MACROECONOMICS

CHAPTER 1: INTRODUCTION
Definition of economics
 Economics is a field of knowledge concerned with managing scarce resource to satisfy unlimited human
wants and needs.
 Scarcity refers to the inadequacy of resources, i.e, land, labor, capital and entrepreneurship to be
allocated properly to all sectors of the economy.
 The lack of parking spaces is an example of land allocated improperly.
 It can be assumed that land is insufficient and improperly managed due to a large population density and
thus, a high demand for space.
Unlimited human wants and the economic problem
 Personal objectives are concentrated in getting what one desires.
 The problem is that nobody can have everything.
 Even if one works an entire lifetime, he or she will never earn enough to buy everything that he or she
wants.
 For instance, a young adult, after buying his first dream car will eventually think of getting a new one.
 As fast a one acquires a new car, his tastes and preferences change.
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Needs
 Consist of the products and services that an individual can not live without based on his/her
existing lifestyle.
 For example: a middle class family living in the city spends its budget on food, school uniforms,
work attire, car gasoline, allowances, and payments for rent and utilities.
 As the family’s income increases, it is possible that its needs will change.
Wants
 Refer to products and services that a person can do without regardless of his/her lifestyle.
Specifically, they include items that have base models.
For example: a cellular phone in its basic form is a device that can make and receive calls
wirelessly. Regardless of the user, this is the purpose of a cellular phone.
However, additional features or parts such as camera, music player, and video recorder are
integrated in the latest models.
If the objective is communication, then a basic cellular phone can be classified as a need. As
other features are desired, then the cellular phone becomes a want.
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The distinction between needs and wants, however, is not strictly fixed. The wants today may
become the needs of tomorrow. Cellular phones with various features are fast becoming a need
rather than a want because of the convenience and utility that technology provides.
It is also important to understand that each person has different needs and wants which keep on
changing.
There is always something now that will come out in the market.
Economics and philosophy
Adam Smith (1776) wrote the famous “An Inquiry” into the nature and Causes of the Wealth of
Nations and separated economics from philosophy of source of knowledge.
He explained that society is based on the interdependence of all people regardless of what they
do.
The underlying interconnection lies in the movement of goods and services in relation to the
needs and wants of people.
This means that each individual has to satisfy his/her needs and wants which is the ultimate
reason for working.
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Basic assumption of economics
 There is always something now that will come out in the market.
Economics and philosophy
 Economics is able to predict actions of people based on rationality.
 Rationality is defined as the decision making process of an individual that is consistent and results in a
logical outcome most beneficial to the person.
 To illustrate further, the rationality test may be considered. For example: if a person prefers mango over
banana and banana over guava, then it follows that he/she prefers mango over guava.
 Economics assumes that individuals make decisions rationally, and thus, it is able to predict certain
behavioral outcomes.
Economic resources or factors of production
Land
 Covers all natural resources that exist without man’s intervention.
 It encompasses all things derived from the elements or components of nature such as air, water, forests,
vegetation, and other forms beneath the earth’s surface.
 These resources are irreproducible. The payment for land is called rent.
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Labor
Refers to human inputs such as manpower skills which are used in transforming resources into
different products that answer people’s needs.
Payment for labor are called wages and salaries.
Capital
Is the man made factor of production used to create another product.
Examples are machinery and equipment used by manufacturing companies.
The payment for capital is interest.
Entrepreneurship
Integrates land, labor, and capital to create new products. An entrepreneur is a person who
innovates and reinvents an old product to create new one.
A person who sells baskets will find it difficult to explore a new market for the product.
However, he/she can innovate and repackage the basket with grocery items, not to sell the
grocery items alone, but to sell the whole bundle as one merchandise.
This way, the basket of grocery items can be sold as a different item with proper packaging.
CHAPTER 1: INTRODUCTION
The scarcity of these four factors of production does not mean people can not produce much; rather,
wants or desires are only relative to the availability of these resources.
The finite nature of land, labor, capital, and entrepreneurship consequently makes the possibility or
occurrence of shortage, on top of the unlimited human wants and needs, a universal and perpetual
phenomenon.
Alternative definition of economics in the 21st century
As the modern economy is driven by technology and innovation, economics needs to have a
dedicated system or organization that implements the matching of resources and human wants and
needs.
Recognizing that economic decisions are due to incentives, choices, and a functioning set of rules to
make things work, maintaining equilibrium relies heavily on the flow of information.
To illustrate this point, the way of managing or implementing traffic rules may be examined.
Traffic congestion is an outcome of the limited number of and heavy demand for wide roads. It is
also caused by vehicular traffic violations.
Most traffic rules punish non compliance. The reverse of punishment is providing incentives, a
possible type of which is giving discounts to registering vehicle owners without traffic violations in a
year.
However, the efficiency of the rules is only as good as its consistent implementation, adherence to
standard operating procedures, and the availability of information to all concerned.
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Ten principles of economics
 Mankiw (2004) observed and elucidated the different principles of economics.
1) People face trade offs
 Each time a person makes a decision, he/she also makes a trade off. An example is a choice between
buying a favorite band’s concert ticket and purchasing a new gadget.
 Only one can be selected over the other. Another is a family’s decision on the allocation of a month’s
salary.
 Will the household spend it on food first then buy durable goods after, or pay first the monthly car or
house amortization and spend the rest for food items?
 It is always important to know what item is prioritized or forgone.
2) The cost of something is what one gives up to get it
 This principle is about comparing the cost of several alternatives or choices.
 Although, it might seem easy to identify costs, the dilemma is identifying the implicit ones.
 Opportunity cost is the value of the second best choice. When resources are limited or scarce, consumers
are compelled to decide how to manage them efficiently and determine how much of their wants and
needs will be satisfied.
 Hence, when a particular need is pursued, all other alternatives are forgone.
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3) Rational people think at the margin
Marginal approach is about incremental changes or differences in small amounts.
Decisions should be made by comparing marginal costs (MC) and marginal benefits.
For example: if MC is 00 from Q1 – Q2 and MC = 25 from Q6 – Q7, what quantity should be
produced?
Surely, the answer is where MC is 25 from Q6 - Q7.
4) People respond to incentives
One reason for workers’ low productivity is poor attendance.
To correct this problem a particular firm can give a health bonus. An incentive or bonus can be a
one month salary for a year’s perfect attendance.
After a year, workers may even insist on working during holidays.
Another example is a cable firm that gives discounts to subscribers who pay on time.
The company can even go further by giving a one month service free of charge for every eleven
months of advance payment.
After these incentives, collectors will hardly get delayed monthly payments.
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5) Trade can make everyone better off
 If there are two countries producing goods A and B with different levels of efficiency, is it better to let
these countries continue manufacturing both goods or make one country produce good A and the other
good B and trade the excess with the other country that does not produce the good respectively?
 A trade off between participants usually gets a bigger output with less input.
6) Markets are usually a good way to organize economic activity
 There was a particular time in the global economic history when the central planners in a command
economic system used to decide on the allocation of a country’s economic resources.
 This centralized system proved to be instrumental in boosting one’s output.
 Most nations turned to a market system where the decisions on allocating resources are dependent on
households and firms.
 It is better for them to determine the proper and wise allocation of resources because central planners
know anything about price adjustments due to buyer’s relative tastes ad preferences, or price changes
due to consumer speculations.
 For these reasons, communism failed in its raison d’etre which is the society’s well being.
 In fact, nations were able to achieve such well being using the system of a market economy where there is
an existence of an invisible hand that places everything correctly to achieve equilibrium.
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10) Societies face a short run trade off between inflation and unemployment
The increase in money supply in the short run fuels the economy to increase spending,
prompting firms to increase output and raise prices.
This in turn, leads to an increase in employment and a decrease in unemployment.
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10) Societies face a short run trade off between inflation and unemployment
The increase in money supply in the short run fuels the economy to increase spending,
prompting firms to increase output and raise prices.
This in turn, leads to an increase in employment and a decrease in unemployment.
SEATWORK
TRUE OR FALSE:
1) smart phone with all its features is considered a want.
2) A sari sari store owner is also considered an entrepreneur.
3) In a trade off, X and Y should be substitute goods.
4) I make the best turon in town, thus, I am considered an entrepreneur.
5) You can borrow money from me; therefore, I am an entrepreneur.
6) The easiest way to eliminate opportunity cost is to get all possible alternatives.
7) Scarcity is not a problem if you do not have a budget constraint.
8) Traffic congestion is not a sign of equilibrium.
9) Standard of living is based on how much you can produce and not how much you can earn.
10) Both the United States and the Philippines produce sugar, thus, they can not use it for trading.
ANSWER THE QUESTION BRIEFLY:
1) Why do we experience road traffic congestion?
2) Is the number coding scheme effective? Justify your answer.
3) What is the direct effect of printing too much money?