RSA the Review School of lccountancy » Monagemerst Sewices ' MS-E1: MACROECONOMICS FUNDAMENTALS OF ECONOMICS ‘+ The fundamental economic problem is SCARCITY; the fact that, human wants cannot be fully satisfied with available resources reflects the definition of scarcity, ‘+ Because the available resources are never enough to satisfy human wants, choices are necessary. +. Economics is the science of choice; it is the social science that studies the choices people, businesses, governments, and societies make as they cope with scarcity + All societies, regardless of their political or economic system, are subject to scarcity; consequently, economics is useful for understanding human behavior in all nations. DIVISIONS OF ECONOMICS ‘+ The traditional domain of economics is divided between MICROECONOMICS, the economics of individual action, and MACROECONOMICS, the economics of the entire nation, + MICROECONOMICS is the study of choices that individuals and businesses make, the way these choices interact, and the influences that governments exert on these choices. + MACROECONOMICS is the study of the effects on the national economy and the global economy of the choices that individuals, businesses, and governments make. + Both micro and macro economic analysis examine the factors that influence people's decisions, but Macroeconomics requires additional step of “adding up” the effects of individual behavior to see what happens on a larger scale as @ result of the decisions of many individuals BASIC ECONOMIC QUESTIONS ‘+ Microeconomics explores three basic questions: 1) WHAT goods and services are produced and in what quantities? GOODS and SERVICES are the objects that people value and produce to satisty wants 2) HOW are the goods and services produced? The resources that businesses use to produce goods and services are called FACTORS OF PRODUCTION. There are four categories: > LAND: the “gifts of nature” such as land, minerals, and water. » LABOR: the work time and work effort people devote to producing goods and services > CAPITAL: the tools, instruments, machines, buildings, and other constructions that businesses Tow use to produce goods and services.” * > ENTREPRENEURSHIP: the human resource that organizes land, labor and capital 3) FORWHOM are the goods and services produced? ° To earn income, people sell the services of the factors of production they own. Land earns RENT; labor earns WAGES; capital earns INTEREST; and entrepreneurship earns PROFIT. % ECONOMIC GOOD is @ good that is scarce; the desire for economic goods exceeds thé amount that Is freely available from nature, > RESOURCE refers to an input used to produce economic good. Land, labor skills, natural resources and capital are examples. + Macroeconomics explore three basic questions: 1). What determines the standard of living? ‘The STANDARD OF LIVING is the level of consumption that people enjoy, on the average, and is measured by average income per person, 2) What determines the cost of ving? The COST OF LIVING is the amount of money it takes to buy goods and services that a typical family. consumes. A rising cost of living. is called INFLATION. A falling cost of living is called DEFLATION 3). Why does our economy fluctuate? The periodic but irregular up-and-down movement in production and jobs is called the BUSINESS CYCLE. There are stages in one complete business cycle > TROUGH ~ is marked by low levels of economic activity and under-usage of resources. PEAK ~ is the period when economic activity Is booming RECOVERY ~ is marked by increasing economic activity RECESSION ~ means economic activities and employment level contract; society's resources are underused, potential national income will exceed actual national income DEPRESSION ~ is a-major, long-lasting downsizing in the economy; conditions are similar to that @f a recession, but more severe and iss easily adjusted; itis a prolonged form of recession Real GOP peak i Time Page 1 of 8 pagesKeSQ - The Review School of Cccoueony. MS-E1 MACROECONOMICS ECONOMIC WAY OF THINKING + Economists refer to the satisfaction that people receive from consuming some good or service as umiiry, + Autiity maximizing Individual will act whenever the utility (benefit) from a proposed course of action exceeds the cost of taking it. This is Called RATIONAL ECONOMIC THINKING. + The difference between benefits and costs of an economic decision or action is the net gain to the Individual - his or her INCENTIVE to act. + Anveconomic choice involves. a TRADEOFF, that is, something is given up to get something else. + The OPPORTUNITY COST of a choice Is the highest-valued alternative foregone, not all alternatives foregone; all tradeoffs involve an opportunity cost. + Choices are made in small steps; this means choices are mgde at a MARGIN: > The benefit that arises fromm an increase in ai activity is called MARGINAL BENEFIT. > The cost of an increase in an activity is called MARGINAL COST. ECONOMICS: A SOCIAL SCIENCE + Economists.distinguish between: > POSITIVE STATEMENTS - statements about what /s. These can be shown to be true or false through observation and measurement. >» NORMATIVE STATEMENTS - statements about what ought to be. These are matters of opinion. + Economic science Is a collection of positive statements that are consistent with the reel world Economic science uses three steps to progress. > Observation and measurement ~ economists observe and record economic data. > Medel building ~ an ECONOMIG MODEL is a description of some aspect of the economic world that includes only those features of the world that are needed for the purpose at hand. » Testing ~ a model is tested to determine how well its predictions correspond with the real world, An ECONOMIC THEORY is a generalization that summarizes what we think we understand about ‘economic choices thut people make and the performance of industries and entire economies. + When developing models and theories, economists use the idea of CETERIS PARIBUS, which is Latin for “other things being equal,” to focus on the effect of one particular factor. + In developing of theories and models, two fallacies are, possible: > FALLACY OF COMPOSITION * the assertion that what is true for a part must be true for the whole oF whet is true for the whole must be true for each of the parts. > POST,HOC FALLACY — the assertion that one event caused another because the first occurred before the second ¥ PRODUCTION POSSIBILITY FRONTIER (PPF) ‘+ The concept of PPF is based on nation that production is lirited by the amount of resources available. + The PPF shows the maximum combinations of outputs (goods and services) that can be produced with given resources and technology. Soda (in botties) 50 Production Possibility Frontier (PPF) 40 30 eM e 10 \ ; orb esa ate | ed 102 30. 40. 50. Coffee (in cups) Production points inside and on the PPF are attainable, Points beyond the PPF are not attainable. > Production points on the PPF achieve PRODUCTION EFFICIENCY, > Production points inside or within PPF are INEFFICIENT, with inisallocated or unused resources. + Moving between production pois on the’ PPF involves trade-off because something must be lost to get more of something else. The opportunity cost of obtaining 30 more cups of coffee by moving from point ‘Ato point B is 20 bottles of sodas. As more and more cups of coffee are produced, the opportunity cost fof a cup of coffee - the bottles of soda that must be sacrificed ~ increases. When resources are not equally productive in producing goods and services, the PPF has increasing opportunity costs and tends to bow outivard (as ilustrated in the graph above). + ECONOMIE GROWTH occurs when the PPF shifts outward, The TECHNOLOGICAL CHANGE (the development of new goods or new ways to produce goods) and CAPITAL ACCUMULATION (the growth of Capital stock) shift the PPF outward and are the main causes of economic growth, Page 2 of 8 pagesRSA. Te Review School of Vecomttoncy MS-E1 MACROECONOMICS i‘ cross DOMESTIC PRODUCT GROSS DOMESTIC PRODUCT (GOP) Is the market value of all the final goods and services produced within a country, whether these are produced by the citizens of that country or by foreigners. A FINAL GOOD ‘is an item thet is bought by its final user while an INTERMEDIATE GOOD Js an item produced by one firm, bought by another and used as a component of the final good. Intermediate goods are not directly included in measuring GDP. ‘Two principal methods of calculating GDP: > EXPENDITURE Approach ~ adds up all expenditures to purchase final goods and services by household (consumers), businesses and the government. GDP =C+14G+(X-M) Where: C = Consumption expenditures (total household spending on consumption goods and services) = Investment (firm’s purchase of plants, equipment, buildings, and addition to inventories) G - Government purchases (government spending on goods and services), (X~ M) = Net exports (exports minus imports = ‘foreign’ sales. foreign’ purchases) » INCOME Approach ~ adds the compensation of employees, net interest, rental income, corporate profits and proprietors’ income. GDP is measured either ih current prices (nominal GOP) or in prices of a given year (real GDP): > NOMINAL GDP - the value of final goods and services produced by a domestic economy for a year ‘at current market prices. » REAL GDP - the value of final goods and services produced in a given year when valued at constant prices. Price level adjustment eliminates the effects of inflation on the measure. When all the economy's resources are fully employed, the value of production is called POTENTIAL GOP, ECONOMIC GROWTH is an increase in real GDP while RECESSION is a period of negative GOP growth, GROSS NATIONAL: PRODUCT (GNP) is the total and final output of land, labor, capital, and entrepreneurial ability produced by the country’s citizens, produced whether inside the country or elsewhere abroad. INFLATION and UNEMPLOYMENT INPUATION sist when tere em sstinedlncrese in the price lvl, The PRICE LEVEL I the averoge “EVES The CONSUMER PRICE INDEX (CP), the PRODUCER PRICE INDEX (PP, andthe GDP DEFLATOR are faeatiuc nceareccron peso laren cid i Rae pm aod a over rasan Adie coanaed i pantsat tie vbollac eft eat ucla gos pct ereicsh sd etait > GB beat messes te changes pie fr goods and services inched n GOP ei _Nominal GOP GOP Deflator Tiered! Primary causes of inflation DEMAND-PULL. INFLATION ~ happens when there is excess or too much demand for certain goods ‘and services that are not met by @ corresponding increase in the supply of those goods and services (i.e., excess demand propels prices to go up, which results to inflation). > COST-PUSH INFLATION ~ happens when there is a. general increase in the cost of production that may be due to higher wages (wage-push theory) or increase in the cost of raw materials and other inputs (supply-shock theory) : There is’an inverse relationship between inflation and unemployment: > When unemployment rate is low, inflation tends to increase. > When unemployment rate is high, inflation tends to decrease. The PHILLIPS CURVE shows a relationship between the inflation rate and the unemployment rate. The LABOR FORCE equals the sum of employed plus unemployed workers, ‘Number of people unemployed Labor Force People are unemployed because of frictional, structural, or cyclical causes: > FRICTIONAL UNEMPLOYMENT ~ occurs because. individuals are forced or voluntarily change jobs; new entrants into the workforce also fall into this category. > STRUCTURAL UNEMPLOYMENT ~ occurs due to changes in demand for products, or technological advances catising not as many individuals with a particular skill to be needed; this can be reduced by retraining programs. > CYCLICAL UNEMPLOYMENT ~ occurs as a result of the business cycle; cyclical unemployment increases during RECESSION and decreases during EXPANSION. FULL EMPLOYMENT occurs when there is no cyclical unemployment. Page 3 of 8 pages © Unemployment Rate = x 100RSM - the Reviews School of Uecowmrtaney MS-E1 MACROECONOMICS FISCAL POLICY vis-a-vis MONETARY POLICY ‘country uses FISCAL and MONETARY policies to efectively counter inflation or inflationary tendencies FISCAL POLICY is government actions, such as taxes, subsidies, and goverament spending, designed to acileve econiomie goals. Examples are © "h reduction of taxes increases personel disposable income, which wil stimulate econornic activity. > Economy may algo be stimulated through increased government spending. rim inctease in deficit, elther due to an increase in government spending or to a decrease in taxes, ts called @ FISCAL EXPANSION. An increase in taxes to Feduce a deficit Is called FISCAL CONTRACTION. Jaxes ove levied by a government based an two general principles: (1) ablity to pay (progressive income tax), and (2) derived benefit (e.g., gasoline taxes used to pay for roads). The following are the inajor types of taxes: 7 INCOME TAX. Income taxes are levied on taxable Income 2 PROPERTY TAX. Property taxes are levied ase of wealth (ie, based on the value of property). SALES TAX. Sales taves are levied based on the aimount of income spent. Sales taxes are viewed a5 regiestive because low-income Individuals pay the same percentage rate os high-income individuals, > VALUE-ADDED TAX (VAT). VAT is levied on the increase in value in each"product as It proceeds through production and distribution process. Ultimately, the tax 1s paid by the final consumer. The VAT is thought to encourage savings becouse it taxes consumption instead of earnings if 2 government collects mare in taxes than it spends, ir has 2 BUDGET SURPLUS; if 9, government spends more than it collects in taxes, thas a BUDGET DEFICIT. Changing interest rates and the amount of money in the economy ts called MONETARY POLICY; these actions, done to counter inflation, are under the control of the BANGKO SENTRAL NG PILIPINAS(BSP): Fen econemy ish recession, BSP might lower Interest rates an infect money to the economy. 2 When economy is in rapid expansion, BSP might Increase interest rates to slow teal GDP growth and prevent iflation rash increasing HONEY isa liquid asset because exchanges easily for other assets polMtt - the most liquide 9. currency, demand deposits, current accounts and taveler’s checks) 2 M2= Mi money plus savings accouit, certificates of deposits, money market mutual funds, money market deposit eecouats, sia!-danomination tune deposits >» M3—M2 money plus other lets liquid for of money (e.g, large denomination time deposits) Three main functiona of money 1), MEDIUM OF EXCHANGE (without money, barterie necessary) 2). UNIT OP ACCOUNT {prices are measured in money) 3}. STORE OF VALUE (money can be stored and exchanged at a later date ~ example: bank deposit) ECONOMIC THEORIES CLASSICAL ECONOMIC THEORY - this theory olds that macket equilibrium will eventually result in full employment.over the long run without government intervention. This theory does not support the use Of fiscal policy to stimulate the economy. KEYNESIAN THEORY ~ this, theory holds that the economy does not necessarily move towards full employment cin its own. It focuses on the use of fiscat policy (e.g., reduction in taxes and government spending) to stimulate the economy. MONETARIST THEORY ~ this theory holds that fiscal policy is too crude a tool for control of the economy. It foctises on the use of monetary policy to control economic growth, SUPPLY-SIDE THEORY ~ this theory holds that bolstering an economy’s ability to. supply more goods Is the most effective way to stimulate growth. A decrease in taxes (especially for businesses and individuals with high income) increases employment, savings, and investments, NEO KEYNESIAN THEORY - this theory combines Keynesian and monetary theories. It focuses on using ‘a combination of fiscal and monetary policy to stimulate the economy and control inflation. INTERNATIONAL TRADE & FOREIGN EXCHANGE RATE Comparative advantage 4s the factor that drives international trade. A country has a COMPARATIVE ADVANTAGE in the production of goods if the country can produce it at a lower opportunity cost than any other country ‘The value of exports minus the vaive of imports is called the BALANCE OF TRADE: > TRADE SURPLUS = when a nation exports inore than it imports. > TRADE DEFICIT ~ when a nation imports more than it exports: Government restricts international trade to protect domestic industries from foreign competition by’ imposing TARIFF (a Lax on an imported product) and QUOTA (a restriction on the amount of a good that may be imported during a period) FOREIGN EXCHANGE MARKET is the market in which the currency of one country is exchanged for the ‘currency of another. it is made up of importers, exporters, banks, foreign currency dealers/brokers, FOREIGN EXCHANGE RATE is the price et which one currency exchanges for another > CURRENCY DEVALUATION when a currency falls in value in terms of another currency. > CURRENCY APPRECIATION ~ when o currency rises in value In terms of another currency. Page 4 of 8 pages+ RSA. The Rerrew School of lecountanay MS-E1 MACROECONOMICS MULTIPLE-CHOICE QUESTIONS - with sugges (Sources: CMA/CIA/AICPA/Various test banks) — Which one of the following would not be included in the calculation of the GDP? ‘a. Purchase of a new home ¢. Adoctor’s fee An automotive worker's wages d, Purchase of common stock 2. The difference between GNP and GOP is that c ‘2. GOP measures what is produced and earned by a nation’s people and property and GNP. measures what is produced and earned in the domestic economy b. GOP emphasizes ownership and GNP emphasizes location ¢. GNPimeasures what is produced and earned by a nation’s people and property and GDP measures what Is produced and earned in the domestic economy 4, GOP includes depreciation and GNP does not 3. The difference between nominal GOP and real GOP is that real GDP A 'a, Measures the level of output in.constant prices, while nominal GOP includes price changes b. Measures the level of output including price changes, while nominal GDP hold prices constant ¢. Measures the price level and nominal GOP measures the level of output d. Measures the level of output and nominal GDP measure the price level 4. The experiditures approach to measuring GOP is the sum of expenditures in all of the following categories, except ° ‘a. Gross private domestic Iavest ment b. Personal consumption expenditures Government spending on goods and services d. Transfer payments by the government When the addition to capital goods in an economy exceeds,the capital consumption allowance, the economy has experienced . D ‘a. Negative net investment . Positive gross investment b. Equilibrium investment , Positive net investment 6, The income approach calculates GDP by considering all of the following, except ° ‘2. Interest © Rent b. Wages d. Investment 7. Which is the proper order for the business cycle? A ‘a, Peak, recession, trough, expansion ¢._-Peak, expansion, trough, recession b. Peak, trough, expansion, recession d._-Peak, recession, expansion, trough 8. During the recessionary phase of a business cycle c ‘a. The purchasing power of money is likely to decline rapidly b. The natural rate of unemployment will increase dramatically , Potential national income will exceed actual national income d. Actual national income will exceed potential national income 9. Which is not a type of key economic indicators? > a. Leading indicators Fi ¢. Lagging indicators b. Coincident indicators +d, Contra indicators ‘Three types af key economic indicators = Leading indicators change in advance of other variables (e.g., capital goods purchases) + Coincident indicators change at the same time as other variables change (e.g., consumer confidence, inflation, ongoing unemployment) + Lagging indicators change after the other variables change (e.g. unemployment figures are lagging indicators of recession), 10, Which ofthe following may provide a leading indicator of a future increase in gross domestic product? 2 a. A reduction in the money sup} b. Adecrease in the issuance of building permits . An increase in the timeliness of delivery by vendors d. An increase in the average hours worked per week of production workers 11, Some economic indicators lead the economy into a recovery or recession, and some fag it. An example of a lagging indicator is A ‘a. Chronic unemployment 6) Consumer expectations b. Housing starts d. Orders for consumer and producer growth Page 5 of 8 pagesReSA The Renew School of lcconrtancg MS-E1 MACROECONOMICS: 12, The primary reason for allowing legal immigration into industrial nations is the immigrants’ potential i ‘a. Reduction of trade deficit & Contribution to economic growth b. Fulfillment of a trade agreement d. Fulfillment of a political agreement 3. If the economy is at full employment, D a. The entire population is employed 5. The entire labor force is emploved . The only unemployment 's frictional unemployment plus discouraged workers d, Real GDP equals potential GDP 14, the rdte of unemployment caused by changes in the composition of unemployment opportunities over time Is referred to as the fs a, Frictional unemployment rate © Structural unemployment rate b. Cyclical unemployment rate d, Full-employment rate 15 A country has an increasing sate of Secondary schoo! dropouts and declining standardized test scores might be expected to experience an increase in 8 3. Cyclical unemployment +c. Frictional unemployment b, Structural unemployment’ d._ Productivity rates 16. Which of the following measures of unemployment would be of least importance to management when trying to predict the future state of the economy? C7 a. Structural unemployment c. Frrictional unemployment b. Cyelical unemployment d. Qverali unemployment 17. The nature) rate of unemployment, oF total unavoidable unemployment, is equal to ° a. Cyclical unemployment . Structural unemployment b. Frictional unemployment dd. Frictional plus struétural unemployment 18. The unemployment resulting from a’pecession 1s called B a. Structural unemployment Frictional unemployment b. Cyclical unemployment d. Overall unemployment 19. In a competitive market for labor in which demand is stable, A 4. Employment must fall b, Governmrient must set a maximum wage below the equilibrium wage Firms in the industry must become smaller d. Product supply must decrease workers try to increase their wage 20. A period of rising inflation D a. Increases the price level, which benefits thosé who are entitled to receive a specific ‘amounts of money b. Enhances the positive relationship between price level and purchasing power of money Will not be affected by contracts that include the indexing of payments, 4d. Increases'the price level, which \s negatively related to the purchasing power of money 21. Which of the following is the best definition of the consumer piice Index (CPI)? c a, It isa cost-of-living index b. Itis defined in absolute peso cc. It is a measure of the average change in prices d. It compares intercity cost of living 22, Which of the following would tend to’ benefit from the effect af unanticipated inflation? A a. Borrowers c. Savers b. Lenders d._ Fixed-income recipients 23. Economies often experience inflation but seldom experience long period of deflation. Which of the following |s true about deflationary economy? A a.’ Companies are hesitant to make investment b. The lower prices encourage conswiners to make major purchases c. Interest rates tend to be high d. Actual GDP is above potential GOP 24. The most effective fiscal proyram {o help reduce demmand/-pull inflation would be to D a. Decrease the rate of growth of the money supply * b. Increase both taxes and government spending Decrease taxes and increase government spending, d, Increase taxes and decrease government spending age 6 of s AS Page 6 of 8 pages ©ReS0- The Review School of Gocowrancy, » Management Services MS-E2: MICROECONOMICS DEMAND ‘+ DEMAND Is the relationship between the price of a good and the quantity demanded. It is also defined as the schedule of quantities of a good that people are willing to buy at different prices. + The QUANTITY DEMANDED of a good is the amount that consumers pian to buy during a period at a particular price, + The LAW OF DEMAND states that “ceteris paribus, the higher the price of a good, the smaller the quantity demanded.” Higher prices decrease the quantity demanded for two reasons: '1) SUBSTITUTION. EFFECT - a higher relative price raises opportunity cost of buying a good; as a result, people buy less of the good as there could be other available goods with a lower price. 2)_INCOME EFFECT ~ a higher relative price reduces the amount of goods people can afford to buy. + A DEMAND CURVE shows the inverse relationship between the quantity demanded and price, ceteris paribus. Demand curves are negatively sloped. + DEMAND CURVE + (pases) | 21 8: Picasa slic ee pobicicaine aN Renee eect se ied 4 a CHANGE IN QUANTITY DEMANDED. a Ah the demand curve i called 9 CHANGE IN DEMAND. An increase in demand drives the demand curve to shift rightwards (D; to D3). 12 3 4 5 Quantity (Units) ‘The factors that affect the demand for a product are the following: —_ Ee FACTOR, | _____ EFFECT on DEMAND _ : a Price of SUBSTITUTE goods | DIRECT. Example: if the price of pork increases, the demand for beef | may increase: j-Price of COMPLEMENTARY | INVERSE, Example: iF the price of gasoline increases, the demand for goods** __ < _| cars tends to decrease. __ Expected future prices DIRECT. If the price of the good is expected to wnerease In the Aikure, there will be an increase in demand. DIRECT for NORMAL goods. As consumer income goes up, the demand for many products (normal goods) increases 4 INVERSE for INFERIOR goods. Demand for inferior goods (e.g., instant | noodle, sardines) increases as Consumer income decreases since. consumers buy more inferior goods when they are short of money. ay Consumer weaith/income ‘Consumer weaith/income Population growin DIRECT. An increase in population increases number of potential BuYerS._| [Size of market DIRECT. ‘As market size expands, demand for the product also increases. | Consumer tastes/preference | INDETERMINATE. The effect depends on whether th | : a pret id for the product. “SUBSTITUTE GOODS are those goods that can be used in place of another because they could perform the same function: butter and margarines; pens and pencils “COMPLEMENTARY PRODUCTS are products that go hand in hand: whiteboard and whiteboard ‘markers; CPU and monitors. = ELASTICITY OF DEMAND (En), which measures the sensitivity of demand to changes in price, is computed: ‘Din Price in Quantity Demanded” ‘Rin Quantity Average Price | A in Price = “average Quantity ——_* Example: Day 1 > unit price was set at P 2.50 each, the sales reached 200 units. Day 2 > unit price was lowered to P 1.50 each, the sales increased to 400 units, Using the abiove formula (ARC method): Ep = (200/300) + (1.00/2.00) = 1.33 + If & > 1, demand is said to’ be ELASTIC (sensitive to price changes) > IF Eq = 1, demand is said to be UNIT-ELASTIC/UNITARY (insensitive to price changes) + If Ey < 1, demand Is said to be INELASTIC (not that sensitive to price changes) ‘The elasticity of demand is greater for a product when there are more SUBSTITUTES for the good, @ larger proportion of income is spent on the good, and a longer period of time is considered. _ For example, the demand for LUXURY goods tends to be more elastic than the demand fer NECESSITIES, Eo + If demand is price-elastic, an increase in sales price results in a decrease in TOTAL REVENUE for all producers. In the above example, demand is elastic, Fo = 1.33 (Eo > 1), the price deciine.of P 1.00 fesulted in an increase in total revenue P 600 (400 @ P 1.50) vs. P 500 (200 @ P 2.50). Page 1 of 8 pagesRSQ - the Review School of Cecowrtawcy MS-E2 MICROECONOMICS +The effect of price changes may be summarized as follows: Price Change Ep > 1 (elastic demand) —Ep.< 1 {inelastic demand) Eo = 1 (unitary) Increase Total revenue decreases Total revenue increases Total revenue is the same Decrease Total revenue increases Total revenue decreases Total revenue is the same + An Individual demands a particular good because of the UTILITY (satisfaction) received from consuming it... The: more goods an individual consumes, the more utility the individual receives. However, the ‘marginal (additional) utility from consuming each additional unit decreases. This is referred to as the LAW OF DIMINISHING MARGINAL UTILITY. + CONSUMPTION decisions depend on many factors but the main one is PERSONAL DISPOSABLE INCOME. Personal Disposal Income is the amount of income consumers have after paying taxes to tha government. When personal disposable incame goes up, consumers buy more. + The consumer's MARGINAL PROPENSITY TO CONSUME (MPC) describes how much of each additional Peso in personal disposable income that the consumer will spend. The MARGINAL PROPENSITY TO SAVE (MPS) is the percentage of additional income that is saved. Since consumers can either spend or save money, then MPC + MPS = 100%, SUPPLY ‘+ SUPPLY is the relationship between the price of a good and the quantity supplied. It is also defined as the schedule of quantities of a good that people are willing to sel! at different prices. + The QUANTITY SUPPLIED is the amount of @ good that producers plan: to sell at particular price during a given time periog + ° The LAW OF SUPPLY states that “ceteris paribus, the higher the price of @ good, the greater is the quantity supplied.” + A SUPPLY CURVE shows the positive relationship between the quantity supplied and price, ceteris paribus, Supply curves are positively sloped. : Wg ‘+ SUPPLY CURVE « (Pesos) Si » A change in the price of product causes a “ o movement along the supply curve, also called a CHANGE IN QUANTITY SUPPLIED. > shift in the supply curve is called @ CHANGE IN SUPPLY. An increase in supply drives the supply curve to shift rightwards (S, to S2), neue 12 3 4 S Quantity (Units) +The factors that affect the supply for @ produ acTOR | Feu UP Praduction costs | Inver As production costs go up, fewer given price. If costs qo down, more product 3 are the followin tla age tt “d will be produced. _ | Number of producers DIRECT. An increase in the number of producers will cause an increase 1 in the amount of goods supplied at a certain level of price. | Price of substitute goods ~ | INVERSE. If other products can be produced with greater returns, | producers will praduce those goods. 2 ‘Price of complementary goods | DIRECT. A rise in the price of a complement in production increases | | supply and shifts the supply curve rightward. | Expected future prices DIRECT. If itis expected that prices will be higher for the good in the’| | es | future, production of the good will increase. Technology DIRECT. Téchnoiogical advancement increases supply and thus Shifts the | Jee | supply curve rightward | | Government subsidies DIRECT. Subsidies reduce the production cost of goods and, therefore, | i increase the goods supplied at a given price. | iegegeea beara [INVERSE Increase in taxes ould raise production costs, thereby | pine __| decreasiig supply | | Special influences Government restrictions, weather conditions, and innovations oF new | | method may affect supply of goods. Example: unexpected storms may | {ie __| destroy farms, decreasing the supply of certain crops. + ELASTICITY OF SUPPLY (Es), which measures the percentage change in quantity supplied of a product resulting from a change in product price, 's computed ‘A % in Quani y ‘.% in Price supplied | 1, supply is said to be UNIT-ELASTIC/UNITARY (insensitive to price changes) < 1, supply Is saidto be INELASTIC (not that sensitive to price changes) Elastic supply means that a percentage increase in price will create a larger percentage increase in supply. 7a Page 2 of 8 pages | + If Es > 1, supply is said to be ELASTIC (sensitive to price changes)ASO. The Review Bhool of Cccommeanen MS-E2 MICROECONOMICS EQUILIBRIUM + EQUILIBRIUM isa state wherein the démand and supply are in balance. es EQUILIBRIUM - (Pesos) | 0 s + EQUILIBRIUM PRICE (P 6.00) is tie price at 10 which the quantity demanded equal quantity supplied. It js determined by the intersection of ~=- SKE Equilibrium Point. the demand curve and the supply curve. ' > EQUILIBRIUM QUANTITY (3 units)" is the “ quantity bought and sold at the equilibrium 12 3 4 5 Quantity (Units) price. ‘+ Below the equilibrium price, @ SHORTAGE exists (i.e., quantity demanded exceeds quantity supplied) and the price will rise; above the equilibrium price, 2 SURPLUS exists (i.e., quantity supplied exceeds quantity demanded) and the price will fll ‘+ Equilibrium is a MARKET-CLEARING situation where neither surpluses nor shortages exist. +A PRICE (CEILING is a maximum price that seller may charge for a good while a PRICE FLOOR is a minimum price. If, set below equilibrium price, @ price ceiling results in shortages; if set above equilibrium price, a price floor results in surpluses. ‘+ GOVERNMENT INTERVENTION may change market equilibrium through taxes and subsidies: > A SUBSIDY paid to farmers will reduce cost of producing farm goods; equilibrium price will be lower. > IMPORT TAXES increase cost of imported products causing the equilibrium price to be higher. + Another factor that causes inefficiencies in the pricing of goods in the market Is the existence of EXTERNALITIES -- damage to environment caused by production (e.9., pollution). MARKET ‘+ AMARKET is any institution, mechanism, or situation which brings together the buyers and sellers of a particular product. It is a place where sellers and buyers meet (e.g., grocery, internet). + The four basic MARKET MODELS are: harket | amberor Tet tt | rr Pe Conditions | examples _ | couperirion.| se | faennicas | Nove | Verveasy | Rc 2 |MONRROUETIC | — Many | oterentited | .timtea | easy | RSM ate ony S| oucorovy | Few | Bimeertotes | srwide | tard | MCS a | 4] wonarow | one bee wide | stocked | pancnise Vtics | > COMPETITION denotes rivalry between among producers, each of which seeks to deliver a better deal to buyers when quality, price and product information are all considered. > In pure competition, the firm's demand curve is PERFECTLY ELASTIC (horizontal). The firm can sell many goods it can produce at the equilibrium price (/.e., very low sales at a higher price). » In monopolistic competition, consumers go for a certain product based on DIFFERENTIATION, > In pure monopoly, the firm has no or very little market Incentive to innovate or control costs; hence, pure monopolies are usually subject to GOVERNMENT REGULATION. > Oligopoly ‘s a competition among few; If left unregulated, oligopolists tend to establish CARTEL that engage in price fixing through collusion. » AMONOPSONY is a market where only one buyer exists for all sellers. > A BLACK MARKET is an illegal market wherein people conduct transactions at prices (usually high) forbidden by the government % PRODUCTION AND COST + The COSTS OF PRODUCTION change as the firm output changes, in the short run and in the tong run. + In the SHORT RUN, at least one input is fixed (¢.g., plant depreciation). Some costs are fixed and some are variable. + Inthe LONG RUN, all inputs are variable. All costs are variable. (¢.9., additional plant can be built,) + TOTAL PRODUCT is the total quantity of the output produced in a given period + MARGINAL PRODUCT i§ the change made in total product from @ change in a variable input (e.9., labor). In economics, the term "marginal is often used to mean “additional.” ‘ + AVERAGE PRODUCT is the total product per unit of input (e.g., labor). It is total product divided by the ‘quantity of labor employed. Another term for average product is PRODUCTIVITY, ‘+ INCREASING MARGINAL RETURNS occur when the marginal product of an additional worker exceeds the marginal product of the previous worker. In most productions, increasing marginal returns occur initially but DECREASING MARGINAL RETURNS will occur eventually. Page 3 of 8 pages &KeSU . The Review School of Gecourctonvey MS-E2 MICROECONOMICS + SHORT-RUN PRODUCTION COSTS « cost] FORMULA <1 — es C+VC(= ATCXQ) | TCs Total Cost | ATC = Average TC vou] Te= Fe = Avex Q) | d.Cost_| AVE = Average VC fi t ble Cost | AFC = Average FC AQ) | MC = Marginal Cost | __Q = Quantity TC = Change in Total Cost ‘AQ = Change in Quantity ASTVC = Change in Total Variable Cost | + AVC is initially constant until inefficiencies of producing in a fixed-size facility cause variable costs to ‘ise; MC initially decreases but begins to increase due to inefficiencies. +. The cause of inefficiencies is known as the LAW OF DIMINISHING RETURNS. This law states that as we try to produce more and more outputs with a fixed productive capacity, marginal productivity will decine, + LONG-RUN PRODUCTION COSTS are ail variable costs. As the firm expands by increasing plant size, ATC tends to fall at first because of the economies of scale, but as this expansion continues, ATC begins to rise because of the diseconomies of scale: + ECONOMIES OF SCALE (@ decline in ATC) arise because of labor and management specialization, efficient capital, and factors such as spreading advertising cost over an increasing level of output. Example: if a firm increases labor hours by 10%, output increases by 50%. Hence, ATC decreases. » DISECONOMIES OF SCALE arise primarily from the problems of inefficiently managing and coordinating the firm’s operations as it becomes a large-scale producer. Example: If firm increases input by 60%, output increases by 3%. Hence, ATC increases. * CONSTANT RETURNS TO SCALE are the range of output where long-run ATC does not change. Example: A firm may double its production by doubling its production facility; the firm can build identical production line and hire an identical number of workers. So when production increases, ATC remains constant. MULTIPLE. CHOICE QUESTIONS (Sources: AICPA/CMA/CIA/Various test banks) 1, The law of demand states that a. Price and demand are directly related, cete b. Price and demand are inversely related, ceteris paribus Price dnd quantity demanded are directly related, ceteris paribus d. Price and quantity demanded are inversely related, ceteris paribus 2: A video store's busiriess sales increased by 20% after the movie theater raised its prices from P 200.00 to P 300.00. Thus, relative to movie theater ad:nissions, videos are a. Substitute goods Complementary goods b. Superior goods . Public goods 3. X and ¥ are substitute products. If the price of product X increases, what is the effect on product Y? a. Price will increase . Quantity supplied will increase Quantity demanded will increase d. Price, quantity demanded, and supply will increase 4. All oF the following are complementary goods, EXCEPT a. Margarine and butter b. Razor and razor blades VER and video cassettes 4d. Cameras and rolls of fim 5. Ifa rise in the price of gasoline decreases the demand for cars, ‘@. Cars are an inferior good b. Gasoline is an inferior good z €. Gasoline and cars are substitutes in consumption d, Gasoline and cars are complements in consumption 6. A decrease in the price of a complementary good wil Increase the price paid for a substitute good Shift the supply curve of the joint commodity to lett Shift the demand curve of the joint commodity to the left Shift the demand curve of the joint commodity to the right é Page 4 of 8 pagesRSQ - the Review School of Gecowrdamey MS-E2 MICROECONOMICS 7. Which of the following would cause the demand curve for a commodity to shift to the LEFT? A rise in the population A rise in average household income Arise in the price of a substitute product ‘A rise in the price of a complementary commodity 8. If a group of consumers decide to boycott a particular product, what is the expected result? A decrease in the demand for the product {An Increase jn the product price to make up lost revenue ‘An increase in product supply because of increases availability ‘The demand for the product would become completely inelastic 9. A decline In the price of a good causes producers to decrease the quantity of goods supplied. . This result illustrates ‘2. The law of supply A change in supply b. The law of demand d. The nature of an inferior good 10. A supply curve illustrates the relationship between 2, Price and quantity supplied Price and quantity demanded b. Price and consumer tastes d. Supply and demand, 11, Which of the following will cause a shift in the supply curve of a product? ‘a. Changes in the number of buyers in the market b. . Changes in consumer tastes and preferences ¢. Changes in the price of the product d. Changes in production taxes 12: Which of the following is NOT likely to affect the supply of a particular good? ‘a, Changes in technology b, Changes in consumer income Changes in production costs d, Changes in government subsidies 13. The equilibrium market price of a good Is the a, Price that maximizes profit for sellers b. Price where shortages exceed surpluses ©. Price that buyers are willing and able to pay d, Price where the quantity demanded-equals the quantity supplied 414. An improvement in technology that leads to improved worker praductivity would MOST likely result in fa, shift to the right inthe supply curve and a lowering of the price of the output b. A shift to the left in the supply curve and a lowering of the price of the output An increase in the price of the output if demand is unchanged d, Wage increase 45. In any competitive merket, an equal increase in both demand and supply can be expected to always ’a. Decrease both price and market-cleering quantity b. Increase both price and market-clearing quantity Increase market-clearing quantity d._ Increase price f 16, Price ceilings ‘a, Result in persistent surpluses b. Create prices below equilibrium prices create prices greater than equilibrium prices d. Are illustrated by government price support programs in agriculture 17. IF the government regulates @ product or service in a competitive market by setting a maximum price below the equilibrium price, what is the long-run effect? a. A surplus c. Adecrease in demand b. Ashortage 1d, No effect on the market 18. Which of the following market features is likely to cause @ surplus of a particular product? ‘a, A monopoly b. Aprice floor cc. Aprice ceiling d. Aperfect market Page 5 of 8 pages ®KeSU - The Review School of Cccowmstoney, : MS-E2 MICROECONOMICS 19. If market price is HIGHER than equilibrium price a. A Surplus exists and the equilibrium price will rise until jt equals the market price and the surplus is eliminateo 5. A surplus exists and the equilibrium price will fall until it equals the market price and the surplus is eliminated © A shortage exists and the equilibrium price wil rise unti) it equals the market price and the shortage {s eliminated d. A shortage'exists and the equilibrium price will fall until it equals the market price and the: shortage fs eliminated 20. The price elasticity of demand measures the responsiveness of the 2. Quantity demanded to a change in the price of the good b. Quantity supplied to a change in the price of the good : - Price to @ change in the quantity demanded of the good d. Price to a change in the quantity supplied of the good 21. What is the formula for the price elasticity of demand? 2. 4% Quantity Demanded x A% Price c.-A% Price x 4% Quantity Demanded b. A% Quantity Demanded + A% Priced. A% Price + 4% Quantity Demanded 22. Which of the following statements is FALSE? a. When elasticity equals 1, demand is unit-elastic b. When elasticity is less than 1, demand is inelastic When elasticity is more than 1, demand is inelastic d. When elasticity equals 0, demand Is perfectly inelastic 23. If the income elasticity of demand coefficient for a particular product js 3.00, the good Is likely a. A luxury S004 An inferior good b, Ashortage d. Anecessity 24, Which of the following hhas the highest price elasticity coefficient? a. Rice © Bread b. Infant milk d. Ski boats 25, In the pharmaceutical industry where a diabetic must have insulin. no matter the cost and where there 's no other substitute, the dlabetic’s demand curve is best described as a. » Perfectly elastic c. Elastic b. Perfectly inelastic Inelastic 26, Demand for a product terids to be price INELASTIC if a. The product is considered a luxury item be The population in the market areas is large c. Few good complements for the product are avaliable d. People spend a large share of their income on the product 27. In which of the following situations would there be ELASTIC demand? a. 5% price increase results in a 4% increase in thé quantity demanded b. A 5% price increase results in a 4% decrease in the quantity demanded ©. A4% price increase results in a 5%" increase in the quantity demanded d. A.4% price increase results in a 5% decrease In the quantity demanded 28. If the demarid for a product js INELASTIC, then increasing the price of the product will a. Increase total revenue Increase competition b. Decrease total revenue d. Have no effect on total revenue 29. If the demand-for a product is ELASTIC, what is the effect of @ decrease in the price of the product? a. No change in total revenue b. An increase in total revenue . Adecrease in total revenue * d. A decrease in total revenue and th demand curve shifts to the left 30, As a business owner you have determined that the demand for your product is INELASTIC. Based upon this assessment, you understand that a. Increasing the price of your product wili increase competitici b. Increasing the price of your product will increase total revenue Decreasing the price of your product will increase total revenue 4. Increasing the price of your product will have noveftect on total revenue Page 6 of 8 pagesRSG - the Revrew School of lccourdamcy MS-E2 MICROECONOMICS D 31. As the price for a particular product changes, the quantity of the product demanded changes according to the following schedule: Total quantity demanded Price per unit 100 i P50 150 Pas 200 P40, 225 P35, 230 P30 , 232 P25 Using arc method, the price elasticity oF demand for this product when the price decreases from P 50 to Pasis R a 0,20 & 0:10 b. 10.00 d. 3.80 SOLUTION GUIDE ‘Based on the formula stated in No. 21 % Quantity Demanded + A% Price A% Quantity Demanded; (150 ~ 100) + [(150 + 100)/2) A% Price: (50 ~ 45) + [(50 + 45)/2) = 10.525% 40% : 32, Which type of economic market structure is composed of a large number of sellers, each producing an Identical product, and with no significant barriers to entry. and exit? a. Monopoly ¢. Perfect competition b. Oligopoly d. Monopolistic competition 33, A market with many in classified as a. Amonopoly ¢. Monopolistic competition b, Anatural monopoly 4. An oligopoly lependent firms, low barriers to entry, and product differentiation is best 34, Economie markets that afe characterized by: monopolistic competition have all of the following characteristics, EXCEPT ‘a. One seiler of the product b. Economies or'diseconomies of scale Advertising d. Heterogeneous products 35. Which type of economic market structure is characterized by a féw large sellers of a product or service, ‘engaging primarily in nonprice competition? ‘a. Monopoly c. Perfect competition b. Oligopoly 1d. Monopolistic competition 36, A natural monopoly exists because The firms holds patents b. The firm owns naturals resources ¢. The government is the only supplier , Economic and technical conditions permit only one efficient supplier 37. Which of these organizations would MOST LIKELY engage in public relations type advertising? a. Anairline ¢. a toy manufacturer b. A hotel chain d.Anelectric utility company 38. Which of the following is NOT a key assumption of perfect competition? a, Firms sell a homogeneous product b. Customers are indifferent about which firm they buy from ©The level of a firm’s output is small relative to the industry's total output d. Each fie can price its product above the industry 39, Which of the following is NOT a characteristic of @ purely competitive market? a, Differentiated products b. Avery large number of producing firms cc. No barriers to market entry for new firms Lack of control over product price by individual firms Page’7 of 8 pagesKReSQ - the Review Fehool of GhccorTomen MICROECONOMICS: é 40. Which of the following is NOT a likely strategy for a firm in @ purely competitive market? ° 2. Lean manufacturing b. Process reengineering : © Supply chain management 4d. Development of a brand namie 41. What is the distinguishing characteristic of oligopolistic market? . a. A single seller of a homogeneous product with no close substitutes b. A-single seller of a heterogeneous product with no close substitutes ©. Lack of entry and exit barriers in the industry d. Mutual interdependence of firm pricing and output decisions 42. Which of the following is typically an advantage of'a monopoly from the viewpoint of the consumer? A a: Costs of production may be lower because of quantities of scale b. Prices charged to the public are lower because there is no need for advertising c. Quantities produced are greater 4. Products produced are of higher quality 43. Patents are granted in order to encourage firms to invest in the research and development of new products. Patents are an example of - c a. Market concentration b. Vertical integration Entry barriers d. Collusion 44, Because of the existence of economies of scale, business may find that c 3. As more labor js added to a factory, increases in output will diminish in the short run b. Each additional unit of labor is less efficient then tne previous unit Increasing the size of a factory will result in lower average costs d. Increasing the size of a factory will result in lower total costs 45, Inthe long yun, a firm may experience Increasing returns due to D ‘3. Law of diminishing returns b. Opportunity costs c. Comparative advantage d. Economies of scale 46. In microeconomics, the distinguishing characteristic of the supply side in the long run is that ° a. Firms are not allowed to enter or exit the industry b. Only demand factors determine price and output € Only supply factors determine price and output dd. Allinputs are variable 47, Marginal revenue is .- Greater than price in pure competition b. Equal to piece in monopolistic competition c,The change in total reverie associated with increasing prices d. The change in total revenue associated with procucing and selling one more unit 48. If the marginal profit is positive, as output increases A a. Total profit must increase b, Total profit must decrease Average profit must increase d. Average and total profit must increa 49. If profit is to rise as output expands, then marginal profit must be ic a. Falling Po b. Constant isi 50. The law of diminishing marginal utility states that A ‘a. Marginal utility will decline as a consumer acquires additional units of a specific product b. Total utility will decline as a consumer acquires additional units of a specific product ©. Declining utilities causes the demand curve to slope upward 4d, Consumers’ wants wili diminish with the passage of time Page & of 8 page