Introduction to Applied

Economics

Slides prepared by Leigh Lim

 Definition of Economics
• Economics as a study of wealth
– Utilization of wealth for production and
consumption
• Economics as a study of making choices
– Opportunity cost: forgone benefits of an
alternative when making a choice
• Economics as a study of allocation
– Allocation of scarce resources to answer unlimited
human wants
 Definition of Economics
• Economics as a social science
– As a science, uses scientific method of inquiry
– As a social science, uses the scientific method to
study how society creates its material wealth, how
it make this wealth available to its people with
minimum difficulties and it expands its wealth
• Resources and the study of economics
– Natural resources, Human resources, Physical or
man-made resources
 Definition of Economics
• Resources and the study of economics (cont.)
– Raw materials: inputs of production subject to
further processing and transformation
– Factor inputs: transforming inputs that process
the raw materials and intermediate inputs into
final goods and services
– Resources are limited: time-consuming,
competing uses
 Definition of Economics
• Human wants and economic analysis
– Human wants are differentiated human needs
brought about by differences in income, taste,
environment, socioeconomic status, etc.
• Scarcity as a source of economic problem
– Scarcity: limitation of resources to answer the
expanding human wants
– Economic goals of society: material survival,
stability and growth
– Scarcity vs. Shortage vs. Surplus
 Definition of Economics
• Allocation and the act of economizing
– Allocation: Social mechanism of distributing limited
resources to meet expanding human wants
• Market system as an allocation mechanism
– Market: state where buyers and sellers transact on the
purchase or sale of a good or service
– Price as cost (sacrifice) and benefit (satisfaction)
– The problem of scarcity is addressed through the
changes in price and the corresponding responses of
the buyers and sellers
 Definition of Economics
• Market system (cont.)
– How can the market system address shortage? or
surplus?
– 3 basic economic questions:
– What to produce: increasing prices = high demand
– How to produce: maximize profit by lowering cost
of production
– For whom to produce: allocating a higher
proportion of output to members of a society with
high purchasing power
 Definition of Economics
• Command system as an allocation mechanism
– The state or agency of the government may be in
charge in the allocation of resources by using its
political power in addressing the basic economic
problems of production and distribution
– Used in times of calamities, disasters or national
emergencies when the market system cannot fully
operate
– Used in normal times by totalitarian and socialist
states to pursue industrialization and self-reliance,
dictated by the planning agency of the government
 Definition of Economics
• Tradition in the process of allocation
– Useful in situations where the operation of a
market may not be appropriate or the power of an
organized state has no control over a certain
community
– Uses culture, social norms to temper wants by use
of community pressure and criticisms; resources
are communally owned and distribution is
collectively practiced
– Used by indigenous communities
 Economics as a Applied Science
• Economics is a social science and it deals with
how people interact with one another to
sustain, stabilize and develop the material
dimension of a society
• Many of the principles, laws and theories
developed in economics can be applied to a
number of fields.
 A Framework in Understanding
Decisions using Economic Analysis
• Marginal Benefit – additional benefit derived
from an additional activity
• Marginal Costs – additional cost incurred from an
additional production of a good or service
• MB>MC = Net MB positive = Total Net Benefit
increasing
• MB<MC = Net MB negative = Total Net Benefit
decreasing
• MB=MC = Net MB zero = Total Net Benefit
maximum
Variations in Benefits and Costs due to
Stage of Recognition
• Explicit costs: easily recognized since they are
expressed in monetary terms and may involve
actual financial outlays
• Implicit costs: may not have to incur any
monetary expense; opportunity costs
• Explicit benefits: can be measured in
monetary terms or levels of satisfaction or
utility
• Implicit benefits: non-measureable
Variations in Benefits and Costs due to
Stage of Recognition
• Spacial Dimensions in the Issue of Recognition
– Implicit benefits and implicit costs are harder to
recognize because of the spacial consideration of
the decision maker who may not be aware of the
social or public effect of his actions
– Exclusion of implicit social benefits and implicit
social costs will lead to improper allocation of
resources with its accompanying consequences
Variations in Benefits and Costs due to
Stage of Recognition
• Temporal Dimension in the Issue of Recognition
– Present benefits and present costs are readily
realized while future benefits and future costs
(which are implicit benefits and implicit costs) are
too distant in time to affect the awareness of the
decision maker
– Exclusion of future benefits and future costs will
lead to improper allocation of resources with its
accompanying consequences
Variations in Benefits and Costs due to
Differences in Valuation
• Even if the decision maker recognizes the
implicit benefits and implicit costs of his
action, the differences between marginal
benefits and marginal costs can still persist
• The proper pricing and valuation of these
implicit costs may have an effect on the
optimal decision
Variations in Benefits and Costs due to
Differences in Valuation
• Spacial Dimension in the Issue of Valuation
– Even if the decision maker has recognized the
social benefits and social costs of his action,
various individuals may have different valuation of
these social impacts
• Temporal Dimension in the Issue of Valuation
– Discount rate: rate which a stream of future values
is reduced to make them comparable with present
values
 Economics as an Applied Science
• Social, economic and business issues arise
because of the differences in marginal costs
and marginal benefits
• These imbalances result in the improper
allocation of resources and manifest in various
problems and issues in society
• These are due to the non recognition as well
as the differences in valuing the implicit
components of the benefits and costs
Basic Economic Problems Confronting
the Dev’t of the Phils. in the 21st Cen.
• Poverty and Unequal Distribution of Income
– Absolute Poverty: lack of income to buy the basic
food and necessities for subsistence living
– Poverty Threshold: income needed to purchase
the minimum nutritional requirements and other
basic necessities for daily survival
– Poverty Incidence: proportion of households in
the country with family income lower than the
poverty threshold
Basic Economic Problems Confronting
the Dev’t of the Phils. in the 21st Cen.
• Poverty (cont.)
– Relative Poverty: the structure on how the
national income is being distributed among
households in an economy
– Lorenz Curve: shows the share of the various
household groups on the total national income
– Gini Coefficient: measure of income inequality
derived from the Lorenz Curve
• Perfect equality = 0; Perfect inequality = 1
Basic Economic Problems Confronting
the Dev’t of the Phils. in the 21st Cen.
• Demographic Changes and its Economic
Implications
– Population growth, is it good or bad?
– Economics of Childbirth: looks at the benefits and
costs of having a child
• Low Investment in Human Resource
Development
– Knowledge capital: heavy investments in higher
education, science and technology, and research
and development
Basic Economic Problems Confronting
the Dev’t of the Phils. in the 21st Cen.
• Weak Infrastructure
– How to finance? Borrowing, taxation, public-
private partnership
• Pursuing Food Security
– Food security vs. food self-sufficiency
• Slow Adaptation of Modern Technology
– Labor intensive technology vs. Capital intensive
technology
Basic Economic Problems Confronting
the Dev’t of the Phils. in the 21st Cen.
• Environmental Sustainability and the
Country’s Development Thrust
– The environment is part of natural resources
where we derive income from the utilization of its
wealth.
– However, excessive use of our natural resources
may compromise its ability to provide income and
other benefits in the future.
 Synthesis
• We started with the realization that we live in an
environment of limited resources
• These limited resources must be properly used to give
us the highest level of satisfaction, welfare and net
benefit
• Economics gives us three major mechanisms or systems
of allocating resources
• The tools of applied economics can be used in
understanding socioeconomic and business issues
• The tools of applied economics can also be used in
proposing alternative solutions to socioeconomic and
business problems