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
 Opportunitycost: 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
 Naturalresources, 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
 Forwhom 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
 Usedin times of calamities, disasters or national
emergencies when the market system cannot fully
operate
 Usedin 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
 Manyof 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
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
 Explicitbenefits: 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
 Implicitbenefits 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
 Exclusionof 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
 Theproper 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
 Discountrate: 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
 AbsolutePoverty: 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.)
 RelativePoverty: 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
 GiniCoefficient: 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