Topic V: Economics

Microeconomics
Economics – “Household Management”, and is applied as either:
a. Positive Economics – It is a study of the Status Quo and is Objective in nature
b. Normative Economics – It is an economic study of Proposals of what ought to be and supposes
Subjective evaluations of the economic environment.
In a nutshell, Economics is concerned with reconciling unlimited wants with limited resources.
Therefore, it is about Satisfying wants and needs, i.e., Giving a person goods and services. Goods and
Services come from economic resources which are also called the means of production
Capital Anything man-made used for making man’s work easier. This is NOT FINANCIAL
CAPITAL, rather it is more akin to Invested Assets (Properties, Inventory, etc.)
Entrepreneurship Capacity to take risks, innovation, strategy, management skill, intrinsic
Land Anything derived from nature, broadly, anything that could exist without man.
Think Land and Wasting Assets.
Labor Time and Manpower
Scarcity – is Humanity’s realization that apparently, unlimited wants cannot possibly match limited
resources; “no one has everything”. It is dubbed as the main problem of economics.
Solutions:
Determining needs wisely – Demand Using resources efficiently – Supply
• What to produce – What goods are needed? (Consumer Goods, Capital Goods, Essential Goods,
Luxury Goods, Economic Goods, Free or Government Goods)
• How to produce – How much is needed? What’s it worth? How to make it? How much can we make?
• For whom to produce – Who needs it? How to deliver the goods?
Economic Functions and Activities
• Production – creating goods or services for supply of the economy
• Allocation – determining to whom a good should be given to
• Distribution – delivering the goods or services to those demanding the good
• Exchange – a form distribution where those who demand a good give something in return to those
who supply the good demanded
• Consumption – the end goal of all goods or services where the need or want is satisfied
Economic Systems
Who makes the decisions to answer those questions?
• Traditional System - choices are decided by past events, past generations
• Command Economy - choices are decided by a powerful or influential person or institution
• Market Economy - choices are decided by people who participate in trade.
• Mixed Economy - a mix of controls each institution or participant in a society or economy has over
the actions in an economy.
Trade
Trade is where two entities decide that whatever resources they receive from the other are enough to
cover the cost of giving up what they had originally. It is assumed that upon trade, both parties believe
they made the best, optimum choice for themselves.
• Trade-offs and Opportunity Cost – Scarcity forces entities to make decisions, and to make the
most out of those decisions.
• Absolute advantage – No other economy can produce a good that another possesses or produces
• Comparative advantage – Other economies find it difficult to produce a good that one may
already produce so well and efficiently
This means that economy can choose to no longer make trade-offs on its own if it could simply buy it a
lot cheaper from a country that produces it more efficiently, in exchange of what I could produce a lot
cheaper itself. On a macro-perspective, there is always something to gain in Comparative Advantage,
which is why it is preferred over Absolute Advantage.
• Specialization is the Focus on developing a good or service; it is the main driver of advantage.
Production Possibilities
The decision to
trade-off a good for
another determines
which areas an
economy has an
advantage. One good
at manufacturing
may not be so good at
delivering services,
hence it may devote
more resources to
manufacturing and
compensate the
demand for services
by outsourcing from
another that is more
specialized to deliver
that service.
Demand, Supply, Price, and the Market
Market – Where economic participants weld into one lump that decides for the economic questions of
the entire economy. Rather than as a singular entity, it is rather a force resulting from the individual
actions of demand (Consumers) and supply (Suppliers)
Law of Demand: Demand Increase implies a Price fall
• Demand – is the quantity of goods or utils required by consumers. It is expressed as a downward
slope in relation to the price or compensation for the goods required. It is important to bear in
mind, that price or more aptly, money, is also a resource. The consumer’s capacity to earn and
save is its ‘production possibility’ which will be used to trade-off for satisfying one of its needs.
• Diminishing Marginal Utility – The usefulness of a good will eventually come to a point such that
spending an additional peso for a good will not yield as much utils as it once had. An individual
already satisfied will no longer need to consume the same resource at the same level as it may
have once did.
Indifference Curve Marginal Utility and Total Utility

The indifference curve shows the utils a Marginal utility is the additional product
consumer has between two goods a consumer consumes to satisfy a need
• Non-price determinants of Demand:
Disposable Income or Savings Shift to the Right or Increases total Demand
Increases in the Price of Substitutes Shift to the Right or Increases total Demand
Increases in the Price of Complements Shift to the Left or Decreases Demands
Prices are expected to rise Shift to the Left or Demand Increases today
Increases in the Population Shift to the Left or Demand Increases
Improvements in Quality Shift to the Right or Increases total Demand
Favorable Preferences Shift to the Right or Increases total Demand
Law of Supply: Supply increase implies a price hike
• Supply – Quantity of goods that suppliers are willing and able to sell. It is upward sloping to
reflect the Supplier’s interest in generating profits. Any supplier will be rightly compensated for
each unit of production. A productive supplier will have each unit of cost compensated by price.
• Diminishing Marginal Returns – Every supplier will encounter a point in production where the
cost of producing an additional unit eventually exceeds the marginal revenue realized from
selling the same unit. Usually, suppliers have a variable factor to production and a fixed factor;
returns will begin to diminish when productivity from variable factors and can no longer be
supported by the fixed factor of production in the short-run. For instance, there are too many
bakers and too few ovens to make bread efficiently.
• Law of Increasing Marginal Cost – as production capacities increase, the per unit cost of
increasing supply increases cost marginally the consideration of the both above will lead to
Cost Minimization.
Total Product is the actual total production for a
unit of input (i.e., labor) It will never go
negative nor will it decline further. However, it
tends to approach a maximum amount.

Average Product is the actual total production

divided by the units of input. It also will never go
negative, but it is exhibited to decline.

Marginal product is the additional units acquired

for additional units of input. It is exhibited to be
able to be negative and be able to decline once
the maximum point is reached.

As long as Average Product is less than Marginal

product, the total cost will rise. If the Average
product is more than the marginal product, the
total cost will begin to slow down and approach
its maximum amount. (Maximum Total Cost is
where the Marginal Cost intercepts the x-axis.
Non-price determinants of Supply
Producer is motivated to produce Supply shifts to the Left or Increase in total Supply
Technology Improves Supply shifts to the Left or Increase in total Supply
Increase in Competitor’s prices Supply shifts to the Left or increase in total Supply
Increase in Complement’s prices Supply shifts to the right or decrease in total supply
Unfavorable Natural Phenomena Supply shifts to the right or decrease in total supply
Tighter Competition Supply shifts to the left or increase in total supply
Taxes and Strict regulation Supply shifts to the right or decrease in total supply
Elasticity
It is the extent to which price changes with respect to the changes in supply, demand, or any other
factor, it is typically the slopes of the demand and supply curves for context.
∆𝑌 In a nutshell, elasticity can be the sensitivity of any variable given any changes in another
𝑦̅ variable. In this case, ∆𝑌 depicts the difference between two values of either x or y; and 𝑦̅
∆𝑋 depicts the average of the two given values. Do note that the values in both X/Y are absolute.
𝑥̅
• Y is said to be elastic relative to X if the formula returns an amount larger than 1
• Y is said to be inelastic relative to X if the formula returns an amount less than 1
• Y is unitarily elastic with X if the formula returns an amount equal to 1
• Perfect elasticity is represented by a horizontal line, while perfect inelasticity is represented by
a vertical line
Market Equilibrium
Market Equilibrium – The best price for a good is determined by the market’s participants; it is where
Demand & Supply intersect.
Government may intervene and influence Market Equilibrium through Taxes, Subsidies, & Rationing
• Price Ceilings – A Specified Maximum Price charged which cause shortages
• Shortages – Suppliers devote resources to produce other goods since they anticipate making less
profit and volume with Price Ceilings imposed
• Price Floors – A specified Minimum Price charged which cause surpluses
• Surplus – Suppliers devote resources to the goods in question since buyers are forced to buy not
below the minimum price
• Externalities
o Describes damages to production of goods (i.e., Pollution, Competition, etc.)
o Imposing a tax too high will result in a Deadweight Loss, due to a price floor that appears
above the Market Equilibrium point
Costs of Production and Cost Behavior
Cost Formula Alternative Formula
Total Cost FxC+VC Average TC * Qty
Variable Cost TC – FxC Average VC * Qty
Fixed Cost TC – VC Average FxC * Qty
Marginal Cost TC/Qty TVC/Qty
Average TC TC/Q AfxC+AVC
Average VC VC/Q ATC-AfxC
Average FC FxC/Q ATC-AVC
Marginal Revenue SP/Qty -
Short-run Cost Behavior

Long-run Cost Behavior

Economies of Scale – When long-run average costs
fall. Expansion is cheapening since fixed costs are
absorbed. This phase is described as entry.

Constant Returns to Scale – Peak Efficiency is

reached and Fixed Costs can no longer be
reduced. This phase is described by competition.

Diseconomies of Scale – When long-run average

costs begin to rise and the production becomes
too inefficient to pursue. This phase is described
by obsolescence.
Market Structures
Market Producers Products Control Entry Demand Curve
Pure Competition Many Virtually Price Very Easy Firm – Horizontal
Identical Takers Market – Downwards
Monopolistic/Imperfect Many Differentiated Limited Low Firm – Downwards
Competition Barriers
Oligopoly Few May be Limited or High Firm – Kinked
Identical or Wide Barriers
Differentiated
Pure Monopoly One Unique Price Blocked Firm - Downward
Makers
Monopsony Many; one Identical Price High **Supply Curve;
buyer Takers

Perfect Competition – described

by a perfectly elastic price. In the
Short-run, it has minimal profit;
in the Long-run it has zero profit.

Monopolistic Competition – The

goal of the competition is to
achieve monopoly; hence, profits
incentivize entry while losses
encourage exit.

Oligopoly – Producers tend to

cooperate to set prices. There
are substantive economies of
scale and significant barriers to
entry. Competing suppliers cause
the kink in the demand curve,
and will cause prices to be
inelastic, hence, Prices are
inflexible in the longterm.

Pure Monopoly – described by

patenting, and stringent
licensing. Though a monopoly
makes the price, it must set them
low to preserve order. As long as
MR > MC, a monopolist will drop
prices.
Cartels – the coordination of suppliers in fixing prices
• This is typically not allowed, or at least, is heavily regulated by the Philippine Competition
Commission and Department of Trade and Industry.
Collusion – a non-compete agreement among suppliers
• Any non-competition agreement is typically discouraged as it has the potential to disrupt
competition (that is beneficial to society). Although regulations must strike a balance to
preserve intellectual property rights and privacy rights with social benefit.
Macroeconomics
Macroeconomics is the branch of economics concerned with performance, structure, behavior, and
decision-making of an economy as a whole.
• Circular Flow of Income - Institutions and key players in a market depend on each other to make
income. In this case, therefore, one entity's income is another's expenditure.
• Wealth - the total value of material things which possess economic value; these are tangible
goods or assets
• Claims of Wealth - the Financial Value of an asset; these are intangible assets such as
receivables, notes, and treasury bills and investments, which may also include equities.
• Income - productive activity. Rewards for production; rewards for utilizing economic means.
Flows of income create stocks of wealth the Stocks of wealth then also increase if Income is
increasing, or spending is decreasing. Upon use or consumption, on the other hand, wealth
decreases.
• Savings – The excess of the flow of income over consumption; it is the net inflow of wealth.
Economic Activities and Value-adding
• Among Business Firms, there are those that extract raw materials from Nature. Which then sell
them to Processors, which will then sell these half-finished goods to a Retailer. Retailers then
sell to Final Consumers. Every step in the process implies an increment in price of the Goods.
• This increment is drawn out from the utility of the Economic means of production. For goods to
be sold when they are needed, continuous selling is required. To reward this process, values
must be added to the new goods.
a. This implies that, the value of the good is as valuable as the Investment plus the
Consumption; hence in an economy, Income exactly should match Expenditure
b. In this case, the value of a good is counted only in its final form or as a Final Good.
Output = Expenditure = Income = Added Value
Outflow and Inflow
Realistically, an economy is not composed of only businesses and households, it is also composed of
governments, financial institutions, and its interactions with the international community; a nation tends
to save; and that some of the income flowing is not returned as immediately as they should
Effects:
1. Household savings go to banks as leakages out of the flow (if income meets consumption, any
excess is stored in banks). which will circulate back as injections via investments.
2. Firms and households pay taxes to government which leak money out of their own flow of
resources; the government will inject money via government expenditure/saving.
3. Firms and households also tend to buy imports which takes pesos out of the flow and into a
foreign country's own circular flow. As pesos are drawn out, this will theoretically be returned
as exports as other countries tend to buy our products as well because it's cheaper.
National Income Accounting
Income = Consumption = Y = C + I + G + (X-M)
All goods and services cannot be measured relatively. They have to follow a standard of Valuation, which
is the Fair Market Value, or Fair Value, or Market Value
Assumptions on National Income Determination
Aggregate Expenditure implies Aggregate Demand
a. Excess Capacity - When abnormally higher levels of demand are observed because of higher
income, output, expenditure, and added values, there is a possibility to increase overall
production, and thus, demand.
b. Prices are held constant - If demand increases due to increases in output and income, this
implies the efficient use of resources in theory. Macroeconomics assumes that if this is the case,
then prices have not been affected. Costs stay the same.
 c. There is a tendency towards Equilibrium - In a perfect economy, Aggregate Demand will always
match the output a nation report. Implying that Spending is always matched by Income at all
levels, this returns a graph that is perfectly bisected by a 45-degree angle.
d. Equilibrium implies that the Sector has planned its spending and that it has forecasted the income
it needs to match its spending.
e. The consumption function is the actual degree of consumption an economy attempts to control.
f. The Intersection of the Equilibrium Line and the Consumption Function is where savings begin to
accumulate. Before the equilibrium point is reached, savings are negative.
g. Marginal Propensities are rates at which spending or saving money the sector follows.
h. All Leakages should Equal All Injections (SAVINGS + IMPORTS = TAXES + EXPORTS)
i. TAXES, IMPORTS, SAVINGS all relate to INCOME at a certain rate.
j. At Full-Employment, or MAXIMUM CAPACITY, there is no longer Equilibrium; instead, a
Perpendicular Line to Income is generated. This is when Output no longer Increases, but
Expenditures continue to rise.
k. Inflationary Gaps are those changes in consumption that cannot be traced to productivity
a. Shifts Upward in Aggregate Spending Imply an Inflationary Gap
b. Shifts Downward in Aggregate Spending imply a Deflationary Gap
Approaches in National Income Accounting
Expenditure Approach – How each sector spends its stock of wealth will determine the overall income
of the economy.
• Final Consumption of Goods and Services
• Gross Domestic Investments (Private Construction, Inventories)
• Government Goods and Services (Public Construction)
• Net Exports
• The Expenditure Approach does not include disposals of securities and claims of wealth
Industrial Origin Approach – Determining income based on what type of industry produces these goods
or services (Agriculture Fisheries Forestry, Mining, Service, etc.)
• Consumption Goods – anything readily consumable.
• Investment Goods – goods used in production (a.k.a. Gross Private Domestic Investment)
• Public Goods and Services
• Net Exports/Imports - Any transaction that facilitates exchange between two countries
• Net Factor Income from Abroad - Earnings from OFW’s (Remittances, Repatriations to foreign
factors of production)
Agriculture, Aquaculture and Forestry XX
Mining and Quarrying XX
Manufacturing XX
Construction XX
Transportation, Communication, Utilities, and Storage XX
Commerce XX
Service Industry XX
Net Domestic Product XX
Net Factor Income from Abroad XX
Net National Product XX
Indirect Taxes XX
Depreciation Allowance XX
Gross National Product XX
Income Approach – National income may also be determined based on the income earned by all
participants in an economy.
1. Factor income of persons
Salaries and Wages – direct pay for labor Profits and Dividends – returns on investment/risk
Rents – use of land/spaces Interest – returns on financial assets/claims
 2. Government Income from Capital – Income from Government Corporations:
Income Tax Estate/Donor’s Tax Percentage Tax Local Taxes Fees, Licenses, Duties, & Tolls
3. Undistributed Corporate Income or Retained Earnings - earnings not assigned to funds, etc...
4. Indirect Taxes – All taxes that could be shouldered by consumers but are eventually paid by firms
(VAT, Local Amusement Tax, etc...) Net of Subsidies or Tax Credits
5. Depreciation Allowance – This is considered Income because Allowances allow further
recognition of stocks of wealth as if these were as good as new (this is because depreciation had
already been charged against overall consumption and retained earnings.)
Factor Income of Persons (Within and Abroad) Depreciation Allowances
Salaries and Wages XX are added because these
Profits and Dividends XX are estimates and can be
Rents XX far from reality of actual
Interest XX XX wear and tear. We could
use Net Domestic Product
Government Income from Capital XX
only if these would
Unappropriated Retained Earnings XX create reliable measures
Indirect Taxes, net of Tax Credits and Subsidies (or Value-add) XX of consumption. Hence
Depreciation Allowance or Capital Consumption Allowance XX the preference toward
Gross National Product XX Gross National Product.

This graph shows the sources of income or

injection function an economy has, in contrast to
perfect equilibrium of income and consumption.
The differences in consumption from each sector
of the economy reflect inflationary gaps and the
multiplier effect in Keynesian Economics.
• “C” represents the general consumers
• “I” represents Investment spending
• “G” represents government intervention
• “X-M” represents net exporting and trade
advantage
This graph shows the leakage function of an
economy. It also reflects the multiplier effect in
terms of the MPS.
• The function of S+T+M represents the leakages
in the economy in the form of Savings, Taxes,
and Imports
• Only upon matching minimum cost & inflation
premium will savings start to increase.

Gross National Product

GNP – Gross National Product – Total Market Value of all goods and services produced by the economy
in each period of time
GDP – Gross Domestic Product – Total Market Value of all goods and services within Philippine Territories
Problems with using GDP
1. Transactions that are useful, but do not appear in the market such as Housewives labor, unaccounted
profits of Small, Micro Business Entities, etc..., are not reflected in the GDP.
2. Some goods and services cannot be naturally accounted for personal use of crops by a farmer,
landlord's own payment for renting space in his own home are not reflected in GDP
3. Illegal, and even unregistered activities are not accounted for in GDP
4. GNP is hard to appreciate without a reliably normal base year. GNP on the current year is not
reliable, and does not reflect effective growth
**GNP per CAPITA = current output theoretically available for each person in society
Value-added Approach
• Mainly done to avoid double-counting GDP, considering only Value-adding costs at each stage
from Extraction or Agriculture to Distribution, and redistribution up to final consumption.
Income from Stage 1
Value Added by Material Supplier XX
Wages and Salaries XX
Rents XX
Interest XX
Profits XX XX
Income from Stage 2
Value Added by Manufacturers XX
Income from Stage 3
Transportation XX
Wholesale XX
Resale XX XX
Value Added by All Sectors XX
Depreciation Allowance XX
Indirect Taxes XX
Gross National Product XX
Consumption and Income
Average Propensities to Consume or Save: How much of which you earn is spent/saved?
Average Propensity to Consume Total Consumption over Total Income
Average Propensity to Save Total Income less Consumption over Total Income
Marginal Propensity to Consume Change in Consumption over Change in Income
Marginal Propensity to Save Change in Savings over Change in Income
The propensities to consume and save determine the degree to which demand and supply in an economy
is effectively realized.
Gross National Product XX Aggregate Demand – Real Domestic Output
Depreciation Allowance (XX) Demanded or Needed at each possible Price
Indirect Taxes (XX) Level
National Income XX • Prices fall, purchasing powers increase
Retained Earnings (XX) (Higher Consumption)
Government Income from Capital (XX) • Increases in purchasing power is
Transfer Payments from Gov't and Abroad XX denoted by a decrease in inflation
Personal income XX • Decreases in purchasing power is
Personal Taxes (XX)
denoted by an increase in inflation
Disposable Personal Income XX
Aggregate Supply – Real Domestic Output
𝑴𝒂𝒓𝒈𝒊𝒏𝒂𝒍 𝑷𝒓𝒐𝒑𝒆𝒏𝒔𝒊𝒕𝒚 𝒕𝒐 𝑪𝒐𝒏𝒔𝒖𝒎𝒆 (𝑴𝑷𝑪) Available at each possible Price Level
= 𝑪𝒐𝒏𝒔𝒖𝒎𝒑𝒕𝒊𝒐𝒏/𝑰𝒏𝒄𝒐𝒎𝒆 • Prices should not rise when resources are
𝑴𝒂𝒓𝒈𝒊𝒏𝒂𝒍 𝑷𝒓𝒐𝒑𝒆𝒏𝒔𝒊𝒕𝒚 𝒕𝒐 𝑺𝒂𝒗𝒆 (𝑴𝑷𝑺)
underused
= 𝑺𝒂𝒗𝒊𝒏𝒈𝒔/𝑰𝒏𝒄𝒐𝒎𝒆
• Full Employment will make the price
𝑨𝒗𝒆𝒓𝒂𝒈𝒆 𝑷𝒓𝒐𝒑𝒆𝒏𝒔𝒊𝒕𝒚 𝒕𝒐 𝑪𝒐𝒏𝒔𝒖𝒎𝒆
= 𝑪𝒐𝒏𝒔𝒖𝒎𝒑𝒕𝒊𝒐𝒏/𝑰𝒏𝒄𝒐𝒎𝒆 level rise with no increase in output
𝑨𝒗𝒆𝒓𝒂𝒈𝒆 𝑷𝒓𝒐𝒑𝒆𝒏𝒔𝒊𝒕𝒚 𝒕𝒐 𝑺𝒂𝒗𝒆 **Changes in Taxes will either encourage or
= 𝑺𝒂𝒗𝒊𝒏𝒈𝒔/𝑰𝒏𝒄𝒐𝒎𝒆 discourage spending.
𝑲𝒆𝒚𝒏𝒆𝒔𝒊𝒂𝒏 𝑴𝒖𝒍𝒕𝒊𝒑𝒍𝒊𝒆𝒓 = 𝑴 **Changes in Policies will either encourage or
= 𝟏/(𝟏 − 𝑴𝑷𝑪) 𝒐𝒓 𝟏/𝑴𝑷𝑺 discourage more saving than spending
The Business Cycle

a. Troughs – Low levels of economic activity and inefficiency of production

b. Recovery or Expansion – Increase in activity
c. Peak – Highest point of productivity
d. Recession – Economic Activity and Employment levels contract.
a. Resources are underused
e. Economic Depression – A long-lasting recession
a. Typically, this is characterized by 2 quarters of sustained recession
b. Characterized by high unemployment
c. Caused by overextending credit, large and sudden cuts in spending, accumulating but
unliquidated inventories (Surplus), Unutilized investments and Accumulating Savings
Keynesian Economics
Keynesian Multiplier – Real Income is increased by factors of autonomous injections. If any factors
(impediments to production) that prevent multipliers from operating exist, then the multiplier is not
really an income multiplier, rather a money multiplier.
• KE more aptly reflets the effect of multipliers on money, since it is actually the most
‘exchangeable’ resource in existence.
• KE typically relies on the assumption that there are various motives for using money, i.e.,
contingencies, transactions, and speculation
• Since Inflationary Gaps exist in instances of full capacity, then the income is no longer necessary
since people are willing to spend despite the lack in supply, hence:
o People will release more money to meet their demands, even if shortages exist,
artificially raising prices
▪ This will in turn, elicit the printing of lots of money
o Price flexibility is not reliable for providing full employment of resources
o Changes in price does not elicit significant impact in disposable wealth enough to create
a multiplier
o This is where Keynes’ famous phrase: “In the long-run, we are all dead” comes from,
emphasizing the need for intervention when economies can no longer revive themselves
naturally by shifts and changes in demand and supply.
• Equilibrium GNP does not provide full employment
• Irrespective of income, supply (of money) will still determine the spending patterns of people
Factors that Influence Consumption
• Habits and Preferences
• Size of the Population = Higher Population; Higher Consumption
• Changes in Income Distribution = More Income Available + Larger Allocated Income; Higher
Consumption
• Credit Availability = Higher Credit Availability; Higher Consumption
• Expectations of prices and income = More Income tomorrow; Less Consumption Today;
• Higher Prices Tomorrow; Higher Consumption today
• Interest Rates = Higher Interest Rates = More Savings = Less Consumption
The Multiplier effect posits that an artificial injection by Government Spending induces a change in
income in the whole economy in order to stimulate activity. This is a function of disposable income.
𝑻𝒂𝒙 𝑴𝒖𝒍𝒕𝒊𝒑𝒍𝒊𝒆𝒓 = 𝑻 = – 𝑴𝑷𝑪 ∗ 𝑻𝒂𝒙 𝑹𝒂𝒕𝒆 /𝑴𝑷𝑺
Since the Government derives its investments from taxes, a tax multiplier is also expected to influence
marginal national income. The Tax multiplier is independent of personal consumption, and is a function
of consumption, rather than of income.
Hypotheses on Savings and Consumption
• Life Cycle = Younger = More Consumption
• Permanent Income (APC = MPC); Consumption becomes as permanent as Income tends to be.
Which is why it is not natural for deflation to occur.
• Relative Income = More difficult to reduce consumption than to reduce savings.
Investment and Income
• At Equilibrium, Planned investment = Planned savings
SAVINGS IS INCOME NOT SPENT. **[Savings of HH, BF and G = Domestic Savings]
Personal Savings XX
Corporate Savings XX
Government Savings XX
Net Domestic Savings XX
Depreciation Allowance XX
Gross Domestic Savings XX
Net Capital Transfer from Abroad (Foreign Investments) XX
Net Borrowings Abroad XX
Gross National Savings XX
Investment is generally the spending for goods used for future consumption.
Investment in Economics means the Spending on PPE, Wasting Assets, Inventories, etc., since these
accounts can produce a RETURN ON INVESTMENT, they do not include securities.
Net Investment = Gross Investment - Depreciation
Capital = Stock; Investment = Flow
Investment Process - An Injection of Funds into the flow that results to increases in income. Increases
in income decreases each round, the sum of all decreased income eventually leads to the original
investment by a multiplier. This Multiplier is caused by the payments done by a firm to sustain itself.
These payments recirculate into the flow until all injections are reabsorbed into the economy.
Investment and Profits - Firms are motivated by profits, that is why they invest, however, the cost of
investing on a rate of return is not constant. Which is why interest is termed as the cost of borrowing for
profits. Therefore, investment behavior is determined by the rate of return (r), and the interest rate (i).
• Investment & Interest = Marginal Efficiency of Investment [r vs i] in a function [I = f(i)]
Innovations - new good, new method of production, new market, new sources of materials, new
organizations/industries; HIGHLY PROFITABLE INVESTMENTS; DONE BY ENTREPRENEURS
Expectations on Investments – How likely is an investment going to match its cost?
Determinants of Investments
1. Changes in Inventory = Changes in stock of inventory, not level of quantity of inventory.
2. Residential Construction = demand for basic human needs.
3. Property, Plant, and Equipment
Investment Spending
a. Should be Productive - directed to areas that enhances output obtained in production
b. It should create additional external Economies - Aside from the focused area that deserves
productivity, the excess in output produced by productivity should be able to translate into additional
consumption by other sectors involved in a transaction
Sources and Uses of Money
Money – Medium of Exchange of Economic resources and Goods and Services; Unit of Account for Deferred
Payments; Store of Value
Types of Money
a. M1 – Money for day-to-day transactions
b. M2 – Near-money, Money deposited, not immediately circulated + M1
c. M3 – Deposit substitutes, money meant for accretion of wealth by interest. + M2
d. M4 – Money that includes foreign exchange + M3
All currencies that any person holds are actually Liabilities to the Central Bank, Guaranteed by the
Government. All monies, therefore, is backed by the Central Bank, while Checking Accounts or Peso
Deposits are our liabilities to our commercial bank, backed by ourselves as debtors.
Uses of Funds
• For Investment Loans – guarantee against illiquidity, easily convertible to cash, earns interest
• The Long-term – credit use, for private use only
o Governments should never loan from commercial banks, as this is competition for credit
o Banks tend to secure themselves from bad debts, hence the use of credit scores
o Banks function to allow entities to enter trade via financing and commerce. Thus, are
production oriented.
Sources and Uses of Public Funds
Government is the country’s largest buyer, largest employer.
It has 5 roles in the Economy: Income earner, consumer, saver, borrower, investor
The Government has the power on deciding which projects needs loaning and investment. It doesn’t only
loan, but it also invests. It can borrow easily, and it has income through Taxes
Push-spending leads to reduced taxes Pull spending leads to increased tax
Sources
Taxes – The Lifeblood of the Government; it is the just and equitable contribution paid by a state’s
constituents to its government and forced charged, levied by its legislative, to defray the government’s
expenses.
“Who should shoulder the tax burden?”
Impact of Taxation – the Person liable to the tax
Incidence of Taxation – the Person liable to pay the tax
• Benefits received – How many have we given you?
• Ability to pay – How many can we get from you?
• Regressive taxes – Taxes decrease as Income Increases
• Progressive taxes – Taxes Increase as Income Increases
• Proportional taxes – Everyone gets the same rate of Tax in their income
• Direct Taxes – You shoulder the burden immediately
• Indirect Taxes – Your burden could be shifted elsewhere
Ideally, taxes should collect more from income and business taxes than sales and production taxes.
Public Debt - If Taxes are not enough, the Government may borrow internally and externally.
• Government may borrow as far as its taxes allow it. It will think about how it will repay Interest.
National Debts – internal debts held as bonds by the native community. It transfers debt from the
taxpayers to bondholders in theory (even if the community is both) (G borrows from BF and HH)
• Cost of Borrowing – Public debt is not shifted to future generations. Therefore, there is no
opportunity cost in employing the unemployed because there is no sacrifice in so doing.
Burdens only manifest in losses incurred today.
• Deficits shift from private to public sector. If the government does not absorb the deficit,
opportunity cost will be taken-in by the present generation in terms of reduced consumption and
increased savings and will tend toward deflation. If these leakages/savings are not used to invest
in capital, the deficits will leak into the future causing a deflationary spiral.
• Creation of Money – Increase in prices, lowering purchasing power, inflation losers bear costs.
• Size of Debt – It should at least be 40% of GDP to be sustainable and to foster growth.
Uses of Funds
a. Nation Building
b. Social Investments
 c. Consumption Expenditures
d. Capital Outlays – Public works, Infrastructure
e. Security and Defense
f. Social Services
g. Emergency funds
Sources and Uses of Dollars/Foreign Currencies
Why the Dollar? – interdependence makes everyone better-off; The dollar is the strongest currency.
• Currency represents Philippine Wealth with respect to other Currencies.
• The Dollar as an ingredient for Growth - comparative advantage allows countries to trade
resources efficiently. The same principle applies as well for money. This is because Exports and
Imports are investments as well. (These are sources of productivity and efficiency outside the
local economy.)
Sources of Dollars
a. Exports - Our goods and services are translated into dollars. These dollars are deposited to
commercial banks, and commercial banks may either exchange these dollars with BSP to meet
reserve requirements.
b. Gold - Dollars are able to come into the economy via purchases. These purchases increase dollars
simply because Gold prices may rise.
c. Dollars from the U.S. Government - Their government still has expenditures in our economy
(veteran’s payment, education, cultural exchange programs, military spending, etc...)
d. Invisibles - Remittances sent in, Dividends declared by Filipino Companies abroad, Interest
payments and income from foreign property, Investments to external businesses by Filipino
Nationals. (They cannot be handled by the Bureau of Customs)
e. Foreign Borrowing - Foreign Credit extended by foreign banks (but also has to pay interest by
Forex currency)
f. Transfer Payments in Dollars - Donations, grants by foreign Entities
g. Direct Foreign Investments - Investments by foreigners into our economy (MCDONALD’s)
Uses of Dollars
a. Imports - We pay out goods from outside in our currency, but these equivalents are paid.
a. Imports also follow bills.
b. Government spending abroad = pensionados, state visits
c. Invisible payments = Remittances by foreigners here in the Philippines
Trade Balance = Net Exports – Net Imports
Payments Balance = All Dollars out – All Dollars In
Inflation and Unemployment
Inflation - A sustained and general increase in prices in all or nearly all of the markets in an economy
• Not generally adverse. Must be maintained steadily.
• Sudden Increases or Decreases are adverse
• Those earning fix income sustain losses in periods of inflation
• Those earning variable income sustain gains in periods of inflation
Deflation - A sustained and general decrease in prices in all or nearly all of the markets in an economy
Adverse Effects of Inflation
a. Difficult to negotiate credit
b. Efficiency is reduced
c. Discourages borrowing if the cost of debt is too high
d. Rate is difficult to predict
e. Breaching contracts is encouraged or even necessary
f. Creditors and fixed-income earners are disadvantaged
Types of Inflation
a. Demand-pull – Excess demand forces a pull of supply and thus a pull-up of prices, use fiscal
policy to control national spending
b. Cost push – Increased cost to produce such as through labor and materials input
 c. Structured Inflation – Bottlenecks in the economic system due to inadequate social overhead
capital. Usually experienced by Developing Countries; this means that there are lacking social
infrastructures that populations may not be able to realize.
Consumer Price Index – Measures Pricing of items
CPI = 100*Price of Market Basket in a Year/Price of Same Basket in the Base Year
Unemployment
• Individuals willing and able to work cannot find work
• Frictional Unemployment – Inherent Unemployment in the Labor Market; the period of time an
employable individual spends looking for jobs or taking further studies without working
• Structural Unemployment – Aggregate Demand can employ workers, but distribution of demand
does not accommodate the entire labor force; either wages are too low, or labor unions are
rejecting working conditions
• Cyclical Unemployment – Caused by insufficient Aggregate Demand; there are too few employers
or rather, too few jobs that humans can fill. This is currently occurring in industries that are
getting replaced by digitized and automated processes
• Seasonal Unemployment – Certain periods cause unemployment such as holidays
• Okun’s Law – An empirical observed relationship between unemployment and GDP. It predicts
that a 1% increase in cyclical unemployment will usually be associated with a 2% drop in GDP.
𝒚 − 𝒚′ Where: y= actual GDP y’= potential GDP Β= Okun’s coefficient
= 𝒌 − 𝜷(𝒖 − 𝒖′ )
𝒚′ u = current unemployment rate u’ = potential unemployment rate
In this case, Β is almost always 2, expressed by the relationship of Okun’s Law; and k is the observed
growth rate in Employment output.
Fiscal Policy
Progressive Tax System - has automatic stabilizing effect, inhibits rapid growth
More taxes to more income mean disincentives to spending, while tax revenues decrease slowly
• Government Spending is rigid because it has guarantees to the public to provide daily services.
• Taxation is the most flexible tool used by government to influence people’s spending patterns.
• In times of Inflation, Taxes increase to discourage spending, Contractionary Fiscal Policy
• In times of recession, Taxes decrease to encourage spending, Expansionary Fiscal Policy
• For Economic Growth; Short-term oriented
Tools of Fiscal Policy
• Changes in Government Spending – very rare, structural, dependent on budget conditions
(deficits or surplus)
• Changes in Tax Rates
• Borrowing from BSP, Abroad, Domestic Money Market
o Borrowing from BSP - Increase in Money Supply
o Borrow Abroad - Expands Imports, increasing dollars that are used to translate into peso,
neutral effect
o Borrow from Domestic Institutions - discourages spending, Government displaces private
sector in credit availability for investments.
▪ This crowds out investors, and forces investors to invest outside the domestic
market (Competition occurs due to the government being a virtually secured
debtor, being able to pay to any extent, all its obligations.)
Monetary Policy
Monetary Policy comes from the notion that Supply of Money is virtually perfectly elastic to interest
rates, since the BSP can print-out enough bills to pay-off all of its debts. This does not mean, however,
that it should.
• The BSP Control volumes of money
Lower Interest Rates = Expansionary Policy = Higher Interest Rates = Contractionary Policy =
borrowing or spending period = Inflation savings period = Deflation
• Demand for Money – Transitionary, Precautionary, Speculative (in increasing slope)
• Government could only control M1; Less supply means higher interest rates
 • Supply for Money is more or less, assumed as always elastic
• For Economic Stability, Long-term oriented monetary policy is preferred
Tools of Monetary Policy
• Purchase of Forex
o The BSP purchases Dollars using pesos. This reduces local pesos in exchange for more
dollars. Resulting to Increases in Interest Rates.
• Open-market Operations
o BSP engages in open market for securities, allowing credit encouraging spending.
o This is the BSP’s primary economic tool for monetary policy
Repurchasing Government Securities Selling Government Securities
Increase Money Supply Decrease Money Supply
Prices of other Securities rise Prices of other Securities fall
Interest rates decline Interest rates rise
• Reserve Requirements
o A relaxation of requirements leads to more multiplier, more money, more spending
o A stringent reserve requirement leads to smaller multipliers, less money, more saving
o The BSP seldom uses this tool since its effect is too difficult and unpredictable to control
➢ BSP controls discretions on reserve requirements
➢ Defines Deposit substitutes and reserves
➢ Sets interest rates against deposits
• Rediscounting: When Banks borrow money from Central Banks
o If the rediscount rate that the C. Bank offers is relatively small, money is expanded,
encouraging more spending
o If the rediscount rate that the C. Bank offers is relatively large, money is limited,
encouraging more savings
• Non-quantitative Controls
o Selective Controls - balance Marginal Deposits, control value of imports (Administrative
Control in Trade Policy)
▪ This means selectively choosing which entities or even countries get easements
o Moral Suasion - Governor of Central Banks persuades commercial banks to gear
themselves towards monetary policy goals.
Trade Policy
𝑆+𝑇+𝑀 =𝐼+𝐺+𝑋 𝑀 = 𝑛 + 𝑚𝑌
𝐶 = 𝑏 + 𝑐𝑌𝑑 𝑌𝑑 = 𝑌 – 𝑇
𝑇 = 𝑠 + 𝑡𝑌 ∗∗∗ 𝑌 = (𝑏 − 𝑐𝑠 − 𝑛 + 𝐼 + 𝐺 + 𝑋) / (1 − 𝑐 + 𝑐𝑡 + 𝑚)
Price Effects - Imports Stabilize the Economy, Exports destabilize the Economy
Determinants of Imports and Exports
• Exports determine how much we are to participate in determining the value of the dollar.
Demand is less of a problem; devaluation of pesos promotes exports -> more incentive for
exporters to produce more since dollars are more valuable than pesos.
• Imports determine how much we are to participate in determining internal supply of goods
• Devaluation implies that domestic goods have income increased. Foreign goods therefore become
more attractive if they are less common.
• Protectionism – preferring local labor and goods over imports. It is proven that in the long-run,
protectionism does not generate more labor or jobs in a country
External Equilibrium - equilibrium required in foreign transactions in an economy. (inclusive of capital
transactions and trade dynamics)
𝑪𝒂𝒑𝒊𝒕𝒂𝒍 𝑭𝒍𝒐𝒘 + 𝑵𝒆𝒕 𝑬𝒙𝒑𝒐𝒓𝒕𝒔 + 𝑵𝒐𝒏 − 𝒕𝒓𝒂𝒅𝒆 𝒔𝒐𝒖𝒓𝒄𝒆𝒔 = 𝑬𝒙𝒕𝒆𝒓𝒏𝒂𝒍 𝑬𝒒𝒖𝒊𝒍𝒊𝒃𝒓𝒊𝒖𝒎