ECONOMICS 1

Basic
Microeconomics

CHERRYVILLE S. MEJARES
ROMEO J. GAVIOLA JR.
GERYL M. BERMUDES
 LESSON 1

INTRODUCTION TO ECONOMICS

Learning Objectives:

To be able to:
- familiarize with the meaning of economics;
- differentiate microeconomics from macroeconomics;
- identify the basic terms used in Economics;
- - identify the basic economic problems;
- -distinguish the models of economic system.

Basic Concept

Every man of any distinction makes an economic decision everyday.

Deciding on how much to spend and save, the kind of food to buy, the
type of school to enroll, the amount of time for work and leisure, and
many more are only some situations where one applies economics. Thus,
it is very important to understand the various issues and intricacies
concerning economics.

Definition of Economics
“Economics is concerned with humanity’s well-being or welfare. It
encompasses the social relationships or social organizations involved in
allocating scarce resources among alternative human wants and in using
those resources toward the end of satisfying wants as fully as possible.”
Richard Leftwich (1979)

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 “Economics is the study of how societies use scarce resources to
produce valuable commodities and distributes them among different
groups.” Paul Samuelson and William Nordhaus (1989)

“Economics is the study of how people make their living, how they
acquire food, shelter, clothing and other material necessities and comfort
of this world. It is a study of the problems they encounter and of the ways
in which these problems can be reduced.” Paul Wonnacott and Ronald
Wonnacott (1986)

“Economics is a scientific study which deals with how individuals

and society generally make choices. Individuals and groups in society
have innumerable wants. To satisfy those wants, there are resources that
can be used. These resources, however, are not freely available. They are
scarce and furthermore have other alternative uses. Dimensions of choice
include present and future use of available resources. Moreover, the uses
of these resources carry with them costs and corresponding benefits.
Concerns with costs and benefits require efficiency in resources use.”
Gerardo Sicat (1983)

Generally, Economics can be defined as a social science which deals

with the proper allocation and efficient use of available resources for the
maximum satisfaction of human wants (Fajardo, 1990).

Divisions of Economics

1. Microeconomics deals with the problems and analysis of behavior

of individual economic unit such as the consumer (household),
seller (firm) and owners of factors of production.
2. Macroeconomics deals with the problems of the whole economy
and how aggregated economic units or sectors such as
consumer, business, government and foreign sectors are
interrelated.

MICROECONOMICS

Microeconomics is the study of the way the market for a particular

good or service works, that is, how the market-clearing price and the
quantity of goods and/or service that we exchange are determined. In a
capitalist economy, the market is the central concept of microeconomics.
It focuses on its two main players – the buyer and the seller, and their
interaction with one another.

Microeconomics operatives in the level of the individual business

firm, as well as that of the individual consumer. It concerns how a firm
maximizes its profits, and ho a consumer maximizes his satisfaction.

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 Microeconomics is also described variously as Price Theory or the
Economics of the Firm.

Human Wants
Human wants are the goods and services needed by human beings.
Goods and services are those that yield satisfaction. It may be tangible
(i.e. shoes, dress, pencils, food) or intangible (i.e. haircut, foot spa, dental
care).

Classification of Goods
1. Consumer goods vs. Capital goods
Consumer goods- When we eat hamburger, we get immediate
satisfaction.
Hence, hamburger is a consumer good.
Capital goods- those that are used in the preparation of the
hamburger does not give a direct satisfaction (instead an indirect
satisfaction because
without which, the hamburger cannot be prepared.)
Money is considered a “Capital” good because it does not give direct
satisfaction. Instead, it provides a means to buy (consumer) goods.
2. Essential goods vs. Luxury goods
Essential goods- These are the “basic” needs of man.
Luxury goods- These are those that contribute to man’s comfort
and well-being.

Characteristics of Wants
1. Unlimited
2. Varied
3. Insatiable (over an aggregate period of time)

Origin of Wants

1. Survival. People want food, clothing and shelter because they

are needed to survive.
2. Dictated by culture. The desire to have appliances such as
television, refrigerators and gas stoves are dictated by the
culture where one lives.
3. Generated by activity necessary to satisfy other wants. The
desire to complete college education is not because one really
wishes to spend and sacrifice in coming to school but this
activity is needed because it is essential to satisfy the
ultimate desire of getting a better job in the future.

Resources
Resources refer to the factors or inputs of production. They are
those which are needed to produce goods and services. These include:

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 1. Economic Resources. These are those with price tag because they
are scarce.
2. Free resources. These are those that has no price (because they
are abundant).

BASIC ECONOMIC PROBLEMS

1. What goods and services to produce and how much?

2. How to produce the goods and services?
3. For whom are the goods and services?

ECONOMIC SYSTEM
A system is a structure. So an economic system is the economic
structure of a given economy.
Models of Economic System

1. Capitalism – the factors of production and distribution are owned

and managed by private individuals or corporations. It has been
known by similar terms like market economy, free-enterprise
economy, or laissez faire economy. The latter are French words
which mean no government intervention in economic affairs. The
essential characteristics are:
-private property -free competition
-economic freedom -profit motive
2. Communism – the opposite of capitalism wherein the government
contr0ls the economy. This is also called command economy or
classless society. The essential characteristics of communism are:
-no private property -no profit motive
-no free competition -presence of central planning
-no economic freedom
3. Socialism – the combination of capitalism and communism. The
major and strategic industries are owned and managed by the state
while the minor industries belong to the private sector. Karl Marx,
the “father of modern socialism”.

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 Well, that ends our introductory lesson in economics.
Let’s find out this time if you fully understand the different
concepts of economics by answering SAQ – 1.

SAQ – 1

I. True or False. Write the word TRUE if the given statement is

correct and FALSE, if otherwise.

_____1. Economics is about making right choices.

_____2. Microeconomics is concerned with the performance of the
economy as a whole or its major aggregates. _____3. Essential goods are
always free.
_____4. Laissez faire means no government intervention.
_____5. The dictator or planning committee determines what to produce in
a market economy.
_____6. Money is a resource and classified as capital.
_____7. To decide on how to use scarce resources to satisfy human wants,
capitalism relies on price system.
_____8. Macroeconomics studies individual units such as consumers,
firms, and owners of the factors of production.
_____9. Human wants are insatiable over aggregate period of time
because man is never contented.
_____10. Goods and services are those that yield satisfaction.

II. Research Analysis

1. Based on your personal observation, make a short discussion of

the current status of the Philippine economy.

Guideless:
• Government system and its performance
• Politics in the Philippines
• Environmental status
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 2. Briefly explain how you can apply economics in your daily life.

Guidelines
• Daily or weekly budget
• Time management
• Chosen school and course

LESSON 2

DEMAND, SUPPLY AND MARKET EQUILIBRIUM

Learning Objectives:

To be able to:
- familiarize with the mechanics of demand as well as supply;
- identify the factors affecting demand and supply;
- state and apply the laws on demand and supply interactions.
- determine equilibrium price and equilibrium quantity when
given the demand and supply of a particular product

Introduction

In a market economy or capitalist economy, the interaction of demand

and supply of goods and services determine the prices of goods and
services. This chapter explains the law of demand and supply and
determination of price.

Demand
Demand is the schedule of various quantities of goods and services
which buyers are willing and able to purchase at a given price, time
and place, all other factors are held constant (ceteris paribus).

The law of demand states that as the price increases, the quantity
demanded decreases; and as the price decreases; the quantity demanded
increases, ceteris paribus.

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Various factors affecting demand include the following:
1. Income of the buyers - Persons basically purchase the necessities
with their income. As their incomes increase they tend to buy more
of the things they like to buy. A family with a car, for example, my
purchase a second unit. A person with two pairs of shoes may buy
another pair.
2. Tastes and preference – People of different cultures vary in tastes
and preferences. A large ethnic group, for instance, has a taste for
mixing their food with strong dose of spices. In another light, some
groups of people prefer to spend a large part of their incomes on
luxuries even if basic necessities are not satisfied.
3. Size of the market – The demand curve is affected by the number of
people living in a given area. A market with a big population like
Metro Manila tends to buy more appliances and electricity than a
less populated region like Panay Island.
4. Price expectation – When people expect changes in the economy,
their reaction will affect demand for certain products. Expectations
about a forthcoming war, for instance, greatly affect demand for
goods and services.
5. Price and availability of related goods – Goods that are related tend
to influence each other’s demand. Related goods and services are
of two types: substitutes and complements. Substitutes are goods
that compete with each other such as meat and fish. Complements
are goods that are used jointly, like cement and steel bars. The
demand for meat will tend to fall if the price of fish (a substitute)
decreases. When the price of cement falls, the demand for steel
bars (a complement will tend to increase.
6. Special influences – There are certain developments that influence
demand for certain goods and services. Heat and humidity, for
instance, contribute to the demand for air-conditioning equipment
and light clothing.

A demand schedule is a listing of the different quantities of goods

and services that buyers will purchase given the various alternative
prices.
Example:

Table 1. Demand Schedule for Commodity X

Price of X (P x) Quantity demanded for commodity X (Qd x)

10 9
20 8
30 7
40 6

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 50 5
60 4
70 3
80 2

Market demand curve is the total demand obtained by taking the

horizontal summation of all individual demand curves of the consumers in
the market. It is downward sloping.

SUPPLY

Supply is the schedule of various quantities of goods and services

which sellers are willing and able to sell at a given price, time and place,
all other factors are held constant (ceteris paribus).

The law of supply states that as the price increases, the

quantity supplied also increases, and as the price decreases, the
quantity supplied also decreases.

Factors affecting supply:

1. Cost of production – Supply is highly dependent in the cost of

production. Firms are able to increase their output when prices of
inputs decreases. Conversely, output tends to decrease when
production costs increase. Plans for expansion of capacity are
jeopardized by increasing costs of production.

2. Number of Sellers/Suppliers – Supply is also dependent on the

number of sellers. When new firms begin to operate, they bring in
additional supply to the market, increasing the total available
supply. In contrast, the withdrawal of existing firms reduces the
amount of supply in the market.

3. Technology – Improvements in technology make possible the

production of goods and services at lower costs. When these are
adapted by firms, they will be able to produce more.
4. Price of other goods and services – Price of some goods and services
affect the supply of other goods and services. If a producing firm,
for instance,, finds that the price of its current output (bicycles, for
example) has gone down considerably, it may change its products
to a new one (motorcycle, for example). If this happens, the supply
of motorcycles will increase. Consequently, the supply of bicycles
will decrease.
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 5. Taxes and subsidies – Payment for taxes in an added component of
the cost of production. Higher taxes mean higher production costs,
and firms are discouraged to produce more goods and services
Subsidies are money given to firms by the government to help
them maintain their current or desired output. The money received
by firms effectively reduces their cost of production, and they are
encouraged to produce more goods and services.

A supply schedule is a listing of the different quantities of goods and

services that sellers will sell given the various alternative prices. Price
and quantity supplied are directly proportional.
Example:

Table 2. Supply Schedule for Commodity X

Price of X Quantity Supplied for commodity X

(Px) (Qsx)
10 1
20 2
30 3
40 4
50 5
60 6
70 7
80 8

A supply curve is a plotted supply schedule. It is upward sloping.

Market supply curve is the horizontal summation of all individual supply of
the sellers in the market.

The law of supply states that as price increases, the quantity

supplied also increases and as price decreases, the quantity
supplied also decreases.

MARKET EQUILIBRIUM

The condition when quantity demanded is equal to quantity supplied

is said to be market equilibrium.

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 Figure 3. Market Equilibrium

The law of demand and supply states that when demand is

greater than supply, price increases. When supply is greater that
demand, price decreases. And when demand is equal to supply,
price remains constant. When there is no equilibrium, there is no
balance between the demand and supply. Shortage is a condition when
quantity demanded exceeds supply. This happens when the price gets
lower than the equilibrium.
Surplus is a condition when the quantity supplied is greater than the
quantity demanded. This occurs when the price is above the equilibrium
price.

Table 3. Demand and Supply Schedule

Price of X Quantity demanded for Quantity Supplied for

(Px) commodity X (Qdx) commodity X (Qsx)
10 9 1
20 8 2
30 7 3
40 6 4
50 5 5
60 4 6
70 3 7
80 2 8

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============================================
====================

At this point let’s pause to answer the Self-Assessment

Questions.
SAQ - 2

Answer the following questions:

1. Differentiate demand from supply.

2. What are the determinants of
demand?
3. What are the factors affecting
supply?
4. What is the law of demand and
supply?

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 LESSON 3

THE CONCEPT OF ELASTICITY

Learning Objectives:

To be able to:
- discuss the elasticity of demand and elasticity of supply;
- compute the coefficient of elasticity of demand based on the demand
data and the coefficient of supply from supply data;
-differentiate the types of demand elasticity as well as supply
elasticity.

The Concept

Based on the law of demand, buyers are willing and able to

purchase more goods and services at lower prices that at higher prices.
These are natural reactions or inclinations of buyers. However, such

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reactions vary depending on the importance and availability of the goods
and services. These varying reactions are known as demand elasticity.
In the case of producers or sellers, they have also their reactions to
price changes. Clearly, they tend to sell more goods and services when
prices are higher. Their reactions also vary depending on their ability to
produce in a given time. For instance, they cannot take advantage of
higher prices if they cannot produce the goods and services. Such varying
reactions of producers are known as supply elasticity.
ELASTICITY – refers to the reaction of response of the buyers or sellers to
changes in price of goods and services.
DEMAND ELASTICITY refers to the reaction or response of the buyers to
changes in price of goods and services. Buyers tend to reduce their
purchases as price increases, and tend to increase their purchases
whenever price falls. These are logical reactions to prices changes.
However, such reactions vary in accordance with the nature of the
products and the particular needs of the buyers.

5 Types of Demand Elasticity

1. Elastic Demand – A change in price results to a greater change in

quantity demanded. This shows that buyers are very sensitive to
price change. These are the luxury goods like stereo, car, television
set, jewelries, etc.
2. Inelastic Demand – A change in price results to a lesser change in
quantity demanded. This means buyers are not sensitive to price
change. Products under this category are very essential to buyers.

3. Unitary Demand – A change in price results to an equal change in

quantity demanded. Goods or services under this category are
considered semi-luxury and semi-essential.

4. Perfectly Elastic Demand – Without change in price, there is an

infinite change in quantity demanded.

5. Perfectly Inelastic Demand – A change in price creates no

change in quantity demanded. This is an extreme situation which
involves life or death to an individual.
Determinants of Demand Elasticity

1. The price of the good in relation to the consumer’s budget.

Consumers are more sensitive to price changes of goods that take
a big amount of their budget.

2. The availability of substitutes. The demand elasticity of the

good is affected by the availability of substitutes. The more and
the closer substitutes are, the more people will switch to
substitutes, when the price of the good rises.
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 3. The type of good. The demand elasticity of a good is affected by
its type, like whether it is a luxury or necessity.

4. The time under consideration. The demand for a good becomes

more elastic over a longer period of time.

Classifications of Demand Elasticity

1. Price Elasticity – used to determine the responsiveness of demand

to changes in the price of the commodity. It may be calculated with
the use of the formula below:

Ep = percentage change in quantity demanded

percentage change in price

= QD2 - QD1 / QD1

P 2 - P1 / P 1

Where :
Ep = price elasticity of demand
QD2 = new quantity demanded
QD1 = original quantity demanded
P2 = new price
P1 = original price

2. Income Elasticity of Demand – refers to the determination of the

responsiveness of demand to a change in consumer income.

Ey = percentage change in quantity demanded

percentage change in income

= QD2 - QD1 / QD1

Y 2 - Y1 / Y 1

Where: Ey = income elasticity of demand

Y2 = new income
Y1 = original income

3. Cross Elasticity of Demand – the responsiveness of the quantity

demanded of a particular good to changes in the price of another
good.

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 Ec = QA2 - QA1 / QA1
PB2 - PB1 / PB1

Where:
Ec = cross elasticity of demand
QA2 = new demand for product A
QA1 = original demand for product A
PB2 = new price of product B
PB1 = original price of product B

SUPPLY ELASTICITY – refers to the response or reaction of the sellers or

producers to price change of goods. Based on the law of supply,
producers are willing to and able to offer more goods at a higher price,
and less goods at a lower price. However such response of the producers
vary in accordance with the kind of goods they produce.

5 Types of Supply Elasticity

1. Elastic Supply – A change in price results to a greater change in

quantity supplied. This means producers are very responsive to
price change. Examples of these goods which can be produced
immediately or in short time like those produced by manufacturing
firms.
2. Inelastic Supply – A change in price results to lesser change in
quantity supplied. This shows that producers have a very weak
response to price change. With a high price, they like to increase
their quantity supplied, but they cannot do it at once.

3. Unitary Supply – A change in price results to an equal change in

quantity supplied. Goods under this category are those that are
classified as semi-industrial or semi-agricultural products.

4. Perfectly Elastic Supply – Without change in price, there is an

infinite (without limit) change in quantity supplied.

5. Perfectly Inelastic Supply – A change in price has no effect on

quantity supplied.

Determinants of Supply Elasticity

1. The feasibility and cost of storage. Regardless of price,

perishable goods like vegetables must be brought to the market. If
storage cost is high, even if it is available, the sellers have no choice
but to sell at prevailing price. Supply is inelastic in this case.

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 2. The ability of producers to respond to price changes. If the
producers can easily increase or decrease output when price rise or
fall, supply is elastic.

3. Time. With the passage of time, especially for long periods, supply
tends to be elastic. If there is a rise in prices, the producers may
not be able to make adjustments quickly, but given sufficient time,
they may be able to produce more.

Before we proceed to our next lesson, let’s do first the

self-testing exercises!
SAQ – 3

I. True or False. Write the word TRUE if the given statement is

correct and FALSE, if otherwise.

1. Price elasticity of demand measures the responsiveness of buyers to

changes in prices.
2. Consumers are very sensitive to price changes, the demand is
inelastic.
3. If supply is perfectly inelastic, a change in the price has no effect on
the quantity supplied.
4. Agricultural products are elastic supply.
5. If the good has many close substitutes, demand is said to be elastic.

II. Solving for Elasticity. Describe the significance of the value.

Round off your final answer to the nearest hundredths. Show your
solution. (5 points each number)

1. Suppose that the price of commodity ABC due to changes in cost of

production increases from P25 t0 P32, causing a decline in the
quantity demanded of the good by 10% from 5,000 kilos.
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 2. An increase in the price of yellow corn from P20.00 to P22 causes an
increase in the production of farmers from 10,000 to 12,500 sacks.

LESSON 4

THEORY OF CONSUMER BEHAVIOR

Learning Objectives:

To be able to:
- identify what economist mean by utility and law diminishing
marginal utility;
- discuss what indifference curves are and show how to construct one;
- show how a budget line and indifference curve can be combined to
identify the point of consumers equilibrium.

Introduction

In the attempt to satisfy wants, consumers make choices as

frequent as wants are felt. Should a person wake up early or late? Should
he eat rice and eggs or rice and fish for breakfast? Call a plumber or do
the fixing himself? These are examples of choices that a consumer makes
and they are important considerations in the study of consumer behavior.

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But how useful is knowledge of consumer behavior? The answer lies on
how important are profits to the firms.

Utility Concept

Utility means satisfaction. Marginal utility refers to the additional

satisfaction of a consumer whenever he consumes one more unit of the
same good. The law of diminishing marginal utility refers to the
consumption of more successive units of the same good increases total
utility, but at a decreasing rate because marginal utility diminishes. For
example, consumption of 1 cone of ice cream gives satisfaction to the
individual. Consumption of another cone of ice cream of the same kind
gives an additional satisfaction. Again, he consumes the third cone of ice
cream of the same kind. His total satisfaction has increased by consuming
3 cones of ice cream in just one sitting. But his additional satisfaction
from the third cone of ice cream is lesser that his additional satisfaction of
the second cone of ice cream.

Table 4.1. Total utility increases at a decreasing rate due to a diminishing

marginal utility.

Quantity of a good Total Utility Marginal Utility

consumed
1 5 -
2 9 4
3 12 3
4 14 2
5 15 1
6 15 0

INDIFFERENCE CURVE

The word “indifference” means showing no bias or neutral.

Supposing there are five combinations of two products (like meat and
fish): the first combination constitutes 5 kilos of meat and 1 kilo of fish
while another combination is composed of 5 kilos of fish and 1 kilo of
meat, and so on. Since all combinations give the same level of
satisfaction or utility, the consumer would be indifferent as to which
combination he receives. This means any combination would be desirable
for him. He has no particular choice. By definition, an indifference curve

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is a curve which shows different combinations of two goods which yield
the same level of satisfaction.

Table 4.2. An indifference schedule showing the various combinations of

meat and fish

Combinations Kilos of Meat Kilos of Fish

A 5 1
B 4 2
C 3 3
D 2 4
E 1 5

A consumer’s indifference curve: every point on an indifference

curve indicates a combination of two products which provides the same
level of satisfactions.
An indifference map is composed of a series of indifference curves.
Each curve indicates a different level of total utility. Each curve to the
right of another curve provides greater satisfaction because it constitutes
combinations of more units of two products.
BUDGET LINE

A budget or consumption possibility line indicates the various

combinations of two products which can be purchased by the consumer
with his income, given the prices of the products. A consumer has a fixed
budget, and he has to spend his money wisely to be able to maximize his
satisfaction. He has several combinations of two products to choose.
However, his choice is confined within the limits of his budget.

As an example, unit price of both products A and B is P25.00. The

budget of the consumer is P150.00. It is possible for him to buy 5 units of
A and 1 unit of B, or 5 units of B and 1 unit of A. He can also choose 4
units of B and 2 units of A. Any of these combinations is worth P150.00

Table 4.3. A budget line schedule showing the various combinations of

two products with a fixed budget of P150.00 and the unit price of both
products at P25.00.

Units of Product A Units of Products B Total Expenditures

5 1 P125 + P25 = P150
4 2 P100 + P50 = P150
3 3 P75 + P75 = P150

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 2 4 P50 + P125 = P150
1 5 P25 + P150 = P150

The Equilibrium of the Consumer or the Consumer Equilibrium

Consumers are expected to behave in a rational manner, i.e., they make

decisions on the basis of choosing which alternative would be most
advantageous to them. Decision-making, however, will be simple if the
consumer wants only a single good at a given time. This is not realistic,
however, because consumer find it necessary to buy a variety of goods.
This will make his decision-making a little complicated as he has to
determine which goods to buy and at what quantity. To complicate
matters, the consumer is faced with the following realities:

1. The varying prices of goods competing for his attention, and

2. The limited income or purchasing power he has.

The consumer cannot buy everything he wants because of his

limited income. Rather, he is forced to compromise and decide what and
how much of each of the many times he can afford and will best suit his
needs. The most preferred combination of goods to buy is referred to as
consumer equilibrium.

SAQ – 4

Write the word TRUE if the given statement is correct and FALSE, if
otherwise.

____1. Total utility increases at a diminishing rate when marginal utility is

decreasingly positive.
____2. Marginal utility measures the change in the total utility from a
change in the consumption of one unit of a commodity.
____3. Indifference curve shows various combinations of goods each
which yield different levels of total utility.
____4. A budget line shows the infinite points of combinations in
consuming two goods that the same amount of budget can buy at
constant prices.
____5. Utility is the basis of choice.
____6. Indifference curves do not intersect.
____7. Assuming the same amount of budget which can buy two goods, a
change in the price of one good can change the entire allocation of
income.
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____8. The optimum combination of two goods can be obtained at the
tangency of the budget line and indifference curve.
____9. The farthest right indifference curve suggests the highest utility.
____10. A budget line is convex in shape.

LESSON 5

THEORY OF PRODUCTION
Learning Objectives:

To be able to:
-explain the meaning and concept of production and
production function;
-state the law of diminishing returns;
-distinguish total, average and marginal product; -
identify different periods of production; -explain cost
and profit.

Introduction

Production is the creation of goods and services using the inputs of

production. The physical relationship between the inputs and outputs of
goods and services is called production function and expressed in
mathematical form:

Q = f (X)
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Where: Q = Output
X = Inputs

Output refers to the goods and services that have been created using the
production inputs.
Inputs of production refer to the factors of production which include
land, labor, capital, and entrepreneurship. Inputs are classified as
follows:

1. Fixed Inputs- they are those that remain constant regardless of the
volume or quantity of production. This means that whether you
produce or not, the factors of production is unchanged.
2. Variable inputs- these are those that vary in accordance to the
volume or quantity of production. If there is no production; then,
there is no variable inputs.

The Law of Diminishing Returns

It states that when successive units of variable input is combined

with a fixed input, the total product (TP) or output (Q) will increase, but
beyond some points the resulting increases in output will become smaller
and smaller.

Total Product (TP) refers to the total production or output. (Q)

Marginal (Physical) Product (MP). it is the additional output
produced by employing one additional unit of input (X) holding the level of
usage of all other inputs constant.

TP Q
MP = x or using Q to denote TP = MP

Average (Physical) Product (AP). It is the output produced per unit of the
input.

TP Q
AP = x or using Q to denote TP AP= x

Table 1: Total product (in cavans) schedule of rice production with workers
as variable input (x).

Units of Total Product Marginal Average

workers (TP) or Output Product (MP) Product (AP)
(x) (Q)
0 0
1 5 5 5.0
2 15 10 7.5
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 3 29 14 9.7
4 44 15 11.0
5 55 11 11.0
6 61 6 10.2
7 64 3 9.1
8 64 0 8.0
9 62 -2 6.9
10 59 -3 5.9

THREE STAGES OF PRODUCTION

The Stage 1 of the production process is characterized by an increasing

AP. The increasing AP is explained by specialization and teamwork gained
from an additional X. Moreover, at this stage the fixed input is grossly
underutilized. The point of equality between AP and MP serves as the
boundary between Stages 1 and 2 of the production process. At this point
of intersection (MP = AP), it is noticeable that the AP has reached its
maximum value.

The Stage 2 of the production process corresponds to the range of x from

5 up to 8. The end point of stage 2 corresponds to the point of maximum
output on the TP curve. This maximum TP happens when the MP is equal
to zero (MP=0). This point serves as the boundary between stages 2 and 3
of the production process. At this level, both MP and AP are declining.

The Stage 3 of the production process encompasses the range of x over

which the total product is declining (which corresponds to negative MP).
Stage 3 occurs when x exceeds 8 where the crowding effects overwhelm
any output attributable to additional workers.

THEORY OF COST AND PROFIT

COST CONCEPT

Cost of production refers to the total payment by a firm to the owners of

the factors of production.

Factors of Production Factor Payment

Land Rent
Labor Wage or Salary
Capital Interest
Entrepreneurship Profit

23
The price of the resources is measured in terms of opportunity cost.
Opportunity cost is the value of the foregone opportunity or alternative
benefits. This means that in order for a business firm to secure the
services of resources, it must pay an amount equal to what these
resources can earn in other alternative uses.

Important cost concepts include:

A. Explicit vs. Implicit costs

Explicit cost (Visible cost). It is the actual (explicit) expenditures
made by the firm (that is usually thought of as its only expenses).

B. Short run and Long run viewpoints

Short run. It is the planning period of the firm so short that some
resources can be classified as fixed while some are considered
variable. Long run. It is the planning period of the firm so long that
all resources eventually become variable.

Short Run Cost Curves

In the short run, the total costs of a firm depend on the firm’s size and
on the level (r volume) of production. The component parts of Total
Costs (TC) are Total Fixed Costs (TFC) and Total Variable Cost (TVC).

TC = TFC + TVC

Fixed cost. It is the kind of cost which remains constant regardless of

the level (or volume) of production. The summation of all the fixed
costs incurred by a firm in its production is the Total Fixed Cost (TFC).

Variable cost. It is the kind of cost which changes in proportion to the

level (or volume) of production. Total Variable Cost (TVC) is the totality
of all the variable cost spent by the firm in its production.

Average and Marginal Cost Curves

Average cost is also called unit cost. These curves show the same kind
of information as the total cost curves in a different form. The average
cost curves include the Average Cost (AC), Average Fixed Cost (AFC),
and Average Variable Cost (AVC).

Average Fixed Cost (AVC) refers to the fixed cost per unit at various
levels of output. This is obtained by dividing the TFC by the output (Q).

TFC
AFC = Q
24
Average Variable Cost (AVC) is the variable cost per unit at various
levels of output. It is the quotient of TVC and the output.

TVC
AVC = Q

Average Cost (AC) is the overall costs per unit of output. This can be
obtained in two ways:

TC
AC = Q

or

AC = AFC + AVC

Marginal Cost is the additional or extra cost brought about by

producing one additional unit (of output). Also, this is known as the
slope of the TC. It is obtained by dividing the change in the total cost
by the change in the output.

TC
MC = Q

Profit Concept

Total and Marginal Revenue

Total Revenue (TR) is the payment for the output produced by the firm.
This represents the income of the firm. It is obtained by multiplying the
price (P) and the output (Q) produced.

TR = P x Q

Marginal Revenue (MR) is the additional income of a firm obtained by

producing and selling one additional unit of product. It is also
equivalent to the slope of the TR. The mathematical formula to derive
MR is as follows:

TR
MR = Q

Profit, Loss and Break-even

Profit maximization involves the comparison of TR and TC. The

mathematical formula to derive profit (π) is by getting the difference
between total revenue (TR) and total cost (TC).
25
 π = TR – TC

A positive difference indicates profit (π>0); a negative difference

means loss (π<0); and when π=0, it suggests break-even or TR is equal
to TC.

Profit maximization is a point where the (positive) difference between

the TR and the TC is highest. This point corresponds to the equality of
the slope of the TR (MR) and the slope of the TC (MC).

Maximum profit : MR = MC

SAQ – 5

Write the letter of your choice on the space provided before each
number on Column A.

Column A Column B

____1. Total Cost a. Product

____2. Creation of any good or service b. AP is increasing
____3. Marginal Product c. Combination of inputs to produce
____4. Inputs same level of output
____5. Fixed Input d. Land
____6. Variable Input e. Capital
____7. Average Product f. Production
____8. Stage 1 of production process g. ∆TP/∆X
____9. Cost per unit h. FC + VC
____10. Output i. Factors of Production
j. Average Cost

26
 LESSON 6

MARKET STRUCTURES

Learning Objectives:

To be able to:
-identify the market structures;
-discuss the characteristics of each market structure;
-identify the determinants of market structures.

Basic Concept

Business firms produce goods and services based on consumer demand

and on what they believe consumers should buy, own, and enjoy. Once
the products are available, they compete against each other for consumer
attention and patronage. The kind of competition among them follows
definable patterns called “market structures.” There are four of them: (1)
pure competition, (2) monopoly, (3) monopolistic competition, and (4)
oligopolistic competition. , Different industries fall under different market
structures pattern.

The four comprise the supply side of the market with the consumer
sector representing the demand side.

27
 At least eight factors define all four market structures, but in differing
ways.

1. The product

2. Number of sellers

3. The buyers

4. Degree of control over supply

5. Degree of control over price

6. Market knowledge

7. Marketing approaches

8. Government control

Basic Market Models

1. Perfect/pure type
a. Perfect or Pure Competition
b. Pure Monopoly

2. Imperfect/non-pure type
a. Monopolistic Competition

Pure Competition – is a market situation there is a large number of

independent sellers offering identical products.

Pure Monopoly – refers to a market situation where there is only one

seller or producer supplying unique goods and services. A one-buyer
market situation is known as monopsony.

Monopolistic Competition – pertains to a market situation where there

is a relatively large number of small producers or suppliers selling similar
but not identical products.

Oligopoly – is associated with a market situation where are few firms

offering standardized or differentiated goods and services. Few seller-
market situation is called oligopsony.

28
Characteristics of Market Models

Pure Competition

1. There is a large number of independent sellers.

2. Products are identical or homogeneous.

3. No single buyer or no single seller can influence the change in

market price of a product.

4. It is easy for new firms to enter the market and for existing firms or
sellers to leave the market.

5. There is no non-price competition like advertising, sales promotion,

or packaging. There is no need for such non-price competition
because the products are identical which means they have the
same features.

Pure Monopoly

1. There is only one producer or seller.

2. Products are unique in the sense that there are no good or close
substitutes available. Most public utilities supplying water and
electric are monopolists.

3. The monopolist makes the price. Since he is the only supplier, he

can reduce his output in order to increase his price. Or he can
increase his supply if his means an increase in his total profit.

4. It is extremely difficult for new firms to enter the market. There are
several formidable barriers like very big capital and very keen
competition. The existing monopolist is an established giant in
the industry. There are also natural monopolies which refer to
existing goods and services in which competition is not practical or
profitable. Most public utilities enjoy natural monopolies. These
are granted exclusive franchises by the government.

5. There may be or no extensive advertising or sales promotion

depending on the goods or services of the monopolists. In case
there is advertising, it is only for public relations or goodwill to
induce more people to buy their products or improve their public
image.

29
Monopolistic Competition

1. There is a large number of sellers acting independently.

2. Products are differentiated or similar but not identical. This means

physical differences as well as variations in location of the store,
services of the sales staff, packaging of the product, credit
conditions, advertisement, and other sales promotion strategies.
Examples are banks, book publications, drugs, tailoring shops,
gasoline stations, among others.

3. There is a limited control of price. It is possible for some sellers to

slightly reduce or increase their price because of differences of their
products. Example, some banks have lower or higher interest rates.
Likewise soap products have different prices.

4. Entry of new firms in the market is relatively easy. However,

compared with pure competition, it is more difficult for firms under
the monopolistic competition to put up their business. It requires
bigger capital and the competition is greater in the sense that they
have to offer better product features and more effective sales
promotion.

5. There is an aggressive non-price competition in product quality,

credit terms, services, locations, and physical appearance of the
product.

Oligopoly

1. There are very few firms which dominate the market. Each firm
produces a big portion of the total industry output.

2. Products are identical or differentiated. Raw materials like steel,

zinc, lead, cement and other industrial raw materials are identical
products. Finished goods like airplanes, cars and locomotives are
differentiated products.

3. There is a price agreement among the producers to promote their

own economic interests. The biggest among the producers is the
price leader.

4. The entry of new competitors in the market is difficult. It requires

enormous capital and large-scale production. It is very difficult for
new firms to compete with existing firms because these are already
wellestablished. However, despite formidable competition, it is still
possible for new firms to enter the market.

30
 5. There is strong advertising among those who produce differentiated
products.

Determinants of Market Structure

1. Government laws and policies. In some industries, the

government controls the degree of competition in the interest of the
economy and the consumers. For instance, in certain industries like
those which supply water and electricity, the government requires
only one company for each product and service.

2. Technology. The discovery of better technology by some firms has

driven way less efficient competitors. So that only very few have
remained in the industry.

3. Business policies and practices. The presence of giant firms

discourage the entry of new firms with little resources. In some
cases, the bigger firms resort to cut-throat competition which is an
unfair business practice to drive away their competitors. There are
also cases where existing big firms merge their resources to
improve their shares in the market. Another strategy of big firms is
to buy the resources of their competitors with attractive price. This
eliminates or reduces competition.

4. Economic freedom. The existence of economic freedoms like the

right to own private properties, right to engage in any lawful
business, the right to accumulate income, and other similar
economic freedoms associated with a free-enterprise economy have
a changed market structures. In a free-enterprise economy or free-
competition economy, it is the survival of the fittest. The most
efficient firms remain in business. They conquer their competitors
and drive them out of the market.

-------------------------------------------------------------------------------------------------

31
SAQ - 6

Fill-in the corresponding answer in an empty box provided. Use the word box
below.

Market Product Number of Non-price Entry/Exit

Models Classification Sellers Competition

Pure
Competition

Pure
Monopoly

Monopolistic
Competition

Oligopoly

32
 LESSON 7

BUSINESS ORGANIZATION

Learning Objectives:

To be able to:
-understand the functions of business in the economy;
-know why people become entrepreneurs;
-identify the different business organizations;
-discuss the characteristic features of business organizations.

Basic Concept

The Importance of Business

Business is the second major player in the economy, the other two
being the households (or consumers) and the government. The business
community plays three basic but vital functions in the economy.

1. Business produces and sells the goods and services that we

need and want. To appreciate this function better, think of life
without the business sector. Without it, we must do everything for
ourselves: grow, hunt, and fish for food; fashion our own clothes.
There will be no jobs and no income.

33
 2. Business creates jobs. Business creates jobs in the course of its
producing goods and services for everyone in the economy. In
exchange for their work, business pays its workers (both managerial
and nonmanagerial) salaries and fringe benefits. The workers use
said pay to buy the goods and services they need and want. The
more income they earn the higher their standard of living gets.

3. Business pays taxes. The business community pays the local and
national government hundreds of billion pesos in various taxes
annually. Without such revenues, the government won’t be able to
function effectively.

Business defined

Business is (a) an activity, (b) trade, (c) occupation, or (d) profession.

“Trade” is commerce; “occupation” is chosen work; and “profession,”
career. As an “activity,” business is any legitimate economic enterprise
formed to produce and/or sell goods and services with the intention of
satisfying consumer demand and earning a fair amount of profit.

1. Legitimate activity. An activity is legitimate when it conforms to

the law and is duly registered with the government. Legitimate
business activity numbers into thousands. To make things simple,
these activities are broadly classed into (1) manufacturing and (2)
service industries.

2. Economic activity. An activity is “economic” when the resources

are used lead to the creation of wealth in the form of goods and
services. The production of goods and services is the foundation of
the country’s livelihood. Thus, an economic activity creates jobs
and pays salaries.

3. Business objectives. A firm is in business for profit and service.

Profit is what remains after deducting expenses from revenue. Part
of the profit returns to the owners as “payment” for risking their
capital in business.

Entrepreneurship: Why go into Business?

1. Financial rewards. People invest their own money in a business

venture to make money. They study which line of business has a
strong consumer demand, high profit potential, and a bright future.
34
 2. Independence. Some people are dissatisfied with their past and
present job. Thus, leave their employers to become employers
themselves. With self-interest in mind, they would rather work for
themselves and place their destiny into their own hands.

3. Attain self-actualization. A person who owns and operates a

successful business enhances his morale, confidence, price and self-
respect.

4. To stay active. This particular motivation refers to retired private

and public executives and employees who decide to go into
business for one simple reason: to stay active. It is a widely held
opinion that a person who works continuously up to retirement
thrives on a daily work regimen.

BUSINESS ORGANIZATIONS

Single Proprietorship

A single proprietorship is a business enterprise that has only one

owner, called the “proprietor.” This is the most prevalent kind of
business in the Philippines. They are usually family-run businesses.

Characteristic Features of Single Proprietorship

1. Registration. The firm’s trade name is registered with the

Department of Trade and Industry (DTI). It must also register with
the Bureau of Internal Revenue (BIR), Social Security System (SSS),
PhilHealth, and the barangay where it is located. The firm must also
be duly licensed by the Mayor’s Office in the city or town where it
intends to operate.

2. Capital. There is no minimum capital required to start the

business. Neither is there a maximum limit to it.

3. Unlimited Liability. All profits and losses of the business accrue to

the owner. Moreover, the proprietor has unlimited liability toward
creditors. If the business cannot pay its debts, the creditors can run
after the personal property of the owner, including his house and
everything therein.

4. Organizational flexibility. A proprietorship is also very flexible

because it can always convert to either a partnership or a
corporation.

35
 5. Credit Access. Lending institutions, mainly banks, are not too
keen in providing wide credit access to proprietors. This is because
the business usually has little capital.

PARTNERSHIP

A partnership is a contract between two or more persons to engage in a

business enterprise. The co-owners are called “partners.” Accounting
office as well as law offices are organized as partnerships. Relatives and
friends also enter into business partnerships.

Characteristic Features of Partnerships

1. Registration. A partnership registers with the Securities and

Exchange
Commission (SEC), the government agency that approves the
formation
of and regulates partnerships and corporations. It must also
register with the other agencies with which the single proprietorship
registers.

2. Profit sharing. A partnership is organized for profit-making

purposes. Profits are divided among the partners according t their
contract, such as equally or in proportion to their capital
contribution. Business losses are also divided in the same manner
that profits are shared.

3. Unlimited liability. Like proprietors, business partners also have

unlimited liability. However, the law allows one or more partners to
have only limited liability, the prime reason being they are not
active in the management of the business. These partners are
called “limited partner.” Their opposites are the “general
partners” whose liability is unlimited.

4. Partnership dissolution. A partnership is dissolved when the

reason for its formation is completed. For example, Peter and John
form a partnership for the purpose of having a single concert. Once
the concert is done and the profits shared, the partnership is then
considered dissolved.
A partnership is also automatically dissolved when partner
resigns, retires, dies, or is declared insane by the courts.

5. No rights of succession. No one can succeed a partner in a

partnership business for whatever reason. Examples, a partner
wishing to sell or give his partnership share to a relative should
have the permission of the rest of the partners. Even then, the

36
 partnership must first be dissolved and a new one organized, this
time, with the new partner.

CORPORATIONS

Section 2 of the 1980 revised Corporation Code of the Philippines

defines a Corporation as “an artificial being created by operation of law,
having the right of succession and powers, attributes, and properties
expressly authorized by law or incident to its existence.”

A corporation organized under the provision of the Corporation Code

becomes a legal entity when duly registered with the SEC. As a legal
entity, its personality is different from that of its owners. And not being a
real person, the corporation is said to an “artificial being.”

The “right of succession” means a part-owner of a corporation may

transfer his interest in the business to anyone. The latter then becomes
the next part-owner of the corporation. The corporation, being a separate
entity, is no affected at all by the changes in its ownership.

The “powers, attributes, and properties” of a corporation are partly

provided to it by the Corporation Code and partly by its own Articles of
Incorporation.

Characteristic Features of Corporations

1. Registration. For an entity to be a corporation, it must first be
registered with the Securities and Exchange Commission.
2. Constitution and By-laws. The code is quite rigid with
corporations and requires it to have a constitution or “Articles of
Incorporation” that spell out is (a) corporate name, (b) principal
purpose of its formation, (c) place of business, (d) length of
existence in years (i.e., 50 years maximum), (e) names of
incorporators, principal officers, and directors, (f) capital structure,
and (g) ownership shares of the incorporators.
The Code also requires that a corporation submit for
SECapproval its “By-laws.” These are the rules governing the
(a)power, duties, and responsibilities of its officials and (b) affairs of
the corporation.
3. Profit motive. A corporation may be formed either for profit or
not. Business corporations are for profit. Foundations, societies,
associations, and similar groups are non-profit corporations.
Business corporations are also called “stock corporations”
while the non-profit ones are “non-stock corporations.”
4. Corporate owners. Five (5) or 15 natural persons can organize a
corporation. The organizers are called “incorporators,”
“stockholders,” or “shareholders.” A corporation may also be a

37
 stockholder of another corporation. Once, incorporated, later, the
new corporation can have as many stockholders as it wants.
In non-profit corporations, the owners are called “members.”
5. Exercise of powers. The policy-making body of a corporation is
the board of directors. The directors choose from among
themselves the corporate officers, namely, the chairman of the
board, to the president, vice president, treasurer and secretary.
6. Dissolution. A corporation may be dissolved before the end of its
corporate life only upon consent of the SEC. Or its life may be
extended for another 50 years, maximum.
7. Liability. Unlike proprietors and partners, stockholder liability
towards the creditors of the corporation is limited to their
investment.

SAQ – 7

I. Indicate which business organizations have the following characteristics.

Write the letter only.

a. Sole Proprietorship b. Partnership c.

Corporation

____1. The policy-making body is the board of directors.

____2. It is easy to organize.
____3. It has a limited liability.
____4. Possibility of bigger resources.
____5. Management is centralized.
____6. Better management because of the presence of more participants
in the operations of the business.
____7. It has the most effective means of raising money capital for its
operations.
____8. Financial operations are not complicated.
____9. Limited life.
____10. There is difficulty in attracting and keeping quality employees.
____11. Conflict among owners is always a possibility.
____12. Expansion is easily facilitated.
____13. Employees lack personal identification and commitment with the
company.
____14. Government requirements and restrictions are less stringent.
____15. The knowledge and skills of the owners may be pooled together to
the advantage of the firm.

38
 LESSON 8

FACTOR MARKETS AND INCOME DISTRIBUTION

Learning Objectives:

To be able to:
-discuss the factor markets;
-distinguish demand for labor from supply of labor;
-identify the factors affecting factor demand;
-explain pricing of productive resources;
-explain the theories of income distribution;
-discuss the causes of income inequality.

Introduction

In a market economy – where there is free interaction between

forces of demand and supply – there are not only markets for goods and
services, but also for productive resources or factors of production: land,
labor, capital and entrepreneur. The suppliers of goods and services in
the product markets are the business firms and the buyers are the
households.

However, the transactions or exchanges in the product markets

constitute only half of the circular flow of transactions. Equally important
are the factor markets where households are the suppliers of the
productive resources to the business firms. The incomes of households
depend on the prices of their productive resources. Such incomes
39
determine their ability to buy the goods and services offered by business
firms.

Determinants of Factor Demand

The demand for goods and services is direct demand. An individual

buys a kilo of rice for consumption. He purchases a television for his
pleasure. However, in the case of productive resources, it is a derived
demand. A firm buys a machine not for satisfaction or pleasure, but for
the production of goods and services.

Other determinant of the demand for productive factors is their

productivity. In general, the most productive resources have the highest
demand, because they are the most efficient. Such resources provide
maximum profits to the business firms. Technology plays a key role in the
productivity of the factors of production. Modern machines are more
efficient than primitive tools of production.

Moreover, the prices of factor substitutes and complementary

resources affect the demand for productive resources. In highly
developed countries, labor resource is scarce, and therefore very
expensive. Industrial firms find it more economical to use machines as
substitutes for labor. This has, of course reduced the demand for labor.

Demand for Labor

Like the quantity demanded for goods in relation to prices, the

quantity demanded for labor has an inverse relationship with wage rates.
Business firms are willing and able to hire more workers at lower wage
rates, and vice versa. Whenever wage rates rise due to the command of
government laws, inefficient firms either shut down or reduce the number
of their workers. Other firms schedule the work of their workers on
rotation basis.

A firm hires additional labor if it gets additional profits. There is no

sense in hiring such labor if its cost is greater than its incomes. In the
language of economics, a firm’s decision to employ an additional man-
hour depends on the difference between marginal revenue product of said
man-hour, and the marginal resources cost of employing it. A marginal
product of labor is the additional output produced by the employment of
an additional man-hour of labor. In the case of marginal revenue product
of labor, it is defined as the additional revenue (income) obtained by
selling the marginal product of labor. Marginal resource cost is the
payment of the additional man-hour of labor – and other productive
resources like land and capital.

Employment Decisions

40
The business firm’s decision to employ an additional man-hour depends
on the following:

1. If the marginal revenue product of the additional man-hour is

greater than its wage, the additional man-hour adds more to the
firm’s revenue than its cost. With this situation, the firm keeps
on employing additional labor until marginal revenue product no
longer exceeds the wage. There is profit as long as MRP is
greater than MRC.

2. If the marginal revenue product s less than the wage, the firm
reduces the number of man-hours. Such reduction in labor
continues as long
as wage exceeds marginal revenue product. When MRC is
greater than MRP, it is a loss for the firm.

3. The firm maximizes its profits up to a point where MRP is equal to

MRC. Remember the MR=MC rule. This is the same as the
MRP=MRC concept. The only difference is that MRP and MRC
apply to the inputs of production, such as labor, land, capital and
entrepreneur while MR and MC refer to outputs of production like
cars, rice, shoes, etc.

Supply in the Factor Market

The law of supply governs the behavior of resources in the factor

market just like the behavior of goods and services in the product market.
The sellers of productive resources – land, labor, capital, and entrepreneur
– are the households. Their willingness to offer their productive resources
to the business firms depends on the prices of such resources. In general
at higher prices, more productive resources are offered in the factor
market.

The suppliers of goods and services have one common goal: profit
maximization. Thus, all economic decisions are based on production costs
and product prices. But in the factor market, the suppliers are the
households. They also make their decisions on the basis of self interests.
However, such personal interests do not necessarily mean profit
maximization. Some individuals prefer leisure to an additional profit or
income. Others are sociallyoriented. They are more concerned about
their social responsibility than in accumulating more money. So, they
tend to get a job which they feel they can contribute something valuable
to society although such job gives them lower income.

41
Supply of Labor

More individuals are willing to work when wage rates are higher.
Generally, this is true in an economy or society where there are abundant
job opportunities. People can choose their jobs and their wages. The
firms which offer the highest wage rates, together with the best working
conditions and fringe benefits, attract most of the competent workers.
But individuals balance their desire to work more to get more income and
their desire to have more leisure. At a certain point, money is not the
most important factor. People also need time for rest and recreation.

INCOME DISTRIBUTION

Income distribution is the allocation of income among the owners

of the factors of production. There are ideas or theories of income
distribution. The early social philosophers crusaded not only for economic
equality but also for social and political equality. For instance, the French
philosopher Rousseau contented that private property was robbery and it
did not exist in the state of nature. Another social reformer, Babeuf stated
that nature has given to every man an equal right in the enjoyment of all
goods. Likewise, Proudhon, a believer in equality and bitter enemy of
private property, claimed that employers robbed laborers by not rendering
to them the full value of their labor. In the case of Karl Marx (Father of
Modern Socialism), he said that the capitalist is a recipient, of surplus
value (profit). He claimed further that the capitalist, in the process of
accumulating wealth for himself, therefore robs and exploits the worker.

The misdistribution of income and wealth among the less developed

countries has been more widespread. The gap between the rich and the
poor is getting wider and wider. Only very few are rich while most of the
people exist under the poverty line.

Types of Income Distribution

Personal distribution – is the allocation of income among persons or

households. The degree of income inequality among households or
families is shown by the Lorenz Curve.

Functional distribution – is the allocation of income among the factors

of production: land, labor, capital and entrepreneur. The incomes of the

42
factors of production are rent for land, wages for labor, interests for
capital, and profits for the entrepreneur.

Causes of Income Inequality

1. Intelligence and talents. Individuals who are more intelligent and

talented are more likely to earn more income. Such differences in
the ability of individuals contribute to income equality.
2. Education and training. Those with higher levels of education and
training generally gets higher income. However, in countries where
there is an over-supply of professionals, their salaries are low.
3. Unpleasant and risky jobs. In highly developed countries,
employers provide financial incentives to work that is dirty,
unpleasant, difficult, and risky. Otherwise, people would take other
jobs. But in poor countries where the rate of unemployment is high,
workers have very little choice or no choice at all. They are force to
take dirty and risky jobs in order to eat three times a day.

4. Ownership of productive factors. Only few families own most of the

productive factors like land, machines, buildings, and so forth.
These are the ones who are rich. They derive their big incomes
from their properties. Such unjust distribution of wealth and income
is the root of poverty. Almost all people are born poor have
remained poor for the rest of their lives. Their chances of improving
their economic conditions are extremely slim, except in a kind of
society where there are many opportunities, and these are available
to everyone.

5. Luck and connections. The more experienced old folks claim that is
luck that counts much. It has been said that the destiny of a person
has been made, and no amount of hard work can change it.
Likewise, people with big connections are more likely to succeed in
life. It is whom you that matters.

The theories of income distribution based on the following:

Marginal productivity – holds that the income of the factor of production is

equal to the value of its marginal product. This simply means that the
owners of the factors of production are paid based on their contribution to
production under competitive market condition.

Needs – determine the amount of income of families or individuals. Those

who have more needs receive more income in proportion to their needs.

Social usefulness – is the basis of income distribution. Jobs which are

more useful to society are paid higher. Jobs under this category are
teachers, farmers, fishermen, doctors and nurses.

43
Equality – refers to an income distribution in which all members of society
receive an equal amount of income. This is the idea of communism in an
attempt to erase the gap between the rich and the poor.

Pricing of Resources

Pricing of resources refer to payments of the factors of production.

Factor prices of factor payments are determined by the law of supply and
demand.
However, due to the limitations of the market forces, the government
interferes to a certain degree in the pricing of the productive resources to
protect the interest of the workers who constitute a great majority of the
productive resources. In addition, the unjust pricing of some productive
factors results in higher costs of production. And this means higher prices
of goods and services. Thus, government does not only promote the
welfare of the workers but also the consumers of goods and services.

Wages – The Price of Labor

Wage is the most important price of the productive resources. To

most people, wage or salary is the only source of income. Since wage
rate is extremely low in the Philippines, it is one of the major reasons why
most people are poor. Every time prices of goods and services increase,
real wages decrease. Real wages refer to the number of goods and
services that a worker can buy with his money wage – his nominal income.
A real wage therefore is the purchasing power of the worker.

The determinants of wage rates are:

Supply and demand. Wage rates, like goods and services, are determined
by the free interaction between supply and demand for labor. If demand
for workers is greater than supply of workers, the wage rates increase. On
the other hand, if supply of workers is greater than demand for workers,
then wage rates decrease.

Minimum wage. The government imposes minimum wage rates for

various workers like those in the industrial and agricultural sectors. The
objective of such wage determination is the desire of the government to
protect the interest of the low-income workers in relation to the increasing
cost of living.

Labor unions. More active labor unions are likely to protect and promote
the legitimate interests of their members against the exploitations by the
employers. Through persistent collective bargaining, labor unions can
realize fair demands from their employers, especially under a good
government. In some poor countries, government even uses the military
or police to discourage the legitimate activities of labor unions.
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Economic Rent

To most people the word “rent” refers to the payment of a room,

apartment, building, or machine. However, in economics rent is the
payment for the use of land and other natural resources which are
completely fixed in total supply. It is obvious that economic rent has
tremendously increased. This is understandable because the supply of
land is fixed while the demand for it has greatly increased, especially in
urban areas. It is noted that rent increases as demand increases.

Land Rent is an Unearned Income

Both David Ricardo, author of the classical theory of comparative

advantage, and Henry George, author of the book Progress and Poverty,
claimed that rent was an unearned income. Adam Smith, the leader of
the classical economists, declared that rent was a monopoly price.
Ricardo further stated that higher prices of crops were due to rent which
increased, as a nation became more fully populated and the best land had
been exhausted.

Henry George proposed that the increase in rent or value of land

should be taken by the government in the form of tax. All other taxes
should be abolished, except land tax.

Interest

Interest rate is the payment for using the money of other

individuals. The imposition of unreasonably high interest rate on loans
has been condemned by society, then and now. This practice is called
usury. Those who charge extremely high interest rates are known as loan
sharks or usurers. At present, there is no more legal limit to interest rates.
These are determined by the law of supply and demand. Banks which
need more savings grant higher interest rates to attract more depositors.
Interest rates on time deposits fluctuates depending on the interaction
between the supply of and demand for money. Whenever demand is
greater than supply, interest rate increases.

Money is not a productive factor. It cannot produce goods and

services. Its basic function is only as a medium of exchange. This means
money can be exchanged with goods and services. When we buy goods,
we exchange our money with goods.

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Profits
Economic or pure profits refer to the earnings of a firm after
deducting the cost of production. Such costs include explicit cost (actual
expenditures of a firm) and implicit cost (payments to productive
resources owned and selfemployed by a firm). However, in the case of
business profits, only the explicit cost is computed. Any excess of such
cost is known as business profit.

Profits are rewards for the entrepreneur for taking the risks, or
making innovations. Profits are usually bigger for a seller who has very
few competitors or none at all. Profit expectations induce investments.
This results in more employment, production and income.

SAQ – 8

I. Matching Type. Match Column A with Column B.

Column A Column B

____1. Payment for the use of land a. Personal Distribution

____2. Author of the book Progress and Poverty b. Interest
____3. The number of goods and services c. Wage
that a worker can buy with his money wage d. David Ricardo
____4. The earnings of a firm after deducting cost of e. Functional
Distribution
production f. Rent
____5. Allocation of income among persons or g. Henry George
Households h. Profit
____6. The payment of the additional man-hour i. Real Wage
of labor j. Marginal Resource Cost
____7. Payments of the factors of production k. Pricing of Resources
____8. The payment for using the money of other
Individuals
____9. Author of the theory of comparative advantage
____10. A payment for labor

II. Essay

1. Why wage rates generally very low in the Philippines?

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 2. Explain one cause of income inequality.
3. What is the difference between demand for labor and supply of
labor?

References:

Danilo F. Marcelo Jr., Microeconomics: Theories and Applications.

Unlimited Books, Library Services and Publishing Inc., 2017.
Cristobal M. Pagoso, et. al., Introductory Microeconomics, Third
Edition. Rex Bookstore, 2016.
Edilberto B. Viray Jr., et. al., Microeconomics Simplified. National
Bookstore, 2016
Karl E. Case, Ray C. Fair, Sharon M. Oster, Principles of Economics;
Volume 1: Microeconomics. Pearson Education South Asia Pte
Ltd., 2015.
Roberto G. Medina, Principles of Economics, Rex Book Store, Inc.,
2003 http://www.acdcecon.com
http://www.khanacademy.org/economics-finance-domain/
apmacroconomics-and-microeconomics

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