must
be demonstrable to be either true or false based upon hard data called from the real world. For
example, a positive economist might say predatory lending caused inflation in the housing market.
This would be a positive statement, because the economist could objectively prove it to be either
true or false. Positive economists avoid making value judgments.
2. Normative Economics – the study of how things ought to be. Consider factors such as the social
and ethical implications of economic phenomena and make arguments about the goals of public
policies should be. Is subjective, because not everyone agrees on what is economically fair and
what the goals of public policy should be. For example, a normative economist might say that
mortgage lending should be federally regulated so that banks do not make loans to people who
would not be able to repay them, drive the housing prices up, and then cause these people to lose
those homes. This argument includes the value judgement that policy should prevent people from
losing their homes and inflating the housing market.
3. Applied Economics – the study of the relationship between positive and normative economics.
➢ Three Major Types of Economic Systems
The term “economic system” refers to the way in which the decisions about producing goods and
services are made within a given society and the rules that govern distribution of those. Who decides
what to produce and how? Who owns the resources? How are the produced goods to be allocated to
their end users? The economic systems are usually classified into three major types:

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1. Market Economy – in here, consumers’ behavior drives the production. If the consumers demand,
and are able to purchase, the goods, the goods, the goods get produced. The dynamic between
demand from the consumers and the supply from the producers determines the price of the goods.
The government does not intervene in the running of the economy beyond setting up the basic,
large-scale, stable framework for the market to operate in. There are no subsides, price controls or
economic planning by the government. The government owns no economic resources and is not
active player in the market.
2. Command Economy – or planned, economy, the decisions of the government drive the production.
If the government decides that certain goods are to be produced, they get produced. The prices are
also set centrally by the government. All the economic activity is either controlled by or directly
performed by the state. The state owns all the economic resources and is either the only or the
predominant player in the market.
3. Mixed Economy – while both market economy and command economy are somewhat idealized
models, in reality, most national economies are mixed economies. Some tend more toward the
market model, and others toward the command model, but all mixed economies have elements of
both. The state can be a producer/supplier, for example in the case of health, education or
nationalized public utilities, media or transport companies. The state can be also a consumer, for
example for private providers of health services, or producers of steel and concrete used for road
infrastructure, and often both, as can be the case when the government buys weapons from
nationalized armaments producer.
Advantages and Disadvantages
The market system is generally more efficient, faster to react to changing environments and thus more
responsive. It allows individuals to express initiative and fosters innovation. However, large-scale
market economies tend to be volatile, and lead to concentration of capital and thus social inequalities.
The allocation of scarce resources might not be socially advantageous, and unscrupulous pursuit of
profits above all can lead to unacceptable social consequences, for example by allowing dangerous
products to be sold or creating environmental pollution. Command economies can be inefficient, and
central planning can be slow to respond to changing environments. Individual initiative and creativity
can be hampered and often a class of powerful bureaucrats develops. Most successful economies
nowadays combine elements of the command and market systems in an attempt to balance the
advantages and disadvantages of both.
➢ Scientific Methods in the Study of Economics
Economics began as a branch of moral philosophy during the 18th century but has developed over time
to become a discipline that emphasizes a scientific approach to understanding how economies work.
As social scientists, along with sociologists, psychologists and political scientists, economists employ
some scientific methods to the study of how societies allocate scarce resources to meet their needs and
wants.
1. Testing Hypotheses, Developing Theories
In economics, this means developing theories about such questions as what causes inflation, why
people save or consume, and what conditions favor increased hiring and investment by firms. To
explain these and other economic issues, economists develop hypotheses, collect and analyze data,
and formulate theories based on their results.
2. Observation and Theory
Economists develop their theories about how the worlds of economics and finance work based on
extensive observation of real-world activities. Mankiw cites as an example an economist who lives
in a country experiencing rapid inflation. This economist may devise a hypothesis of why inflation
increases, then test this hypothesis by collecting and analyzing data from other countries. These
data will include information on prices, money supplies, consumer and business activity, and
government spending.
3. Considerations
Although economics relies on observation and theory like other sciences, economists face an
obstacle that their counterparts in natural sciences such as biology and chemistry do not have: the
lack of laboratory controls. Mankiw points out that while physicists can repeatedly drop objects
from different heights to test the theory of gravity, economists cannot manipulate national monetary

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 policy to test theories about inflation. Economic researchers must do what they can with the data
that the real world supplies them.
4. Solution
Because they are unable to conduct controlled laboratory experiments, economists often look to
history for lessons and explanations about how the economic world works, according to Mankiw.
Analysis of historical events represents another scientific method by which researchers understand
and explain present-day economics.
5. Models
Like other scientists, economists use models to convey simplified explanations of a complex world.
For economists, these models consist of figure and mathematical equations that explain such
concepts as supply and demand, and gross domestic product. Like other fields of science, economic
models present a simplified version of reality. Just as an astronomer’s model of the solar system
does not fully account for the complexity of the cosmos, an economist’s model does not include
every feature of a dynamic modern economy. Yet, through their simplicity, economic models help
illustrate how the economic world works.
➢ Five Economic Factors
1. Supply and Demand – The higher the demand for goods and services, the greater the need for
workers to produce them, leading to economic growth.
2. Interest Rates – Fluctuation in interest rates can have an impact on consumer purchasing. People
who have adjustable-rate home mortgages can face financial hardship or even lose their homes
when interest rates spike. Retirees who live largely off investment income may need to lower their
standard of living when interest rates decline.
3. Inflation
Higher inflation is typically accompanied by higher prices, so consumers may be less willing to buy
non-essential or luxury items. If wages do not rise at the same rate of inflation, people actually lose
money. The changing of national monetary policy, such as adjusting the prime interest rate of
putting more money into circulation can influence inflation.
4. Unemployment
The rate of unemployment can have a major effect on the economy. The more people who are out
of work, the less money that is circulated into the economy through the purchase of goods and
services. Even the threat of unemployment has an impact, as workers who fear losing their jobs are
less inclined to spend or invest their money.
5. Foreign Exchange Rate
A nation’s foreign exchange rate is the value of its currency in the international market. In the
United States, when the value of the $ is high in relation to other countries’ currencies, the more
goods and services we are able to import. In contrast, a higher value of the $ means that other
nations may be less inclined to import products from the United States.

Let’s Apply

I. Multiple Choice. Choose the letter of the best answer.

1. Economics is the study of
a. production technology b. consumption decisions
c. how society decides what, how, and for whom to produce d. the best way to run society
2. A resource is scarce if supply exceeds demand at zero price
a. True b. False
3. The opportunity cost of a good is
a. the time lost in finding it b. the quantity of other goods sacrificed to get another unit of that good
c. the expenditure on the good d. the loss of interest in using savings
4. A market can accurately be described as
a. a place to buy things c. the process by which prices adjust to reconcile the allocation of resources
b. a place to sell things d. a place where buyers and sellers meet
5. A command economy decides resource allocation by government planning
a. True b. False
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II. Identification. Please provide the word/term being asked or defined. Write it on the space
provided.
1. __________________. The study of the relationship between positive and normative economics.
2. __________________. It refers to large – scale interactions, examines the economy as a whole.
3. __________________
Analyzes the flow of goods and services between nations. Concerned with international banking,
monetary exchange rate, tariffs and the effects of different economic and governmental systems.
4. _________________. Named as planned economy, the decisions of the government drive the
production.
5. _______________. Analyzes the production, consumption and distribution of goods and services.

Let’s Analyze
I. Modified True or False. Write True if the statement is true and False if the
statement is false.
1. Applied economics is all about the application of theory to real-life situations.
2. People’s wants are not related to production, exchange, distribution and consumption.
3. Economics deals with the economic activities of human being.
4. The term “economic system” refers to the way in which the decisions about producing goods and
services are made within a given society and the rules that govern distribution of those.
5. Market system does not allow individuals to express initiative and fosters innovation.

Let’s Try
Multiple Choice. Choose the letter of the best answer.

A. Market Economy G. Mixed Economy

B. Testing Hypotheses, Developing Theories H. Considerations
C. Observation and Theory I. Solution
D. Models J. Interest Rates
E. Supply and Demand K. Inflation
F. Unemployment L. Foreign Exchange Rate
1. In economics, this means developing theories about such questions as what causes inflation, why
people save or consume, and what conditions favor increased hiring and investment by firms. To
explain these and other economic issues, economists develop hypotheses, collect and analyze data, and
formulate theories based on their results.
2. Consumers’ behavior drives the production, and the government does not intervene in the running
of the economy beyond setting up the basic, large-scale, stable framework for the market to operate in.
3. Impacts a nation’s Gross Domestic Product (GDP), which is the combined value of all goods and
services produced by a country in a given year.
4. The value of its currency in the international market.
5. Used to convey simplified explanations of a complex world, that consist of figure and mathematical
equations that explain such concepts as supply and demand, and gross domestic product.
6. It is the combination of market economy and command economy where the state is also often a
player in the market.
7. Can have a major effect on the economy. The more people who are out of work, the less money that
is circulated into the economy through the purchase of goods and services.
8. Because they are unable to conduct controlled laboratory experiments, economists often look to
history for lessons and explanations about how the economic world works, according to Mankiw.

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9. Increase or decrease of this can have an impact on consumer purchasing. According to Federal
Reserve Bank of San Francisco, when _________ are high, consumers may be less inclined to borrow
money to buy a new home or car.
10. Economists develop their theories about how the worlds of economics and finance work based on
extensive observation of real-world activities.
11. Higher _________ is typically accompanied by higher prices, so consumers may be less willing to
buy non-essential or luxury items.
12. Although economics relies on observation and theory like other sciences, economists face an
obstacle that their counterparts in natural sciences such as biology and chemistry do not have: the lack
of laboratory controls.