EBC 101 / ECO 1: Introductory Economics

Module V: ECONOMIC INSTITUTIONS AND POLICIES

SCOPE OF THE MODULE

This module consists of four lessons, namely:
Lesson 1 Money, Banking and Monetary Policies
Lesson 2 Government and Fiscal Policies
Lesson 3 Philippine International Trade and Foreign Exchange Policies

OVERVIEW OF THE MODULE

This module discusses the role of the banking system, the government, and the
foreign trade system in maintaining an equilibrium situation while the ecosystem
operates tools that regulate the inflow and outflow of money supply, public funds, and
dollars. These are referred to as economic policies, specifically the monetary fiscal, and
foreign exchange policies.

LEARNING OUTCOMES OF THE MODULE

After studying this module on economic institutions and policies, you should be able
to:
1. describe how the banking system regulates the demand and supply of
money, through monetary policies;
2. justify how the government controls the inflow and outflow of public funds
through fiscal policies;
3. analyze how the Philippine trade system balances the sources and uses of
dollars through foreign exchange policies.

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Thought Supplement:
Economic Policies in Action
How the market economy can make use of the policies to affect recessionary and
inflationary gaps? This video presents the interventions available to situations
affecting aggregate demand and supply.
https://www.youtube.com/watch?v=bv-uNNkE39I
Monetary Policy
How the Central bank operates with the three (3) monetary instruments to
stabilize and make the economy’s money supply/demand stable? Watch this
video focused on BSP’s monetary approaches.
https://www.youtube.com/watch?v=QJRyJs2lMQM
Fiscal Policy
Why is crowding out becomes a condition in the exercise of fiscal policies?
Watch this video to observe government operations in the economy. Should
really government necessary in the economy’s affairs?
https://www.youtube.com/watch?v=otmgFQHbaDo
Trade Policy
Watch the video on Global economy’s operations with respect to exports, imports
and exchange rates influencing international trade deficit and surplus. Why
exchange rate matters? How comparative advantage works among trading
countries?
https://www.youtube.com/watch?v=geoe-6NBy10

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 EBC 101 / ECO 1: Introductory Economics
MODULE V, LESSON 1:
MONEY, BANKING AND MONETARY POLICIES

LESSON OUTCOMES:
After studying this lesson on money, banking and monetary policies, you should be
able to:
1. classify the composition of money supply;
2. appraise the importance of money; and
3. cite and explain monetary policies needed to regulate money supply in the
economy.

In Module IV, we came to know how to estimate the income of the whole nation in
one year, through the use of income approach; the expenditure approach, and the
value-added approach. Income, it can be recalled, is the payment made by the firms to
the resource owners - the landowner, the laborer, the capitalist, and the manager. A
landowner charges rent for his land. Workers offer their services for a wage or salary. A
food manufacturer sells his products for a sum of money. The capitalist buys the
machines that he needs for operating his business.

What is Money?
Prior to the use of money, barter was practiced. Goods were exchanged with other
goods and services. Transactions then were inefficient, cumbersome and time
consuming. All these necessitated the use of money.
Money is any commodity or token that is generally acceptable as a means of
payment for economic goods and services. Commodity standard is the value of the
commodity used to determine the monetary exchange of goods and services. This was
utilized under the barter system. Monetary standard is a token/paper bill used as the
legal tender to determine the monetary exchange of goods and services. The present
monetary exchange today defines this standard.
Money is defined as a medium of exchange and standard of value. Why is it
important in a modern economy?
With money, trade can be easily facilitated. There is smooth and rapid flow of goods.
Producers can sell their goods in exchange for money of buyers.
Money stimulates production. This is because it is now easy for people to sell their
goods and services. The profits people get encourage them to sell more.
Money accelerates economic growth. Why? Because individuals who have surplus
provide funds to people wanting to invest.

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 Lastly, it is said that money gives power, prestige and privilege.
For money to serve as an efficient medium of exchange it must have these
functions.
First, it is a means of payment. Money is used as a tool to facilitate transfer of
goods from the buyers to the seller or vice versa. The fact that it is used to make
payments, good money must have these characteristics:
1. it must be generally acceptable;
2. it must be divisible (e.g., in different denominations);
3. it must be uniform (similar to avoid confusion);
4. recognizable;
5. portable (easy to carry); and
6. durable (staying power).
Secondly, money is a unit of account. It is used as a yardstick in measuring the
values of goods and services in the exchange process. It performs its function when the
value is given for every commodity or service produced in a certain number of units.
Lastly, it is a store of value. Money can be accumulated in the same manner as
wealth. To suspend current exchange or consumption for goods and services, money
can be kept for a certain period of time.

Demand for Money

Why do you hold money? Why do people hold money into their pockets? Why do
you hold money balances in your wallets?
There are 3 motives for holding money: transactional demand, precautionary
demand, and speculative demand.
People hold money balances to answer the day-to-day transactions. We retain cash
to be able to buy goods and services in the future. The bigger the size of money
balances, the more transactions can be made. The demand for money varies directly
with the level of income. If households and firms have more money than they need to
hold for transactions purposes, they are assured to spend the excess on purchasing
goods and services. If, on the other hand, they have less money than what they need
for transaction purposes, they cut down their spending in an effort to build up their
holdings of money to the desired level.
In addition to the transactions motive, people hold balances because of uncertainty
about the exact timing of receipts and payments - precautionary demand. The larger the
money reserves, the greater the degree of assurance against being unable to pay bills
because of some temporary fluctuations. Hence, the demand for money varies directly
with the level of income, in either receipts or disbursements.
Firms hold more funds for precautionary purposes when the opportunity cost of

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holding such funds is low. If we consider the market interest rate as an opportunity cost,
the higher the interest rate, the higher the cost of holding money, the less money will be
held. On the other hand, when interest rate is low, the opportunity cost of holding money
is low, the more money will be held. Hence, the precautionary demand for money varies
inversely with the interest rate.
Lastly, people hold money to speculate on the course of future events. If one thinks
prices are now very low and will soon rise, (as in the case of sales promotions on
October and May), his tendency would be to buy now and to put off selling until prices
rise. If one thinks prices are high now (as in the case of sales in December and June)
and will soon fall, his tendency is to sell now and postpone buying until prices have
fallen. If the price of bonds is very high (i.e., the interest rate is low), people tend to sell
bonds now and postpone purchases until prices have come down. Large quantities of
money may be held to anticipate more favorable chances to purchase stocks and bonds
in the future. If the price of stocks is very low (i.e., the interest rate is high), people tend
to buy stocks now, hold little cash now, hold more stocks now, and to postpone sales
until a more favorable price can be obtained. Thus, holding money for speculative
purposes varies inversely with the rate of interest; the lower the interest rate, the more
money will the public wish to hold.
As a recapitulation, the demand for money varies directly with the level of income
but inversely with the opportunity cost of holding money (interest rate).

Supply of Money
To the student, money is his "baon" or allowance used to be spent for buying his
lunch and merienda in the school canteen, and necessary school supplies in the
bookstore. To the jeepney driver, it means payment of the passengers earned during
the day, part of which goes to the operator and the other part, to his wife to meet family
expenditures. To the housewife, it is an instrument which enables her to buy food for the
family and keep the children happy in going to school, to pay electric and telephone
bills, and to buy some clothes in the market. To the government, money is the total
taxes collected and spent for the welfare of the nation. To the businessman, it is a
means of investment and better profits. To the banker, it means the savings of
thousands of individuals which he, in turn, loans out to corporations and other business
entities at a given interest rate. All these peso notes and coins circulating around with
the public (except those being held by the Central Bank (CB) and the commercial banks
(KB) in their vaults) are called currency in circulation. This form of money is what
most of us frequently encounter everyday.
Have a closer look into the coins and paper bills. The inscriptions on the peso bills
and coins in your possession tell a story. "Ang salaping ito ay isang bayarin ng Bangko
Sentral at lubos na pinanagutan ng Pamahalaan ng Republika ng Pilipinas. Ang papel
na ito ay salaping umiiral sa Pilipinas at pambayad sa lahat ng uri ng pagkakautang."
The message of these inscriptions is simple: the peso notes or coins you are holding or

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spending are an evidence of debt to the Central Bank to you. With this piece of paper
comes the guarantee of the Central Bank (CB) and the government that it can purchase
anywhere in the Philippines.
The second form of money is what most businessman and well-to-do individuals in
our society are most familiar with checks or demand deposits. Instead of carrying big
bags of peso bills and coins to transact their business, firms and businessmen simply
sign their checkbooks and issue checks for the amount needed to pay their creditors.
Checking accounts or demand deposits are also a form of liability - this time of the
commercial banks.
If we add currency in circulation and demand deposits, we have the limited concept
of money supply, we call M1;
If time deposits and other near money assets (time deposits) are added to M 1, we
have an M2 money supply;
M3 type of money supply is M2 plus deposit at mutual savings bank and savings and
loan associations;
M4 is M2 plus large certificates of deposits; and
M5 is M3 plus large certificates of deposits.
In a capsule, whether the money comes in the form of currency in circulation or
demand deposits, it is clear that money is a debt. Money supply forms part of a liability
of the entire banking system. It is what is owned by the CB, KB's and rural banks to the
individuals, business establishments, and the general public.
Since money is a form of debt by whoever created it, it is CB and the KB's that
create money. How? The CB justifies the issuance of new currency, and therefore
increases money supply, when it:
1. purchases dollars from exporters or any earner of dollars from abroad;
2. borrow dollars from foreign creditors (like the World Bank, International
Monetary Fund, and the Asian Development Bank);
3. lends money to the government and buys securities issued by the
government; and
4. gives loans and advances to banks.
On the other hand, the KB's create demand deposits (and, therefore, increase the
money supply) when they grant loans to their customers under the limited required
reserve system and through rediscounting arrangements with the Central Bank, when
they buy securities issued by the government and private business.
As a whole, out money supply changes where there are changes in:
1. the level of our foreign reserves;
2. the level of domestic credits granted by the CB to government and other

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 banks; and
3. the level of domestic credits granted by the KB's to business and government.

Money Policies
When there is so much money supply in circulation, people experience that prices of
commodities increase faster than their incomes. The increase in prices is used to wipe
out excess liquidity. This is described to be an inflationary situation. At other times,
production may be so active that there exists an excessive supply in the market. But
when the capacity of people to buy (due to limited income) is so limited, prices of
commodities are usually pushed down. This manifests a deflationary situation. Both
cases are examples of a disequilibrium situation. The demand for money is not
proportionate to the supply of money within the circular flow.
To achieve monetary stability, the Central Bank uses certain monetary policies to
regulate money through credit and the banking system. During an inflationary situation,
the objective is to remove excess money supply within the system through a
contractionary monetary policy. During a deflationary situation, the objective is to infuse
money supply into the system through an expansionary monetary policy. A
contractionary monetary policy is characterized by "tight money" or "tight credit"; an
expansionary monetary is characterized by "easy money" or "easy credit." Tight and
easy money refer to the availability of money supply, as determined by the CB through
its regulatory power or commercial (and rural) banks.
In a nutshell, the rule observed by the Central Bank in relation to credit and money
supply is: when the economy is at a feverish pace, tighten credit; when it is at a
dragging pace, loosen credit. Tight and easy money generally operate on a cycle. When
money has been easy too long such that investment, production and income are
running at a feverish pace, tight credit may have to be applied. When money has been
tightened too long such that economy is running at a dragging pace, credit may have to
be loosened up. The criteria for determining the pace of the economy are the price level
and dollar availability.
How does the Central Bank enforce the implementation of easing or tightening credit
in the economy? The Central Bank has the following instruments: required reserves,
rediscounting rate, open market operations, and some selective credit controls.
a. Required Reserves. All commercial banks are required by the CB to keep a
certain percentage of their total deposits in "reserve" (i.e., cannot be re-lent). If
the required reserve should be 10% of deposits, then the commercial banks can
lend only 90% of its deposits. If the required reserve, after six months is
increased to 20%, the monetary policy being implemented is "tight".
If after sometime, the reserve requirement was decreased to 15%, the CB
indirectly enforces an "easy" monetary policy. Hence, through this instrument, the
KB's controls the lending behavior. Consequently, CB can determine how much

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 additional deposits and loans are allowed and how much additional money is
going to be supplied to the circular flow. Under the discretion of the CB, required
reserves may be in form of deposits with the CB, or a cash which may be kept in
the bank's vaults, or a government securities that are declared as eligible (such
as Treasury Bills, DBP Countryside Bills, Biglang-Bahay Bonds).
b. Rediscounting Rate. The Central Bank is the banker of commercial banks.
When a KB lends out to individuals and firms, such loan approvals are subjected
to a discounting rate (interest rate). These loan papers in turn are used by the KB
as collaterals to back up their loan application to the CB. The CB simply
rediscounts these loan papers and the rate of interest it charges the KB's is
called the rediscounting rate. With the use of the CB's rediscounting window, the
KB can lend far more than the reserve requirement would allow them. The effect,
therefore, is to increase lending and subsequent deposits.
In cases where CB wants to constrict deposits and money supply, it simply raises
the rediscounting rate, which would reduce the amount of funds available for KB
relending. If CB wants to enforce an expansionary monetary policy, it reduces the
rediscounting rate, and, therefore, relends a bigger portion of the face value of
the loan papers that backs up the KB loan.
c. Open Market Operations. The Central Bank is the bank of the government. If
government needs money to answer some budgetary deficits, it authorizes the
CB (and commercial banks) to engage in the purchase or sale of government
securities in an active money market set-up.
When the CB sells securities, it obtains money. This money comes from the
buyers of those securities in the money market (which can either be the
commercial banks or others in the non-banking sector). Drained of funds, these
buyers would thereby feel some tightness. With such tightness, they may not be
willing to lend as much as before. The final effect of this buying of government
securities would be a lessening of money supply within the system. On the other
hand, when CB buys securities, it gives away funds into the system to the KB's,
making them feel some ease in lending out more to the public.
d. Selective credit controls and moral suasion. To prevent the unnecessary
outflow of dollar reserves, the CB discriminates the approval of letters of credit on
specific important goods (luxury items vs. producer's durables). To implement the
government's priority program in the countryside, the CB can require the banking
system to expand its resources and provide credit towards the agricultural and
rural areas. Lastly, the CB practices its "moral suasion' by merely asking banks
to be conservative in granting loans during a tight-money policy. When the need
for restriction is over, the commercial banks can then be told that it is all right to
go ahead granting loans and extending deposits up to the legal maximum.
In a nutshell, when CB exercises a contractionary monetary policy (and,

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 therefore, tightens credit), it usually the reserve requirement of commercial
banks, increases the rediscounting rate on KB loans, and sells out government
securities to effect a decrease in money supply within the system. When it
exercises an expansionary monetary policy (and, therefore easing credit) the CB
usually decreases the reserve requirement of KB's, decreases the rediscounting
rate on KB loans, and buys government securities from the public to effect an
increase in the money supply in the economy. Finally, it can be selective in
granting credit or apply persuasion to KB's to let the latter tow the CB policy.

Financial Institutions: Banking and Non Banking

Banking Institutions accept deposits, withdrawals, letters of credit, extend kinds of
financial loans, discount drafts and promissory notes and other forms of indebtedness.
a. Commercial banks
b. Thrift banks, savings banks
c. rural banks
d. Government specialized banks
Non-banking Institutions release large accumulated funds that can be useful in
facilitating and funding public and private investment projects and other financial
ventures to improve the productive capacity of the economy.
a. insurance companies
b. pawnshops
c. specialized nonbank government financial establishments
d. investment houses
e. finance companies

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EBC 101 / ECO 1, Module 5, Lesson 1
SELF-PROGRESS CHECK TEST

Test I. Matching Type

Column A Column B
_____ 1. money a. reserve requirements
_____ 2. sale of government securities b. quantity of money in circulation
_____ 3. anything generally acceptable in c. automatic transfer accounts
the trade of goods and services
d. value of money balances people wish
_____ 4. form of money that involves to hold
transfers between banks
e. precautionary demand
_____ 5. method by which commercial
f. rise in interest rates
banks "create" deposit money
and thus increase the money g. selective credit control
supply h. rate of interest at which the CB will lend
_____ 6. reserve by KB’s in order to reserves to member banks
increase money supply i. functions as a medium of exchange,
_____ 7. purchase of government store of value, and unit of account
securities j. open market operations
_____ 8. demand for money k. excess reserves
_____ 9. desire for holding money l. expansion of loans
balances that varies directly
m. action to permit an expansion of the
_____ 10. speculative demand money supply
_____ 11. money equilibrium n. equality of demand for supply of money
_____ 12. final effect of decrease in money o. desire for holding money balances that
supply by the CB varies inversely
_____ 13. discount rate
_____ 14. fraction of demand and time
deposits that a KB must hold in
reserve
_____ 15. tools such as preferential
interest rates, installment, credit
control, down payments on
mortgages

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Test II. Multiple Choice
_____ 1. The Philippine peso is money because
a. it is generally accepted as a medium of exchange.
b. it acts as a store of purchasing power.
c. it acts as a standard of value
d. people are confident that its value will remain reasonably.
e. all of the above.
_____ 2. The opportunity cost of holding money
a. is the interest rate that has to be forgone.
b. is products that have to be forgone.
c. is less that the benefits of the amount of money that is actually held.
d. all of the above
e. none of the above.
_____ 3. People demand money
a. to carry out anticipated purchases.
b. for security reasons.
c. to take advantage of future decreases in the price of government.
d. in anticipation of future profits.
e. because of all of the above.
_____ 4. The narrowest definition of the money supply is
a. cash in circulation
b. demand deposits
c. M2
d. M2
e. the money stock.
_____ 5. The transactions demand for money asserts that people hold on to money
a. for unexpected or emergency purchases.
b. to make anticipated
c. for M2 purposes
d. for M2 purposes
e. to make more money.
_____ 6. Which of the following economic variables may affect the transactions
demand for money?
a. personal income
b. the interest rate
c. expectations about changes in the general price level
d. the general price level.

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 e. all of the above
_____ 7. An increase in personal income will most likely
a. increase the precautionary demand for money
b. decrease the speculative demand for money
c. cause people to hold on to less money for any purposes
d. increase the transactions demand for money
e. cause M2 to decrease
_____ 8. The Central Bank can increase the money stock by
a. increasing the reserve requirement
b. decreasing the total reserves of banks
c. decreasing the reserve requirement
d. decreasing taxes
e. decreasing excess reserves
_____ 9. Demand deposits are
a. time deposits held by the public
b. checking accounts held by the public
c. a percent of the required reserves that must be held in the vaults at
commercial banks
d. insurance against runs on a bank
e. required reserves to be held at the CB.
_____ 10. Excess reserves are
a. equal to vault cash plus reserves deposits that are not required to be
held at the CB
b. the amount of the reserves held at the CB
c. required to be held at the CB
d. equal to required reserves plus vault cash
e. equal to required reserves minus total reserves.
_____ 11. The required reserve ratio determines
a. the total reserves of a bank
b. the reserve deposits of a bank
c. the demand deposits of a bank
d. the required reserves of a bank e. none of the above
_____ 12. The money multiplier is equal to
a. the reserve requirements
b. the reciprocal of the required reserve ratio
c. the required reserve ratio
d. the reciprocal of the excess reserve ratio e. 1/total reserves

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_____ 13. An increase in the required reserve ratio will
a. increase required reserves and decrease the money multiplier
b. decrease excess reserves and decrease the money multiplier
c. increase excess reserves and increase the money multiplier
d. increase the money multiplier and decrease excess reserves
e. none of the above
_____ 14. The functions of money include which of the following?
a. increasing the efficiency of a barter economy
b. changing the interest rate
c. the transactions demand for money
d. acting as a store of purchasing power
e. all of the above
_____ 15. The money-creating ability of banks may be affected by
a. changes in the excess reserves
b. changes in the required reserves
c. changes in the way in which people wish to hold money either as
currency or in checking accounts.
d. changes in the required reserve ratio
e. all of the above
_____ 16. When a check is written against Bank X and deposited in Bank Y
a. money is created
b. money is destroyed
c. the money supply is not changed
d. Bank X experiences an increase in its reserves and Bank Y
experiences a decrease in its reserves.
e. none of the above
_____ 17. The money supply decreases when
a. a foreign loan is repaid
b. checks are written and cleared
c. excess reserves increase
d. people wish to hold more currency and lower checking account
balances
e. reserve requirements decrease
_____ 18. If people are demanding money for speculative purposes, then they are
holding on to money
a. in anticipation of unexpected or emergency purposes
b. in anticipation of possible future profits

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 c. to carry out anticipated purchases
d. because the benefits of doing so are less than the opportunity cost of
holding into money
e. for precautionary measures
_____ 19. The Central Bank's reserve requirements is a means of
a. ensuring that depositors will be able to get all of their money upon
request.
b. ensuring the liquidity of banks
c. controlling the bank's money-creating ability
d. affecting a bank's total reserves
e. aiding in the check-clearing process
_____ 20. Monetary policy consists of
a. open market operations
b. changing the money supply
c. changing the required reserves of banks
d. changing the discount rate
e. all of the above
_____ 21. A decrease in the discount rate
a. is not a very powerful instrument of monetary policy.
b. means an increase in the interest rate banks must pay for loans
c. is a form of tight monetary policy
d. will discourage loans
e. will do none of the above
_____ 22. Open market operations affect
a. the price of government securities
b. the interest rate
c. the excess reserves of member banks
d. the money-creating ability of banks
e. all of the above
_____ 23. Open market operations are primary designed to
a. increase the flow of information in the stock market
b. help stockbrokers sell to small investors
c. increase the competition among brokerage firms
d. do all of the above
e. do none of the above
_____ 24. If Congress is running a deficit and the monetary authorities accommodate
this fiscal policy by increasing the money supply, then

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 a. prices will rise
b. the value of the dollar increases
c. the CB is attempting to increase the interest rate
_____ 25. Which of the following is considered part of monetary policy?
a. the progressive income tax
b. the providing of public goods and services
c. calculation of the consumer price index
d. the stock market
e. open market operations
_____ 26. Tight monetary policy is associated with which of the following
a. a decrease in the discount rate
b. selling government securities
c. decreasing the required reserve ratio
d. buying government securities
e. increasing excess reserves
_____ 27. If people decide to hold less currency and more money in their checking
accounts we could expect which of the following?
a. banks' excess reserves to increase
b. banks' required reserves to decrease
c. a decrease in the money supply
d. the discount rate to rise
e. none of the above
_____ 28. Which of the following is an example of a non-banking institution?
a. BPI, Bank of the Philippine Islands
b. Rural bank of Kidapawan, South Cotabato
c. Land Bank of the Philippines
d. Manulife Insurance Company
_____ 29. The following are functions of money except
a. unit of account
b. standard of value
c. exchange for barter
d. store of wealth
_____ 30. Which of the following is an example of a banking institution?
a. CAP Insurance Company
b. Insular Life Plans
c. Allied Bank
d. MV Lhuilier Pawnshop

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 EBC 101 / ECO 1: Introductory Economics
MODULE V, LESSON 2: GOVERNMENT AND FISCAL POLICIES

LESSON OUTCOMES:
After studying this lesson on government and fiscal policies, you should be able to:
1. explain using the circular flow model the role of government in the flow of
public funds; and
2. distinguish between a regressive tax system and a progressive tax system.

Public sector constitutes all agencies of national and local governments that possess
control of commodities and resources in the economy. Public sector produces economic
goods and services for the general consumption with the philosophy of service rather
than profit.
Necessities on the power of the government in economic affairs as an economy can
be determined through the following:
a. The existence of public goods and services
b. The existence of production externalities
c. The importance of an equitable income distribution
d. The need to pump prime the economy to prosperity
e. The attainment of genuine economic growth
We have previously discussed how the banking system in a market economy,
specifically the Central Bank (CB) and the commercial banks (KB’s), mobilize the
system through monetization. With the use of monetary policies, the Central Bank
regulates the supply and demand of money within the system to maintain a certain
equilibrium/stable level of economic activity. But as a country develops, economic
activities too, become more complex and, more often than not, the government sector
plays an important role to complement the banking system in managing the growing
economy.
Today, we shall look into the role of the government in influencing the behavior of
the economy. The government as an economic entity plays the five roles which any
individual plays in the economy; income-earner, consumer, saver, borrower, and
investor. As a giant consumer, the government supports thousands of local suppliers
and producers because it buys about 15% of all goods and services in the country. As a
big firm, it employs about 8% of total employment force and, therefore, gives wages and
salaries that affect demand. As a gigantic income-earner, it runs its own financial
institutions (like Philippine National Bank, Development Bank of the Philippines, Land
Bank, Government Service Insurance System, Social Security System), whose total
assets comprise of about 54% of total assets of the entire banking system of the

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Philippines. This gives the government the power to be selective and discriminating on
projects that can avail of much-needed loans in the different economic sectors or
industries. The government, moreover, does not only lend but can also borrow from any
private corporation or local/foreign investor to augment temporary cash problems
because its financial position is backed up by all the wealth of the nation's national
resources. If it encounters permanent cash problems, it can always levy heavier taxes
to increase its revenues, in the same way as a corporation can increase its rates for
services or prices for its products.

Circular Flow of Public Funds

Looking back into the Circular Flow Model (as discussed in Module I), one cannot
ignore the responsibility that the Government assumes to maintain and balance
between the inflow (G) and outflow (Tx) of public funds in order to minimize fluctuations
in employment and business activities (Figure 5.1). Taxes (Tx) are compulsory
deductions from the pay envelopes of employees-laborers and from the income of the
corporations. These outflow funds diminish their disposable incomes, hence spending
capability is lessened. However, these deductions are remitted to the government and
become one of its major sources of revenue. Just like any enterprise, the government
spends (G) for its administrative and operational functions, as well as for projects that
will implement its socio-economic growth rate targets. When government spends, there
is an outflow of fresh public funds into the circular flow and once more mobility and
liquidity changes the levels of employment, production, and income.

Sources of Public Funds

The following are sources of public funds:

Y
Inflow

E G

Households Firms Government

P Tx

Outflow
C

Figure 5.1: Circular Flow of Public Funds

a. Money coming from various forms of taxes (direct and indirect taxes)

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 b. Earnings from government-owned business and property
c. Sale of government assets and properties
d. Grants from institutions and official development assistance (ODA)
e. Money borrowings from local and foreign markets
f. Money creation
The biggest source of government funds or revenues is taxes. Whatever be the form
of government, be it a monarchy, dictatorship, republic or oligarchy, the principle
remains: the government's right to tax goes hand in hand with its duty to promote the
common good of society. Hence, taxes are inherent to the concept of government.
There are two types of taxes according to source: internal and external. Internal
taxes are levied on locally-produced goods and services. These are usually collected by
the Bureau of Internal Revenue (BIR). External taxes are levied on goods produced
from abroad but are sold in the local market. These are usually collected by the Bureau
of Customs. Taxes collected by these agencies include some taxes of individuals and
businesses, realty/property taxes, transfer taxes, taxes on goods and services, taxes on
international trade and transactions, import duties and export taxes, residence taxes,
stamp taxes, and other non-tax revenue. Other non-tax revenues are in the form of fees
and fines, licenses and registration charges, profits earned by government operated and
controlled corporations and grants.
Taxes can be classified according to incidence of tax: regressive and progressive.
Who should shoulder the burden of paying the tax? There are two schools of thought:
(1) tax burden must be shouldered by whoever receives the benefits of
government spending and (2) by whoever can afford to pay. Tax burden is
measured by the ratio of the amount of taxes paid by an individual to his income.
Taxation is said to be progressive if it imposes a heavier burden on the richer man
than the poorer man. The higher is the income, the higher is the tax paid. The richer
man pays a higher share of his income than the poorer man. On the other hand, the tax
is said to be regressive if those receiving higher incomes pay lower taxes than those
with lower income. So, the lower the income is, the higher is the tax paid. The poorer
man, therefore, pays a higher percentage of his income than the richer man for the
taxes incorporated in the commodities he buys.
Assume that the income of Mr. A is twice that of the income of Mr. B. A progressive
tax, like income tax of 10%, levied on the income of Mr. A and Mr. B would result in Mr.
A paying a higher burden than Mr. B. Mr. A will pay in taxes twice the amount Mr. B
pays.
A regressive tax, like a sales tax of P 1.00 for every kilo of rice bought, does not take
into consideration the income of the buyer, whether it is Mr. A or Mr. B. Hence, Mr. B
(person with the lower income) pays or gives up a greater percent of his income to tax
just to buy a basic commodity than Mr. A (the person with higher income).

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 What happens if the money collected from taxation is not sufficient to meet
governmental expenditures? To supplement the income from taxation, the government
resorts to borrowings, either domestic (in peso) and/or (in dollar), which have to be paid
back with interest.
In the previous lesson, we have seen that if the government borrows from the
Central Bank, there would be an increase in the money supply, equivalent to the
amount loaned by the creditor. But if the government borrows from commercial banks
(KB’s), money supply remains the same since the money taken from the creditor
(decreasing money supply) is in turn the money spent by the government (increasing
money supply once more). Today the Central Bank relies on bonds sold to common
people or the KB’s to undertake a not-so-inflationary borrowing. Besides, when the
government borrows from within the country, the interest payments are owed back to
the country.
However, if our internal sources of public borrowings cannot sufficiently finance the
growing budget, the government resorts to external borrowings, specifically from the
International Monetary Bank (IMF), the ADB (Asian Development Bank), and the World
Bank. However, let's bear in mind that interest payments (in dollars) on these foreign
loans actually leave the country causing a net outflow from the economy or a depletion
in our international reserves. In 1986 external borrowings has reached $26B with an
annual interest payment of $2.2B. As of May 2013, government borrowing has
ballooned to PHP 5.309 Trillion as shown in the table below.

Domestic Debt 3,461,357 3,438,919

Short term 295,091 300,856

Medium term 423,368 392,521

Long term 2,742,898 2,745,542

Foreign Debt 1,902,704 1,869,869

Debt guaranteed by central government 479,360 475,052

Domestic 143,806 143,993

Foreign 335,554 331,059

Total 5,364,061 5,308,788

in Millions of Pesos

If the government resorts to borrowings only to finance capital/investment projects

i.e., to use the loan for production purposes for the construction of additional roads,
dams, bridges, power plants, and other infrastructures), then the government gives up
its current expenditures on the production of more consumer goods to boost capital

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production. In the long-run, the cost lf the loan, i.e., interest payment may be by far
smaller than the benefits that the future generation would enjoy once the capital project
is completed. There are, however, alternatives to finance public debt, like additional
taxes, increase in exports, import controls, tight credit, increased foreign aid, and
devaluation. All of these alternatives involve a sacrifice of the current consumption for
the future generation.
In a nutshell, the source of public funds of the Philippine government are tax
revenues, borrowings (foreign and local), other incomes (includes operating and service
to income, sale of assets, income from public enterprises, transfer funds), and returned
income of local governments.

Uses of Public Funds

Where does the government spend the revenues that it can collect? The following
are the expenditure items included in the national budget: social services, economic
services, defense, general public services, net lending, and debt service.
 General public services, consists of the maintenance of all branches,
departments, bureaus, and agencies of the government.
 Economic development expenditures are composed of the infrastructure projects
like airports, railroads, highways, hospitals, electricity, waterworks, and
telephone services.
 Social development expenditures are composed of education and health
services, as well as servicing the changes in the welfare benefits of all
government workers.
 Expenditures on national security assume the maintenance of the facilities of the
Armed Forces of the Philippines including the police force.
 Lastly, the budget allocates for the debt servicing of all our local and foreign
loans, as well as loans of the private sector that are guaranteed by the
government through the CB.

Fiscal Policies
Through the years, the actual income of the national government has fallen short of
its expenditures. Refer to the table below as provided by the Bureau of Treasury as of
July 2013 (http://www.nscb.gov.ph/secstat/d_finance.asp). Does this trend imply
overspending? Not necessarily.

Item 2012 2011 2010 2009 2008 2007 2006

Revenues 1,534,932 1,359,942 1,207,926 1,123,211 1,202,905 1,136,560 882,435

Expenditures 1,777,759 1,557,696 1,522,384 1,421,743 1,271,022 1,149,001 940,755

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 Surplus (Deficit) (242,827) (197,754) (314,458) (298,532) (68,117) (12,441) (58,320)

How does the government regulate the inflow (government spending) and outflow
(taxation) of public funds into the system? Through the instrument called fiscal policies.
During an inflationary situation, the government takes away funds from the mainstream
by an increase in taxation. If the increase in taxation is greater than the increase in
government spending (Tx > G) the government is said to be operating on a surplus
budget. On the other hand, during a deflationary situation, when the economy is in need
of inflows, the government pumps funds into the mainstream by an increase in
government spending. If the increase in government spending is greater than the
increase in taxation (G > Tx), the government is said to be operating on a deficit budget.
By means of these fiscal policies, the government can effect a more efficient
allocation of resources through taxation of undesirable activities (like importation of
luxury goods and/or services) and by giving tax exemptions and subsidies to those
activities, which are crucial to development.

To boost your understanding and appreciation of government income and

expenditures, the following readings are required:
1. A Q&A on Financing National Government’s Expenditures –
http://www.dbm.gov.ph/wp-content/uploads/2012/03/PGB-B5.pdf
2. A summary of Central Government Operations (Revenues,
Expenditure and Financing or Debt Servicing for the years 2009 to
2015 –
http://www.treasury.gov.ph/wp-
content/uploads/2016/03/sdds_cgoper.pdf
3. The General Appropriations Act, commonly known as the National
Budget for 2016 –
http://www.dbm.gov.ph/?page_id=15034

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EBC 101 / ECO 1, Module 5, Lesson 2
SELF-PROGRESS CHECK TEST

Test I. Matching Type

Column A Column B
_____ 1. use of government and tax a. balanced-budget multiplier
policies to expenditures
b. built-in stabilizer
_____ 2. budget deficit
c. excess of government's expenditures
_____ 3. measurement of effect of over revenues
balanced change in
d. fiscal policy
government expenditures and
taxes e. estimated government tax revenues
after exceeding expenditures at full
_____ 4. automatic adjustments in taxes
employment
and government expenditures
f. the ultimate payor who shoulders the
_____ 5. full employment surplus
burden of tax
_____ 6. decreasing ratio of taxes to
g. tax on sale of a specific commodity
income with increased income
h. regressive tax
_____ 7. tax incidence
i. ad valorem tax
_____ 8. tax based on a fixed
percentage of the value of a j. increasing ratio of taxes to income with
commodity increased income
_____ 9. excise tax
_____ 10. progressive tax

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Test II. Multiple Choice
_____ 1. The key determinant to the level of economic activity is
a. the level of aggregate demand (total spending).
b. the quantity of resources
c. foreign competition
d. the balance of payments deficit or surplus
e. the budgetary deficit or surplus.
_____ 2. The enactment of a national guaranteed minimum annual income would
be an example of the government exercising which of its functions?
a. defining and protecting property rights
b. protecting common access resources
c. providing for public goods and services
d. correcting for externalities
e. providing for income security and health insurance
_____ 3. In a recession it is appropriate for the national government to
a. increase taxes, decrease spending, and decrease the money supply.
b. decrease taxes, decrease spending, and increase the money supply.
c. decrease taxes, increase spending, and increase the money supply.
d. run a budgetary surplus.
e. increase taxes, decrease spending, and increase the money supply.
_____ 4. During periods of inflation in its appropriate for the national governments
to
a. increase taxes, decrease spending, and decrease the money supply.
b. decrease taxes, decrease spending, and increase the money supply.
c. decrease taxes, increase spending, and increase the money supply.
d. run a budgetary surplus.
e. increase taxes, decrease spending, and increase the money supply.
_____ 5. Fiscal policy refers to
a. the manipulation of taxes and expenditures.
b. the regulation of budgetary policy.
c. the manipulation of the nation's money supply.
d. the effectiveness of counterfeiting.
e. the cost of regulation.
_____ 6. Fiscal policy is part of
a. macroeconomic policy
b. monetary policy
c. the government's role of defining and protecting property rights.

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 d. the private sector e. none of the above
_____ 7. Fiscal policy is best defined as
a. the physical limitations imposed upon the import of foreign products.
b. the manipulation of the balance of payments.
c. private individuals' contribution toward public goods and services
d. the protecting of property rights
e. none of the above
_____ 8. A budgetary surplus
a. means receipts are greater than outlays.
b. means outlays are greater than receipts.
c. is always the result for the federal government.
d. refers to the surplus of governmental regulations imposed upon state
government
e. refers to the surplus of money in the economy
_____ 9. Government involvement in the economy
a. leads to a reallocation of resources
b. always causes an increase in social welfare.
c. does not affect people's willingness to work, save, and invest.
d. does none of the above
_____ 10. Public goods and services are
a. goods and services from whose benefit no one can be excluded
b. common access resources
c. paid for voluntarily by private individuals
d. always associated with external costs
e. provided by the private sector for everyone's benefit.
_____ 11. Suppose a chemical factory pollutes a nearby river until a law is passed
requiring it to stop. The effect on the market for this chemical would be
a. an increase in the equilibrium price
b. a decrease in the equilibrium quantity
c. a decrease in supply
d. fewer resources devoted to this chemical
e. all of the above
_____ 12. The National Government collects most of its receipts from
a. corporate income taxes
b. personal income taxes
c. social security taxes
d. interest on the national debt

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 e. exercise taxes
_____ 13. Collecting and spending tax revenues is an example of
a. fiscal policy
b. monetary policy
c. monopoly policy
d. the market process
e. the government exercising its powers over common access resources.
_____ 14. Public goods and services are a result of
a. the fact that they would not be provided by the private sector
b. the fact that they are very large spill over benefits associated with them
c. government funds channeled into this area
d. a need to allocate our resources more efficiently into what most
satisfies society
e. all of the above
_____ 15. General sales taxes are
a. a progressive tax system
b. a regressive tax system
c. a proportion tax system
d. a form of excise taxes
e. the main source of revenues for the federal government

217
 EBC 101 / ECO 1: Introductory Economics
MODULE V, LESSON 3: PHILIPPINE INTERNATIONAL TRADE
AND FOREIGN EXCHANGE POLICIES

LESSON OBJECTIVES:
After studying this lesson on Philippine international trade and foreign exchange
policies, you should be able to:
1. characterize foreign trade;
2. explain using the circular flow model, the role of the foreign sector in the flow
of funds;
3. distinguish the top exports of the country;
4. appraise the top imports of the country.

It can be recalled in the first lesson of this module that our money supply in
circulation depends on the level of international reserves of our country, i.e., our dollar
reserves. Where do we get our dollars? But we use the peso bill, not the dollar bills,
when we buy goods and services within the country, isn't it?
We use the peso bills (and coins) when we buy things which are made/or produced
within the country. Example, when we buy food in the market, clothes in the department
store, television sets and electric stoves in the appliance store, and a new dining set in
the furniture shop.
But not all the things that we buy in the market are made in the Philippines! Some
are made in Taiwan, Japan, U.S.A., Korea, China, and even Saudi Arabia. These goods
which are made from abroad are called imported (M) goods. When we buy imported
goods, we convert our peso bills into the currency of the source country. In this manner,
our foreign currency reserves are used up.
The more imports we buy, the more dollars will be outflown from the circular flow.
How can we recover this outflown dollars? If we let other countries sell their products
to us (and, therefore, become our imports), then we can rightfully sell, too, our products
to them. From our country's standpoint, these domestically-made but externally sold
products and services are called exports (X). When these are bought by other countries,
we are paid back in dollars. Hence, exportation is considered an inflow of dollars into
the system or circular flow. The more exports we have, the more dollars are flown back
into our economic system.

218
 Y
Inflow

E X

Households Firms Foreign Trade Market

P M

Outflow
C

Figure 5.2: Flow of Dollars

These exchanges of goods, which are produced locally but are sold abroad, with
goods which are bought from abroad but are sold in the local market comprise a
country's foreign trade. Foreign trade can be defined as the process of commercial
exchange of goods and services among nations. If a country has more exports than
imports (I > M), then we have a favorable BOT (Balance of Trade). Inversely, when
imports are greater than exports (M > X), the economy is experiencing an unfavorable
balance of trade (BOT) or a trade deficit.
Payments on imports are called dollar disbursement (since dollars are outflown)
while payments on exports are called dollar receipts (since dollars are flown into the
ecosystem). If dollar receipts are greater than dollar payments ($ receipts > $
payments), then we have a favorable balance of payment (BOP). Inversely, when dollar
payments are greater than dollar receipts ($ payments > $ receipts), then the result
would be an unfavorable BOP. Any unfavorable BOP causes a drain to our $ reserves.
By international standard, a country is stable if its $ reserves equal value of the import
requirements for three months. Hence, our level of dollar reserves indicates the
country's economic status and performance in the process of development.

Sources of Dollars
Where do we get our dollars? We have discussed earlier that we get dollar receipts
from exports. It should be noted that the country's export products have undergone a
major structural change - a diversification from traditional agro-based products towards
exports in manufactured form (apparel, furniture, semi-conductors) and a concentration
of country destination to East (Japan) and Southeast Asia (Malaysia, Singapore and
Thailand).
Aside from our exports, other sources of dollars are the U.S. and Japanese
governments. Dollar spending of these countries to the Philippines are in the form of

219
payments to veterans, educational / cultural exchange programs, military expenditures
for the US bases maintenance (by USA), infrastructure projects like Philippine-Japan
Friendship Highway (by Japan).
Lastly, dollars can be gotten from invisible receipts in the form of tourism (foreigners
coming into the country), donations from abroad, personal remittances of individual
Filipinos from abroad, foreign loans/investments for capital transactions.

Uses of Dollars
Where do we use our dollars? Our dollar reserves are used for the needs of the
import-dependent industries (i.e., raw materials without local supply and highly capital
intensive technology). It should be noted that intermediate goods, like fabric and base
metals, and capital goods like industrial machines and electrical equipment still
comprise our imports.
Secondly, the Philippine government spends abroad to finance the staff of all its
embassies and consulates, the pensionados or government scholars overseas and the
Filipino sportsmen/athletes who attend international competitions.
Thirdly, the country's dollar reserves are used by Filipino abroad, when foreign
companies or investors here remit profits to the mother company abroad, and to pay the
interest payments of our foreign loans.

Gains from Trade

Who benefits from trade? Trade allows two challenging countries to obtain the
good/commodity in which they do not have a comparative advantage at a lower
opportunity cost (in terms of units sacrificed for the commodity in which they do have a
comparative advantage) than they would have to accept if they were to product the
commodity for themselves. This allows both countries to have more of both
commodities than they could have if they made themselves self-sufficient.
Let us differentiate between absolute and comparative advantage. If the Philippines
has an absolute in the production of rice over Indonesia, while Indonesia has an
absolute advantage over the Philippines in the production of coconut, then total
production of both commodities can be raised if each country moves resources into the
production of the commodity in which it has the absolute advantage. One country has
an absolute advantage over another country (region or group) in the production of a
commodity if, with the same input of resources in each country, it can produce more of
the commodity than the other. But absolute level of efficiencies in these two countries
does not influence the gains that can be obtained by both if they specialize and trade.
On the other hand, a high productivity and a low productivity country can each gain
by trading with the other because this allows each of them to specialize in the
production of commodities in which they have comparative advantages, and this in turn
makes more goods available to the people of both countries. Hence, comparative

220
advantage refers to the relative advantage one country enjoys over another in the
various commodities. If, for example, the Philippines is ten times as efficient in
producing furniture we say that the Philippines has a comparative advantage over
Taiwan in furniture-making (its margin of advantage over Taiwan is larger in furniture-
making than it is garment-making).
How can nations promote free trade and benefit from specialization and increase in
output? In the international trade market, the formation of trade agreements, common
markets, and trade associations have boosted free trade. Countries can enter into
bilateral or multilateral agreements, like GATT (General Agreement on Tariffs and
Trade), which provide no quotas, no increase in tariffs, and no product discrimination
among member nations. Common markets, like CACM (Central American Common
Market) and EEC (European Economic Community) provide no tariffs among member
nations and adapt common trade policies vis-à-vis non-member countries. On the other
hand, trade associations, like LAFTA (Latin American Free Trade Association) and
EFTA (European Free Trade Association) usually agree on decreased tariffs on
preferential imports from among themselves.
Nevertheless, there are realities in the foreign trade market that serve as barriers to
free trade and not benefit from comparative advantage. One reality is the infant industry
argument among developing countries, which impose high tariffs on products from
abroad that compete with the output of domestic infant industries. Another reality is that
of retaliation. If South Korea, for example, imposes restrictions on the imports from the
Philippines, the latter retaliates by raising tariffs against South Korean goods. Thirdly,
countries with BOP deficits usually restrict their imports to keep them close to their
export possibilities.

Foreign Exchange Policies

In the early part of this lesson, we have pointed out that through exports (Figure 5.2),
dollars flow into the ecosystem while through imports, dollars flow out of the same
circular flow. Hence, ideally, during a deflationary situation, wherein there is a need for
fresh money inflow, exportation must be increased as a matter of policy. On the other
hand, during an inflationary situation, wherein there is a need to cutback on excess
money supply in the economy, importation must be increased. However, in the
Philippine experience, such ideal policies cannot just be operational because of the
limitations of the ecosystem. Increase in importation during an inflationary situation is
limited by our dollar reserves, which is our most scarce resource. Increase in
exportation during a deflationary situation is limited by the inelasticity of our exports.
In the case of BOP deficits (i.e., $ receipts < $ payments), a short term remedy can
be done tightening credit and increasing our non-trade surplus (or invisibles) through
promotion of tourism. A medium-term solution may be done through exchange controls
(e.g., exchange rate) and import controls (e.g., tariffs, subsidies, quotas). If our trade
deficit still persists in the long-term basis, the country resorts to devaluation.

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 In theory, Free Trade exists when goods and services can be imported and exported
without any barriers in the form of tariffs, quotas and other restrictions. Trade advocates
described this as an engine for economic growth for it entices countries to specialize in
activities where they have comparative advantage, thus, increasing productivity and
efficiency on their produced goods and services.

Common Trade Barriers

1. Tariff, a general term on the fixed percentage tax imposed/levied on the value of
the imported good upon entry into the importing country.
2. Quota, a physical limitation on the quantity or volume of a commodity that can be
imported into a country.

Required reading: http://www.census.gov.ph/business/foreign-trade

222
EBC 101 / ECO 1, Module 5, Lesson 3
SELF-PROGRESS CHECK TEST

Test I. Matching Type

Column A
_____ 1. gains from trade
_____ 2. comparative advantage
_____ 3. quantity of domestic goods that
must be sacrificed to obtain a
unit of imported goods
_____ 4. greater production of commodity
X from equal quantity of
resources in region A than in
region B
_____ 5. dumping
_____ 6. absence of restrictions on
importing and exporting
_____ 15. International Monetary Fund
Column B
a. greater margin of absolute advantage
in producing commodity X than in
producing commodity Y
b. terms of trade
c. increased production that results from
specialization and trade
d. absolute advantage
e. free trade
f. non-tariff barriers to trade
g. tax applied on imports

_____ 7. use of trade barriers to reduce h. protection

imports of domestically i. charging lower prices abroad than at
produced products home
_____ 8. quotas j. difference between the value of exports
_____ 9. tariff and import

_____ 10. exchange rate k. balance of payments deficits

_____ 11. balance of trade l. price for purchase or sale of foreign

currency
_____ 12. cause of loss in nation's foreign
exchange reserves m. price of currency determined by forces
of supply and demand
_____ 13. floating exchange rate
n. lending institution concerned with
_____ 14. system in which exchange rates
bridging short-term deficit
between currencies of various
countries were fixed in terms of o. gold standard
gold

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Test II. True or False
_____ 1. A country must import to be able to export.
_____ 2. If some export is restricted, this ultimately means imports are also
restricted.
_____ 3. Consumer gain from increased imports, while some domestic are also
restricted.
_____ 4. A tariff is a physical limitation on the amount of a product that can be
imported.
_____ 5. A quota permits any level of importation for which consumers are willing to
pay.
_____ 6. Tariffs are usually imposed on a particular product, whereas quotas are
usually imposed across the board.
_____ 7. If imports are reduced, this may not reduce exports in the short run, but
most certainly will in the long run.
_____ 8. Quotas generate income for the federal government.
_____ 9. Anything that restricts international trade reduces real income.
_____ 10. Exports pay for imports.
_____ 11. One should reason for increasing tariffs is to strengthen our bargaining
position in international trade conferences.
_____ 12. Filipino banks want to buy foreign currency when the value of the dollar is
high and to sell foreign currency when the value of the dollar is low.
_____ 13. The supply of francs coming into the international money market reflects
the French people's demand for Filipino goods, services, and securities.
_____ 14. If the French wish to purchase more Filipino products, they must offer
fewer francs in the international money market.
_____ 15. If two nations' inflation rates differ, the exchange rate will even out the
difference.

Test III. Multiple Choice

_____ 1. The international balance of payments is
a. a summary of all international transactions between one nation and the
rest of the world.
b. a summary statement of all international transactions among all
nations.
c. the difference between the dollar value of exports and the dollar value

224
 of imports.
d. always positive when there is a balance of payments deficit.
e. the same as the merchandise trade balance.
_____ 2. International trade
a. promotes specialization and trade based on absolute advantage
b. promotes specialization and trade based on comparative advantage.
c. always increases every individual's income in any nation that trades
d. is most beneficial to a domestic economy when domestic firms are
able to receive protection from foreign competition.
e. is no necessary for a nation such as the United States in order to
promote increases in income.
_____ 3. Absolute advantage in production is the
a. capacity to produce more units of output than a competitor can for any
given level of resource use.
b. capacity to produce more units of output than a competitor can with
fewer resources.
c. same as comparative advantage
d. ability to out-produce another nation because of more resources.
e. basis for international trade.
_____ 4. Comparative cost advantage
a. is the ability to produce a product without having to give up as much in
the way of another goods and services as a competitor
b. is the basis of international trade
c. can raise the incomes of all involved in trade.
d. means an opportunity cost is present
e. is all of the above
_____ 5. Tariffs
a. are special tax on imported goods
b. are a limit on the amount of a good that can be imported
c. increase the supply of a product
d. increase the demand for a product
e. are usually proposed by foreign producers.
_____ 6. Tariffs and quotas cause
a. market supply to decrease and market price to increase, and they
encourage domestic production.
b. market supply to increase and market price to decrease, and they
discourage domestic production
c. market demand and market price to decrease, and they discourage

225
 domestic production.
d. market demand and market price to increase, and they encourage
domestic production.
e. none of the above.
_____ 7. A quota is
a. a special tax on imported goods
b. a limit on the amount of a good that can be imported.
c. the maximum amount of a product that can be exported.
d. the maximum tax that can be imposed on an imported product
e. none of the above.
_____ 8. If a product has a quota imposed on it domestic demand increases, this
will cause
a. the price of the product to rise.
b. the price of the product to fail.
c. a surplus of the product
d. domestic production to fall
e. b and d
_____ 9. Some argue that a tariff is necessary to protect an infant industry until it
can grow and compete effectively on its own. A problem with this
argument is that government may not accept that
a. the industry will ever be able to compete effectively
b. the industry will have a comparative cost advantage after it grows.
c. the higher consumer prices caused by tariffs during the industry's
growth period will be outweighed by future benefits.
d. the benefits of tariffs will outweighed by the future entrepreneurs who
are willing to risk inventing in the industry.
e. all of the above.
_____ 10. A tariff imposed on a foreign product
a. attempts to protect domestic producers from domestic worker's higher
wage demands.
b. attempts to protect domestic producers from foreign competition.
c. attempts to protect foreign markets from domestic producers.
d. increases the demand for the product in the domestic market.
e. attempts to increase foreigners' profits so they can import more for the
domestic market.
_____ 11. If a tariff is imposed on a product and demand increases, then the
a. price of the product will fall and imports will rise.
b. price of the product will rise and so will imports.

226
 c. price of the product will rise and imports will fall.
d. price of the product will fall and imports will fall.
e. importation of the product cannot exceed the tariff limit.
_____ 12. The international exchange rate is
a. the price of one national currency stated in terms of another national
currency.
b. an exchange rate system in which the prices of currencies are
determined by competitive market forces.
c. an exchange rate system in which the prices of currencies are
established and maintained by governments.
d. a reduction in purchasing power in terms of another national currency.
e. none of the above.
_____ 13. Appreciation of the dollar means
a. that the dollar becomes the international currency.
b. that people come to realize that the dollar maintains its value over time
better than any other currency.
c. that people come to realize that dealing with money yields all the
benefits not found in a barter system.
d. that the use of the dollar specialization and trade along the lines of
comparative advantage enables countries to escape the confines of
their own production possibilities curve.
e. none of the above.
_____ 14. Depreciation of the dollar means
a. foreign product's prices are now higher.
b. foreign product's prices are now lower.
c. the value of the dollar has increased in relation to foreign currencies
d. the price of the products in terms of foreign currencies has risen.
e. we will export less.
_____ 15. If the dollar price of the yen decreases, then
a. Americans will want to buy more Japanese products
b. Americans will want more yen.
c. the price of Japanese products decreases.
d. all of the above.
e. none of the above.
_____ 16. One of the problems with a fixed exchange rate system is that it
a. causes exchange rates to be less stable
b. increases the risks of international trade
c. creates balance of payment imbalances if market conditions change.

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 d. does all of the above
e. does none of the above
_____ 17. To correct a persistent balance of payments deficit under a fixed
exchange rate system a government should.
a. increase domestic taxes.
b. decrease domestic government spending
c. decrease the domestic money supply.
d. deliberately cause domestic inflation
e. decrease tariffs and quotas
_____ 18. To correct a persistent balance of payments surplus under a fixed
exchanged rate system a government should
a. increase imports and reduce exports.
b. increase exports and reduce imports.
c. increase domestic taxes
d. decrease government spending and taxes
e. a and c.
_____ 19. An increase in the rate of inflation in the Philippine soil
a. cause Filipinos to buy less foreign goods and more domestic goods
b. cause foreigners to want to buy more Filipino products
c. cause on increase in the demand for foreign currencies and a
decrease in their supply
d. cause a decrease in the demand for foreign currencies and an
increase in their supply.
e. none of the above
_____ 20. We were taken off of the fixed exchange rate system because
a. the value of the dollar was too weak.
b. our gold stock increased too much, creating international political
problems
c. the world money market was saturated with overhauled dollars.
d. people have come to expect an appreciation of the dollar, creating
panics.
e. not enough speculation was taking place in the international money
market.

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EBC 101 / ECO 1, Module V
ANSWER KEYS TO THE SELF-PROGRESS CHECK TESTS

Lesson 1
Test I.
1. i 3. b 5. l 7. m 9. e 11. n 13. h 15. g
2. j 4. c 6. k 8. d 10. o 12. f 14. a

Test II.
1. e 4. d 7. d 10. a 13. d 16. c 19. c 22. e 25. e
2. d 5. b 8. c 11. d 14. d 17. a 20. e 23. e 26. b
3. e 6. e 9. b 12. b 15. e 18. b 21. a 24. a 27. a

Lesson 2
Test I.
1. d 2. c 3. a 4. b 5. e 6. h 7. f 8. i 9. g 10. j

Test II.
1. a 3. c 5. a 7. e 9. a 11. e 13. a 15. b
2. e 4. a 6. a 8. a 10. a 12. b 14. e

Lesson 3
Test I.
1. c 3. b 5. i 7. h 9. g 11. j 13. m 15. n
2. a 4. d 6. e 8. f 10. l 12. k 14. o

Test II.
1. T 3. T 5. F 7. T 9. T 11. T 13. T 15. T
2. T 4. F 6. F 8. F 10. T 12. T 14. F

Test III.
1. a 3. a 5. a 7. b 9. b 11. b 13. e 15. d 17. b 19. c
2. b 4. e 6. a 8. a 10. b 12. a 14. a 16. c 18. e 20. c

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 EBC 101 / ECO 1: Introductory Economics
Module Test V

Name: DLC: Score:

Test I. Multiple Choice

_____ 1. One reason why inflation if undesirable is that
a. it causes loss to lenders and savers who do not anticipate it.
b. it benefits buyers, not sellers.
c. wages rise faster than profits and prices.
d. it puts an extra burden on people who are in debt.
_____ 2. For money to serve as an efficient medium of exchange, it must have all
but which one of the following characteristics?
a. general acceptability
b. convertibility
c. high value for its weight
d. divisibility
_____ 3. A requirement for a gold standard was that
a. the price level be stable.
b. there be no paper money.
c. the paper money be convertible into gold.
d. gold coinage by 100% of money supply.
_____ 4. The value of money depends primarily on
a. the gold backing of the currency
b. the gold backing of both currency and deposits
c. its purchasing power
d. who issues it
_____ 5. Demand deposits are
a. not usually considered as part of a country's money supply.
b. backed by gold but not convertible into it
c. categorized as belonging to M2 money supply.
d. categorized as belonging to M1 money supply.
_____ 6. One way that time deposits differ from demand deposits is that
a. it is in practice always necessary to give advance warning before
withdrawing money from the deposits.
b. time deposits are not considered very liquid assets.
c. demand deposits earn interest; time deposits do not.

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 d. time deposits usually cannot be drawn on by personal check (except
for NOW accounts).
_____ 7. A government bond could fill one function of money by acting as
a. medium of exchange
b. store of wealth
c. unit of account
d. hedge against inflation
_____ 8. The "narrow" definition of money, based only on its use as a medium of
exchange, is
a. currency
b. currency and demand deposits
c. currency and demand and time deposits
d. currency, demand deposits, and near money.
_____ 9. The commercial banking system is distinct from investment banks and
savings banks in that it
a. lends the savings to the public borrowers
b. pays interest on savings account
c. is subject to some government regulation
d. creates money
_____ 10. A commercial bank is able to create money by
a. printing it
b. creating a demand deposit as it extends a new loan.
c. maintaining reserves
d. issuing checks to its deposits.
_____ 11. The process of creation of deposit money by commercial banks
a. is possible because of the fractional reserve banks.
b. is consciously undertaken by each bank
c. always occur if there are excess reserves
d. permits only small, gradual changes in the supply of money.
_____ 12. A bank that has insufficient reserves may
a. borrow from other banks or from Central Bank (CB).
b. stop making new loans
c. sell securities to other banks or to the public
d. do all of the above
_____ 13. Which of the following is not a tool that CB can use to alter money supply?
a. open market operations
b. changes in the discount rate

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 c. changes in the required reserve ratio
d. changes in tax rates
_____ 14. Open market operations are
a. used by the CB regularly to meet seasonal, cyclical, and erratic
fluctuations in the banks' need for reserves.
b. used only sparingly by the CB in order not to upset the government
bond market.
c. conducted primarily in order to make a profit for the CB.
d. not very effective as a means of influencing the supply of money and
credit.
_____ 15. An increase in the required reserve ratio has the effect of
a. reducing total reserves
b. reducing the multiple by which the money supply can expand.
c. increasing excess reserves
d. enabling the banks to reduce borrowings from the CB.
_____ 16. The amount of money held for transactions balances will
a. vary in the same direction as income
b. vary in the same direction as interest rates
c. vary inversely with savings
d. be larger the shorter the interval between paydays
_____ 17. Precautionary balances would be expected to increase if
a. business conditions were to become less certain.
b. interest rate increased
c. people were expecting securities prices to rise
d. prices and incomes fell
_____ 18. The speculative motive for desiring to hold money balances
a. means that more cash will be held if bond prices are expected to rise in
the future.
b. means that more cash will be held if interest rates are expected to be
lower in the future.
c. varies directly with income
d. is greater the lower the rate of interest.
_____ 19. An excess supply of money balances causes
a. bond prices and interest rates to rise.
b. bond prices and interest rates to fall.
c. bond prices to fall and interest rates to rise
d. bond prices to rise and interest rates to fall

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_____ 20. If the CB wishes to pursue an expansionary monetary policy, it should
a. buy bonds on the open market, thus containing reserves of commercial
banks and causing interest rates to rise.
b. sell bonds on the open market, thus expanding reserves of commercial
banks and causing interest rates to fall.
c. buy bonds on the market, thus expanding commercial bank reserves
and causing interest rates to fall.
d. sell bonds on the open market, thus contracting reserves of
commercial banks and causing interest rates to rise.
_____ 21. Suppose the CB believes that there is too much inflationary pressure in
the economy. Its contradictory policy should include
a. the purchase of government bonds on the open market.
b. forcing the National Treasury to buy more government securities.
c. the sale of government bonds on the open market
d. a decrease in reserve requirements.
_____ 22. One advantage of monetary policy over fiscal policy is that
a. the decision lag is much shorter
b. its effects are easier to predict
c. its effects are felt uniformly throughout the economy
d. high interest rate do not hurt anybody, but high taxes do
_____ 23. One way that monetary policy deliberately tries to influence the course of
the economy
a. directly affecting income
b. making it harder (more costly) or easier (less costly) to borrow money.
c. changing the velocity of money
d. directly affecting the price level
_____ 24. Generally recognized as a sign of a policy favoring tighter money is a
a. reduction of the required reserve ratio
b. rise in government bond purchases by the CB
c. rise in the money supply
d. rise in the discount rate
_____ 25. A tax takes the same amount from everyone, regardless of income is
a. regressive
b. progressive
c. not fair at all
d. proportional to the benefit received
_____ 26. The judgment concerning whether a tax is regressive, proportional, or
progressive is based on a comparison of the amount of tax with the

233
 a. tax base
b. value of the item being taxed
c. taxpayer's income
d. distribution of income
_____ 27. The 10% surtax on personal income taxes passed by Congress raised the
tax rate in each bracket by 10% of itself. This meant that the income tax
a. became slightly more progressive than before
b. became slightly closer to proportional than before
c. required an equal absolute increase from everyone
d. even affected those with no taxable income
_____ 28. Property taxes generally
a. fall entirely on the homeowner or landlord
b. are less likely to be shifted in the long-run than in the short-run
c. fall on renters aw well as homeowners and landlords
d. are borne entirely by the occupant of a house
_____ 29. The marginal rate of taxation of a progressive income tax is necessarily
a. the same as the average rate
b. less than the average rate
c. more than the average rate
d. higher the lower the income
_____ 30. The marginal rate of 70 percent on a taxable income of P200,000.
a. means that the average person with P200,000 of income pays P
140,000 in taxes
b. has no effect whatever because of exemptions, deductions and tax
avoidance.
c. signifies the collection of P.70 on each additional peso of income for a
person in that tax bracket.
d. applies to capital gains as well as to dividend income
_____ 31. Tax "incidence" indicates
a. who actually bears the final burden of the tax
b. who pays the tax to the Federal Treasury
c. the progressivity of the tax
d. whether or not the tax is fair
_____ 32. A country is relatively more efficient than another in producing a good if
a. it produces it more cheaply in terms of alternate goods not produced
b. it produces it at lower money cost
c. it has lower wage levels

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 d. there are economics of scale available
_____ 33. Which of these statements represents the least appropriate use of concept
of opportunity cost?
a. Exports can be though of as the opportunity cost imports
b. The opportunity cost of product B is the amount of product A that could
be produced with the same resources.
c. The opportunity cost increased output may be measured by the utility
of leisure given up to produce the output
d. The opportunity cost of producing C is the sum of its fixed and variable
costs.
_____ 34. Nations through trade
a. may consume at levels beyond their production possibilities frontiers
b. will be limited in their consumption to points on the production
possibilities frontier
c. will not alter their previous production patterns
d. are more likely to be confined to choice inside their production
possibilities frontiers.
_____ 35. The doctrine of comparative advantage says that there are gains from
international trade
a. only if both comparative and absolute advantage are present
b. if opportunity costs are the same in the countries involved
c. only if there are economies of scale available
d. if countries specialize in the production of goods in which they are
relatively more efficient.
_____ 36. Inaugurating trade with nations whose wage levels are much lower
a. will lower the real wages in the high-wage nations
b. will probably raise per capita real income in both countries
c. may help political relationships but does not contribute economically
d. will lower the real wages in low-gain nations.
_____ 37. A country would welcome an improvement in its terms of trade because
a. it can then export more
b. its exchange rate will rise
c. the cost of its imports will fall in terms of what it must give up to get
them
d. it now becomes cheaper to produce the same goods at home instead
of importing them
_____ 38. For a country with one important exported commodity (such as soil)
a. a rise in its price in international exported markets will improve the

235
 country's terms of trade.
b. a fall in its price will improve the terms of trade
c. its terms of trade will be unaffected by a change in its price
d. a rise in its price will be helpful to the terms of trade and balance of
payments only if world demand for it is elastic
_____ 39. The principle of comparative advantage indicates that
a. free trade is invariably best
b. free trade is hardly ever best
c. free trade is better than some trade
d. trade with mutual gain is possible
_____ 40. From the point of view of the domestic standard of living, a country should
a. welcome cheap imports
b. try to expand exports
c. impose tariffs to keep out foreign competition
d. try to be self-sufficient.
_____ 41. The infant-industry argument for tariffs
a. is recognized as wrong because protections often extends beyond
infancy.
b. is recognized as wrong because it is present and not future
comparative advantages that should be considered
c. is recognized as theoretically sound if economies of scale exist
d. says that industries should be protected in poor countries to provide for
the welfare of infants there
_____ 42. Which of the following would be the least valid reason for imposing a
tariff?
a. to protect an infant industry that will eventually be competitive.
b. to diversify the economy
c. to maximize real income
d. to maintain a vital bur high-cost defense industry
_____ 43. A general increase of import duties by a nation during a time of
unemployment
a. is unlikely to produce any short-run increase of income and
employment
b. should prove a very substantial stimulus to employment
c. would have the same effect on the allocation of resources as an export
subsidy.
_____ 44. The European Economic Community
a. is an example of a completely free-trading area, externally as well as

236
 internally.
b. was intended to allow the free movement of labor, capital, and goods
among its members.
c. now includes all of Europe
d. has completely fixed exchange rates among its currencies and in
relation to others.
_____ 45. Which of the following statements is true about the balance of payments?
a. Current account debits must equal current account credits
b. Visibles must equal invisibles
c. Total debits must equal total credits
d. Desired payments must equal actual payments
_____ 46. A loan accompanied by delivery by the United States of $2 million in
military equipment to Philippines leads to the following in the balance of
payments
a. a $2 million credit in the current account.
b. a $2 million debit in the capital account
c. both (a) and (b)
d. no record because the transaction was of military equipment
_____ 47. Increased preferences of Philippine consumers for Japanese cars would
a. shift the supply of dollars curve to the left and lead to an appreciation
in the value of the yen.
b. shift the demand for dollars curve to the left and lead to a depreciation
in the value of the yen.
c. shift the demand for dollars curve to the right and lead to an
appreciation in the value of the yen
d. shift the supply of dollars curve to the right and lead to a depreciation
in the value of a dollar.
_____ 48. People like to hold cash for
a. transactions purchaser
b. precautionary motives
c. speculative motives
d. all of the above
_____ 49. To increase money supply in circulation, the CB can do the following
except
a. decrease bank reserve requirement
b. buy government bonds
c. increase taxes
d. decrease government expenditure

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 e. c and d
_____ 50. All are functions of money except one
a. it is a medium of exchange
b. it acts as a store of value
c. it serves as a unit of account
d. generally acceptable

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