MAS PART 4 DISCUSSION

MANAGEMENT SERVICES MODULE four main standards: (1) competence, (2) confidentiality, (3) integrity, and (4)
credibility/objectivity.
1. MANAGEMENT ACCOUNTING
B. Cost terms, concepts, and behavior
Cost terms
A. Objectives, role, and scope of management accounting
✓ Out-of-Pocket Cost – involves an actual outlay of cash
Difference between Financial Accounting and Managerial Accounting
✓ Marginal Costs – the sum of costs necessary to affect a one-unit increase in the
Financial Accounting Managerial Accounting
activity level.
User ✓ Opportunity Cost – the foregone benefit or lost opportunity of the path not taken
Primarily for external users Exclusively for internal users
Perspective ✓ Cost drivers – a “measure of activity”, such as direct labor hours, machine hours,
Monetary and non- monetary beds occupied, miles driven and etc., that is a causal factor in the incurrence of cost
Types of
Financial statements reports such as budgets, an entity.
reports
performance evaluation ✓ Direct Cost – can be easily and conveniently traced to a unit of product or other cost
Guiding What management wants and object.
GAAP
Principles needs ✓ Indirect Cost – costs that cannot be easily and conveniently traced to a unit of
Financial Reporting and Decision-making, planning and product or other cost object.
Purpose
Compliance control ✓ Controllable Cost – costs that can be affected by the efforts of a manager.
Nature of Objective, reliable, and Subjective, relevant and future- ✓ Committed Costs – those that are required as a result of past decisions.
information historical oriented ✓ Discretionary Cost – cost that management decides to incur in the current period to
Periodically (monthly, enable the company to achieve objectives
Frequency Prepared as needed
quarterly, annually) ✓ Manufacturing cost – all cost incurred to produce the physical product
Necessity Mandatory Discretionary or optional ✓ Non-manufacturing cost – all other cost incurred not related to the production of
the physical product.
Roles and Activities of Controller and Treasurer ✓ Relevant cost – has the potential to influence a decision; must be differential and
✓ Controllership is the process by which management assures itself that company incurred in the future
resources are obtained and utilized according to plans that are in line with the ✓ Irrelevant cost – cost that will not influence a decision.
company’s set objectives.
→ A controller is an officer of an organization who is responsible for supervising Cost Behavior
the personnel in the accounting department and for preparing the information ✓ Variable Cost
and reports used in both managerial and financial accounting. → Total Variable Cost increases as Production increases
→ Treasurer, on the other hand, is an officer responsible for raising capital, → Unit Variable Cost is constant regardless of production
safeguarding the organization’s assets, managing its investments, credit policy, ✓ Fixed Cost
and insurance coverage. → Total Fixed Cost remains constant as Production increases
→ Internal auditor is an officer responsible for reviewing the accounting → Unit fixed cost decreases as Production increases
procedures, records and reports in both the controller’s and treasurer’s areas
of responsibility. C. Cost-volume-profit (CVP) analysis
Formula Contribution Margin Ratio (CMR)
✓ A controller, who is primarily concerned with accounting, must not hold at the same ✓ CM per Unit/Selling Price
time the position of a treasure, who is primarily concerned with custody of funds.
PROBLEM
Managerial Accounting as a Career ABC Company incurred the following cost in the production and sale of 10 000 units of its
✓ Certified Management Accountant (CMA) examination - The examination consists main product, product X:
of the following four parts: Economics, Finance, and Management; Financial Direct Materials P15
Accounting and Reporting; Management Reporting, Analysis and Behavioral Issues; Direct Labor 12
and Decision Analysis and Information Systems. Variable Overhead 10
✓ The Certified in Financial Management (CFM) examination is similar to the CMA Variable Selling and administrative Expenses 18
examination with one major difference: the Financial Accounting and Reporting Fixed Overhead 220 000
section is replaced with Corporate Financial Management. Fixed Selling and administrative expenses 88 000
✓ Professional Ethics - The IMA Statement of Ethical Professional Practice contains
 MAS PART 4 DISCUSSION

Required: D. Standard costing and variance analysis

• Determine the contribution margin – P450 000 Direct Materials Direct Labor
• Determine the CM ratio – 45% AP x AQ AR x AH
SP x AQ SR x AH
Formula Breakeven Point SP x SQ SR x SH
✓ BEP (units) = FC / CM per unit
✓ BEP (pesos) = FC/ CMR or BEP (units) x Selling price Manufacturing Overhead (4 way)
VARIABLE FIXED
Formula Required SP, Unit and Peso Sales Actual AVR x AH AFR x AH
✓ Sales (units) for target profit
FC + Desired profit (before tax) / CM per unit BAAH SVR x AH BFC
✓ Sales (peso) for target profit BASH SVR x SH BFC
FC + Desired Profit (before tax) / CMR Standard SVR x SH SFR x SH
✓ Sales (peso) with target return on sales
FC / CMR – Return on sales
PROBLEM
ABC Company has the following standards for one unit of product:
PROBLEM
Presented below are the costs incurred during production: Direct Material: 96 pounds x P7.20 P691.20
Direct Materials P50
Direct labor: 3.6 hours x P20 72
Direct Labor 30
Variable Overhead 40 Variable Overhead: 1.5 hours (MT) x P60 90
Variable Selling and Admin Exp 30 Fixed Overhead: 1.5 hours (MT) x P36 54
Fixed Overhead 400 000
Fixed Selling and Admin Exp 280 000
The predetermined overhead rates were developed using a capacity of 7 200 units per
The products sell for P200 per unit.
year. Production is assumed to occur evenly throughout the year.
Requirement:
During July 2019, the company produced 630 units. Actual data for the month is as follows:
• Determine the BEP in units. 13 600
DM purchased – 64 000 @ P7.10
• Determine the BEP in peso sales P2 720 000
DM used – 60 600 pounds (all from July purchases)
• Assume that the Company wants to earn a profit of P220 000, how many units must
Total Labor Cost – P29 000 for 1 800 hours
it sell to earn this profit? 18 000 units
Variable OH incurred – P52 500 for 960 hours of machine time
• Determine the revenue needed in order for the company to have a profit of P184. Fixed OH incurred – P27 300 for 960 hours of machine time
P3 456 000
• If the company wishes to have a return on sales of 12.50%, determine the target Required:
sales. P 5 440 000 • Direct Materials Price Variance. P6 400 F
• Determine the number of units to be sold in order for the Company to have a profit • Direct Materials Quantity Variance. P864 UF
after tax of P128 000. Assume that the company is subject to 30% income tax rate.
• Labor Rate Variance. P7 000 F
17 280 units
• Labor Efficiency Variances. P9 360 UF
• Variable OH Spending Variance. P5 100 F
• Variable OH Efficiency Variance. P900 UF
• Fixed OH Spending Variance. P5 S100 F
• Fixed OH Volume Variance. P1 620 F
 MAS PART 4 DISCUSSION

E. Variable vs. Absorption Costing G. Relevant costing and differential analysis

Production vs Sales Effect on Inventory Difference in Income PROBLEM: Make or Buy
ABC Manufacturing uses 10 units of Part X each month in the production of Product A. The
Production > Sales Increases AC Income > VS Income
unit cost to manufacture 1 unit of Part X is presented below:
Production < Sales Decreases AC Income < VC Income Direct Materials P1 000
Production = Sales No change AC Income = VC Income Materials Handling (20% of DM cost) 200
Direct Labor 8 000
PROBLEM Manufacturing OH (150% of DL) 12 000
The following data relate to ABC company, a new company Total Manufacturing cost P 21 200
Planned and actual Production 200 000 units
Sales at P48 per unit 170 000 units Materials handling represents the direct variable cost of the Receiving Dept. that is applied
Manufacturing Costs: to direct materials and purchased components based on their cost. This is a separate
Variable P18 per unit charge in addition to manufacturing overhead. ABC’s annual manufacturing overhead
Fixed P840 000 budget is 1/3 variable and 2/3 fixed. XYZ Company, one of ABC’s reliable vendors, offered
Selling and Administrative costs: to supply Part X at a unit of P15 000.
Variable P7 per unit
Fixed 925 000 Required:
There were no variances during the period. • If ABC purchases Part X from XYZ, the capacity ABC used to manufacture these parts
would be idle. By how much would the unit cost of Part X increase or decrease should
Required: ABC decide to purchase the parts from XYZ? Increase by P4 800
• Determine the number of units in the ending finished-goods inventory. 30 000 units • Assume ABC Manufacturing can rent all idle capacity for P25 000 per month. If ABC
• Calculate the cost of the ending finished goods inventory under decides to purchase the 10 units from XYZ Company, by how much would ABC’s
→ Variable Costing. P540 000 monthly cost for Part X increase or decrease? Increase bP23 000
→ Absorption Costing. P666 000
• Determine the company’s variable costing income. P2 145 000 PROBLEM: Accept or Reject a Special Order
• Determine the company’s absorption costing income. P2 271 000 Kamikazee Company is selling its product at P60 per unit. The cost of producing and selling
this product are presented below:
F. Responsibility accounting and transfer pricing
Manufacturing Costs
PROBLEM: Service Cost Allocation Direct Materials P26 per unit
The SM Cinema has two servicing departments (A and B) and two production departments Direct Labor 5 per unit
(X and Y). Services performed by A and B and their usage by other departments are Variable Overhead 1 per unit
presented below: Fixed Overhead 836 000 per month
Service Department Operating Department Selling and administrative exp
A B X Y Variable P1.50 per unit
Fixed 292 000 per month
Direct Cost P400 000 600 000
Services Performed by An order has been received from a customer for 2 400 units at a special discounted price
20% 45% 35% of P45 per unit.
Dept A
Services Performed by
20% 60% 20% Required: Decide whether the Company should accept or reject the special order and
Dept B
determine the minimum selling price for each scenario
Required: Compute allocated cost to departments X and Y using the following method: • The company has excess capacity. Accept; P33.50
• Direct method. P675 000 and P325 000 • The company is operating at full capacity. Reject; P60
• Step Down method (Cost of Dept A is allocated first). P690 000 and P310 000
• Step Down method (Cost of Dept B is allocated first). P625 500 and P347 500 PROBLEM: Continue or Shutdown
• Reciprocal method. P668 750 and P331 250 ABC Company currently has three divisions: A, B, and C. The B division does not seem to
be performing well, and the company's president is considering dropping this line. If it is
dropped, the revenues associated with the B Division will be lost and the related variable
 MAS PART 4 DISCUSSION

costs saved. Also, 50% of the Division B fixed costs would be eliminated. The income shares outstanding
statements, by divisions, are as follows: o Price/Earnings Ratio = stock Market Price/Earnings per Share
Division A Division B Division C Division D o Dividend Yield = Dividend per share/price per share
Sales 550 000 850 000 1 000 000 2 400 000 o Dividend Pay-out
VC (400 000) (720 000) (820 000) (1 940 000) → Common dividend per share/Earnings per share
150 000 130 000 180 000 460 000 → Ordinary share dividends/Net Income
Contribution Margin
FC (100 000) (200 000) (110 000) (410 000)
✓ Liquidity Ratios
Operating profit (loss) 50 000 (70 000) 70 000 50 000
o Current Ratio = CA/CL
o Quick ratio (Acid-test ratio) = Quick Assets (Cash, Short-term Investments
Required: Should the Company discontinue Division B and if it does drop Division B, how and AR)/Current Liabilities
much would profit increase or decrease? No. Decrease by P30 000 o Cash Ratio = (Cash + Marketable Securities)/ CL
o Receivable turnover = Net credit Sales/Average Receivables
PROBLEM: Sell or process further – rework or scrap o Average age of receivables or Days’ sales outstanding = Number of days
A company has 7 000 obsolete toys carried in inventory at a manufacturing cost of P6 per in a year/Receivables’ turnover
unit. If the toys are reworked for P2 per unit, they could be sold for P3 per unit. If the toys o Inventory Turnover = COGS/Average Inventory
are scrapped, they could be sold for P1.85 per unit. o Average Age of Inventory or Days in Inventory = Number of days in a
year/Inventory Turnover
Required: Which alternative is more desirable and what is the total peso amount of the o Days in Operating Cycle = Days in AR + Days in Inventory
advantage of that alternative? Scrap, P5 950 o AP Turnover = Net credit purchases/average trade payables
o Average age of trade payables or Days in Trade Payables = Number of
Days in a year/TP turnover
o Cash Conversion Cycle = Days in Operating cycle – Ave age of Trade
Payables
2. FINANCIAL MANAGEMENT o Current Asset Turnover = (COS + OPEX (exclude non-cash)) /Average
A. Financial Statement Analysis current assets
I. Vertical analysis (Common-Size Financial Statements)
Items are compared vertically, from one account balance against another, and ✓ Solvency Ratios
are typically expressed as percentages to reveal the relative contributions o Debt to Assets = Total Liabilities/Total Assets
made by each financial statement item. o Times Interest Earned = EBIT/Interest Expense
o Debt to equity Ratio = Total Liabilities/Total SHE
II. Horizontal Analysis
It compares information horizontally, from one period to the next, with the B. Working Capital Management
general goal of identifying significant sustained changes. I. Working capital investment and financing policies
Formula = (Current year – Base year)/Base year ✓ Financing Policies
o Moderate Approach – Matching Assets and Liabilities maturities
III. Financial Ratios o Aggressive Approach – Financing of some of its permanent assets
✓ Profitability Ratios (current and fixed) with short-term debt.
o Net Profit margin or return on Sales = Net Income/Net Sales o Conservative Approach – Long-term capital is used to finance all the
o Return on total sales = Net Income/Average total assets permanent assets and to meet some of the seasonal needs (temporary
o Return on Equity current assets)
→ Net Income/Average Shareholders’ Equity
→ Profit Margin (net income/sales) x Total Asset Turnover II. Cash and marketable securities management
(sales/average total asset) x Equity multiplier (Average total Cash and Short-term investments are crucial to a firm’s continuing success. Sufficient
assets/average total equity) liquidity must be available to meet payments as they come due. At the same time,
o Gross Profit Percentage = (Net Sales – COGS)/Net Sales liquid assets are subject to significant control risk. Therefore, liquidity and safety are
o Fixed Asser Turnover = Net sales/Average Net fixed asset the primary concerns of the treasurer when dealing with highly liquid assets. Cash
o Earnings per share = Net Income (for common shares)/Ave # of common and short-term investments are held because of their ability to facilitate routine
operations of the company.
 MAS PART 4 DISCUSSION

✓ Types of Float → Interest rate risk – the risk that the price of the securities would
o Positive Float (Disbursement float) – occurs when the bank balance fluctuate due to changes in the market interest rates
exceeds the book balance, such as when checks issued by the firm are → Inflation risk – the risk that inflation will reduce the “real value” of
already delivered to the supplier but the same have not yet been cleared the investment
by the bank.
o Negative Float – occurs when the book balance exceeds the bank C. Capital Budgeting
balance. It shows that there is more cash tied up in the collection cycle. Capital Budgeting is concerned with long-range decisions, such as whether to add a
This type of float should be decreased or if possible, eliminated. product line, to build new facilities, or to lease or buy equipment.

✓ Cash Management Strategies Two Types of Capital Investment Decision

o Accelerate Cash Collection ✓ Screening Decisions – whether the capital investment meets the minimum criteria
Bill customers promptly; Offer cash discounts for prompt payment; use set by the company. This is often used to narrow down a set of projects for further
of lockbox system; establish local collection office; ask customers to consideration
make direct payments to the firm’s depository bank; use of automatic ✓ Preference decision – evaluate and compare more than one capital investment
fund transfer or electronic fund transfer alternative since companies may have limited capacity to invest in all the project
o Control or Slow down cash disbursement alternatives.
Stretch payables; maintain zero-balance accounts; less frequent payroll
and schedule issuance of checks to suppliers I. Capital investment decision factors
o Reduce the need for precautionary cash balance 1. Net Investment – cost or cash outflows less cash inflows or savings incidental
More accurate cash budgeting; have ready lines of credit; invest idle cash to the acquisition of the investment projects.
in highly liquid, short-term investments instead of holding idle 2. Cost or Cash inflows:
precautionary cash balances a. Initial cash outlay for all expenses on the project up to the time when it
is ready for use, such as purchase price and incidental project-related
cost (freight, insurance, taxes, etc)
✓ Cash flow management b. Working capital requirement to operate the project at the desired level
o Cash Break-even chart – similar to basic knowledge on break-even c. Market Value of an existing, currently idle asset, which will be transferred
analysis. The chart would show the amount of sales in pesos or the to or be utilized in the operations of the proposed capital investment
number of units to be sold so that the total cash inflows would equal total project
cash outflows. 3. Savings or cash inflows:
o Baumol Cash Management Model – an EOQ-type model which can be a. Trade-in value of old asset (in case of replacement)
used to determine the optimal cash balance where the costs of b. Proceeds from the sale of the old asset to be disposed of (less applicable
maintaining and obtaining cash are at the minimum. tax in case there is a gain on sale, or add tax savings, in case there is a loss
on sale)
✓ Marketable Securities Management c. Avoidable cost of immediate repairs on old asset to be replaced, net of
o Are those short-term money market instruments that can be easily tax
converted into cash 4. Cost of Capital – the cost of using funds. It is the weighted average rate the
o The company may hold marketable securities because company must pay to its long-term creditors for the use of their funds. It is also
→ It would serve as a substitute for cash balances known as the hurdle rate.
→ It would serve as a temporary investment that yields return while
funds are idle
→ It is need to meet known financial obligations SAMPLE PROBLEM – ABC Company is considering purchasing a new machine to replace
o The return on marketable securities is the opportunity cost of idle cash an old one used in production. The new machine would cost P2 480 000. Details regarding
i.e., the return that cash could be earning if it were invested at the market the old machine were provided for decision-making:
rate rather than held in a noninterest bearing account. This return is the • The cost of the machine was P1 488 000, which had a useful life of 10 years and was
denominator of the optimal formula provided in the Baumol cash already used for 7 years;
management model. • Much-needed repairs amounting to P310 000 will be incurred if the company does
o Risks involved: not sell.
→ Default risk – the risk that the issuer may not be able to pay the • If the machine is sold, the proceeds would amount to P446 400. The company is
interest or principal on time or at all subject to a 30% income tax.
 MAS PART 4 DISCUSSION

a. What is the Net Cost of Investment for Decision-making purposes? ✓ A decrease in operating leverage would cause an increase in optimal amount
(2 480 000 – [(310 000 – (310 000 x 30%)) + 446 400] = P1 816 600 of financial leverage
b. Assume that the proceeds from the sale would only amount to P300 000, ✓ A decrease in operating leverage would result in a decrease in the optimal
determine the net cost of investment for decision making. amount of debt.
2 480 000 – [(310 000 – (310 000 x 30%) ✓ Degree of total leverage = DOL x DFL
+ [300 000 + ((446 400 – 300,000 x 30%)]
= P1 919 080 III. Other terms
✓ Forward contract – an executory contract in which the parties involved agree
D. Risks and leverage to the terms of a purchase and a sale, but performance is deferred.
I. Types of risks ✓ Futures contract – entered into as either a speculation or a hedge. Prices are
✓ Business Risk – the risk a firm’s common shareholders would face if the firm marked to market every day at the close of the day; thus, the market price is
had no debt. It is the risk inherent in the firm’s operations, which arises from posted at the close of business each day
uncertainty about future operating profits and capital requirements. ✓ Speculation – involves the assumption of risk in the hope of gaining from price
✓ Financial Risk – the additional risk placed on the common shareholders as a movements.
result of the decision to finance with debt. ✓ Hedging – is the process of using offsetting commitments to minimize or avoid
✓ Market Risk – the risk that changes in a stock’s price will result from changes the impact of adverse price movements.
in a stock market as a whole. Commonly referred to as non-diversifiable risk.
✓ Liquidity risk – the possibility that an asset cannot be sold on a short notice for E. Capital Structure
its market value. If an asset must be sold at a high discount, it is said to have a ✓ Capital – refers to investor-supplied funds comprising debt, preferred stock,
substantial amount of liquidity risk. common stock, and retained earnings.
✓ Political risk – the risk that a foreign government may act in a way that will ✓ Capital Structure – the percentage of each type of investor-supplied capital, with
reduce the value of foreign currencies the value of the company’s investment. the total being 100%. It is the mix of the long-term sources of funds used by the firm.
It may be reduced by making foreign operations dependent on the domestic ✓ Optimal Capital Structure – the mix of debt, preferred stock, and common equity
parent for technology, markets and supplies. that maximizes the stock’s intrinsic value. Note that the capital structure that
✓ Exchange rate risk – the risk of loss because of fluctuations in the relative value maximizes the intrinsic value also minimizes the WACC.
of foreign currencies. ✓ Equity Financing – retained earnings may be used to pay common cash dividends or
✓ Security risk – the risk of a single stock, whereas portfolio risk is its risk if it is be plowed back into the firm in the form of additional capital investment through
held in a large portfolio of diversified securities stock dividends.
✓ Company risk – the risk inherent in a particular investment security. Also ✓ Hybrid Financing – sources of funds that possess a combination of features; these
known as unsystematic risk or diversifiable risk. include preferred stock, leasing, and option securities such as warrants and
✓ Interest rate risk – the risk that an investment security will fluctuate in value convertibles.
due to changes in interest rates.

II. Degree of operating, financial, and total leverage

✓ Leverage – refers to that portion of the fixed costs which represents a risk to
the firm.
✓ Operating leverage – refers to the fixed operating costs found in the firm’s 3. ECONOMIC CONCEPTS
income statement. The higher the firm’s operating leverage, the higher its A. MACROECONOMICS
business risk, and the lower its optimal debt ratio. ✓ Economics – a social science that analyses the most efficient way to use our scarce
Formula: Degree of Operating leverage resources.
= Contribution margin/Earnings before interest and taxes ✓ Scarcity – revolves around the concept of unlimited wants but with limited
resources.
✓ Financial Leverage – refers to financing portion of the firm’s assets, bearing ✓ Opportunity cost – most desirable alternative given up when you make a choice
financing charges in hopes of increasing the return to the common
shareholders. The higher the financial leverage, the higher the financial risk, I. Three Major Economic Goals
and the higher the cost of capital. ✓ Promote Economic Growth
Formula: EBIT/EBIT – interest expense o The most important concept to answer economic growth is Gross Domestic
Product (GDP). GDP is the peso value of all final goods and services produced
✓ Total Leverage – the measure of total risk within a country’s borders in one year,
 MAS PART 4 DISCUSSION

o GDP Calculation II. fiscal and monetary policies

→ Expenditure approach ✓ Fiscal Policy – government action, such as taxes, subsidies, and government
GDP = Consumption expenditures + Investment setting, designed to achieve economic goals and can either be:
+ Government Purchases + (Exports – Imports) o Expansionary Fiscal Policy – laws that reduce unemployment and
→ Income Approach – add up all the income that resulted from selling all increase GDP
the final goods and services produced in a year o Contractionary Fiscal Policy – laws that reduce inflation and decrease
GDP = Rent + Wages + Interest+ Profit GDP
✓ If a government collects more in taxes than it spends, it has a budget surplus;
o Real GDP vs Nominal GDP if a government spends more than it collects in taxes, it has a budget deficit.
→ Real GDP – the price of all goods and services produced by the company ✓ Monetary Policy
at price level adjusted (constant) prices; adjust for inflation; best measure o Changing interest rates and the amount of money in the economy is
of economic growth called monetary policy; these actions, done to counter inflation, are
→ Nominal GDP – the price of all goods and services produced by a under the control of the Bangko Sentral ng Pilipinas.
domestic economy for a current market price; measured in current prices o Contractionary Monetary Policy – decrease in the supply of money
hence, does not account for inflation from year to year. causes money in the nation’s banking system to become more scarce
causing the interest rates in the economy to rise.
o Net Domestic Product (NDP) = GDP minus depreciation o Expansionary Monetary Policy – an increase in the supply of money puts
o Gross National Product downward pressure on the equilibrium interest rate.
→ Total and final output of land, labor, capital, and entrepreneurial ability
produced by the country’s citizens, produced whether inside the country III. foreign exchange rates
or elsewhere abroad. ✓ Factors influencing exchange rates – as with any other market, the exchange
rate between two currencies is determined by the supply of, and the demand
✓ Limit Unemployment for, those currencies. In general, the following factors will affect the exchange
o Unemployment – workers who are actively looking for a job but are not rate of a particular currency:
working. o Inflation tends to deflate the value of a currency because holding the
→ Frictional Unemployment – temporary unemployment or being currency results in reduced purchasing power
between jobs. This occurs because individuals are forced or o Interest rates – if interest returns in a particular country are higher
voluntarily change jobs. relative to other countries, individuals and companies will be enticed to
o Structural Unemployment – changes in the labor force make some skills invest in that country.
obsolete. These workers do not have transferable skills and these jobs o Balance of Payments – used to refer to a system of accounts that catalogs
will never come back. the flow of goods between the residents of two countries.
o Cyclical Unemployment – caused by a recession. As demand for goods o Government intervention – the central bank of a country may support or
and services falls, demand for labor falls, and workers are fired depress the value of its currency.
o Other factors – political and economic stability, extended stock market
✓ Keep Prices Stable (Limit Inflation) rallies, or significant declines in the demand for major exports.
o Inflation – rising general level of prices and it reduced the purchasing
power of money. B. MICROECONOMICS
o Causes of Inflation I. Concept of and factors affecting demand
→ Demand-Pull Inflation – occurs when aggregate spending exceeds ✓ Law of Demand
the economy’s normal full-employment output capacity. (example: o There is an inverse relationship between price and quantity demanded.
because labor is short – companies bid up price and inflation occur) Demand is the quantity of a good or service that consumers are willing
→ Cost-Pust Inflation – occurs from an increase in the cost of and able to purchase at a range of prices at a particular time.
producing goods and services. It is usually characterized by o Graphically, a demand curve shows an inverse relationship between
decreases in aggregate output and unemployment because price and quantity demanded, i.e., less products are demanded at higher
consumers are not willing to pay inflated prices. prices.
o Deflation – decrease in price levels. o The substitution effect – refers to the fact that as the price of a good
falls, consumers will use it to replace similar goods.
o The income effect – this refers to the fact that as the price of a good falls,
consumers can purchase more with a given level of income.
 MAS PART 4 DISCUSSION

o The law of diminishing marginal utility – an individual demands a price at which all the goods offered for sale will be held (i.e., quantity
particular good because of the utility he or she receives from consuming demanded = quantity supplied). The equilibrium price is the price at which the
it. The more goods an individual consumes, the more total utility the demand and supply curve intersect.
individual receives. This provides that the marginal utility from ✓ Price Ceiling – a specified maximum price that may be charged for a good. If
consuming each additional unit decreases. the price ceiling is set for a good below the equilibrium price, it will cause a
good shortage because suppliers will devote their production facilities to
✓ Demand Curve shift producing other goods.
o A demand curve shifts when demand variables other than price change. ✓ Price floor – a minimum specified price that may be charged for a good. If the
o Factors that affect the demand other than its price: price floor is set for a good above the equilibrium price, it will cause
→ Expectations of price increases overproduction and surpluses will develop.
→ Consumer income and wealth ✓ The Law of Diminishing Marginal Returns – as variable resources are added to
→ Consumer tastes fixed resources, the additional output produced from each additional worker
→ Size of the market will eventually fail.
→ Group boycott
✓ Elasticity – measures the sensitivity of demand to a change in price. IV. Market Structures
Formula: Elasticity of Demand = Percentage Change in Quantity Number of Type of Control Over Conditions of
Market
Demand/Percentage Change in Price Producers Product Price Entry
o Elasticity of demand>1 = sensitive to a change in price
Pure Virtually None
Large Very Easy
✓ Price elasticity is an important concept because if demand is elastic, an Competition Identical (Price Takers)
increase in sales price results in a decrease in total revenue for all producers. Monopolistic Relatively
✓ Income elasticity measures the change in the quantity demanded of a product Differentiated Limited Low Barriers
Competition Large
given a change in income.
✓ Marginal propensity to consume – describe how much each additional dollar Few Identical or Limited or High Barriers
Oligopoly
in personal disposable income a consumer will spend (Less than 10) differentiated Wide to Entry
✓ Marginal propensity to save – percentage of additional income that is saved.
✓ MPC plus MPS is equal to one. Pure Wide
One Unique Blocked
Monopoly (Price Makers)
II. Concept of and factors affecting supply
✓ Law of Supply
o There is a direct relationship between price and quantity supplied. It is
upward sloping. The curve shows the amount of a product that would be
supplied at various prices. The higher the price the more products that
would be supplied.

✓ Supply curve shift

o Occurs when supply variables other than price change.
o An increase in the number of producers will cause an increase in the
amount of goods supplied at a given price
o As production costs go up fewer products will be supplied at a given price
o Government subsidies reduces the production cost of goods and
therefore, increases the goods supplied at a given price

✓ Elasticity of Supply
o Measures the percentage change in the quantity supplied of a product
resulting from a change in the product price.

III. market equilibrium

✓ A product’s equilibrium price is determined by demand and supply. It is the