ECONOMICS

CHAPTER 1
Basic needs- mans needs required for his survival
Capital- materials used in the production of goods and services including money.
Economic resources- input used in the production of goods and services.
Economic system- framework in which society decides on its economic problems.
Economics- social science concerned with man’s problem of issuing scarce resources to
satisfy unlimited wants.
Empirical validation- the use of statistical evidence to prove the validity of a hypothesis.
Entrepreneur- organizes all other factors of production.
Free enterprise system- economic resources are privately owned.
Function- relationship between two or more variables.
Labor- human effort
Land- natural resource
Luxury goods- goods that man can do without
Macroeconomics- studies the economy as a whole.
Market- context by which buyers and sellers buy and sell goods, services, and resources.
Microeconomics- deals with parts of the economy such as household and the business firm:
also known as price theory.
Normative economics- analysis that deals with what should be
Positive economics- analysis that deals with what actually is.
Right to private property- right of private individuals to own things of value
Theory/ hypothesis- unproven proposition
Variable- subject to change
Wants- desires and needs
Human wants- unlimited and vary from the needs for survival otherwise known as basic
needs.
Technique of production- how resources are used and combined in production.
Resources Payment
Land Rent
Labor Wage/ Salary
Capital Interest
Entrepreneurship Profit

Household- the basic consuming unit in the economy.

Opportunity Cost- value of the foregone alternative of a specific resource.
Business firm- serves as the economy’s producing unit to satisfy human wants with goods
and services.
Some Economic Problems:
1. Unemployment
2. Economic instability (highs and lows in production and investment levels)
3. Low levels of growth and development
4. Inequality in income distribution
5. Determination of the type of economic system to be adopted
Economic Analysis- process of directing economic relationships by examining economic
behavior and events and determining the causal relationships among the data and activities
observed.
Logic- first tool of economics (drawing conclusions from the particular to the general or vice
versa) ~student
Statistics- quantitatively describe economic behavior and therefore serve as a basis in
hypothesis testing.
Mathematics- third tool of economics (enables analyst to foresee and assess a hypothesis for
empirical validation.
Economic Policy- courses of action taken by the government or private institutions to
manipulate the results of economic activity.
Economic Theory- theory of any other science, consists of sets of principles or causal
relationships among the important facts or variables that surround and permeate economic
activity.
Consumer rationality- desire of consumers to secure as much satisfaction they can in
spending their incomes.
Steps in constructing a theory:
1. Specification and definition of postulates
2. Observation of facts concerning the activity about which we want to theorize
3. Application of the rules of logic to the observed facts
4. Testing of hypothesis
Economic policy- making- conscious intervention in economic activity with the intent of
altering the course that it will take.
Price Theory- abstract because it does not and cannot encompass all the economic data of
the real world.
Economic Mode- composed of series of assumptions or given and statements of implications
or deductions.
Mathematical notations- shortcut representation of verbal explanations.
Comparative statics- focuses on the shift of equilibrium positions (statics) for an individual
decision unit, a market or an economic system.
Equilibrium- state in which there is a balance of internal forces and no tendency for the
situation to change unless outside forces intervene. May also be termed as “static”
Dynamic analysis- focuses on the pattern and rate of change for some variable between
points in time.
Partial equilibrium analysis- assumes for the purpose of analysis that other factors will remain
the same.
General equilibrium analysis- examines changes within the context of the entire system. All
variables are allowed to adjust in response to the initial change.
Basic Economic Problems
1. What to produce?
2. How much to produce?
3. How to produce?
4. For whom to produce?
Traditional economic system- production decision is based on customs and tradition.
Command economy- answers to economic problems are dictated by the government.
Market system- deals with the economic problems by considering consumers’ choice.
Mixed economy- what to produce and how to produce are answered predominantly through
the price mechanism, and modified through government intervention in the form of direct
controls, taxes, ad subsidies.
CHAPTER 2
Aggregate demand- the totality of a group of consumer’s demand.
Aggregate supply- the totality of a group of producer’s supply
Ceteris paribus- the assumption that other things are equal or other things remain the same.
Defined by J. Bruce Linderman.
Demand- reflects the consumer’s desire for a commodity
Demand curve- graphical representation of the demand schedule that contains the same
prices and quantities presented in the demand schedule.
Demand function- shows how quantity demanded is dependent on its determinants.
Demand schedule- the quantities of a good consumers are willing to buy at various prices.
Directly proportional- means the both variables increase and decrease at the same time.
Equilibrium point- point of equality of demand versus supply.
Inversely proportional- means that one variable goes up while the other goes down.
Market- place where buyers and sellers interact and engage in exchange.
Movement along the curve- change from one point to another on the same curve.
Non- price factors- or parameters; factors other than price that affect demand or supply.
Price- the value of a good in terms of money.
Price ceiling- the maximum limit at which the price of a commodity is set.
Price floor- minimum limit beyond which the price of a commodity is not allowed to fall.
Shift of the curve- change in the entire curve caused by a change in the entire demand or
supply schedule.
Supply- amount of commodity available for sale.
Supply function- shows how the quantity supplied is dependent on its determinants.
Supply schedule- the quantities producers are willing to offer for sale at various prices
Surplus- an excess of supply over the demand and for a good.
Shortage- consumer’s demand to products will not be completely met.
Price- value of good in terms of money.
Law of Demand- as price increases, the quantity demanded of the product decreases, but as
the price decreases, the quantity purchased will increase.
Increase in income Shift to the right
Decrease in income Shift to the left
Greater taste/ preference Shift to the right
Less taste/ preference Shift to the left
Increase in population Shift to the right
Decrease in population Shift to the left
Greater speculation Shift to the right
Less speculation Shift to the left
Individual schedule- quantities are offered by only one seller
Market supply schedule- aggregate supply quantities of a group of sellers.
Increase in the number of sellers Shift to the right
Decrease in the number of sellers Shift to the left
Decrease in the cost of production Shift to the right
Goals of the firm It depends
Equilibrium point- demand is exactly equal to supply.
Factors that affect the Law of Demand Factors that affect the Law of Supply
Income Cost of production
Expectation on future prices Availability of economic resources
Prices of related goods like substitutes and Number of firms in the market
complements
Size of the population Technology applied
Quality of the product Producer’s goals
Taste and preference Price of the product
Promotion and/ or advertisement Taxes and subsidiaries
religion Price of the product
Customs/ traditions Price expectation
Fad or fashion

CHAPTER 3
Arc elasticity- the coefficient of price elasticity of demand between two points along the
demand curve.
Coefficient of elasticity- absolute value of elasticity.
Complementary goods- goods that supplement each other and are used together.
Cross elasticity of demand- measures the percentage change in quantity demanded of one
good compared with the percentage change in the price of a related good.
Elasticity- responsiveness of demand/ supply to a change I its determinant.
Engel curve- a curve depicting the quantities of a good the consumer is willing to buy at all
income levels, assuming all other things remain the same.
Income elasticity of demand- measures the percentage change in quantity demanded
compared with the percentage change in income.
Inferior goods- goods which are bought when income levels are low, the demand for income
levels are low, the demand for which tends to decrease when income increases.
Normal goods- goods for which demand tends to increase when income increases.
Price elasticity- the percentage change in quantity compared with the percentage change in
price.
Point elasticity- the coefficient of price elasticity of demand at one point along the demand
curve.
Prestige goods- goods bought for the status and prestige they give to the consumer and are
bought when the prices are high.
Substitute goods- goods used in place of another.
Total revenue- the price of an item multiplied by the number of units of that item sold.
Price elasticity of demand- degree of responsiveness of quantity demanded to a change in
price.
Elastic- % change in quantity demanded > % change in price. Elasticity coefficient is greater
than 1.
Inelastic- % change in quantity demanded < % change in price. Elasticity coefficient is less
than 1.
Unitary- change in quantity demanded is equal to the change in price.
 The measurement of point elasticity is more exact than that of arc elasticity.
 Arc elasticity becomes point elasticity when the distance between the two points
originally measured becomes zero.
Factors of substitution:
1. Number of competing products.
2. Desirability of a product relative to its substitutes due to quality
3. Relative importance of consumer’s needs
 Absence of substitutes makes the demand for a product highly price inelastic since it is
only income effect that is behind price- demand relationship.
Price Increase Price Decrease
Elastic Decrease Increase
Inelastic Increase Decrease
 When a good is sold, a sales tax has to be paid to the government on the sale of that
commodity. The question on who between the buyer and the seller shoulders the
burden is dependent mostly on the degree of elasticity of the demand for that good.
As income increases, a coefficient of:
> 1 means demand is elastic and the good is superior or important.
<1 means demand is inelastic and the good is inferior.
= 1 means demand is unitary and the good is normal.
Consumption line- connecting the points of tangency of hierarchy of budget lines and
indifference curves which determines different levels of consumption.
Underlying reasons for the change in the relative importance of commodity items as income
continues to increase:
1. One is the gradual satisfaction of the consumer’s hierarchy of needs from the basic to the
non- basic.
2. Theory of diminishing marginal utility that is the cornerstone of the concept of income
elasticity of demand.
Methods of making a forecast:
1. Average Arithmetical Growth Rate Method
2. Trend Line Using the Least Square Regression Method

CHAPTER 4
Money- a medium of exchange and vehicle of economic activities. Serves as the vehicle for
the free flow of the products.
Function of money- as a medium of exchange began to assume a significant role in the
advent of market economy marked by specialization, interdependence and trade.
Money Supply consists of the following:
1. Coins and bills in circulation
2. Demand deposits in banks
3. Quasi Money (savings deposits and time deposits)
4. Deposits substitutes
Money Velocity and Income- the number of times money circulates and changes to become
income also depends on the propensity of every wealth holder to temporarily hold money as
idle balances before transaction.
The Fractional Reserve System- banks are supposed to be conduits of funds linking
investors/ borrowers to the sources. They accept deposits which chiefly supply their lending
operations. In the process, they are liable to the depositors and borrowers for money on
demand in the same manner as the borrowers in the turn for periodic loan payment.
Sources of Money Supply- the leading operation of the banking system determines the
volume of money checks it creates. The government prints new money at ties to help finance
its expanding operation.
 Foreign currency inflows are sold to the central bank for peso through commercial
banks based on a fixed exchange rate prescribed by the former.
 Taxes also change the level of money supply as leakages from the circular flow. Taxes
are foregone consumption and saving which could otherwise be part of currency in
circulation and reserves which enable the banks to create money checks.
Central Bank- administers the monetary, banking ad credit systems of the republic. The only
authorized government entity to print money and is responsible for the proper administration
of the monetary, banking and credit system of the republic.
Functions:
1. to maintain internal and external monetary stability in the Philippines and to preserve the
international value of the peso and its convertibility to other freely convertible currencies.
2. to foster monetary credit and exchange conditions conducive to a balanced and
sustainable growth of the economy.
 Commercial Banks can lend more than their actual deposits and create money by
creating more deposits liabilities.
Short Run Tools Affecting Money Supply:
1. Reserve Requirements
2. Rediscounting
3. Open Market Operations
4. Selective Control
5. The Need for Policy Coordination
CHAPTER 5
Consumption- is the act of using goods and services to satisfy human wants. It is not the
monopoly of households since businesses and the government also use goods and services
to attain some ends.
Household consumption- satisfies human wants and one of the determinants of national
factor income.
Business consumption- does indirectly inasmuch as business activities provide the
households with economic income to meet consumption expenditures.
 The economy dissaves by borrowing from its stock of savings to meet current
consumption needs in the absence of income.
The Multiplier Concept- the process of generating income through the circular flow exchange
between the households and the firms.
Multiplier coefficient- measures the average number of times every peso of inflow circulation
and changes in the system of income.
Marginal propensity to consume- the consumption factor.
Marginal propensity to save- the savings factor.
Savings- gradually diminishes the inflow that the system circulates and generates into
income.
 If income is initially generated through the borrowings, the corresponding savings
outflow can be used for debt payments. Therefore, generating more income means
more savings outflows to retire more debts and reduce what the economy owes to its
past accumulated savings.
 It is only when income is fully generated that the debt balnce is reduced to zero.
Factors of Consumption:
1. Framework- personal consumption is household’s realized demand to satisfy current
needs. However, one should not be misled to the conclusions that demand factors are the
only direct determinants of consumption.
2. Taste or Preference- depends on how the product satisfies one’s desires. A change in
collective attitude can change aggregate taste or preference, consumption, and marginal
propensity to consume.
Duesenberry’s Relative Income Hypothesis- the difference in consumption behavior could be
explained by the difference in income level relative to what one is accustomed to.
Gaya gaya system- influences consumption not because of the product utility but because
others also possess the goods.
Colonial mentality- regards locally made goods as inferior to their foreign counterparts. There
is a standing bias for goods marked “imported” which is also associated to economic status.
3. Population- determines consumption needs and, therefore, affects consumption
expenditures with a given income. An increase in household size with income and other
factors as constant may decrease the propensity to consume and increase savings at the
expense of non- essential items in the consumption basket.
4. Income- the level of income can increase with more infusions in the circular flow.
 Propensity to consume varies across consuming units to which income is distributed
because of the varying influence of demand factors.
5. Price Level- individual product demand is inversely proportional to price due to the change
in purchasing power and substitution with other products.
6. Innovation and Promotion- can expand the line of consumers’ choice and extend the
influence of demand factors on consumption and propensity to consume income.
 Promotions and advertising serve as media of introducing new products in the market
which create demand and consumption.
7. Engel’s Law and the Compositional Change in Consumption Expenditure- the name Ernest
Engel in the 19th century found a relation between the level of family income and the
composition of its consumption spending. As family income level rose, the proportion to total
income of essential items like education and recreation followed the opposite trend.
 Changing the relative importance of items in the consumption basket depends on how
consumers spend additional income.

CHAPTER 6
Investment Expenditure- is a capital spending mainly derived not from current income and
consumption but from accumulated savings and other sources external to the circular flow. It
also simply assumed as an exogenous component of National Income. (pre- payment of long
run consumption)
 Investment increases the capital stock and the expenditures for which generate income
as inflows to the system.
Consumption Expenditure- is spending on current consumption or consumption of non-
durable goods.
 Business and household investments tend to increase the economy’s stock of capital
and total output; whereas, depreciation has the opposite effect as it represents capital
consumption.
Investment and the Stock Adjustment Process- the capital stock is not a headcount but rather
the aggregate production capacity of existing capital goods in the economy which can
diminish due to usage and depreciation.
Savings- the unspent portion of income during the period intended for spending as in the case
of salary earner who sets aside a portion of his half- month pay earmarked for the next fifteen
days.
Savings- Investment Equilibrium- implies that increasing, decreasing or maintaining the level
of investment expenditure will respectively increase, decrease or maintain the level of income
and savings assuming ceteris paribus.
Determinants of Savings:
1. The price level of which can affect expenditures and savings.
2. Population growth which may change the level of savings depending on the well being of
the economy.
Investment Demand Determinants:
1. Interest Rate- investment demand is inversely proportional to the interest rate level with
other factors as constant (ceteris paribus) resulting in an investment demand curve that is
downward sloping.
2. Acceleration Principle- the level of investments is a function of desired changes in output.
3, Innovations- long- run factor which can shift the investment demand curve. Joseph
Schumpeter describes innovation as the introduction of an unfamiliar product and untested
technology.
4. Profit- the basic reason why a business invests and therefore, profit trends influence
business investments in the long- run. Economic crisis happened in 1984.
5. Expectations- delves into underlying changes to anticipate turning points in the business
environment and decides at present the magnitude and type of investment he should make.
 While investment creates a multiplier effect of inducing output, the durability of capital
can introduce a strong, element of instability in the economy. This instability is in the
 form of business cycle especially evident when the economy’s pace of innovation is
slow.
Durability of Capital: A Source of Instability (assumptions):
1. Price level is constant implying that variations in the desired expenditure level indicate
changes in the desired production level.
2. Ratio of expenditure to capital stock is equal to 2.
3. Price of capital is equal to 2.
4. Marginal propensity to consume is 0.50 and, therefore, the multiplier is 2.
5. Periodic replacement in the capital stock is 5.
6. Replacement of additions to the capital stock because of depreciation only takes effect
after 4 periods.
7. No investment- output time lag.
8. A change in the level of investment expenditure only affects income in the subsequent
period.
 The level of investment falls and creates a multiplier effect of decreasing real income
and the level of economic activities which is an instability due to capital durability.
 Capital is durable because it is for long- term use and needs no periodic replacement
to support the same level of output.

CHAPTER 7
Demand estimation- aggregate supply can be met by aggregate demand.
Consumption- is the largest component expenditure which can account to about 65 to 70
percent of GNP. There is a close relationship of aggregate consumption expenditure to the
level of disposable income.
Consumption Function- schedule that relates consumption to disposable income.
 Disposable income is measured on the horizontal axis; consumption is measured on
vertical axis.
Marginal propensity to consume- indicates the percentage of each additional peso of
disposable income that will be consumed.
Saving- the difference between consumption and income.
Marginal propensity to save- expresses the ratio of the change in the level of savings that
occurs as a consequence of change in income.
John Maynard Keynes- aggregate real consumption is a function of the aggregate level of
income (The General Theory of Employment, Interest and Money)
INCOME= CONSUMPTION + INVESTMENT
Investment- is the most volatile of the major components of aggregate expenditure.
Multiplier- the number of times money has changed hands and generate income.
Full employment equilibrium- is an ideal objective because at that level of income, there is no
available and useful resource that is wasted.
Inflationary gap- aggregate demand would exceed equilibrium income leading to pressures
for higher prices.
Deflationary gap- aggregate demand would fall short of equilibrium income leading to less
income produced in the economy.
Fiscal Policy- when the government uses its powers to influence total spending either directly
by changing its purchases of goods and services or indirectly by altering the disposable
income of persons through changes in the level of taxation or transfer outlays.
Deficit budget- during periods of deflation or recession, economic policy dictates deficit
budget. It means that the government can or should spend more than what it collects through
the taxes.
Tax cuts- taxes imposed in person or in businesses are cut.
Inflationary period- economic policy dictates a surplus or balanced budget.
Surplus budget- it means that the government should spend less than its budget.
Major macroeconomic effects of government expenditure and tax policy:
1. Expenditure impact
2. Financial impact
3. Supply impact