CHAPTER 1: INTRODUCTION TO APPLIED ECONOMICS

LEARNING OBJECTIVES

At the end of this chapter, the students should be able to:

1. differentiate between economics as a social science and as an applied science;

2. apply the concept of opportunity cost when evaluating options and making economic
decisions;
3. make decisions based on how man can satisfy most of his wants given limited resources;
4. differentiate macroeconomics and microeconomics;
5. describe and state the importance of economic resources;
6. differentiate positive and normative economics;
7. differentiate gross national product and gross domestic product;
8. distinguish the different approaches used in solving for the gross national product:
9. identify the basic problems of the Philippine economy;
10. analyze basic economic problems and propose solutions to the problems using the
principles of applied economics; and
11. describe the various economic systems.

Lesson 1.1. Introduction to Economics

Everybody goes through a day faced with constraints or limitations: motorists complain of high
gasoline prices, times when people suffer due to a shortage of chicken in the market, or
insufficient allowance for a student who needs to buy books and school supplies. People always
complain about not having enough-not enough food on the table, not enough money to pay their
debts, or not enough income to meet all the family's needs. This, in effect, is the existence of
what we call scarcity, that is, insufficiency of resources to meet the wants of consumers and
insufficiency of resources for producers that hamper enough production of goods and services.

Scarcity is the reason why people have to practice economics. Economics, as a study, is the
social science that involves the use of scarce resources to satisfy unlimited wants Part of
human behavior is the tendency of man to want to have as many goods and services as he can.
However, his ability to buy goods and services is limited by his income and purchasing power. It
is therefore in this context that man has to practice economics.

Well-known economist Alfred Marshall described economics as a study of mankind in the

ordinary business of life. It examines part of the individual and social action that is most closely
connected with the attainment and use of material requisites of well-being

Scarcity is a condition where there are insufficient resources to satisfy all the needs and wants
of a population. Scarcity may be relative or absolute. Relative scarcity is when a good is scarce
compared to its demand. For example, coconuts are abundant in the Philippines since the plant
easily grows in our soil and climate. However, coconuts become scarce when the supply is not
sufficient to meet the needs of the people. Relative scarcity occurs not because the good is
scarce per se and is difficult to obtain but because of the circumstances that surround the
availability of the good. Bananas are abundant in the Philippines and are being grown in a lot of
regions around the country. But when a typhoon destroys banana plants and the farmer has no
bananas to harvest, then bananas become relatively scarce.

On the other hand, absolute scarcity is when supply is limited. Oil is scarce in the country since
we have no oil wells from which we can source our petroleum needs, so we rely heavily on
imports from oil-producing countries like Iran and other Middle Eastern countries. Cherries are
scarce in our country since we do not have the right to grow them and we have to rely on
imports for our supply of cherries. This explains why cherries are very expensive in the
Philippines.
CHOICE AND DECISION-MAKING

Because of the presence of scarcity, there is a need for man to make decisions in choosing how
to maximize the use of scarce resources to satisfy as many wants as possible. A homemaker
who has a monthly budget needs to decide how to utilize it to pay the rent, buy food, pay the
children's tuition fees, and buy new clothes and shoes. If the budget is not enough, then the
homemaker has to give up some of these things. She needs to make a choice. If she decides
not to buy new shoes for her children at the start of the school year, then this is the choice she
gave up.

Opportunity cost refers to the value of the best-foregone alternative. When land is devoted
exclusively to the cultivation of rice, we give up an output of bananas or mangoes that we could
have planted on that land area. A producer who decides to transform all his leather into shoes
gives up the chance to produce bags with that leather. A school teacher who could have worked
in a bank gives up the salary that she would have earned as a bank employee. A manager who
quits his job to take up a master's degree gives up his salary as a manager. That salary is his
opportunity cost. Without scarcity, a person does not need to make choices since he/she can
have everything he/she wants.

The concept of opportunity cost holds for individuals, businesses, and even society. In making a
choice, trade-offs are involved. The opportunity cost of watching a movie in a cinema is the
value of other things that you could have bought with that money such as a pint of ice cream, a
combo meal in a fast food, or a simple t-shirt to be used in a PE class. Another example is
giving up work in favor of a recreational activity, say you go on a week's stay in Boracay on a
leave without pay. Then you are giving up the income you would have earned had you not
decided to go on that trip. Another example would be a business proprietor who withdraws
P10,000 from his savings account so he can buy materials to be used in his business. He gives
up the interest the savings would have earned but his goal is to earn more money that would be
generated by the business.

ECONOMIC RESOURCES

Economic resources, also known as factors of production, are the resources used to produce
goods and services. These resources are, by nature, limited and therefore, command a
payment that becomes the income of the resource owner.

1. Land soil and natural resources that are found in nature and are not man-made. Owners of
lands receive a payment known as rent.

2. Labor physical and human effort exerted in production. It covers manual workers like
construction workers, machine operators, and production workers, as well as professionals like
nurses, lawyers, and doctors. The term also includes jeepney drivers, farmers, and fishermen.
The income received by laborers is referred to as wage.

3. Capital man-made resources used in the production of goods and services, which include
machinery and equipment. The owner of capital earns an income called interest.

ECONOMICS AS A SOCIAL SCIENCE

Economics is a different science from biology and chemistry as these are physical sciences.
Economics is a social science because it studies human behavior just like psychology and
sociology. Social science is, broadly speaking, the study of society and how people behave and
influence the world around them. As a social science, economics studies how individuals make
choices in allocating scarce resources to satisfy their unlimited wants.
MACROECONOMICS AND MICROECONOMICS

There are two branches of economics. These are macroeconomics and microeconomics.

Macroeconomics is a division of economics that is concerned with the overall performance of

the entire economy. It studies the economic system as a whole rather than the individual
economic units that make up the economy. It focuses on the overall flow of goods and
resources and studies the causes of change in the aggregate flow of money, the aggregate
movement of goods and services, and the general employment of resources. Macroeconomics
is about the nature of economic growth, the expansion of productive capacity, and the growth of
national income.

Microeconomics, on the other hand, is concerned with the behavior of individual entities such as
the consumer, the producer, and the resource owner. It is more concerned with how goods flow
from the business firm to the consumer and how resources move from the resource owner to
the business firm. It is also concerned with the process of setting prices of goods which is also
known as Price Theory. Microeconomics studies the decisions and choices of the individual
units and how these decisions affect the prices of goods in the market. Likewise, it examines
alternative methods of using resources to alleviate scarcity. It does not focus on aggregate
levels of production, employment, and income.

BASIC ECONOMIC PROBLEMS OF SOCIETY

All societies are faced with basic questions in the economy that have to be answered to
cope with constraints and limitations. These are:

1. What to produce and how much - society must decide what goods and services
should be produced in the economy. Having decided on the nature of goods that will be
produced, the quantity of these goods should also be decided.

2. How to produce - is a question on the production method that will be used to produce
the goods and services. This refers to the resource mix and technology that will be
applied in production.

3. For whom to produce - is about the market for the goods. For whom will the goods and
services be produced? The young or old, the male or female market, the low-income or
the high-income groups?

How these questions are answered depends on the nature of the economic system in
place. The economic system is how society answers the basic economic problems.

ECONOMIC SYSTEMS

The economic system is the means through which society determines the answers to the basic
economic problems mentioned. A country may be under any of the following types or even a
combination of the three economic systems

1. Traditional economy. Decisions are based on traditions and practices upheld over the years
and passed on from generation to generation. Methods are stagnant and therefore not
progressive. Traditional societies exist in primitive and backward civilizations.

2. Command economy. This is the authoritative system wherein decision-making is centralized

in the government or a planning committee. Decisions are imposed on the people who do not
have a say in what goods are to be produced. This economy holds in dictatorial, socialist, and
communist nations.

3. Market economy. This is the most democratic form of economic system. Based on the
workings of demand and supply, decisions are made on what goods and services to produce.
People's preferences are reflected in the prices they are willing to pay in the market and are
therefore the basis of the producers' decisions on what goods to produce.

WHY ECONOMICS IS IMPORTANT

Students may ask, "Why do we need to study economics?" To know how important the
subject is, all they need to do is read the front page of the newspapers to see that the most
important news is economic in nature. Watch the news on TV and for sure, economic news
always presents important issues.

Economics will help the students understand why there is a need for everybody, including the
government, to budget and properly allocate the use of whatever resources are available. It will
help one understand how to make more rational decisions in spending money, saving part of it,
and even investing some of it.

On the national level, economics will enable the students to take a look at how the economy
operates and to decide for themselves if the government officials and leaders are effective in
trying to shape the economy and formulate policies for the good of the nation.

SCIENTIFIC APPROACH IN THE EMPIRICAL TESTING OF AN ECONOMIC THEORY

Economics is a study that attempts to explain how an economy operates and how the consumer
attempts to maximize his/her wants within limited means. Using tools such as logic,
mathematics, and statistics, the student needs to approach the empirical testing of an economic
theory in a scientific manner. This scientific approach involves the following steps:

1. State the propositions or conditions that are taken as given and do not need further
investigation, as the basic starting point of investigation. These propositions will serve as the
premises upon which the theory is established

2. Observe facts in connection with the activity that we want to theorize.

3. Apply the rules of logic to the observed facts to determine causal relationships between
observed factors and eliminate facts that are unnecessary and irrelevant.

4. Establish a set of principles such that formulated hypotheses may be tested as to whether
they are valid or not.

5. Use statistics and econometrics as empirical proof in testing the hypotheses.

POSITIVE ECONOMICS VERSUS NORMATIVE ECONOMICS

Positive economics deals with what is-things that are happening such as the current inflation
rate, the number of employed labor, and the level of the Gross National Product. Normative
economics, on the other hand, refers to what should be that which embodies the ideal such as
the ideal rate of population growth or the most effective tax system. Positive economics is an
overview of what is happening in the economy that is possibly far from what is ideal. Normative
economics focuses on policy formulation that will help to attain the ideal situation.

MEASURING THE ECONOMY

We always get to read in the newspapers how our economy has grown in recent years. Before
we go into the essence of applied economics, it is beneficial that students get to learn first how
the growth of the economy is measured. The national government is always happy to inform the
people that the country's Gross Domestic Product (GDP) has grown at rates, much higher than
in the previous administration. We will now go into a short discussion of what the GDP is all
about.

The government plans for a better economy from the perspective of what the economy has
been. Shaping the economy's future is changing past and present perspectives extended to the
future. In particular, looking ahead is grounded on past and present performance and the health
of the economy. The heart of the economy is production whose value measures both resource
input and output of people. The interplay of resources and outputs tells how well the economy
has performed

Counting All through GNP

As the mirror of all products, Gross National Product (GNP) is the market value of final products,
both sold and unsold, produced by the resources of the economy in a given period. Market
value is determined by supply and demand while the economy's resources are those belonging
to Filipino citizens and corporations. Not all resources belonging to the economy are in the
economy, like the capital and entrepreneurship that brought the SM mall to China. Conversely,
not all resources in the economy belong to the economy like the capital and entrepreneurship
brought to the country by multinationals like Nestlé and Procter and Gamble (P&G). In addition,
the value of final products already includes the values of its components from the lower
production stages. For example, the price of your leather wallet already includes the value of
leather which in turn includes the value of animal hide. In other words, counting the values of
products from the raw material to the intermediate and on to the final production stages, double
counts and overstates the value of the economy's production. Likewise, the value of any product
in a certain period should no longer be counted in succeeding periods to avoid double counting
and overstatements that can mislead decision-making.

GNP/GDP: Expenditure Approach

One way to account for GNP and classify its components is by end-use expenditure. Products
are final when they have reached the highest levels of processing in the economy for different
uses in the given period. They are household and individual consumption (C), and government
expenditure on goods and services including labor (G) and exports (X). Products, regardless of
production stages, are also considered final when stocked (unused) as capital goods and
inventories of raw materials and intermediate products. Classified as investments (1), they are
stocks of value for future use and therefore, have reached the highest possible production
stages for the given period. On the other hand, their import components (M) are excluded since
import products are produced in other economies. To restate the GNP equation:

GNP=C+I+G+(X-M)

Table 1.1 presents Philippine GNP statistics whose components are classified by expenditure
accounts. Capital Formation is Investment (1) by both the private sector and government that
consists of fixed capital and inventory changes. Fixed Capital includes capital goods (buildings,
machinery, equipment) while inventory changes are stocks (unused) for future use from all
stages produced in that year. Net Factor Income from abroad is the net export of factor services
equal to Factor Income from abroad less the factor payments of other countries. Factor
payments are for the direct services of resources like the remittances of our overseas contract
workers for labor export. Likewise, profit remittances to the home countries of multinational
companies like Nestle and Procter and Gamble (P&G) represent our payments for importing
their capital and entrepreneurship. These factor payments to other countries represent
additional imports excluded from our GNP. On the other hand, payments for non-factor services
as part of the trade balance (X- M) are for services using all factors (resources) of production.
Profit brought home by a Filipino construction firm for construction services in Saudi Arabia is an
example of a non-factor service export receipt.
However, a better indicator of domestic employment opportunities is Gross Domestic Product
Gross Domestic Product (GDP) is defined as the market value of final products produced within
the country. The resources in the economy include capital and entrepreneurship belonging to
other countries brought to the domestic economy by foreign businesses. In Table 1.1, GDP is
net of GNP after deducting Net Factor Income from abroad or by deducting factor income from
abroad and adding back Factor Payments to other countries. In other words, a negative sign to
Net Factor Income from abroad changes the sign of Factor Income from abroad from positive to
negative and Factor Payments to other countries from negative to positive. The table shows that
Household Consumption is the biggest GDP expenditure (74%) followed by Capital Formation
(19%) led by the construction industry. In other words, our economy mostly produces consumer
goods buildings, and other construction structures. The dominance of household consumption
reflects households' propensity to consume more and save less. On the other hand,
construction is both private investments by the rich and public capital spending by the
government largely financed by borrowings.
 Net Inflow = Inflow-Outflow to Net Inflow = - Inflow + Outflow

GNP/GDP: Income Approach

Another way to account for GNP and classify its components is by resource uses and
contributions that make up the production stages. As basic factors of production, resources
(land, labor capital, and entrepreneurship) add value to products (e.g., leather) as processed
into higher forms (e.g., shoes). If all payments for resource contributions (rent, wage, interest,
and profit) went to resource owners, GNP would simply be the sum of all factor payments from
the raw material to the final product stage. In Figure 1.1, the value of, say, the final product
(P700) is equal to the intermediate product (P300) plus the factor contributions (P400) that
transformed the latter into its final form. Following the arrow directions, the value of the
intermediate product (P300) is from the factor contributions at the intermediate stage (P200)
and the raw material stage (P100). In other words, factor contributions made the raw material
(P100) and the intermediate product (P200) through the value added by factor contributions.
The same logic applies to the final product whose material purchase is a product of factor
contributions from the lower stages. In conclusion, all products and their values are the
contributions of these essential (basic) factors of production.

Table 1.2 presents the Philippine GNP statistics whose components are classified by factor
contribution of the economy's producing sectors. The biggest contributor of GNP is the Service
Sector (48%) serving all industries. Next is the import-dependent Industrial Sector (44%)
providing industrial input across sectors. The smallest sector is Agriculture, Fishery, and
Forestry combined (8%), needing import complements to provide for the food requirements of
the population. Net Factor Income from the rest of the world is factor income apart from the
factor contributions of the sectors. It includes the OFW remittances and transfer payments from
abroad.
 Lesson 1.2. Economics as an Applied Science

Applied Economics is the application of economic theory and econometrics in specific settings
to analyze potential outcomes. As one of the two sets of fields of economics (the other set being
the core'), it is typically characterized by the application of the core, referring to economic theory
and econometrics, as a means of dealing with practical issues in fields that include demographic
economics, labor economics, business economics, agricultural economics, development
economics, education economics health economics, monetary economics, economic history,
and many others. John Neville Keynes is attributed to be the first to use the phrase "applied
economics" to designate the application of economic theory to the interpretation and
explanation of particular economic phenomena.

We should be able to improve human welfare among Filipinos through the investigation and
analysis of economic problems in the real world. Applying economic theory in our lives means
trying to address actual economic issues and be able to do something about it the concept of
scarcity and choice should encourage us as individuals to help in our way to provide solutions to
the country's economic problems.
APPLIED ECONOMICS ABOUT PHILIPPINE ECONOMIC PROBLEMS

A solid understanding of economic principles and how they are applied in real-life situations can
serve as significant tools to help address the country's economic problem. For example,
understanding the existence of scarcity can help Economics students analyze how to maximize
the use of available resources to overcome scarcity. Knowledge of economic theories such as
the Law of Supply and Demand can help in analyzing why prices are high and what the
government can do to help bring down prices.

The Philippines' Basic Economic Problems

The Philippine economy has grown significantly during President Benigno Simeon Aquino's
administration. With a growth rate of the country's Gross Domestic Product of 6.8% in 2012,
improving to 7.2% in 2013, and slowing down to 6.1% in 2014, these rates are an improvement
of past rates preceding President Aquino's term. It is also higher than its Asian neighbors such
as Malaysia, Thailand, South Korea, Hongkong, India, and Indonesia (CIA World Factbook
2013).

Despite this admirable growth, people, especially the poor, have been complaining of non-
inclusive growth. Millions of Filipinos are claiming they experience hunger or they still live below
the poverty level.

Unemployment is still a main problem of the Philippine economy despite improvements reported
by the National Statistics Office. The unemployment rate in the Philippines decreased to 6.4% in
the second quarter of 2015 from 7.0% in the previous year. The Philippines' unemployment rate
average is 8.85% from 1994 until 2015, reaching an all-time high of 13.90% in the first quarter of
2000 and a record low of 6.0% in the fourth quarter of 2014. In July 2015, the Labor Force
Survey (LFS) released by the Philippine Statistics Authority (PSA) showed the country's
unemployment rate at 6.4% or an estimated 2.68 million individuals.

Another significant socio-economic problem in the country is poverty. As reported by the

National Statistics Coordination Board, in 2006, the poverty incidence of the population
registered at 26.4%, 26.5% in 2009, 25.2% in 2012, and 28.8% in the first semester of 2014.

The booming population growth in the Philippines is another basic economic problem that can
be connected to the issue of scarcity. When population becomes the big, economic resources
may no longer be enough to support the growing population. Let us take a look at the bad
population data. According to the 2010 census, the Philippine population stood at 92.3 million.
As of 2014, it has reached more than 100 million- growing by 2% from the previous year and
one of the highest in Asia. The population of the Philippines represents 1.37% of the world's
total population. This is the reason why schoolrooms are not enough for our children who are of
school age. This could also be an explanation for why government hospitals are crowded with
sick people and maternity wards are full of women giving birth with hospital beds that are not
enough to accommodate them. The population issue will be further discussed in Chapter 2.

The country's problems vary with times and circumstances. It is now a challenge for the
students to observe and identify what these problems are.

ASEAN ICON

Lee Kuan Yew (1923-2015) is an economic icon and an example of how a leader of a previously
undeveloped country can overcome its country's basic economic problems and move toward
economic growth.

Lee Kuan Yew was the prime minister of Singapore from 1959 to 1990, making him the longest-
serving prime minister in history. During his long rule, Singapore became the most prosperous
nation in Southeast Asia.
Born in Singapore on September 16, 1923, Lee Kuan Yew became the longest-serving prime
minister in world history. Before Lee rose through the ranks of his country's political system,
Singapore was a poor nation that is mired in debt and plagued by poverty. When he became the
first prime minister of Singapore in 1959, Lee Kuan Yew introduced a five-year plan calling for
urban renewal and construction of new public housing, greater rights for women, educational
reform, and industrialization. In 1962, Lee led Singapore into a merger with Malaysia but three
years later, Singapore left the union for good. Lee resigned as prime minister in 1990 and his
son became the prime minister in 2004. He died on March 23, 2015.

Lee has left behind a legacy of an efficiently run country and as a leader who brought prosperity
unheard of before his tenure, at the cost of a mildly authoritarian style of government and by
imposing discipline among his people. By the 1980s, Singapore, under Lee's guidance, had a
per capita income second only to Japan's in East Asia and the country had become a chief
financial center of Southeast Asia envied by many Asian countries including the Philippines.