ECONOMICS

ISSUES FACING
FILIPINO
ENTREPRENEURS
OBJECTIVES

- Learn the Concept of Investment and Identify its determinants.

- Learn about the link between investment and interest rate.
- Discuss the factors that affect the investment demand curve.
- Describe the labor demand and labor supply in a perfectly
competitive market.
- Understand why governments need to impose minimum
wages.
- Learn about the role and importance of taxes in the economy.

INVESTMENT
A DETERMINANT OF INCOME
When we hear the word
"Investment," what often comes
to mind are money, funds, and
resources we want to put into
something that will generate or
earn benefits in the form of
income or profit.
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INVESTMENT IS A PROCESS OF A BUILDING UP CAPITAL
STOCK OR THE EXPENDITURE WHICH DETERMINES THE
INCOME AND PRODUCTION IN THE ECONOMY.
INVESTMENT EXPENDITURE MEANS "CAPITAL SPENDING"
IT IS MAINLY DERIVED FROM ACCUMALATED SAVINGS
AND OTHER RESOURCES EXTERNAL TO THE CIRCULAR
FLOW; IT DOES NOT COME FROM THE CURRENT INCOME
AND COMSUMPTIONS.
 Back to Agenda Page

INVESTMENT

INVESTMENT IS THE CAPITAL EXPENDITURE ON THE PURCHASE OF

PHYSICAL ASSETS SUCH AS PLANT, MACHINERY, AND EQUIPMENT (ALSO
KNOWN AS FIXED INVESTMENT AND STOCKS (ALSO KNOWN AS INVENTORY
INVESTMENTS).
INVESTMENT ALSO REFERS TO THE VALUE OF MACHINERY, PLANTS, AND
BUILDING THAT ARE BROUGHT BY FIRMS FOR PRODUCTION PURPOSES
(PIANA 2001)
WHY IS INVESTMENT ESSENTIAL TO THE ECONOMY?
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CLASSES OF
INVESTMENT
INVESTMENT ARE CLASSIFIED INTO TWO TYPES: FIXED INCOME
INVESTMENT AND VARIABLE INCOME INVESTMENT.
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TWO TYPES
FIXED INCOME INVESTMENT (FIIs) VARIABLE INCOME INVESTMENT(VIIs)
INVESTORS ARE AWARE THAT THERE ARE THESE ARE FORMS OF INVESTMENT THAT
RISKY INVESTMENT OPTIONS. FOR ARE SUITABLE FOR RISK-TOLERANT
INVESTORS WHO ARE AVERSE TO RISK, INDIVIDUALS.
FIXED-INCOME INVESTMENTS ARE THE RETURNS ARE NOT FULLY GUARANTEED
BEST OPTION SINCE THESE INVESTMENTS AND MONEY OR RESOURCES INVESTED
ARE GUARANTEED TO HAVE A LOWER RISK MAY ALSO NOT BE FULLY RECOVERED.
OF LOSSES.
GENERALLY SAFE INVESTMENT OPTIONS.
BECAUSE THEY ARE SAFE, THE YIELD OR
RETURN ON INVESTMENT IS USUALLY
LOWER BUT GUARANTEED.
INVESTMENT AND
INTEREST RATE

INTEREST RATES PLAY A KEY ROLE IN INCREASING CAPITAL STOCK, WHICH IN TURN AFFECTS
INVESTMENTS. WE OFTEN HEAR NEWS OF INTEREST RATES BEING REDUCED TO ATTRACT MORE
INVESTMENTS AND VICE VERSA. THIS IS BECAUSE THERE IS A NEGATIVE OR INVERSE
RELATIONSHIP BETWEEN THE TWO. THE HIGHER THE INTEREST RATE, THE LOWER THE QUANTITY OF
INVESTMENTS; THE LOWER THE INTEREST RATE, THE HIGHER THE QUANTITY OF INVESTMENTS.

BUT WHAT IS INTEREST RATE? WHAT IS ITS ROLE IN

INVESTMENTS?
 iNTEREST IS USED IN TWO WAYS. IT CAN BE THE PRICE OF THE

INTEREST CREDIT, WHICH IS OFTEN REFERRED TO AS LOANABLE FUNDS. IT

CAN ALSO BE THE RETURN THAT THE CAPITAL EARNS AS AN INPUT

RATES IN THE PRODUCTION PROCESS. INTEREST RATES REPRESENT THE

COST OF USING OR BORROWING MONEY.

LOANABLE FUNDS
REFERS TO THE AMOUNT OF MONEY LENT OUT BY A LENDER TO A BORROWER, FOR WHICH THE
BORROWER WILL PAY AN INTEREST RATE TO THE LENDER FOR THE USE OF THAT FUND.
THE RETURN ON CAPITAL
INTEREST IS THE RETURN EARNED BY THE CAPITAL AS AN INPUT IN THE PRODUCTION PROCESS.
Figure 5.1 SHOWS THE MARKET
FOR THE LOANABLE FUNDS
WHERE THE DEMAND IS THE
AMOUNT OF FUNDS THAT FIRMS
AND INDIVIDUALS WILL BORROW
AT A GIVEN INTEREST RATE. A
DOWNWARD-SLOPING DEMAND
CURVE INDICATES LOW-
INTEREST RATES, WHICH MEANS
THAT BORROWING MONEY IS
QUITE CHEAP. WHEN THE COST
OF BORROWING IS LOW, MORE
PEOPLE ARE ENCOURAGED TO
AVAIL OF LOANS.
THE SUPPLY CURVE IS THE AMOUNT THAT INDIVIDUALS WISH TO
SAVE. IT IS UPWARD SLOPING SINCE INDIVIDUALS GET A HIGHER
RETURN ON THEIR MONEY WHEN INTEREST RATES ARE HIGH, AND
THEY ARE THUS WILLING TO SAVE MORE.
INTEREST RATES AFFECT THE LEVEL
OF PRODUCTION OF INVESTMENT
GOODS. A CHANGE IN INTEREST
RATES RESULTS IN A CHANGE IN
INVESTMENT DEMAND. THE RATE AT
WHICH A BORROWER PAYS FOR THE
MONEY THAT IS BORROWED IS
USUALLY INFLUENCE BY
MACROECONOMIC CONDITIONS
SUCH AS INFLATION. WHICH
REDUCES THE PURCHASING POWER
OF CAPITAL AND MONEY SUPPLY.
THIS RELATIONSHIP IS BEST
DESCRIBES BY THE INVESTMENTS
DEMAND CURVE. A CHANGE IN THE
INTEREST RATE CAUSES A
MOVEMENT ALONG THE INVESTMENT
DEMAND CURVE AS SHOW IN FIGURE
5.2
 DETERMINANTS Back to Agenda Page

OF INVESTMENTS
FACTORS THAT AFFECT INVESTMENTS.
EXPECTATIONS
FUTURE EXPECTATIONS REFLECT TO CHANGE IN PRODUCTION CAPACITY. AS
EXPECTATION CHANGE, ANTICIPATING FUTURE RETURNS FROM INVESTMENTS,
THE INVESTMENT DEMAND CURVE SHIFTS TO THE RIGHT. ON THE OTHER HAND, IF
THERE ARE EXPECTATIONS OF LOWER PROFITS, THE INVESTMENT DEMAND
CURVE SHIFTS TO THE LEFT.
LEVEL OF ECONOMIC ACTIVITY
WHEN GDP IS HIGH, THE LEVEL OF PRODUCTION INCREASES. THIS BOOSTS THE
DEMAND FOR CAPITAL AND ENCOURAGES INVESTMENTS. WHEN HOUSEHOLD
INCOME INCREASES, CONSUMPTION ALSO GOES UP, WHICH FURTHER LEADS TO A
RISE IN AGGREGATE DEMAND
 DETERMINANTS Back to Agenda Page

OF INVESTMENTS
FACTORS THAT AFFECT INVESTMENTS.
TECHNOLOGICAL CHANGE
WITH CHANGES IN TECHNOLOGY, THE DEMAND FOR CAPITAL WILL HAVE TO
INCREASE IN ORDER TO KEEP UP WITH THESE IMPORTANT DEVELOPMENTS. FOR
INSTANCE, ADVANCEMENTS IN TECHNOLOGY LEAD TO ENORMOUS INVESTMENTS
IN COMPUTER TECHNOLOGY. THESE SMART APPS HAVE MASSIVELY INCREASED
THE INVESTMENT OF PHONE AND DIGITAL COMPUTING COMPANIES
PUBLIC POLICY
IN THE FORM OF GRANTING INCENTIVES TO FIRMS CAN SIGNIFICANTLY AFFECT
THE DEMAND FOR CAPITAL, THEREBY INCREASING INVESTMENTS. INVESTMENT
TAX CREDITS AND TAX HOLIDAYS CAN ENCOURAGE INVESTMENT IN A COUNTRY
 Back to Agenda Page

RENTALS
RENT TYPICALLY REFERS TO THE
USE OF PROPERTY FOR A
CERTAIN AMOUNT. NATURALLY,
IT WOULD BE THE AMOUNT YOU
RENT IS THE PRICE PAID FOR THE USE OF LAND AND OTHER
PAY IF YOU ARE RENTING A
NATURAL RESOURCES OR FACTORS OF PRODUCTION THAT IS
HOUSE, AN APARTMENT, OR
IN FIXED SUPPLY.
LIVING IN A DORMITORY OR
BOARDING HOUSE. RENT HAS BEEN TRADITIONALLY ASSOCIATED WITH LAND,
WHICH IS A FIXED FACTOR OF PRODUCTION.

ECONOMIC RENT IS A PAYMENT IN EXCESS OF OPPORTUNITY

COST
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RENT

ACCORDING TO DAVID RICARDO, AN INFLUENTIAL BRITISH CLASSICAL

ECONOMIST IN THE EARLY 1800s.
RENT IS A SURPLUS OF REVENUE OVER COST, WHICH ARISES DUE TO
DIFFERENCES IN THE LEVEL OF USABILITY OF THE LAND. THE SCARCITY OF
LAND BECOMES THE CONCEPT OF RENT.
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RENT ON LAND

LAND IS ONE OF THE MOST COMMON TYPES OF INVESTMENT ASIDE FROM

OWNING SHARES, CASH, AND SECURITIES.
SINCE THE SUPPLY OF LAND IS PERFECTLY INELASTIC, THE LEVEL OF
DEMAND IS WHAT DETERMINES THE RENT ON LAND. SINCE THE SUPPLY OF
LAND IS FIXED, DEMAND BECOMES THE DETERMINANT OF RENT. ASIDE
FROM RENTING THE LAND OUT, THE OWNER OF THE LAND ALSO OPT TO SELL
THE LAND AT A HIGHER PRICE TO EARN PROFIT.

HOW IS THE DEMAND FOR LAND DETERMINED?

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RENT ON LAND
Economic rent also relies on productivity differences. Several determinants
indicate the productiveness of land: (a) products grow on the land, and (b) the
prices of other resources which are combined with the land.
The location attribute of the land can also be considered for its demand. City
areas have higher land rents than remote areas with difficult access to
transportation and communication.
A person keen on investing in land must realize that there are also risk to watch
out for. for one, it takes a long time to sell such property, which means money is
not easily realized.

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WAGES
DETERMINANTS OF MARKET WAGE RATES.
A BASIC PRINCIPLE OF ECONOMICS IS THE NOTION THAT THE
PRICE OR VALUE OF GOODS, SERVICES, AND EVEN RESOURCES,
SUCH AS LABOR, IS DETERMINED BY THE BEHAVIOR OF DEMAND
AND SUPPLY.
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LABOR DEMAND
THE DEMAND FOR LABOR IS SIMILAR TO THE DEMAND FOR A GOOD, AND
THUS GENERALLY FOLLOWS THE LAW OF DEMAND. THE WAGE, WHICH IS THE
PRICE OF LABOR, IS PLOTTED ON THE Y- AXIS OF THE GRAPH, AND THE
QUANTITY OF LABOR, WHICH CAN BE EXPRESSED BY THE NUMBER OF
EMPLOYMENT AVAILABLE IN THE MARKET, IS PLOTTED ON THE X-AXIS.
SIMILAR TO THE LAW OF DEMAND, WHEN THE PRICE OF LABOR INCREASES,
THE RELATED QUANTITY OF LABOR DECREASES, WHICH MAKES THE PRICE
OF LABOR INVERSELY RELATED TO THE QUANTITY OF LABOR. THIS MEANS
THAT EMPLOYERS WILL HIRE MORE PEOPLE WHEN WAGES GO DOWN.

 Back to Agenda Page

LABOR SUPPLY

AS THERE IS A LABOR DEMAND, IT ONLY FOLLOWS THAT THERE SHOULD

ALSO BE A SUPPLY OF LABOR. IT FOLLOWS THE PRINCIPLES OF THE LAW OF
SUPPLY, WHICH SAYS THAT IF THE PRICE OF LABOR INCREASES, THEN THE
SUPPLY OF LABOR ALSO INCREASES, AND VICE VERSA. AS WAGE INCREASES,
MORE PEOPLE WILL ENTER THE LABOR MARKET AND COMPETE FOR HIGHER-
PAYING JOBS. BUT IF WAGES DECLINE THERE WILL BE FEWER PEOPLE
LOOKING FOR JOBS AND COMPETING FOR THESE LOWER WAGES.
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LABOR SUPPLY

THE MARKET LABOR SUPPLY GENERALLY TENDS TO CURVE UPWARD, SIMILAR

TO THE SUPPLY CURVE OF THE GOODS AND SERVICES MARKET OR PRODUCT
MARKET.
LABOR IS VERY MUCH DIFFERENT FROM LEISURE. WHILE LABOR REFERS TO
WORK RENDERED, LEISURE INVOLVES ACTIVITIES THAT AN INDIVIDUAL
ACTUALLY DOES NOT GET PAID TO DO.
WHEN THE LABOR DEMAND AND SUPPLY MEET AT A CERTAIN WAGE AND
QUANTITY OF WORKES, AN EQUILIBRIUM IS REACHED.
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LABOR SUPPLY

THIS POINT OF EQUILIBRIUM IS CALLED THE MARKET CLEARING, WHERE

FIRMS MAY HIRE AN EMPLOYEE AT THE EXISTING WAGE RATE AND PEOPLE
WHO WOULD LIKE TO HAVE THAT WAGE RATE WOULD BE ABLE TO DO SO.
HOWEVER, AS THIS IS COMPETITIVE LABOR MARKET, EVEN THOUGH THERE
IS AN IDENTIFIED MARKET CLEARING, EMPLOYERS AND EMPLOYEES MAY
LEAVE THE LABOR MARKET, AS FIRMS MAY WANT TO PAY LOWER WAGES OR
WORKES WITH TO EARN HIGHER WAGES.
EQUILIBRIUM Back to Agenda Page

WAGES

WHEN JOBS ARE SAFE AND EASY, WE CAN ASSUME THAT THE WAGES THEY
PAY ARE AVERAGE. MOST PEOPLE WANT TO HAVE SUCH JOBS. AS THE JOBS
BECOME MORE DIFFICULT AND DANGEROUS, WORKERS NATURALLY
REQUIRE A HIGHER WAGE TO DO SUCH WORK. THIS COMPENSATING
DIFFERENTIAL IS THE DIFFERENCE IN WAGES THAT ARISE TO OFFSET THE
NONMONETARY CHARACTERISTICS OF DIFFERENT JOBS.
EQUILIBRIUM IN A Back to Agenda Page

COMPETITIVE LABOR
MARKET

IN A PERFECTLY COMPETITIVE LABOR MARKET, FIRMS AND WORKERS ARE

FREE TO ENTER AND EXIT THE MARKET. THIS MAKES THE EQUILIBRIUM
ALLOCATION OF WORKERS TO FIRMS EFFICIENT.
A COMPETITIVE EQUILIBRIUM LEADS TO AN EFFICIENT ALLOCATION OF
RESOURCES.
IN THE SUPPLY AND DEMAND ANALYSIS
FOR A LABOR MARKET, THE HORIZONTAL
AXIS REPRESENTS QUANTITY AND THE
VERTICAL AXIS REPRESENTS PRICE OR
WAGE. IN THIS CONTEXT, THE QUANTITY
OF LABOR, WHICH CAN BE MEASURED AS
EMPLOYMENT HOURS, IS LABELLED L, AND
THE PRICE OF LABOR, MORE COMMONLY
CALLED WAGE, IS LABELLED W.

FIGURE 5.3 SHOWS THE INTERSECTION

OF THE LABOR SUPPLY AND THE LABOR
DEMANDIN A COMPETITIVE MARKET.
THE X-AXIS REPRESENTS THE WAGE
LEVEL. THE DEMAND CURVE GIVES THE
TOTAL NUMBER OF EMPLOYEE HOURS
THAT FIRMS IN THE MARKET DEMAND
AT THE WAGE, WHILE THE SUPPLY
CURVE SHOWS THE TOTAL NUMBER OF
WORK HOURS THAT AGENTS IN THE
ECONOMY ALLOCATE TO THE MARKET
AT ANY GIVEN WAGE LEVEL
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MINIMUM WAGE

IS THE LOWEST ALLOWED WAGE PAID TO WORKERS BY VIRTUE OF

LEGISLATION AND GOVERNMENT POLICIES. THIS IS A FORM OF
GOVERNMENT INTERVENTION TO ALLEVIATE POVERTY AND INCOME
INEQUALITY IN TERMS OF RENDERING JOBS SERVICES,
THE EFFECTS OF MINIMUM WAGES MAY IN PRINCIPLE DIFFER BETWEEN
INDUSTRIES IN WHICH EMPLOYERS DO AND DO NOT HAVE CONTROL OVER
THE WAGE RATES THEY PAY FOR THE LABOR OF A GIVEN SKILL AND
APPLICATION.
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PROGRESSIVE,
PROPORTIONAL,
AND REGRESSIVE
TAXES
PROGRESSIVE Back to Agenda Page

TAXES

ARE TAXES THAT PLACE GREATER BURDEN ON THOSE BEST ABLE TO PAY AND
PUT PROGRESSIVE LITTLE TO NO BURDEN ON THE POOR. THE BEST EXAMPLE
OF A PROGRESSIVE TAXES IS THE INDIVIDUAL INCOME TAX. FOR THE MOST
TAXPAYERS TODAY, THE MORE THEY EARN, THE HIGHER PERCENTAGE THEY
PAY FOR TAX. IN TERMS OF THE AVERAGE TAX RATE, PEOPLE IN HIGHER
INCOME BRACKETS PAY SUBSTANTIALLY HIGHER AVERAGE TAX RATE THAN
THOSE IN THE LOWER BRACKETS
PROPORTIONAL Back to Agenda Page

TAXES

ARE TAXES THAT PLACE AN EQUAL BURDEN ON THE RICH, THE MIDDLE
CLASS, AND THE POOR. IN OTHER WORK, TAXES ARE LEVIED AT A CONSTANT
RATE AS INCOME RISES, 1O PERCENT OF EACH INCREMENT OF INCOME AS
INCOME GOES UP. THIS FORM OF TAXATION TAKES THE SAME PROPORTION
OF TAX FROM LOW-INCOME TAXPAYERS AS FROM HIGH-INCOME
TAXPAYERS.
REGRESSIVE Back to Agenda Page

TAXES

ARE TAXES THAT FALL MORE HEAVILY ON THE POOR THAN ON THE RICH.
UNDER THIS TAXATION STRUCTURE, TAXES ARE LEVIED AT A DECREASING
RATE AS INCOME RISES. THIS FORM OF TAXATION TAKES A GREATER
PROPORTION OF TAX FROM A LOW-INCOME TAXPAYER THAN FROM A HIGH-
INCOME TAXPAYER, INDIRECT TAXES SUCH AS THE VAT OR EXCISE TAXES
ON CERTAIN PRODUCTS ARE REGRESSIVE WHEN TAKEN AS A PROPORTION
OF TOTAL NET INCOME
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BASIC
PRINCIPLES OF
TAXATION
REFERS TO KEY CONCEPTS THAT GUIDE GOVERNMENTS IN
DESIGNING AND IMPLEMENTING AN EQUITABLE TAXATION REGIME.
THESE BASIC PRICIPLES ARE GENERALLY REFERRED TO AS A ADAM
SMITH'S CANON OF TAXATION.
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ADEQUACY

TAXES SHOULD BE JUST ENOUGH TO GENERATE REVENUE REQUIRED FOR THE

PROVISION OF ESSENTIAL PUBLIC SERVICES LIKE HEALTH, EDUCATION,
AND NATIONAL DEFENSE AND POLICE PROTECTION
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BROAD BASING

TAXES SHOULD BE SPREAD OVER AS WIDE AS POSSIBLE TO ALL SECTORS OF

POPULATION OR ECONOMY TO MINIMIZE INDIVIDUAL TAX BURDEN
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COMPATIBILITY

TAXES SHOULD BE COORDINATED TO ENSURE TAX NEUTRALITY AND MEET

THE OVERALL OBJECTIVES OF GOOD GOVERNANCE.
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CONVENIENCE

TAXES SHOULD BE ENFORCED IN A MANNER THAT FACILITATES VOLUNTARY

COMPLIANCE TO THE MAXIMUM EXTENT POSSIBLE
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EARMAKING

TAX REVENUE FROM A SPECIFIC SOURCE SHOULD BE DEDICATED TO A

SPECIFIC PURPOSE ONLY WHEN THERE IS A DIRECT COST-AND-BENEFIT
LINK BETWEEN THE TAX SOURCE AND THE EXPENDITURE, SUCH AS THE
ALLOCATION OF MOTOR USERS' TAX FOR ROAD MAINTENANCE
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EFFICIENCY

TAX COLLECTION EFFORTS OF THE GOVERNMENT SHOULD NOT COST AN

INORDINATELY HIGH PERCENTAGE OF TAX REVENUES.
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EQUITY

TAXES SHOULD EQUALLY BURDEN ALL INDIVIDUALS AND ENTITIES IN

SIMILAR ECONOMIC CIRCUMTANCES
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NEUTRALITY

TAXES SHOULD NOT FAVOR ANY ONE GROUP OR SECTOR OVER ANOTHER
AND SHOULD NOT BE DESIGNED TO INTERFERE WITH OR INFLUENCCE
INDIVIDUAL DECISION-MAKING.
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PREDICTABILITY

THE COLLECTION OF TAXES SHOULD REINFORCE THEIR INEVITABILITY AND

REGULARITY.
RESTRICTED Back to Agenda Page

EXEMPTIONS

TAX EXEMPTIONS MUST ONLY BE DONE FOR SPECIFIC PURPOSES AND

WITHIN A LIMITED PERIOD
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SIMPLICITY

TAX ASSESTMENT AND DETERMINATION SHOULD BE EASILY UNDERSTOOD

BY AN AVERAGE TAXPAYER