Applied Economics

module 1
darwinpena
 Learning Outcomes for Unit 1

1. Understand economics as an Applied Science and

its value in addressing the economic problems of the
country.
2. Demonstrate understanding of the law of supply and
demand, factors affecting an economic situation.
3. Analyze and propose solution/s to economic
problems using the principles of applied economics.
4. Conduct a survey of current economic situations
within your vicinity.
 In this module, you will be able to

 define applied economics and understand the

basic terms in applied economics;
 identify the basic economic problems of a
country;
 identify the tools and methods in economics;
 differentiate the main branches of economics;
and
 explain the common microeconomic and
macroeconomic concepts.
ECONOMICS
Economics – everywhere (all activities,
decisions that we make).

WHY?

> Actions/ decions – involve –

ANALYSIS – where you weigh the pros and
cons. This is refered to as cost and benefit
analysis.
Reflect Upon (1/2 sheet – paper):
What decisions have you made since
waking up this morning? Why did you
choose such option/s over other choices?
Economics – is the efficient allocation of available
resources.

Assumptions:
That people have unlimited needs and wants, and
these needs and wants drive consumption.
That the concept of scarcity which means resources
are limited.

This constraint leads to the allocation of

available resources in the most efficient way possible.
Reflect Upon:
In your own words, how would you
differentiate needs from wants?
What are your examples of needs?
What are your examples of wants?
 Economics as an Applied Science:
Applied Economics – application of economic
theories and models in real life.
> consists of learning how choices affect
individual decision-making and how the availability
of factors aid decision makers formulate sound
judgment.
 Basic Economic concepts:
1. Scarcity
2. Needs
3. Wants
 Opportunity Cost
• This is defined as the benefit you give up
because you choose to take one action in
favor of another.
Example:

For instance, given a weekly allowance of

P1000, how will you spend it? How much
will you spend on food and how much for
transportation? How about entertainment?
 To the given example, what would be
the opportunity cost?
• Assume that your P1000 is enough only to
cover food and transportation. You have to
decide to cut back either food or
transportation if you want to spend on
entertainment. Say, you decided to just
walk home and save your transportation
budget for a movie ticket.
• The benefit of getting home faster by taking a
jeep or riding a train is the opportunity cost of
seeing a movie.
• Similarly, if you decided to cut back on food
in order to see a movie and be able to afford
a ride home, then your opportunity cost is the
food you will not be able to eat.
 Why is opportunity cost important?

• It is essential in the study of economics

because individuals, firms, and the
government are always faced with
choices.
Other examples of opportunity cost:
 Comparative Advantage
• having a lower opportunity cost.
• the ability of an individual or group to carry
out a particular economic activity (such as
making a specific product) more efficiently
than another activity. - Wikipedia
• is an economic law referring to the ability of
any given economic actor to produce goods
and services at a lower opportunity cost than
other economic actors. - investopedia
Example of Absolute and Comparative
Advantage:

4 12
 OPPORTUNITY COST
• grapes (TOM) 12/9 = 1.33 BAGS OF nuts
• grapes (MARY) 4/7 = .6 BAGS OF nuts

• nuts (TOM) 9/12 =.75 BAGS OF grapes

• nuts (MARY) 7/4 = 1.75 BAGS OF grapes
 Illustrate I absolute advantage I
opportunity cost I comparative advantage

COUNTRY DRIED MANGO (KG) Chocolate (KG)

PHILIPPINES 200 150

INDONESIA 120 130

 Basic Economic Problems

• What to produce
• How much to produce
• For whom to produce
 Basic Economic Problems

1. What goods to produce and services to

provide? A question of resources.

2. How to produce and how much to produce of

these goods and services? It focuses on the
actual production of goods and services and
the allocation of resources.

3. For whom to produce these goods and

services? Focuses on the distribution and
consumption of goods and services.
Goods and services are used
extensively in economic discussions that
these are sometimes referred to as
economic goods.

Economic goods cover goods, services,

products and the like that have a price
and are sold in a market.
 Factors of Production

1. Land – this represents land and similar

natural resources available such as farms
and agricultural land.

2. Labor – this represents human capital such

as workers and employees that transform
raw material and regulate equipment to
produce goods and services.
3. Capital – this represents physical assets
such as production facilities, warehouses,
equipment, and technology used in the
production of goods and services.

4. Entrepreneurship – this referred to as

enterprise.
“Consumption drives the economy.”
 Circular Flow Diagram

• is an economic model that illustrates the flow

of factors of production in the economy.

• this shows the flow of goods and factors of

production in the economy through
households and firms.
 Households represents end consumer while
firms represents producers.
Household – provide labor
Firms – hire labor to produce goods and services
and labor is compensated in the form of WAGES
and it represent the income from labor which will
be used to purchase goods and services to firms.
The payments from households becomes the
firms’ profit which will be used to increase the
factors of production.
Basic Circular Flow Diagram
 Households > provide capital input to firms
in the form of INVESTMENT. For instance, if the
firm is a public company, it can raise capital by
issuing stocks to households where it will receive
interests in the form of dividends, which may be
used to purchase goods and services to firms.
 Production Possibility Frontier
• is an application of the concept of
allocation of resources and factors of
production.
 Production Possibility Frontier
(PPF) Theory
• A simplified economic model which portrays
scarcity, choice and opportunity cost

The Static Production Possibility Frontier

• Analyses the economy at a fixed point in time
• Is based on the following assumptions:
– There is a fixed quantity of resources
– The economy only produces two products
– Resources can be used interchangeably
– All resources within the economy are used
– Resources are used at maximum efficiency
 The PPF Graph

E
400- PPF
D
300-
Tractors C
200-
B
100-
A
0 200 400 600 800
Video recorders
 Maximum Output Levels
• The PPF shows the maximum output of
the economy
• If the economy devotes all of its resources
to the production of VCRs it is able to
produce 800 (+ zero tractors)—Production
Possibility A
• Alternatively, if the economy chooses
Production Possibility C it is able to
produce 200 tractors and 400 VCRs
 Opportunity Costs

• The PPF shows that to produce more of

one product means producing less of
another
• Opportunity costs of production can be
measured e.g. if the economy moves from
point C to D (along the PPF) it will produce
an extra 100 tractors BUT 200 VCRs must
be sacrificed
• Hence the opportunity cost is 200 VCRs
 Points Outside the Static PPF
• Points outside the PPF (e.g. X) are not
possible using existing technology and
resources
A
.X

PPF
B
Points Inside the Static PPF
PPF
A • At point Y, the economy is
satisfying fewer needs
and wants than is
possible
• This is due to:
.Y
– Resources not being fully
employed and/or
B
– Resources not being used
in the most efficient way
 Basic Economic Activities
• Production - the use of economic resources in
the creation of goods and services for the
satisfaction of human wants.
• Consumption - the using up of goods and
services by consumer purchasing or in the
production of other goods.
• Employment - the use of economic resources in
production; engagement in activity
• Income Generation - the production of maximum
amount an individual can spend during a period
without being any worse off.
 Two Economic Units
• Household
• The basic consuming unit.

• Firm
• The basic producing unit.
Economic Model of Production
The Circular Flow of the Production Process
ECONOMIC
RESOURCES

PRODUCING UNITS
HOUSEHOLDS

GOODS AND
SERVICES
 Implications of the
Circular Flow of Economic Activity
1. The goods, resources, and money payments
will flow as long as households continue to
consume, and as long as firms continue to
produce.

2. That since goods and resources flow in

exchange for payments, the rate of payments
flow will in the end be the same. Money is the
inducing factor, and the pillar of the price
system. Without it, there is no price system.
 Inflows and Outflows
 Outflows (factors that decrease the level of
economic activity)
• Savings
• Taxes
• Import
Outflows are difficult to control because they
are dependent on income. When income
increases, we expect savings, taxes, and
imports to increase.
 Inflows and Outflows
 Inflows (factors that increase the level of
economic activity)
• Investment
• Government Spending
• Exports
Inflows are easier to manipulate. The proper
use of policy enables the government to
encourage exports and investments and to
increase its expenditures when it desires to
expand the flow of economic activity.
Determine which is efficient and not
efficient
 Methods Used In Economic
Analyses

1. Qualitative vs. quantitative Analysis

2. Economic Theories and Models
3. Time-series vs. Cross-sectional Data
 Qualitative versus Quantitative Analysis

1. Qualitative Analysis – this refers to interest

and price relationship. “ Money supply is
positively correlated to price.”

2. Quantitative Approach – involves

mathematical and statistical analysis of
economic data. It also referred as
econometrics.
 Tools used in the study of economics
1. Economic variables
2. Functions and economic equations
3. Graphs
Functions and economic equations
Functions (f) explain the relationship between two
or more economic variables.

Example: D stands for demand; P for price

D = f (P)

This reads as “ Demand is a function of price,”

which means that the price of commodities
determines the quantity demanded.
 ECONOMIC EQUATION
• A mathematical expression of an economic
thought or concept.
• Often used to further explain economic
theories and models.

Y = C + I + G + Xn
 Y = C+I+G+Xn
Y = C + I + G + (X-M)
Y = f (C,G,X,M)
• Consider the expression as the national income formula.
• Y = stands for national income
• C = consumption
• I = investment
• G = government expenditures
• X = exports
• M = imports
• Xn = for net exports
 Graph
• provides a visual representation
of the relationship between two
or more economic variables. It
helps breakdown abstract ideas
or theories through diagrams.
 DEMAND
• Is a schedule or a curve showing the various
amounts of a product consumers are willing
and able to purchase at each of a series of
possible prices during a specified period of
time.
 LAW OF SUPPLY
• As price rises, the corresponding quantity
supplied rises; as price falls, the quantity
supplied falls.
• There is a positive or direct relationship
between price and quantity supplied.
 Economic theories and models
• These are statements or observations on the
relationship of variables. They provide a
broader understanding of economic concepts
through behavioral observations and research.

.
• Marginal utility theory – is an example of an
economic theory. It states that people buy
goods that give the highest personal
satisfaction. This theory further explains that
a rational person will maximize his or her
utility given some constraints such as budget
or income.
Utility
- Refers to the satisfaction achieved in
consuming goods and services.
Two Classification of Utility
Marginal Utility – added satisfaction you
get
Total Utility – satisfaction you get in
buying and using the products
Everything you do in life involves choices
Your choices involves in many things including
incentives MB=MC, and utility maximization
Example:
With money in your pocket, you make choices
by Maximizing your satisfaction with each pesos
you spend.
Utility?
Marginal Utility
Example:
Let’s say you have a choice between either renting a
DVD or going to the movies
Which would you choose?
It depends on two things – budget constraint and what
is marginal utility per peso spent for each
Budget Constraint – how much money allotted for
renting a DVD or watching a movie
Marginal Utility per peso spent is additional
satisfaction per peso “you receive from each item you
purchase.
  

Suppose Maria's preferences

for eggs and milk can be
described by the following
marginal utility schedules.
Both eggs and milk cost $4;
Maria has allocated $16 to the
purchase of these two
products.
  
  Eggs   Milk

Total 
Utility MU per 
Units of  Marginal  MU per  Total  Marginal  dollar 
Product Utility $ spent Utility  Utility spent

0 0 - 0 0 -
 
First 24   36
 

Second 20   30
 
Third 16   24
 

Fourth 12   18
 
Fifth 8   12
 
Sixth 4   6
1.How should Maria allocate her $16
between eggs and milk so as to achieve
maximum utility?

2.Verify that the marginal utility per dollar of

each good is the same at the utility
maximizing bundle.
    Eggs   Milk
 
Units of 
Product MU/P eggs   MU/P milk
First   6   9
 
Second 5   7.5
Third   4   6
 
Fourth 3   4.5
Fifth   2   3
Sixth   1   1.5

The first unit of milk yields the biggest increase in utility per dollar, and
uses $4 from the budget. The second unit of milk is still better than the
first unit of eggs, and uses another $4. Either the first unit of eggs or the
third unit of milk yields the same increase in utility per dollar. With $8
left in the budget, purchase one of each. Three units of milk and one
unit of eggs maximize Maria's utility.
The marginal utility per dollar on the first unit
of eggs is 6 utils, the same as the marginal
utility per dollar of the third unit of milk.
Time-series versus Cross-sectional data
• Time-series – means that data are collected
for particular element for several time
periods.
Example: GDP Growth Rate; Census
 Cross-sectional data
• This includes different variables for a single
time-period. Rather than growth, it provides
insights on the components, it compares age,
gender, income level and other similar
variables

• Examples: demographic information;

 Normative versus Positive
Economics
1. Normative economics – evaluates economic
decisions, policies, or outcomes as good
and or bad. It is based on opinions and is
subjective.

2. Positive economics – evaluates economic

scenarios and policies based on qualitative
and quantitative analysis. This makes
factual and objective.
 ECONOMICS
• Greek word “oekonomia”, which means
management of the household.
Economics has its own theories, concepts and laws,
so it is definitely a science though not an exact
science, like Physics and Chemistry. Science is
classified as follows:

CLASSIFICATION OF
SCIENCE

POSITIVE SCIENCE NORMATIVE SCIENCE

What is? What ought to be?
What was? What ought to have
What will be? been?
Positive Science
 It deals with actual happening. It presents the
real picture of facts without any comments and
suggestions. Economics also deals with the
positive issues, so it is a positive science.

Normative Science
 It deals with norms and facts and suggests, what
ought to be. It promotes social and economic
values. Economics is also normative science
because it suggest ways and measures to be
adopted for economic betterment of people
 Main Branches of economics:
1. Microeconomic concepts
2. Macroeconomic concepts
 Micro
economics
Micro economics: The branch of economics that
analyzes the market behavior of individual
consumers and firms in an attempt to understand the
decision-making process of firms and households.
Micro economics : Microeconomics (from Greek
prefix mikro - meaning "small" and economics) is a
branch of economics that studies the behavior of
individuals and small impacting players in making
decisions on the allocation of limited resources.
—“Microeconomics is the study of the
economic actions of individuals and
well defined groups of individuals.”

—“Microeconomics is the study of the

economic actions of individuals and
well defined groups of individuals.”
Macroeconomics (from the Greek
prefix makro- meaning "large" and
economics) is the study of the
macroeconomy. It is a branch of
economics dealing with the
performance, structure, behavior, and
decision-making of an economy as a
whole, rather than individual markets.
"Macroeconomics is the branch of economics
concerned with aggregates, such as national
income, consumption, and investment “

The Economist's Dictionary of Economics

defines Macroeconomics as "The study of
whole economic systems aggregating over the
functioning of individual economic units.
Macroeconomics (from the Greek
prefix makro- meaning "large" and
economics) is the study of the
macroeconomy. It is a branch of
economics dealing with the
performance, structure, behavior, and
decision-making of an economy as a
whole, rather than individual markets.
 "Macroeconomics is the branch of economics concerned
with aggregates, such as national income, consumption,
and investment “

 The Economist's Dictionary of Economics defines

Macroeconomics as "The study of whole economic
systems aggregating over the functioning of individual
economic units.
 Macroeconomics : The word “Macro” comes from a
Greek word “Makros” which means large.
Macroeconomics is concerned with aggregates and
averages of the entire economy, such as national
income, savings and investments, aggregate demand
and supply
 Microeconomics vs macro
economics
1.Microeconomics is the study of particular markets, and
segments of the economy.
Macro economics is the study of the whole economy.

2.Micro economics looks at issues such as consumer

behaviour, individual labour markets, and the theory of
firms.
Macro economics looks at ‘aggregate’ variables, such as
aggregate demand, national output and inflation.
3.The word “Micro” has come from a Greek
word “Mikros” which means millions of
parts.
The word “Macro” comes from a Greek word
“Makros” which means large.
4.Microeconomics is also called price theory.
macro economics is called income theory.
5.Micro economics provides a microscopic
view .
Macro economics provides a bird view of the
whole economy.
6. Micro economics is concerned with:
Supply and demand in individual markets
Individual consumer behaviour . e.g.
Consumer choice theory.
Individual labour markets – e.g. demand for
labour , wage determination.
Externalities arising from production and
consumption.
Macro economics is concerned with
Monetary / fiscal policy. e.g. what effect
does interest rates have on whole
economy?
Reasons for inflation, and
unemployment
Economic Growth
International trade and globalisation
Reasons for differences in living
standards and economic growth between
countries.
Interactions between Micro and Macro
Economics
 Microeconomics and macroeconomics are
inter-related because their fields of interest
are bound together and cannot be separated.
The decisions of individuals make up the
economies studied in macroeconomics
A microeconomist cannot possibly study the
investment policies of businesses without
understanding the impact of macroeconomic
trends such as economic growth and taxation
policies.

Similarly, a macroeconomist cannot study the

components of output in a nation’s economy
without understanding the demand of
individual households and firms.
 Activity:
Provide at least five (5) Basic Economic
Problems of our country and identify the root
cause of the problem.