PRELIM

CHAPTER 1:
Introduction to Applied Economics

I. Learning Objectives:
a. Define basic terms in applied economics
b. Identify the basic economic problems of the country
c. Explain how applied economics can be used to solve economic problems
d. Analyze basic economic issues and propose solutions to the problems using the principles
of applied economics.

II. INTRODUCTION TO ECONOMICS

Scarcity is the reason why people have to practice economics. Economics, as a study, is
the social science that involves the use of scarce resources to satisfy unlimited wants.
Economics will help the students understand why there is a need for everybody, including
the government, to budget and properly allocate the use of whatever resources are available of
both agents Macroeconomics and Microeconomics.
In this module, we will focus economics as social science and applied science by
differentiating it, understanding how an economic theory puts in application and the importance of
econometrics for new policies.
It covers many different learning situations where you can relate your personal
experiences to different practical scenarios about Applied Economics.

III. DISCUSSION

Question 1: Why you should study Economics?

Everybody goes through a day faced with constraints or limitations: motorists complain of high
gasoline prices, times when people suffer due to a shortage of chicken in the market, or insufficient
allowance for a student who needs to buy books and school supplies. People always complain about not
having enough-not enough food on the table, not enough money to pay one’s debts, or not enough
income to meet all the family’s needs. This, in effect, is the existence of what we call scarcity, that is,
insufficiency of resources to meet the wants of consumers and insufficiency of resources for producers
that hamper enough production of goods and services.
Scarcity is the reason why people have to practice economics. Economics, as a study, is the
social science that involves the use of scarce resources to satisfy unlimited wants. Part of human
behavior is the tendency of man to want to have as many goods and services as he can. However, his
ability to buy goods and services is limited by his income and purchasing power. It is therefore in this
context that man has to practice economics.
Economics is derived from the ancient Greek word oikonomia—meaning the management of a
family or a household.
 Well-known economist Alfred Marshall described economics as a study of mankind in the ordinary
business of life. It examines part of the individual and social action that is most closely connected with
the attainment and use of material requisites of well-being.

Because of the presence of scarcity, there is a need for man to make decisions in choosing how to
maximize the use of the scarce resources to satisfy as many wants as possible. A homemaker who has
a monthly budget needs to decide on how to utilize it to pay the rent, to buy food, to pay the children’s
tuition fees, and to buy new clothes and shoes. If the budget is not enough, then the homemaker has to
give up some of these things. She needs to make a choice. If she decides not to buy new shoes for her
children at the start of the school year, then this is the choice to give up.

Figure 2

Economics is defined as the social science that deals with the production, distribution, and
consumption of goods and services. Evolved in the 19th century, the economic studies have become
one of the most significant studies of modern days. From a small shop to a country, Economics plays a
crucial role in the efficient running of both. No business can flourish without applying the principles of
economics. The study of economics is extensive and varied. The nature and scope of economics depend
upon the interaction of economic agents and how economies work. Let’s analyze the nature and scope
of economics deeply.

Nature of Economics
The nature of economics deals with the question that whether economics falls into the category of
science or arts. Various economists have given their arguments in favour of science while others have
their reservations for arts.

Economics is treated as a social science because of the following features:

▪ It involves a systematic collection of facts and figures.

▪ Like in science, it is based on the formulation of theories and laws.
▪ It deals with the cause-and-effect relationship.
 These points validate that the nature of economics is correlated with science. Just as in
science, various economic theories are also based on logical reasoning.
Scope of Economics
Economists use different economic theories to solve various economic problems in society. Its
applicability is very vast. From a small organization to a multinational firm, economic laws come into play. The
scope of economics can be understood under two subheads: Microeconomics and Macroeconomics.

Economics as a Social Science

Economics is a social science because it studies human behavior just like psychology and sociology. Social
science is, broadly speaking, the study of society and how people behave and influence the world around them.
As a social science, economics studies how individuals make choices in allocating scarce resources to satisfy their
unlimited wants.

So, to define Economics as a Social Science, it is a science concerned with using scarce resources to obtain
the maximum of the unlimited wants of society

Economics = Social Science

We use real-life scenarios to build models upon,

No scientific experiments! with which assumptions are made

Economics is a social science. This means that economics has two important attributes. Economics studies
human activities and constructions in environments with scarce resources and uses the scientific method and
empirical evidence to build its base of knowledge.

The evaluation of human interactions as it relates to preferences, decision making, and constraints is a
significant foundation of economic theory. The complexity of the dynamics of human motivation and systems has
led to the establishment of assumptions that form the basis of the theory of consumer and firm behavior, both of
which are used to model circular flow interactions within the economy.
 Circular Flow of the Economy

Economics provides an accessible foundation for understanding the complexity of the interactions in the
world. For example, the circular flow diagram displays the economic framework related to the dynamic
interconnectedness of economic agents. In the graph above the display is limited to households and firms but
other depictions of circular flow incorporate the government and international trading partners.

Economics provides distilled frameworks to analyze complex societal interactions, as in the case of
consumer and firm behavior. An understanding of how wages and consumption flow between consumers and
producers provide agents with an ability to understand the symbiosis of the relationship rather than fixating on
the contentious components that surface from time to time.

By developing an understanding of the foundations of economics, individuals can become better decision
makers with respect to their own lives and maintain a balance with respect to an externality that has the potential
to supplement or deter their plans. Since economic theories are a basis of decision making and regulatory policy,
being knowledgeable about economics foundations allows an individual to be an active and aware participant
rather than a passive economic agent.

Economics is a social science that assesses the relationship between the consumption and production of
goods and services in an environment of finite resources. A focus of the subject is how economic agents behave or
interact both individually (microeconomics) and in aggregate (macroeconomics).

Microeconomics examines the behavior of individual entities such as the consumer, the producer, and
the resource owner or firms within the market. It is more concerned with how goods flow from the business firm
to the consumer and how the resources move from the resource owner to the business firm. It is also concerned
with the process of setting prices of goods that are also known as Price Theory.

Microeconomics examines individual economic activity, industries, and their interaction. It has the
following characteristics:

• Elasticity: It determines the ratio of change in the proportion of one variable to another variable.
For example- the income elasticity of demand, the price elasticity of demand, the price elasticity of
supply, etc.
• Theory of Production: It involves an efficient conversion of input into an output. For example-
packaging, shipping, storing, and manufacturing.
• Cost of Production: With the help of this theory, the object price is evaluated by the price of
resources.
• Monopoly: Under this theory, the dominance of a single entity is studied in a particular field.
• Oligopoly: It corresponds to the dominance of small entities in a market.

Macroeconomics analyzes the entire economy and the issues affecting it. Primary focus areas are
unemployment, inflation, economic growth, and monetary and fiscal policy. Macroeconomics is about the nature
of economic growth, the expansion of productive capacity, and the growth of national income.

It is the study of an economy as a whole. It explains broad aggregates and their interactions “top down.”
Macroeconomics has the following characteristics:
 • Growth: It studies the factors which explain economic growth such as the increase in output per
capita of a country over a long period of time.
• Business Cycle: It advocates the involvement of the central bank and the government to formulate
monetary and fiscal policies to monitor the output over the business cycle.
• Unemployment: It is measured by the unemployment rate. It is caused by various factors like rising
in wages, a shortfall in vacancies, and more.
• Inflation and Deflation: Inflation corresponds to an increase in the price of a commodity, while
deflation corresponds to a decrease in the price of a commodity. These indicators are valuable to
evaluate the status of the economy of a country.

Economics as an Applied Science

Applied Economics - is the study of economics in world situations as opposed to the theory of
economics. It is the application of economic principles and theories to real situations and trying to predict
the outcomes.
Put simply; applied economics is the study of observing how theories work in practice. The discipline
may be practiced at macroeconomic or microeconomic levels.

Macroeconomics’ refers the whole aggregate economy, while Microeconomics’ looks at economics at
the individual consumer company level.

Figure 3. Economic Theory is all about thinking things up, while Applied Economics is about trying things out

- is the application of economic theory and econometrics in specific settings with the goal of analyzing
potential outcomes. As one of the two sets of fields of economics (the other set being the core), it is
typically characterized by the application of the core, referring to economic theory and econometrics, as
a means of dealing with practical issues in fields that include demographic economics, labor economics,
business economics, agricultural economics, development economics, education economics, health
economics, monetary economics, economic history, and many others. John Neville Keynes is attributed
to be the first to use the phrase “applied economics” to designate the application of economic theory to
the interpretation and explanation of particular economic phenomena.
What is Econometrics?
Econometrics – is the application of statistical and mathematical theories to economics for the purpose
of:

⚫ Testing hypotheses
⚫ Forecasting future trends
⚫ The results of econometric are compared and contrasted against real life examples.

Part of Econometrics is converting economic theories into data that policy makers can use

Econometrics Example:
Real life application of econometrics would be to study the hypothesis that as a person’s income
increases, spending increases

QUESTION 2: What is the importance of Applied Economics application in the household?

The Importance of Applied Economic Application

1. Applying economics to a company, household or a country helps sweep aside all attempts to dress up
a situation so that it will appear worse or better than it actually is.
 applied economics becomes a powerful tool to reveal the true and complete situation in order to come
up with things to do.

Example:
Applied economics can assess the profits of a certain company. The result can help the
executives to do some strategies in order to boost its sales.
2. Applied economics acts as a mechanism to determine what steps can reasonably be taken to improve
the current economic situation
 to examine each aspect, one can strengthen areas where performance is weak
Example:
• Purchase of goods and services
• Usage of raw materials
• Division of labor within the entity (e.g., firm, company, agency)

3. Applied economics can teach valuable lessons on how to avoid the recurrence of a negative situation,
or at least minimize the impact.
 to review what steps were taken to improve and correct similar situations and continue good strategies
to keep the economy flowing in a correct direction

We should be able to improve human welfare among Filipinos by the investigation and analysis of
economic problems in the real world. Applying economic theory in our lives means trying to address
actual economic issues and be able to do something about it. The concept of scarcity and choice should
encourage us as individuals to help in our own way to provide solutions to the country’s economic
problems.

QUESTION: What are Economic Resources?

Economic resources, also known as factors of production, are the resources used to produce goods and
services. These resources are, by nature, limited and therefore, command a payment that becomes the income of
the resource owner.

1. Land - soil and natural resources that are found in nature and are not man-made.
Owners of lands receive a payment known as rent

- these resources consist of gifts of nature which include:

 Soil
 Rivers
 Lakes, oceans
 Forests
 Mountains
 Mineral resources
- land is considered an economic resource because it has a price attached
to it.

2. Labor - physical and human effort exerted in production.

- also called “human resources” or all human efforts, be it mental or
physical, that help to produce satisfying goods and services.
- it covers manual workers like
  Construction workers
  Machine operators
 Production workers
As well as professionals like

 Nurses
 Lawyers
 Doctors
The terms also include

 Jeepney drivers
 Farmers
 Fishermen

In return, he earns an income in the forms of wages and salaries.

3. Capital - man-made resources used in the production of goods and services like:
 Machinery
 Equipment

Two (2) economic definitions of capital:

A. Capital - can represent the monetary resources use to purchase natural

resources.

Example:

Companies use capital to buy land and other goods

B. Capital - represents the major physical assets individuals and

companies use when producing goods and services

Example:
Buildings, vehicles, equipment

4. Entrepreneurs -organizers and coordinators of other factors of production: land,

labor, and capital.
-someone who uses his initiative, talent and resourcefulness to
create economic goods

5. Foreign Exchange -refers to the dollar and dollar reserves that the economy has.

-foreign exchange is part of economic resources because we need foreign

currency for international trading and buying materials from other countries.
- International medium - dollar
 Figure 1. Factors of Production

This central problem gives rise to four basic problems of an economy. In this article, we will look at these
basic problems in detail.

The Four (4) Basic Problems of an Economy

The central economic problem of scarcity of resources is broken down into four basic problems of an economy.
Let’s look at each of them separately.

Basic Problems of an Economy – #1 – What to Produce?

What does a society do when the resources are limited? It decides which goods/services it wants to produce.
Further, it also determines the quantity required. For example, should we produce more guns or more butter?
Do we opt for capital goods like machines, equipment, etc. or consumer goods like cell phones, etc.? While it
sounds elementary, society must decide the type and quantity of every single good/service to be produced.

Basic Problems of an Economy – #2 – How to Produce?

The production of a good is possible by various methods. For example, you can produce cotton cloth using
handlooms, power looms or automatic looms. While hand looms require more labor, automatic looms need
higher power and capital investment.

Hence, society must choose between the techniques to produce the commodity. Similarly, for all goods and/or
services, similar decisions are necessary. Further, the choice depends on the availability of different factors of
production and their prices. Usually, a society opts for a technique that optimally utilizes its available resources.

Basic Problems of an Economy – #3 – For whom to Produce?

Think about it can a society satisfy each and every human wants? Certainly not. Therefore, it has to decide on
who gets what share of the total output of goods and services produced. In other words, society decides on the
distribution of the goods and services among the members of society.

Basic Problems of an Economy – #4 – What provision should be made for economic growth?
Can a society use all its resources for current consumption? Yes, it can. However, it is not likely to do so. The
reason is simple. If a society uses all its resources for current consumption, then its production capacity would
never increase.

Therefore, the standard of living and the income of a member of the society will remain constant. Subsequently,
in the future, the standard of living will decline. Hence, society must decide on the part of the resources that it
wants to save for future progress.

Examples of the Economic Problem

Consumers

Households have limited income and they need to decide how to spend their finite income. For example,
with an annual income of P84,000, a household may need to spend P30,000 a year on rent, P10,000 a year for
utility bills. This leaves P44,000 or (P 3,666.67/month) for deciding which other food, clothes, transport and other
goods to purchase.

Workers

Householders will also face decisions on how much to work. For example, working overtime at the
weekend will give them extra income to spend, but less leisure time to enjoy it. A worker may also wish to spend
more time in learning new skills and qualifications. This may limit their earning power in the short-term, but
enable a greater earning power in the long-term. For example, at 18 a student could go straight into work or
they could go to university where they will hope to gain a degree and more earning power in the long-term.

Producers

A producer needs to remain profitable (revenue higher than costs). So, it will need to produce the goods
which are in high demand and respond to changing demands and buying habits of consumers – for example,
switching to online sales as the high street declines. Producers will need to constantly ask the best way of
producing goods. For example, purchasing new machines can increase productivity and enable the firms to
produce goods at a lower cost. This is important for fast-changing industries where new technology is frequently
reducing costs of production. Without firms adapting to how they produce, they can become unprofitable.

Firms may also need to make long-term investment decisions to invest in new products and new means of
production.
 Government

The government has finite resources and its spending power is limited by the amount of tax that they can
collect. The government needs to decide how they collect tax and then they need to decide whom they spend
money on. For example, the government may wish to cut benefits to those on low income to increase incentives
to work. However, cutting benefits will increase inequality and relative poverty.

Opportunity Cost and the Economic Problem

The economic problem can be illustrated with the concept of opportunity cost.

Opportunity cost is the next best alternative foregone. When land is devoted exclusively to the
cultivation of rice, we give up an output of bananas or mangoes that we could have planted on that land area. A
producer, who decides to transform all his leather into shoes, gives up the chance to produce bags with that
leather. A school teacher, who could have worked in a bank, gives up the salary that she would have earned as a
bank employee. A manager, who quits his job in order to take up a master’s degree, gives up his salary as a
manager. That salary is his opportunity cost. Without scarcity, a person does not need to make choices since
he/she can have everything he/she wants.

The concept of opportunity cost holds true for individuals, businesses, and even a society. In making a
choice, trade-offs are involved. The opportunity cost of watching a movie in a cinema is the value of other things
that you could have bought with that money such as a pint of ice cream, a combo meal in a fast food, or a simple
t-shirt to be used in a PE class. Another example is giving up work in favor of a recreational activity, say you go on
a week’s stay in Boracay on a leave without pay. Then you are giving up the income you would have earned had
you not decided to go on that trip. Another example would be a business proprietor that withdraws P10,000
from his savings account so he can buy materials to be used in his business. He gives up the interest the savings
would have earned but his goal is to earn more money that would be generated by the business.

Government in the concept of opportunity cost

A government may have choices on how to spend limited resources. In this simple model, they have a choice
between health care and military spending. If they increase spending on the military, the opportunity cost is less
spending on health care.
 Figure 2
How these questions are answered depends on the nature of the economic system in place. The
economic system is the means by which society answers the basic economic problems.

Economic Systems
The economic system is the means through which society determines the answers to the basic economic
problems mentioned. Economic systems regulate the factors of production, including land, capital, labor, and
physical resources. An economic system encompasses many institutions, agencies, entities, decision-making
processes, and patterns of consumption that comprise the economic structure of a given community.

A country may be under any of the following types or even a combination of the four economic systems:

1. Traditional economy. Decisions are based on traditions and practices upheld over the years and passed
on from generation to generation. Methods are stagnant and therefore not progressive. Traditional societies
exist in primitive and backward civilizations.

Societies with traditional economies depend on agriculture, fishing, hunting, gathering, or some
combination of them. They use barter instead of money. Most traditional economies operate in emerging
markets and developing countries. They are often in Africa, Asia, Latin America, and the Middle East.

Figure 3

2. Command economy. This is the authoritative system wherein decision-making is centralized in the
government or a planning committee. Decisions are imposed on the people who do not have a say in what goods
are to be produced. This economy holds true in dictatorial, socialist, and communist nations.

The command economy is a key feature of any communist society. Cuba, North Korea, and the former
Soviet Union are examples of countries that have command economies, while China maintained a command
economy for decades before transitioning to a mixed economy that features both communistic and capitalistic
elements

Figure 4

3. Market economy. This is the most democratic form of economic system. Based on the workings of
demand and supply, decisions are made on what goods and services to produce.
People’s preferences are reflected in the prices they are willing to pay in the market and are therefore the basis
of the producers’ decisions on what goods to produce.

Figure 5. Features of an Open Market Economy

The United States, England, and Japan are all examples of market economies. Alternatively, a command
economy is organized by a centralized government that owns most, if not all, businesses and whose officials
direct all the factors of production.

4. Mixed Economy. A mixed economy is a system that combines characteristics of market, command and
traditional economies. It benefits from the advantages of all three while suffering from few of the disadvantages.
 A mixed economy has three of the following characteristics of a market economy. First, it protects
private property. Second, it allows the free market and the laws of supply and demand to determine prices.
Third, it is driven by the motivation of the self-interest of individuals.

Economic Utility
A midst of the scarce resources we have in our society, economic utility must also consider to determine
usefulness or value that consumers experience from a product or service and can be judged based on the form,
time, place and possession, these factors help in assessing the purchase decisions and the drivers behind those
decisions.

Economic Utility gives a relative measure of satisfaction for a product. Based on the requirement of the customer,
the product may be assigned its utility. It relies completely on the need and preferences of a customer.
 utility increases only if
the customer possesses a
product

Different forms Introducing a

of a product particular product
may possess at the time when a
customer is in its
( or create)
need will increase
different levels
utility
of utility

A product’s utility is
maximum only at such a
place where its
requirement is created .

Figure 6. Four T ypes of Economic Utility

The understanding utility of a product or service is important from an economic point of view. It may be
different in different situations however it still gives an overall acceptance or rejection of the products. The
economic utility of a product refers to the requirements and expectations of consumers as well, and the
loopholes (if any) in its features. A downward movement in the utility of a particular product in markets may also
indicate new technology or upgraded versions being introduced. This acts as an eye-opener to existing
companies.
Measuring the Economy

It is beneficial that students get to learn first how the growth of the economy is actually measured. The
national government is always happy to inform the people that the country’s Gross Domestic Product (GDP) has
grown in rates, much higher than in the previous administration. We will now go into a short discussion of what
the GDP is all about.
The government plans for a better economy from a perspective of what the economy has been. Shaping
the economy’s future is changing past and present perspectives extended to the future. In particular, looking
ahead is grounded on past and present performance and health of the economy. The heart of the economy is
production whose value measures both resource input and output of people.
Gross National Product (GNP) is the market value of final products, both sold and unsold, produced by
the resources of the economy in a given period.

Market value is determined by supply and demand

The economy’s resources are those belonging to Filipino citizens and corporations.

GNP is calculated by adding personal consumption expenditures, government expenditures, private

domestic investments, net exports, and all income earned by residents in foreign countries, minus the income
earned by foreign residents within the domestic economy. The net exports are calculated by subtracting the value
of imports from the value of the country’s exports.
Unlike Gross Domestic Product (GDP), which takes the value of goods and services based on the
geographical location of production, Gross National Product estimates the value of goods and services based on
the location of ownership. It is equal to the value of a country’s GDP plus any income earned by the residents in
foreign investments, minus the income earned inside the country by foreign residents. GNP excludes the value of
any intermediary goods to eliminate the chances of double counting since these entries are included in the value
of the final products and services.

How to Calculate the Gross National Product?

The official formula for calculating GNP is as follows:
Y=C+I+G+X+Z
Where:

• C – Consumption Expenditure
• I – Investment
• G – Government Expenditure
• X– Export
• Z – Net Income (Net income inflow from abroad minus net income outflow to
foreign countries)
 Alternatively, the Gross National Product can also be calculated as

follows:

GNP = GDP + Net Income Inflow from Overseas – Net Income Outflow to Foreign Countries

Where:
GDP = Consumption + Investment + Government Expenditure +
Exports – Imports

GDP= C + I + G + (X – M)

Gross National Product takes into account the manufacturing of tangible goods such as vehicles,
agricultural products, machinery, etc., as well as the provision of services like healthcare, business consultancy,
and education. GNP also includes taxes and depreciation. The cost of services used in producing goods is not
computed independently since it is included in the cost of finished products.

For year-to-year comparisons, Gross National Product needs to be adjusted for inflation to produce real
GNP. Also, for country-to-country comparisons, GNP is stated on a per capitaL basis. In computing GNP, there are
complications on how to account for dual citizenship. If a producer or manufacturer holds citizenship in two
countries, both countries will take into account his productive output, and this will result in double counting.

Importance of GNP
Policymakers rely on Gross National Product as one of the important economic indicators. GNP produces
crucial information on manufacturing, savings, investments, employment, production outputs of major
companies, and other economic variables. Policymakers use this information in preparing policy papers that
legislators use to make laws. Economists rely on the GNP data to solve national problems such as inflation and
poverty.

When calculating the amount of income earned by a country’s residents regardless of their location, GNP
becomes a more reliable indicator than GDP. In the globalized economy, individuals enjoy many opportunities to
earn an income, both from domestic and foreign sources. When measuring such broad data, GNP provides
information that other productivity measures do not include. If residents of a country were limited to domestic
sources of income, GNP would be equal to GDP, and it would be less valuable to the government and
policymakers.

The information provided by GNP also helps in analyzing the balance of payments. The balance of
payments is determined by the difference between a country’s exports to foreign countries and the value of the
products and services imported. A balance of payments deficit means that the country imports more goods and
services than the value of exports. A balance of payments surplus means that the value of the country’s exports
is higher than the imports.

IV. ACTIVITY 1
Directions. Examine The Philippine National Budget for 2022, page 10, and answer the questions below.

here’s the link: https://www.dbm.gov.ph/images/pdffiles/2022-Peoples-Proposed-Budget.pdf

Questions:
1. Based on the proposed budget for 2022, what expenditures are the government’s top priorities and least
priorities?
________________________________________________

________________________________________________

________________________________________________

2. Why do you think the allocation of budget per sector is not divided equally?
________________________________________________

________________________________________________

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