Chapter 1 Economics And The Real World Many individuals have no clear understanding of economics.

And yet it is an essential part of our lives. Almost always if not all human activities involve economics. For instance, earning money, buying goods and services, putting up a business, or saving money in a bank is an economic activity. Also, the major operations of the government like the collection of taxes from the people, the expenditures of the government, and how to achieve economic growth for the country require economic planning. In the same manner, a businessman has to supply basic economic principles in producing and marketing his goods. We can not isolate ourselves from economics because our physical existence depends on it. We can not live without production and consumption. These are the major activities of economics, among other things. Furthermore, even the economic conditions and policies of other countries can affect the direction and nature of our economic development. For example, if the oil-producing countries do not like to sell oil to us, then the transportation companies and other industries which use oil can not continue their operations unless good substitute for oil are discovered. Likewise, if the food-producing countries do not like to export their products to countries which can not grow food crops, then starvation appears in due time. Clearly, a good knowledge of economics offers many favorable possibilities. It guides us how to make a living, how to use wisely our money, how to run our business, how to distribute properly our available scarce resources, and how to maximize our profits and consumer satisfaction, among other things. With the use of appropriate economic decision and implementation, life for everybody is most likely better for the income earner, housewife, student, teacher, businessman, professional, and top government official. This chapter presents the definition and nature of economics; basic economic problems, economic system models, and economic goals, among others. Economics Defined Economics is the proper allocation and efficient use of available resources for the maximum satisfaction of human wants. Since resources are generally scarce while human wants tend to be unlimited, economics encounters not a few problems. However, the biggest problem is not limited resources like land, money, machines, raw materials, technology, skilled workers, or competent managers. The root problem, which is the real problem, is the unjust distribution of productive resources among the members of the society. Such maldistribution of wealth and income is the root cause of poverty. Our available resources are in the hands of very few families. So, most of the people are mere tenants, clerks, factory workers and servants. The fundamental problem of unfair allocation of resources has been a global problem. Most of the countries of the world experience such problems. There are extremely few rich while there are very many poor. These countries are located in Africa, Asia and Latin America (South America and Central America). These regions are the poorest in the world. Everyday, some 40,000 children die of malnutrition. On the other hand, the few rich countries spend billions and billions of dollars for the foods of their favorite dogs for arms race. Indeed, it is very sad comparative note in illustrating the unjust distribution of resources. But this is what really happens in out own world. Can we not correct the wrong distribution of wealth and income of our society? It is noted that there are very few rich and very few poor in rich countries like the United States, Japan, Germany, France, Canada, and Great Britain. Their lands have been fairly allocated. There are no squatters in their own countries. The poor in these countries can easily acquire their own decent houses through the liberal financial assistance of their own government. Workers have good incomes with profit sharing benefits. In the case of the poor countries (Third World), the maldistribution of productive resources can be corrected by proper economic, social, political and educational reforms. One good example is land reform. The tenants become small developed countries has not been successful. The ruling class (together with their rich relative and friends) does not like to give up its political and economic powers and privileges. Nature of Economics Economics is classified as a social science because it deals with the study of man s life and how he lives with other men. Obviously, economics is interdependent with other sciences like sociology, political science, history, geography and physics. In fact, it is even affected by religion. For example, a jobless man is likely to create a social crime like stealing. The policies of the government influence economic activities. the geography of a region determines the main sources of incomes of the people, like fishing and farming. The solution of economic problems or economic planning may rely on past events or historical developments. In the case of physics, it produces machines and electricity. These are very useful in the production of goods and services. Likewise, religion is related to economics. Religious traditions and beliefs can discourage or encourage economic development. Some tribes in Africa feed wild crocodiles with pigs or chickens in the hope increasing their farm harvest. The crocodiles are one of their gods. Considering the nature of economics, it is not advisable to solve an economic problem with economic solution alone. This will not solve the problem. Our economic problems are not purely economic in nature. These are also cause by noneconomic factors which maybe cultural, educational, social, or political. Therefore, to minimize or completely solve an economic problem, we need not only economic solutions but also political, social, and

cultural reforms. For example, a poor farmer has several bad habits like heavy drinking, and gambling. He remains very poor because he is just a tenant, and he spend his little income mostly on his vices. Giving the poor farmer a land of his own does not automatically improve his economic condition. If he does not know how to use properly his income, and the middleman gets most of the fruits of production of the farmer, then the economic problem of the farmer has not been solved. Methods of Economics Economics, being a science, is a systematic body of knowledge. It uses scientific methods in gathering data, analyzing the data, and making conclusions. Data are obtained through observations and interviews. This is empirical method which also relies on practical experience. Data are properly organized for analysis. This requires a careful study of the cause-and-effect relationships of the various data. Out of this economic analysis, economic principles and theories are formulated or derived. Economic principles are generalizations. This means they do not apply to all people. They tend to be true to a large number of people under certain assumptions. For example, economists qualify the validity of an economic principles by using the assumption of ceteris paribus which means other things being equal or constant. Here is an illustration: one fundamental principles of economics is the law of demand. It states that individuals tend to purchase more quantity of goods are bought. This principle is true if other things are constant, like income. If the income of the individual has increased by 100 percent and the price of the product has only increased by 20 or even 50 percent, it is no longer true that his quantity demanded for a certain product decreases. The reason is that his income has greatly increased which has even improved his purchasing power. Economic principles or theories are useful because they explain certain economic behaviors or conditions. These are helpful in solving economic problems; likewise they serve as guides in economic planning and formulating economic programs. Theories or principles of economics are represented by models in the form of verbal statements, graphs, numerical tables, or mathematical equations. An economic principle or theory which is put in action becomes an economic policy or applied economics. Limitations of Economic Methods It is true that economics uses scientific methods in gathering data, formulating theories or principles, and in making conclusions. However, there are limitations such as the biases and values of those who get the facts, who make the analysis, and who make the conclusion. Biases and values (what is desirable or undesirable) are naturally formed by the political, social, cultural, and economic background of individuals. For instance, a rich man is not in favor of communism. A capitalist may likely have a different idea of income distribution from that of a factory worker.

In addition, the data of economics can not be examined objectively. Economics deals with the study of the behavior of individuals which are not the same because of their different backgrounds. At any rate, there are economic conclusions which can be quantified. But the rest are just generalizations whose accuracies depend on certain conditions or assumptions. It is different in physical or natural sciences such as botany, chemistry, astronomy, or geology. Their materials for investigation and analysis can be placed under a microscope or can be seen through a telescope. Obviously, plants, stars, or rocks have no biases or values. Conclusions are objective and quantifiable. For this reason, such sciences are said to be exact sciences. However, the shortcomings of economics can be minimized. We only need competent economic researchers who have the integrity of a true scientist. Assumptions should be close to realities. Economic terms should be clearly defined. Without these, people say it is only good in theory but not in practice. That is why many people consider economics a difficult subject. Efficient Use of Resources Economics deals with the efficient use of available limited resources. This means we have to use wisely our money. We must make our farms productive. Our factories must produce more. Our government must reduce or minimize its expenditures. For example, the average rice harvest per hectare in Japan or the United States is 300 cavans of palay. The Philippines has the average of 60 cavans of palay per hectare. This shows that we are less efficient in the use of our rice farms. However, such idea of economic efficiency is only favorable in societies where the productive resources are fairly distributed among the members of societies. What is the use of being efficient if you are just a slave or servants, and your master does not give you a fair wage? In most less developed countries, tenants, laborers, office employees and some professionals like teachers, nurses and lawyers are exploited. How could they be efficient? No matter how much they apply all the rules of efficiency on their small earnings, their opportunities for economic prosperity are very slim. In fact, they have no chance to become wealthy like the big landlords and the owners of the factories. Clearly, a just distribution of resources is the first step in achieving an efficient use of said resources. The rich countries are very efficient in the use of their productive resources. They apply modern technology and machines in the farms and factories. However, they combine their technical efficiency with social justice. Thus fruits of their efficient production are fairly shared between the employers and employees. Japan is a very good example of a country which has given first priority to the fullest development of its human resources.

Division of Economics 1. Microeconomics deals with the economic behavior of individual units such as the consumers, firms, and the owners of the factors of production. Such specific economic units constitute a very small segment of the whole economy. Their activities are presented and discussed in details. For example, the price of rice, the number of workers of San Miguel Corporation, the income of Mr., Cruz, the expenditures of MERALCO, etc. 2. Macroeconomics deals with the economic behavior of the whole economy or its aggregates such as government, business and household. An aggregate is composed of individual units. The operations of the various aggregates and their interrelationships are analyzed to provide a profile of the economy as a whole. Macroeconomics is concerned with the discussion of topics like gross national product, level of employment, national income, general level of price, total expenditures, etc. When we study the income or expenditure of Family Savings Bank, we are dealing with microeconomics; but when we deal with the total income or total expenditure of the whole banking industry, then we are involved in the study of macroeconomics. If we discuss the economic crisis of our country, we are concerned with microeconomic analysis. However, what is true in microeconomics may not be true in macroeconomics. For example, a vegetable farmer gets better harvest. This means more income for him. But if all vegetable farmers have increased their harvests, it is no longer favorable for them. More supply reduces the price of vegetables. History of Economics Economics as a science is very young compares with the other sciences which were formed even hundred years before the Birth of Christ. It has started to be known when Adam Smith s book Wealth of Nations was published in 1776. This book became the bible of economics for more than a century. Because of the economic contributions of Smith in the field of science, he has been considered the Father of Economics. However, the ideas and practices of economics have been as old as mankind. These economic thoughts appeared in biblical teachings, philosophy and politics. The primitive people were resourceful. They invented ways and means of food gathering and hunting. Such art of making a living among the ancient tribes represented a form of economics. During the biblical times, economic ideas and activities were influenced by biblical teachings and the wisdom of the great prophets. Even the Babylonian code of Hammurabi contains detailed regulations for economic practices. Justice, charity and honesty were the rules in economic dealings. Usury was prohibited. Profits were despised. The Babylonians had clear ideas about interests and mortgages. The Phoenicians had good knowledge about commerce and money. The Hebrews and the Hindus stressed the virtues of industry, temperance, and economy. The word economics was derives from an ancient Greek word oikonomoswhich means household management. The housekeeper had to see to it that there was enough food, clothing and shelter; that the house was kept in order; that the

necessary duties and responsibilities were performed by the members of the household; and that their products were distributed according to necessity or customs. To the ancient Greeks, however, the term oikonomos applied more on the proper management of citystates. The Greek philosopher Plato recommend division of labor in order to improve production. Another Greek philosopher, Aristotle, explained the functions of money. In the case of the Romans, they believed that agriculture was the only honorable industry. During the early days of the Roman Republic, the boys were taught to be good soldiers and famers by their fathers. During the middle ages, the Church under St. Thomas Aquinas crusaded for distributive justice (fair distribution of goods), and compensatory justice (fair exchange of goods and services). The Basic Economic Problems All countries have economic problems, including the richest countries. However, the poorest countries have more far-reaching economic problems. The rich countries also experience inflation and unemployment; however, such problems do not remain for a long period. In the case of the poor countries, they can not even provide for most of the basic needs of their peoples. Every year, millions of them are dying from hunger like those in Africa. In the Philippines, we have also been experiencing deep economic problems like high prices, unemployment, low income, capital deficiency, etc. The possibility of completely erasing economic problems from the face of the earth is almost nil. Productive resources are not only scarce but also unjustly distributed among the members of society. On the other hand, the needs of people are increasing due to population explosion. Moreover, human wants are unlimited. The urge for satisfaction is endless. This is human nature. That is why even the rich countries have economic problems. Unfortunately, in the case of the poor countries, basic needs like food, clothing, shelter, health and education can not even be adequately supplied. Their rapid population growth, inefficient government, and the maldistribution of wealth have made their citizens more miserable and hopeless. Such social and economic injustices have remained with them for centuries. The three basic economic problems are: 1. What goods and services to produce and how much. In business, feasibility study determines whether certain goods or services become profitable or not in a given market. Investors are only willing to produce goods and services which give them good profit. Apparently, there is no problem. Just simplify conduct a market study or feasibility study. In reality, however, it is not always possible to produce all the goods and services that people need, because resources are limited. For example, without oil our factories can not function. There are times when factories can not operate because imported raw materials are not available. In poor countries, there is no need to conduct a survey to determine the real needs of the people. This is necessary to determine only the quantity of goods to be produced. It is very obvious that they lack food, clothing and shelter. Millions of them have not seen the face of a doctor. Since human wants are many while available resources are few, there is a need to establish priorities. It is not possible to satisfy all our need or wants at the same time. For

instance, a father with limited financial resources has to decide whether to build a new house or send his son to college. A student has to choose whether to purchase his textbooks or have a good time. It is rather unfortunate that the poorest among us have extremely limited priorities. In not a few cases, they do not at all have the opportunity to choose for there is none. Many people can not buy food and medicine because they have no money. Those who survive the agonies of hunger and disease have been lucky to taste the limited relief goods of the rich countries. 2. How to produce the goods and services.This is a problem of production technology of methods of production. As a general rule, goods and services must be produces in the most efficient manner. This means maximum output with minimum input without sacrificing quality. Although the rich countries use advanced technology in the production of goods and services, there are still goods and services which could not be produced efficiently; hence, continuous research and development projects. The application of modern technology has increased output and decreased cost of production. Such production efficiency has greatly contributed to the high standard of living of the industrial countries. In fact, it is cheaper for them to use machines than employ workers. This has not created unemployment problems because of the may commercial and service activities of the rich country. In japan, robots are being used in factories, hospitals and offices due to shortage of manpower. Schumacher, author of Small is Beautiful, suggested intermediate technology for the less developed countries. This is between primitive and modern technology. He stated that primitive technology is less productive while modern technology is expensive. Furthermore, intermediate technology is most appropriate, according to Schumacher, because it uses local materials and skills, and it is labor-intensive. 3. For whom are the goods and services. This is a problem of distribution. Who gets the goods like rice, clothes, shoes, and the services such as education, medicare, etc.? In a pure market economy or capitalism, goods and services are definitely for those who have money and are willing to purchase them. Clearly, the rich acquire more goods and services than the poor. The rich have several cars, mansions, and elegant clothes and jewelries. Their children study in the most prestigious foreign universities. Their doctors are the most famous. They can buy all goods and services that money can buy. In contrast, the poor especially the poorest, can only acquire goods and services depending on their purchasing power. Some of them do not eat three times a day. In certain regions in Africa, people eat only every other day. Millions of children die in the arms of their mothers because of hunger and malnutrition. Goods and services are for sale. Businessmen do not offer these for charity or for fee. Otherwise, they would be out of business. However, in other economic systems, the government interferes in the distribution of goods and services in order to protect the welfare of the poor. The poor can get goods and services based on their needs. In Quatar (a middle east small country), the people have been given free education, housing units, water, electricity, and other basic services. Welfare programs are also widespread in Europe, United States, Japan, and Canada. The aged are given pensions. The jobless are granted unemployment wages. Thus, the shortcomings of the free-market economy have been reduced by the social programs of the government.

Unfortunately, the poor countries are not yet capable of extending such benefits to their poor citizens. Economic Systems Plans and decisions on economic activities like production and marketing vary among with different economic systems. In Russia, almost all crops are produced in state or collective farms. Marketing of such products is likewise done by state enterprises. The farmers receive a share in the net income, but they have no decision on what and how to raise their crops, and where to sell them. Farmers are commanded by the central government to do exactly what the government planners like them to do. Other countries have different ways of performing their economic activities. for instance, their farmers are free to grow any crops as long as these are not against moral or social interests. Likewise they are free to choose their production methods and marketing channels if they are also the landowners. An economic system is a set of economic institutions that dominates a given economy. An institution is a set of rules of conduct, established ways of thinking, or ways of doing things. Examples are taxation, profit motive, economic planning, production, or banking. Economic System Models 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 of capitalism are: private property economic freedom free competition profit motive 2. Communism is exactly the opposite of capitalism. The factors of production and distribution are owned and managed by the state. It is also called a command economy or classless society. The essential characteristics of communism are: no private property no free competition (the government is the only seller). no economic freedoms no profit motives presence of central planning 3. Socialism is a combination of capitalism and communism. The major strategic industries are owned and managed by the state while the minor industries are transportation, electrification, mining, and production of essential products. Examples of minor industries are the production and marketing of candies, cakes, toys, etc. Karl Marx, the father of modern socialism, called socialism as the lower stage of post-capitalism, and

communism as the higher stage of post-capitalism. Since socialism is the combination of capitalism and communism, its essential characteristics therefore constitute both those of capitalism and communism. Prevailing Economic Systems At present, there are no more pure economic systems like pure capitalism, pure socialism, or pure communism. These are just theories or models. Both capitalist and communist countries tend to move towards socialism. Thus, they have mixed economic systems. The early form of capitalism was the laissez faire type. The government adopted hands-off policy in economic activities. The classical economists and the other natural laws of economics would promote the welfare of the individual as well as that of society. However, the expectations of the classical economists did not happen. During the height of the Industrial Revolution in England, the capitalists exploited their workers. They were forced to work for 18 hours a day. Even the aged and the children worked in the mines and factories in order to survive economic difficulties. They were given very low wages for working hard and long. Karl Marx was a witness to such miserable conditions of workers. He was angry and persuaded the workers to unite and fight for their interests. Because of the evils of capitalism, some countries adopted socialism and others, communism. Economic depression, unjust distribution of wealth and income, and deepening poverty have been some of the products of capitalism. In fact, capitalism has been associated with colonialism and economic imperialism. Most less developed countries, like the Philippines, fall under mixed capitalist-socialist system. The industrial or highly developed countries, like Japan, United States, and those in Western Europe, are classified as developed market economy. In these countries, there has been an increasing role of the government in regulating economic activities. in the case of Russia and those countries in Eastern Europe, like Poland, Hungary, and Romania, they are designated as command socialist economy which is an opposite of market capitalist economy. The economic system of Russia and Company is characterized by public ownership of productive resources, and that the whole economy (including prices) is centrally planned. The Gosplan (central planning agency of Russia) provides the economic plan for the whole economy. How to Judge an Economic System All economic systems are basically intended for the good of their own citizens and societies. Russia and the other countries with command socialist economic system believe that their economic system is the most suitable for their own particular social and economic conditions. They claim that the market economy or the capitalist economy of the Western

countries has been an exploiter of the poor. On the other hand, the capitalist countries are very proud of their extremely prosperous economies, and the high standard of living of their peoples. The best example is the United States. However, there are vital criteria to judge the performance of the various economic systems. These are briefly explained: Abundance. This refers to goods and services that individual members of society have receive. Are these sufficient and are the people satisfied? Are there no problems in food, clothing, shelter, medicare, education, and recreation? Has economic system eliminated mass poverty? If he answer to all these questions are in the affirmative, then it is good performance. These people are definitely lucky for not having experienced the pains and indignities of poverty. Growth. The growth of the economy is tangible, and is measurable in terms of the number of buildings, houses, schools, cars, hospitals, factories, or machines made in a given year. More of these mean greater economic growth. However, many question such economic growth because of its destructive fruits like pollution. Drug abuse, and sex crimes. Stability. This refers to the absence of inflation and unemployment. However, if the ups and downs of economic activities like production, consumption, and saving, among other things, are minimal, there is still economic stability. The problem of inflation alone can easily create more economic and social problems. When prices are abnormally high, the purchasing power of the consumer decreases. This means they can buy less number of goods, and this reduces production of goods. The result is unemployment. A family man who is jobless becomes a social risk or liability. Security. Economic security generally depends on economic stability. Workers and employees do not lose their jobs if there is prosperity in the economy. In fact, there is a great demand for jobs. During our deep economic recession which started in 1983, more than one million individuals lost their jobs. Many firms and factories stopped operating. Such great loss of the jobs has favorably affected other sectors of the economy. For example, college population has greatly decreased. The house and lot business went down. In the case of the rich countries, and individual who loves his jobs get social security benefits. Efficiency. This has been discussed earlier. It simply means productivity. It is measured in terms of unit cost or average cost. For example, if the total cost of production is P100 and the total number of the products produced is 100, the unit is P1. Supposing another country can produce the same product at the total cost of P50 and be able to produce 200 units; clearly, the latter is more efficient. Efficiency is acquired by applying appropriate technology, machine, material, and management.

Justice and equity. Is the distribution of wealth, income, and power among the members of society fair? Is there no big gap between the rich and the poor? Is the answer to both questions is no, then there is no justice and equity. These are the main problems of the poor countries. It is very evident that a just distribution of wealth, income, and power stimulates economic activities like innovation, investment and production. This is one key reason why the progressive countries become more progressive. Their employees and workers are encouraged to be more efficient due to the presence of recognition and reward. There are sufficient opportunities for them to improve their social and economic conditions. Economic freedom. If a consumer is free to choose his food, style of his house, any kind of appliances, his recreation, or his education, then there is economic freedom. If the businessman is free to invest his money to put up any business, or to decide his strategy of management, then there is economic freedom. If the producer is free to decide what kind of product he is going to manufacture, what kind of machine he is going to use, or where to sell his goods, then there is economic freedom. However, freedom is construed not to violate moral and legal values. Evidently, in terms of national income and standard of living, the developed market or advanced capitalist economy has the best performance. United States and Japan belong to such economic system. There are four possible reasons for such economic success: economic freedom, profit motive, ownership of private property, and favorable government policies. It is inherent among people to enjoy economic freedom and to acquire private properties. To the businessmen, profit motive is the most important factor. Profits and properties are very good incentives for people to work harder. In contrast, the collective or state farms in Russia are inefficient because the farmers have no power to make decisions and there are no economic incentives. Evidently, the market-oriented economy is not without weaknesses. For instance, the few giant corporations tend to increase their prices through hoarding or reducing their production. The less fortunate members of society can not get their goods from the market. Such limitations of the market economy, and to protect the welfare of the poor. The poor of the United States are not really poor compared with the poor of the Philippines, India, or Uganda. In United States, the poor enjoy many social security benefits like medicare, housing, and old-age pensions. In fact, it is not uncommon to see factory working their own cars. In the less developed countries, it takes a miracle for a janitor, houseboy, or messenger to be able to buy a car. Which is the Best Economic System? An economic system is designed to provide goods and services to the people in a most efficient and equitable manner. So, it is to the people in a most efficient but also a question of equity or fairness. However, these two aspects of allocating goods and services differ

among the various economic systems. They have their own particular concepts and practices. And these have been the products of their long years of experience with their economic and social conditions. Countries which have been exploited by capitalism or economic imperialism have chosen socialism or communism. Besides, they have been influenced by the ideas of Karl Marx, Robert Owen, and other noted social reformers. Many of the rich countries have retained their capitalist economy because this has made them even richer and more powerful. These were the former colonial masters. They divided Asia, Africa, Latin America, and other islands among themselves. The choice, therefore, of the best economic system depends on particular economic interest, cultural, social, and political orientation. An extremely poor man is most likely in favor of communism because under capitalism he is starving, and his children can not go to school. Under communism, the land of the landlord belongs to the state while the business has to surrender his business to the state. On the on other hand, a big landlord or businessman prefers capitalism because this is the most suitable economic system for him. There are people who enjoy economic freedom. They, too, their own concept of the best economic system. Social Justice The Goal of Economics As stated earlier, economics is basically concerned with the fair distribution of goods and services, and the efficient use of available scarce resources. The reason is to obtain both optimum and maximum benefits for the satisfaction of all members of society. Such fundamental role of economics has been focused towards the attainment of the following objectives: economic growth full employment price stability economic freedom equitable distribution of wealth and income economic security It is common knowledge that most countries have been able to achieve such objectives. The rich countries are becoming richer while the poor countries are becoming poorer. The same is true with the members of society of a poor country. The few rich families are getting richer while the many poor families poorer. There is definitely something wrong with the allocation and use of available resources. The great poor masses do not own the productive resources, and so they have remained poor just like their great ancestors. It is obvious that the principal goals of economics have not yet touched or reached the poorest of the poor; it has always been the goal of the governments of poor countries to emancipate the poor from economic slavery. But until now most of them have not experienced a dignified existence.

Social justice has remained just a dream for most of the poor. Dr. Augusto Caesar Espiritu, a noted nationalist economist, said this about the Marcos regime: The government has built monuments to vanity, extravagance and conspicuous consumption, but has failed miserably to provide for basic needs Should we not work for a development strategy which fosters justice, participation, and sustainability?... Ultimately, our development policies will be relevant only in so far as they touchthe lives of those whom Rabindranath Tagore has identified in moving poetry as the poorest, the lowliest, the exploited and the lost.

Chapter 2 The Price of Goods and Services Many unschooled individuals do not really understand how prices of goods and services are being determined. In fact, not a few professionals have very little knowledge about price determination. More often than not, people think that prices are determined by the government. This is true in some basic goods and services like rice, gasoline, or apartment rent. But if government prices are much lower or higher than real market prices, then both sellers and buyers are affected. For instance, if government price is much lower than actual market price, sellers are not willing to offer their goods. They tell buyers to purchase such goods from the newspapers, radio, or television sets. On the other hand, if government price is much higher than the real market price, buyers are forced to reduce the number of goods that they usually purchase. This creates a surplus of the supply. Eventually, such condition will reduce production and employment. Clearly, the role of the price system has been very crucial in the operations of the economy. Hence, there is a need to balance the interests of both buyers and sellers of goods and services. And this task belongs to the government. In a market economy or capitalists economy, price of goods and services are determined by the interaction between supply and demand of goods and services. The government does not interfere; so that whenever demand is greater than supply, prices increase. Buyers have experienced many times such situations. For instance, when there are very few eggs, banana, or bangus in the market, prices are higher. On the other hand, if supply is greater than demand, prices decrease. Again, this situation can be observed or experienced in the market. When fruits are in season, their prices are lower. Many like diamonds but their supply is scarce, so their price is extremely high. Price is the value of a product or service. It is expressed in terms of a monetary unit like peso, dollar, or yen. The price system is very important in the economy. It determines the allocation of goods and services among the members of society. This simply means that goods and services are being acquired by the people by paying them with their money. Naturally, more money means more goods and services. This chapter explains, with the support of tables and graphs, the laws of demand and supply, and the determination of price. In addition, the price system and the role of the government are discussed. Demand Demand is the schedule of various quantities of commodities which buyers are wiling and able to purchase at a given price, time and place. It is determine by factors such as: income

population taste and preference price expectation prices of related goods Table 2.1.Individual demand schedule showing the inverse relationship between price and quantity. Price 1 2 3 4 5 Determinants of Demand Explained Income. People buy more goods and services when their incomes increase. Poor people who become rich naturally pruchase more basic goods like food, clothing and shelter; and services like recreation, medicare, demand for such goods and services also declines. Thus, a change in income brings about a change in the demand for goods and services; either an increase or decrease which is directly related to change in income. Population. More people means more demand for goods and services. There are more consumers in an urban community than in a rural community. That is why we can observe that there are more buyers in city stores than in barrio stores. The presence of American soldiers in Clark Air Base in Angeles, Pampanga has greatly increased the demand for goods and services in that area. Conversely, less poplation means less demand for goods and services. Obviously, business is very poor in a mountain village where there are only 20 families. Tastes and preferences. Demand for goods and services increases when people like or prefer them. Such tastes of preferences are greatly influenced by advertisement or fashion. On the other hand, if a certain product is out of fashion, the demand for it falls. Price expectation. When people expect the prices of goods, especially basic commodities like rice, soap, cooking oil., or sugar, to increase tomorrow or next week, they buy more of these goods. In the same manner, they decrease their demand for such products if they expect prices to decline tomorrow or in a few days. The reason for such consumers behavior is to economize. This is a general tendency of buyers. Prices of related goods. When the price of a certain product increases, people tend to by a substitute product (competitor). For example, if the price of Tide increases, consumer buy Quantity demanded 5 4 3 2 1

less of Tide and more of the other close substitute like Breeze or Marvel. This means the demand for tide decreases while the demand for substitute increases. Conversely, if the price of Tide decreases, then the demand for it increases while the demand for the other competitors decreases. However, in the case of complementary goods, the price of one goods and the demand for the other good are directly opposite. This means if the price of one good increases, the demand for the other decreases. Complementary products are those that go together like bow and arrow, or phonographs and records. If the price of phonographs increases, then the demand for records decreases. Conversely, if the price of phonographs falls, then te demand for records rises. But for independent goods which are not related, the change in price of one has little or no effect on the demand for the other. For example, books, horses, and flowers. Law of Demand Consumers are most likely to buy more goods and services as price decreases, and buy less goods and services as price rises. This is the law of demand. Such general tendencies of consumers can be explained by two reasons: 1. Income effect. At lower prices, an individual has a greater purchasing power. This means he can buy more goods and services. But at higher prices, naturally he can buy less. Supply Supply is the schedule of various quantities of commodities which producers are willing and able to produce and offer at a given price, place and time. Its determinants are: technology cost of production number of sellers prices of other goods price expectations taxes and subsidies Table 2.2.Individual supply schedule showing the direct relationship between price and quantity. Price 1 2 3 4 5 Quantity demanded 1 2 3 4 5

Determinants of Supply Explained Technology.This refers to the techniques or methods of production. Modern technology which uses modern machines increases supply of goods. In contrast, primitive technology which uses animals and people is very slow in producing goods. For example, a hollow block machine can produce more hollow blocks than through manual labor. In addition, technology reduces cost of production, and this encourages the producers or sellers to increase their supply. Lower cost of production results in an increase in profit. Cost of production. In producing goods, raw materials are needed, together with laborers. If the price of raw materials or the salaries of the laborers increase, it means higher cost of production. There are other production costs like the interest of a bank loan, taxes, and land or building/ office rent. If these increase, it result to additional cost of production. Higher cost of production of the business decreases supply, because the viability or profitability of the business decreases. Generally, businessmen are not willing to offer more goods if they are not sure of profit. Of course, when cost of production increases, price also increases. So, there is always profit. This is not always correct. When prices are very high, most consumers reduce their purchase. This means less demand for goods and services. And the producers have no alternative (if they cannot reduce their cost of production) except to cut down production or stop operations. Number of sellers. More sellers or more factories mean an increase in supply. Conversely, smaller number of sellers or factories means less supply. This situation is very evident in rich or industrial countries. They have many manufacturing firms and service industries like those in the United States and Japan. Hence, they have also plenty of goods and services for sale. In fact, their industrial goods are being exported to other parts of the world. Prices of other goods. Changes in the price of goods affect the supply of such goods. For example, a decrease in the price of rice may likely encourage a rice farmer to produce more corn if this gives him more profit. Another example, the price of sugars in the world market was very low: in 1995, because of the oversupply of said product. This posed a big problem to the Philippine sugar planters because their cost of production was even higher than the prevailing world price of sugar. They studied the possibility of producing other crops and of converting sugar into alcohol. Price expectations.If producers expect prices to rise very soon, they usually keep their goods and then release them in the market when the prices are already high. This creates artificial shortage due to hoarding. It has been experienced that whenever the government announces the increase in prices of gasoline, rice, milk or cooking oil, such goods immediately disappear in the market. In case producers expect prices to fall next week, they cut down their production. Farmers, unlike the manufacturers, can not reduce their supply

especially when their crops are already growing. On the other hand, many factories increase the number of their goods due to expected price increase. Taxes and subsidies. Certain taxes increase cost of production. Higher taxes discourage production because it reduces the earnings of businessmen. That is why the government extends tax exemptions to a number of new and necessary industries to stimulates their growth. Similarly, tax incentives are granted to foreign investors in order to increase foreign investment in the Philippines resulting in an increase in production of goods. Subsidies, which are financial grants or financial assistance are likewise given to producers. Example is the fertilizer subsidy granted by the Philippine government to the small farmers. Fertilizers is sold at a price much lower than actual market price. The government pays the difference between the market price and the subsidized price. Clearly, subsidies reduces cost of production. Hence, it reduces the farmers to produce more. Law of Supply As price increases, quantity supply also increases, and as price decreases, quantity supply also decreases. This direst relationship between price and quantity supplied is the law of supply. Producers are willing and able to produce and offer more goods at a higher price than at a lower price. This is obvious. Sellers offer more goods at higher price because they make more profits. More profits create more goods. Such behavior of sellers or producers is natural inclination. No business is willing to produce goods if he makes no profit.

Basic Market Models 1. Perfect/ pure type a. perfect or pure competition b. pure monopoly 2. Imperfect/ non-pure type a. monopolistic competition b. oligopoly Market Models Defined Pure competition is a market situation where 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 there are few firms offering standardized or differentiated goods and services. Such definition is not precise because oligopoly includes a wider range of market structures than the other three market models. On the other hand, a fewer buyer market situation called oligopsony. Characteristics of Market Models Pure Competition 1. There is a large number of independent sellers. 2. Products are identical or homogeneous. Examples are farm products like rice, corn, fruits, vegetables, etc. 3. No single seller and no single buyer can influence the change in market price of a product. There are thousands of sellers selling millions of identical products. In case a firm or one seller decides to reduce its supply even up to 99 percent, the total supply in the market is not affected. The supply of one seller is negligible. Therefore, he can not change the market price. Likewise, if he sells his goods at a lower price than the prevailing market price, his goods are brought in just a few minutes. But the market price remains. On the other hand, if he offers his goods at a higher price than the market price, he can not sell his goods. The rise or fall of market price is due to changes in total demand or total supply. 4. It is easy for new firms or sellers to enter the market and for existing firms or sellers to leave the market. There are no significant barriers like legal financial, or technical

requirements. For example, a vegetable vendor is free to sell in the market. She only pays the market fee. In case, she is no longer interested in her small business, she is also free 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. For instance, even if you advertise rice, egg plant, or tomatoes, it has no effect on buyers. They just purchase such products even from one who has not advertised. Pure Monopoly 1. There is only producer or seller. 2. Products are unique in the sense that there are no good or close substitute available. Most public utilities supplying water, electric and telephone service are monopolists. Examples, MERALCO, PLDT and MWSS. 3. The monopolists 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 this 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 franchise by the government. For example, it is not practical and convenient for several electric, water, or telephone companies to operate at the same time in a community. There would be many electric wires and posts and diggings. In Metro Manila, we have only one water supply company, and yet we are greatly inconvenienced by its endless diggings. 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 pubic image. Monopolistic Competition 1. There is a large number of sellers acting independently. Such number means about 100 firms or sellers more or less, while in the case of pure competition, it indicates thousands or more sellers. 2. Products are differentiated. 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 limited control of price. It is possible for some sellers to slightly reduce or increase their prices because of the differences of their products. Example, some banks have

lower or higher interest rates. Likewise soap products have different prices. Even vitamins have different prices even if they have the same classification like vitamin E. 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, locations, and physical appearance of the product. There is extensive advertising to focus the distinct features of the products of the sellers. For example: Parangnakasandalsapader. Oligopoly 1. There are very few firms which dominates the market. Each firms 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 typewriter, airplanes, locomotives, cars and sewing machines 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. In the case of OPEC (Organization of Petroleum Exporting Countries), the price leader is Saudi Arabia which is the biggest oil producer. Moreover, there is also output agreement among the oligopolists to avoid surplus which causes decline in price. It is not uncommon for them like OPEC to cut down production to secure a higher price. 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 wit existing firms because these are already well-established. However, despite formidable competition, it is still possible for new firms to enter the market. Unlike under pure monopoly, there are certain legal and economic restrictions which is no longer possible or feasible for new firms to enter the market. If they succeed, then it would no longer be pure monopoly such as in the case of San Miguel beer. Another beer company has been able to penetrate the market. 5. There is strong advertising among those who produce differentiated products like cars, cigarettes and appliances. However, in the case of identical products like the industrial raw materials, advertising is only for image-building. Usually the deeper interest of the firms is in the community and the firm s contributions to the growth of the economy.