Micro Economics

1. MICROECONOMICS
Prepared by:
RAMIL B. ENTANA JR., L.Agr
Marginal Product of LaborMarginal Product of Labor

2. I. Production and Costs
Theory of Production
- Production is the creation of utility into a good.
- It is the process or the transformation of 2 or
more inputs into 1 or more products or outputs.
- Inputs
these are resources, means or the
ingredients used to produce a product, i.e.
land, labor, fertilizers, chemicals etc.

3. Factors of production…
•Land
•Labor
•Capital
•Entrepreneurship

4. Labor
•Refers to the physical efforts
expended by man in the production
process.

5. Capital
•Refers to all goods used to
produce other goods and services
or anything which has been
produced used to increase the
effectiveness of current productive
activity, such as machinery,
factories, tools and equipment.

6. Land
•Not only includes the soil
surface, but embraces minerals
under the surface water,
climate, topography, everything
that is free “gift of nature” and
not a result of man’s past
activity.

7. Entrepreneurship
•Refers to the ability on the part of
some individuals to see
opportunities to combine
resources in a new and more
efficient ways to produce a
particular product.

8. Production Curves
1. Total Physical Product (TPP)
-Is the output or total amount of
product produced or yield of the
production process.

9. 2. Average Physical Product (APP)
• The quantity of total output produced per unit of variable
input, holding all other inputs fixed.
• It is attained by:
Y (output)
APP= X (input)
Example:
Such that when X = 1 and Y = 5 then APP = 5
When Y = 130 and X = 10 now APP =

10. 3. Marginal physical product
• the change in output resulting from a unit change in
variable input.
• Average MPP is computed by dividing the change in
output by the change in input.
• Thus, MPP=ΔY/ ΔX. Exact MPP is computed by
deriving the MPP function from a given production
function. Example:
• for a production function given by Y=X+4X2 – 0.2X3 ,
and the MPP function is the first derivative of the
production function taken with respect to the variable
input X. The exact
• MPP equation is: dy/dx=1+8X-0.6X2

11. How to graph the curves in theory of
Production
Amount of
Capital
Amount of
Labor
Total
Product
Average
Product of
Labor
Marginal
Product of
Labor
2 0 0 0 0
2 1 57 57 57
2 2 118 59 61
2 3 177 59 59
2 4 228 57 51
2 5 270 54 42
2 6 300 50 30
2 7 322 46 22
2 8 336 42 18
2 9 342 38 8
2 10 340 34 -2

12. 0
100
200
300
400
0 1 2 3 4 5 6 7 8 9 10
Quantity
Labor
TOTAL PRODUCT CURVE

13. -50
0
50
100
150
200
250
300
350
400
0 1 2 3 4 5 6 7 8 9 10
TPP
AVP (Labor)
MPP (Labor)
Quantity
Labor
Law of
Diminishing
Marginal
Returns

14. Law of Diminishing Returns.
• It was developed by an early economist to
describe the relationship between output and
variable input when other outputs are held
constant in quantity. This law is also known as;
1. The Law of Variable Proportion
2. Law of Diminishing Marginal Products

15. Statement of the Law:
•“If increasing amounts of one input are
added into the production process
while all other inputs are held
constant, the amount of output added
per unit of variable input will eventually
decrease.”

16. 3 Stages of Production
• Stage I
- occurs when MPP is greater than APP. APP is
increasing throughout stage I. Stage I ends when
MPP=APP or when APP is at its maximum.
• Stage II
- occurs when MPP is decreasing and is less than
APP. Stage II ends when MPP=0, or when TPP is
maximum.
• Stage III
- Stage III occurs where MPP is negative or where
TP starts to decline.
Note:
Stage I&III are irrational
or irrelevant stages for
production and stage II
and its boundaries are the
areas of economic
relevance.

17. Elasticity of Production
•a concept that measures the degree of
responsiveness between output and
input.
•It is define as the percentage change
in output divided by the percentage
change in the input.

18. For example, if a firm increases the number
of workers by 10%, and the number of
products produced per month increases by
20%, the elasticity of production will be:
Ep = 20%/10% = 2

19. •Elasticity of production is
measure of the
responsiveness of the
production function to the
change in one output.

20. Movement along the supply: when the price
increases, the quantity supplied decreases.

21. II. Theory of Cost
• refers to the expenses incurred in organizing
and carrying out the production process.
• In economics, costs includes explicit and
implicit costs. Explicit costs are the actual
out-of-pocket expenditures of the firm to
purchase or hire inputs it requires in
production.
• These expenditure include the wages to hire
labor, interest on borrowed capital, rent on
land & building etc.

22. •Implicit cost on the other hand, refers
to the value of the inputs owned and
used by the firms in its own production
process.
• The values of these owned inputs
must be imputed or estimated from
what these inputs could earn in their
beat alternative use, or we call these
the opportunity or alternative cost.

23. Cost . . .
•also classified into private and
social cost

24. 2 types of costs
A. Private Costs
• are the explicit and implicit opportunity
cost incurred by individuals and firms in
the process of producing goods and
services.
B. Social Costs
• are the costs incurred by society as
whole. Social costs are higher than
private costs of production.

25. •Private costs can be made equal to
social costs by public regulation
requiring the firm to install anti
pollution equipment in the case of a
firm dumping untreated waste into the
air, which imposes cost on society (in
the form of higher cleaning bills and
more breathing ailments, and soon.),
that is not reflected in the costs of the
firm.

26. The cost of capital as an opportunity
cost
Opportunity cost
- the financial capital that has been invested
in the business.
- The value of the next-best alternative when
a decision is made; it’s what is given up.

27. • Suppose, for instance that Rene use P
300,000.00 of his savings to buy 2 hectares
lowland farm from a precious owners. If
Rene did not withdraw is money from the
bank, his savings deposit would earn an
interest of 5 percent giving him an interest
earning of P 15,000.00 every year. To earn
2 hectares land therefore, Rene has given
up P15,000.00 a year in interest income.
This P 15,000.00 is one of the opportunity
cost of Rene’s farm business.

28. Measures of Cost
•expenses measured in organizing and
carrying out the production process.
•They include outlays of funds for
inputs and services used in
production. In the short run total costs
includes fixed and variable costs.
•In the long run all costs are variable
because all inputs are variable in the
long run.

29. Fixed and Variable Costs
• A resources or input is called fixed resources if its
quantity is not varied or changed during the
production period.
• A resources or input is variable if its quantity is varied
or changed at the start or during the production
period.
• In general, costs of fixed inputs are
called fixed costs, while cost of variable
inputs are called variable costs.

30. Computation of Costs
• Total fixed cost is the cost of all the fixed
inputs used in production.
• Total variable cost is computed by
multiplying the amount of variable input used
by the price per unit of input.
• Thus TVC=PxX where X is the amount of
variable input & Px the Price of the variable
input X.
Example: A firm imposed a variable input of 5 in
order to produced 50 units of goods with the
price of X is 100. Thus, TVC = 500

31. Total Costs
• Total cost is the sum of the total fixed and variable
costs.
• TC=TFC+TVC
• Average total cost is total cost divided by the output
• ATC=TC/Y
• Average fixed cost is total fixed costs divided by the
quantity of output,
• AFC=TFC/Y
• Average variable cost is total variable cost divided
by the quantity of output,
• AVC=TVC/Y

32. •Marginal cost is the change in total
cost per unit increase in the output. It
is the cost of producing additional unit
of output. It is the increase in total cost
that arises from a one unit increase in
output.
MC= ΔTC/ ΔY
•The AVC, ATC & MC are U-shaped
curves.

33. Relationship between marginal cost and
average total cost
• Whenever marginal cost is less than average
total cost, average total cost is falling,
whenever marginal cost is greater than
average total cost, average total cost is rising.
• Marginal cost curve crosses the average total
cost curve at the efficient scale or when
average total cost curve is at its minimum joint
or when its slope is zero.

34. Exercise
• Following the example of determining TPP, AVP and MPP
complete the table below and create your own graph;
Amount of
Capital
Amount of
Labor
Total Product Average
Product of
Labor
Marginal
Product of
Labor
3 0 0
3 1 60
3 2 120
3 3 180
3 4 220
3 6 300
3 7 350
3 8 377
3 9 380
3 10 420

35. Price and Output Determination Under
Perfect Competition

36. A. Price determination in the market
Period
• The market period in the very short-run period
refers to the period of time during which the
market supply of a commodity is fixed.
• With perfect competition among buyers & sellers,
demand alone determine the price while supply
alone determine the quantity in the market period.
The function of price is to ration the available
supply of the commodity among potential
buyers& ones the length of time of the market
period.

37. 1. Total Approach
• Profit maximization provides the framework
for the analysis of the firm. The equilibrium
output of the firm is the one that maximizes
the total profits of the firm.
• Total profit equals total revenue minus total
costs. Total profits are maximized when the
positive difference between revenue and
total cost is largest.

38. 2. Marginal Approach
• determining the equilibrium output of the firm is a more
valuable widely used approach. The general rule for
project maximization states that at a profit maximizing
level of output, marginal revenue and marginal cost are
exactly equal.
Marginal revenue is the change in total revenue
per unit change in output or the addition to total
revenue attributable to the addition of one unit to
sales.
Marginal cost is the change in total cost per unit
change in output or it is the addition to total cost
resulting from the addition one unit to output.

39. B. Demand and Supply
•Demand and supply are the 2
forces that make the market
economics work. The buyer as a
group determines the demand for
the product, the sellers as a group
determines the supply of a
particular product.

40. The Law of Demand
• The consumer tends to buy more units of goods
when the price is lower, and he reduces his
purchases when prices increase. This behavior of
the consumer is explained by the law of demand.
• The law states that as price increases quantity
demand decreases and vice versa, as price
decreases quantity demanded increases.
• The law of demand is only valid if the
determinants of demand is presumed to be
constant, except price.

41. Elasticity
•the measure of the
responsiveness of one variable
to the change in another
variable

42. Price Elasticity of Demand
• It is the responsiveness of the quantity
demanded of a commodity to a change in
price is very important to consumers and
producers alike.
• Price elasticity of demand is the measure of
the responsiveness in the quantity
demanded of a commodity to the change in
its price; Ed=%ΔQd/ %ΔP.

43. For are elasticity of demand or average
elasticity.
• The formula is given by:
Ed=ΔQd/ΔP · (P2+P1)/1/(Q2+Q1)/2=ΔQ/ΔP · P2+P1/
Q2+Q1
• For example to measure price elasticity for a price decline
from P1.50 to P1.00 per unit and the corresponding
increase in the quantity demanded for 4 to 6 units of a
commodity, we get;
Ed=6-4/1.00-1.50x(1.00+1.50)/2/(6+4)/2=2/0.5 x
2.5/2.5=1

44. •Price elasticity is usually different
at and between different points on
the demand curve and it can range
anywhere from zero to very large
or infinite.
•Price elasticity of demand is a
pure number independent of the
unit in which prices and outputs
are measured.

45. Demand is said to be . . .
1.Elastic if Ed >1
2.Unit (Unity) Elastic if Ed = 1
3.Inelastic if Ed<1

46. Factors Influencing price elasticity of
demand
1. Nature of Good (Necessities or Luxuries)
• Necessity tends to have inelastic demand
• Luxuries have elastic demand
2. Availability of close substitute
• goods with close substitutes tend to have more elastic
demand because it is easier for consumers to switch from
that goods to others.
3. Time Horizon
• goods tends to have more elastic demand over longer
time horizon. The longer is the time period allowed for
consumers to adjust to change in the commodity price,
the larger is the price elasticity.

47. Factors Influencing price elasticity of
demand
4. Number of uses which a good may be
put.
• The greater the number of possible uses of
a commodity the greater is price elasticity
will be.

48. Price cross elasticity of demand
•It measures the relative
responsiveness of quantity
demanded of a given commodity
to changes in the price of a related
commodity

49. Good relationship
a) Substitute relationship - Commodities
X & Y are substitute if more of X is
purchased when the price of Y goes
up.
b) Complementary relationship –
Commodities X & Y are complements
if less of X is purchased when price
of Y goes up.

50. •An increase in the price of a
commodity leads to a reduction in the
quantity demanded of the commodity
(a movement along the demanded
curve for the commodity) but causes
the demanded curve for a substitute to
shift to the right and the demand curve
for a complement to shift to the left.

51. Price cross elasticity of demand coefficient
is measured by the formula
• Exy= ΔQx/ ΔPy·Py/Qx
Where ΔQx is the change in the quantity purchased of x,
ΔPy is the change in the price of y, Py is the original price
of Y and x is the original quantity Qx
• If Exy is greater than zero or positive, X & Y are
substitutes because an increase in Py leads to an
increase in Qx, as X is substituted for Y in consumption
• If Exy is less than zero or negative, X & Y are
complements because an increase in Py leads to a
reduction in Qy and Qx.

52. Total Revenue
•is the total amount of money
earned by sellers of a commodity.
•This is also the amount paid by the
buyer (total expenditure) and
received by the sellers of the
goods.

53. Total revenue = P x Q
• where P is the price of a good and Q is the
quantity of the good sold.

54. • If demand is elastic, a decline in price will result in
proportionately greater expansion in the quantity
demanded and a rise in price will result in a
proportionately decline in the quantity demanded.
Total revenue varies inversely with price if
demand is elastic.
• If demand is inelastic, total revenue and price are
directly related. A fall in price will reduce total
revenue while an increase in price, will increase
total revenue
• If demand is unitary, total revenue is not affected
by changes in price.

55. Income Elasticity of Demand
• a measure of how the quantity demanded changes as
consumers’ income changes. Income elasticity of demand
is the percentage change in the quantity demand divided
by the percentage change in income.
That is;

56. • A good with a negative income elasticity is
said to be inferior, a good with an income
elasticity between zero and one or positive
is said to be normal, and a good with an
income elasticity greater than one is said to
be superior.
• Normal good can be further classified as a
necessity or luxury. A normal good is
classified as necessity if the income
elasticity is less than one, and luxury if the
income elasticity is greater than one.

57. Engel Curve
• is a function relating the equilibrium
quantity purchased of a commodity to a
level of money income.
• The name was taken from Christian Lorenz
Ernest Engel, a 19th century German
statistician.
• Engel’s law states that the proportion of
total expenditures of food declines as
family income rise.

58. The Law of Supply
• a schedule of various quantities of commodities
which producers are willing and able to offer at a
given price, time and place.
Its determinants are;
• - technology
• - cost of production (prices of inputs)
• - number of producers or sellers
• - price expeditions
• - price of others goods
• - price of the good

59. The law states that . . .
•other things being equal, the
quantity supplied of a good prices
when the price of the god rises
and falls as the price falls. There is
that direct or positive relationship
between quantity supplied and the
price of the good.

60. Quantity Supplied
•the amount of good that sellers
are willing and able to sell.

61. Supply schedule
•table that shows the
relationship between the price
of a good and the quantity
supplied.

62. Supply Curve
•a graph of the relationship
between the price of a good
and the quantity supplied.

63. Market Supply
•sum of all supplies of all sellers.
It is obtained by summing up
the quantity supplied at any
price. That is by adding
horizontally the individual
supply curves

64. Change in Supply . . .
• Whenever any determinants of supply other
than price changes, the supply curve shifts.
• A shift of the supply curve to the right indicates
that there is increase in supply and a shift of
the supply curve to the left means that there is
a decrease in supply.
• These movements of the supply curve
either to the left or to the right caused by
the changes, the factors, or determinants
of supply except price.

65. Change in Quantity Supplied
•the movement from one point to
another along the same supply curve
indicates that there is a change in
quantity supplied.
•These movements are caused by the
changes in the price of the good. A
rise in the price of the good, quantity
supplied also falls.

66. Elasticity of Supply
•The law of the supply states that higher
prices raise the quantity supplied.
•The price elasticity of supply measures
how much the quantity supplied of a
good respond to change, in the price of
the good computed as the percentage
change in quantity supplied divided by
the percentage change in price.

67. • using Es as a symbol of price elasticity of supply, to
measure elasticity for a price increase from P2.00 to 3.00
and the corresponding increase in the quantity supplied
form 5 units to 8 units we get:
Es=ΔQ/ ΔP x P2+P1/Q2+Q1=8-5/3-2 x 3+2/8+5=3/1 x
5/13 = 1.15
• Price elasticity (either demand or supply elasticity), and its
value is not affected by changes in the units of
measurement.

68. •A determinant of the price
elasticity of supply is the time
period being considered.
•Supply is usually more elastic in
the long run than in the short run

69. Consumption
•refers to the utilization of services or
material goods for the gratification of
human desire.
•may also mean the use of goods &
services for production purpose as, for
example, when it is said that raw
materials are consumed in the
production of a finished product.

70. Consumer
•refers to one who used up or
consumes goods or services
and who derives satisfaction or
utility from such goods or
services.

71. Macroeconomics

72. Macroeconomics
• concerned with performance of the
economy as a whole or with large sectors
of it, such as government, business firms,
and households.
• Macroeconomics attempts to explain why
the economy’s total output of goods and
services fluctuates overtime, giving time to
the business cycle with its accompanying
upward and downward movements in the
unemployment and inflations rates.

73. National Income Accounting
• National Income Accounting provides us with aggregate
measures of what is happening in the economy. These
are at least three reasons why national income
accounting is important:
1. It allows us to keep a finger on the economic pulse of
the nation.
2. By comparing national income accounts over a number
of years, we can track the long-run course of the
economy and see whether it has grows, been steady, or
stagnated.
3. Information supplied by natural income accounts
provide a basis for formulating, and applying public
policies to improve the performance of the economy.

74. •National income accounts allows us to
keep tabs on the health of the economy
and formulate policies, which will
maintain and improve that health.
•In the Philippines, the accounts are
maintained by the National Economic
Development Authority(NEDA) and
published annually in the NEDA
Statistical .

75. GNP and GDP: Two ways of measuring
economy’s output
Both measure the total market of all
final goods and services product in
the economy in one year. They are
closely related, differing only in how
the “economic” is defined.

76. I. Gross National Product (GNP)
• consists of the total output produced by land,
labor, capital and entrepreneurial talent
supplied by Filipinos, whether these resources
are located in the Philippines or abroad.
• For example, the share of output (income)
produced by a Filipino working in Canada is
included in our GNP. Conversely, the share of
output (income) produced in the Philippines by
foreign-owned resources is excluded from our
GNP.

77. II. Group of Domestic Product (GDP)
• It comprises the value of the total goods and services
produced within the boundaries of the Philippines,
whether by Filipinos or foreign-supplied resources.
• For instance, the value of a good produced at a
Japanese-owned factory in the Philippines, including
profits, is a part of Philippine GDP. Conversely, profits
earned by a Philippine-owned business firm in the
United States excluded from our GDP.
• Specifically, the difference between the GDP and
GNP consists of net foreign factor income earned
(output produced) in the Philippines.

78. Approaches in GNP Management
1. Final Expenditure Approach
• The GNP is the sum of all final sales to end-users. These
final sales are classified as: personal consumption
expenditures(C), gross domestic investment( I), which is
the sum of private domestic investment(Ip) and public
gross domestic investment(Ig), government
consumption(G) and net foreign investment or (X-M)
where X stands for exports and m for imports. In symbols
GNP= C + I + g + (X-M)

79. 2. GNP Derived from Factor Income:
The Income Approach
• In this approach, GNP is distributed as payments
or income to the owners of all the inputs that
contribute to its productions; Define a new term
national income at factor cost (NI) as the sum of
all factor payments received by the owners of
productive services. This is:
• NI = wages and salaries (W) + rental payments
(R) + interest payments (i) + profits (P).
• In order to simplify the presentations of national
income of various factors, the United Nations
suggested the following item as the various
components of national income (NI):

80. (1) Compensations of employees (wages
and salaries)
(2) Income from unincorporated enterprises
(which could be a mixture of profits and
interests earnings);
(3) In come from property (which may be
broken down into total corporate taxes,
dividends paid and corporate undistributed
profits or savings). And
(4) Property and corporate income of
government.

81. • The GNP from the factor income approach
is the sum of national income at factor
costs, indirect business taxes minus
subsidies (IBT), and depreciation (D). Thus,
GNP= NI + IBT + D

82. 3. The Industrial Origin Approach
• In this approach, the value added originating in various
industries or sectors into which the economy is divided is
added together to form the GNP. This approach is really a
different rearrangement of data on income of factors. It
rearranges all data by industry. Thus,
GNP= Sum of all gross value added of sectors 1, 2, 3,..
etc. + IBT (3)
• Two other important measurements are net national product (NNP)
and gross domestic product (GDP).
• NNP= GNP-D
GDP= GNP-net factor earnings from abroad

83. Real and Nominal GNP (or GDP)
• Nominal GNP or GDP measures the value
of output in a given period in the prices of
that period, or, as it is sometimes put, in
current pesos.
• Thus 2000 nominal GNP measures the
value of the goods produced in 2000 at the
market prices prevailing in 2000, and 1995
nominal GNP measures the value of goods
produced in 1995 at the market prices that
prevailed in 1995.

84. Nominal GNP changes from year to year
for two reasons.
•The first reason is that the physical
output of goods and services
changes.
•The second is that market prices
change.

85. • Real GNP measures changes in physical
output in the economy between different
time periods by valuing all goods produced
in the two periods at the same prices, or in
constant pesos.
• For example if real GNP is measured in the
national income accounts in the prices of
1995, this means that, in calculating real
GNP, today’s output would have been worth
had it been sold at the price of 1995

86. 4. Problems of GNP (or GDP)
Measurement
• GNP (or GDP) data are, in practice, used not only as a
measure of how much is being produced, but also as a
measure of the welfare of the residents of a country.
• Economists and politicians talk as if an increase in real GDP
means that people are better off. But GNP (or GDP) data are
far from perfect measures of either economic output or
welfare. There are, specifically, four major problems:
1. Some outputs are poorly measured because they are not
traded in the market.
2. It is difficult to account correctly for improvements in the
quality of goods.
3. Some activities measured as adding to real GNP in fact
represent the use of resources to avoid or contain “bads”
such as crime or risks to national security.

87. 4. Macroeconomic Equilibrium
• Macroeconomics analysis involves modeling the
economy. The economy is in equilibrium in self-
balancing position when aggregate demand equals
aggregate supply. Following the national income
activities framework (discussed earlier). The
economy is in equilibrium when
GNP (or Y)= C + I + G + X-M
That is, aggregate supply- aggregate demand
• The left-hand side of equation represents the level
of aggregate supply (or income) which the right-
hand represents the level of aggregate demand.

88. • If we assume an economy with no government
and no external relations (no foreign trade),
then the economy is in equilibrium when
Y= C + I
• Where; Y= national income C= aggregate
consumption I= aggregate investment
• The income received can be used in two
ways; it can be spent on consumer goods, C,
or saved, S (S includes both personal and
business savings). This can be indicated as:
Y=C+S

89. Consumption, Savings and Investment
•Consumption and investment are
two major components of
aggregate demand while savings,
as indicated in equation : Y-C = S
is the residual after subtracting
aggregate consumption (C) for
aggregate income (Y).

90. 1. The Consumption Function
• was based on the assumption that aggregate current
consumption expenditures are a function of aggregate
current disposable income.
• It was Keyner who made the consumption function the
basic element in the income-expenditure approach to
national income determination.
• This function is the principal building block in the multiplier
analysis.
• Assuming a linear relationship between consumption and
disposable income, the consumption function can be
written as: C = a + b λ d, where: a>0, b<1.

91. • In this equation, a is the vertical intercept, b is the
slope of the function, which is called the marginal
propensity to consume (MPC), and λ d is the
residual after deducting taxes from income that is,
λ a = λ – T
• A hypothetical consumption function is shown in
Figure 1, together with the savings functions. The
savings functions shows the relationship between
savings and income. Following equation 10, the
savings function can be written as:
• S = λ d – C
S = λ d – (a+b+λ d)
• S = -a + (1-b) λ d

93. The Average Propensity to Consume
(APC)
• is the function of total income spent on consumption, C/λ
d.
• the slope of a line drawn from the origin to any point on
the consumption function is the average prosperity to
consume, C/λ d. Obviously, the average propensity to
save S/λ d is equal to 1 – (C/λ d).

94. The Marginal Propensity to Consume
(MPC)
• Another important relationship is the
marginal propensity to consume (MPC),
which relates a change in consumption Δ C,
to the change in income, Δ /λ d, that causes
it.
• The marginal propensity to consume (MPC)
is symbolically indicated as Δ C / Δ λ d. The
marginal propensity to consume is equal to
the slope of the consumption function –
dC/dλ d.

95. Simple Income Determination
• National income determination is one of the
subject matters of macroeconomics.
• Using simple equilibrium model, the equilibrium
level of income consumption and savings can be
determined.
Without any government or retained earnings, Y =
Yd and the accounting framework in this economy
include:
1. Y=C + Ir: where Ir = the net realize investment
2. = C + Sp if Sg = 0, then Sp = S
3. Ir = S →the fundamental accounting identity

96. Now supposed that . . .
C = 25 + 0.75Y and that the producers desire to spend P
20 million investment goods at all levels of income, what
will be the market equilibrium?
Solution:
• Given: C = 25 + 0.75Y
I= 20
• Then: Y = C + I
= 25 + 0.75Y + 20
(-0.75) + Y = 25 + 20
(-0.75) + Y = 45
Y = 180

97. Unemployment and Inflation
• Unemployment and inflation are considered
as two most serious economic problems in
many countries including the Philippines.
• The fact is that there is a trade-off between
the two. That is, inflation cannot be
eliminated without rising unemployment
and at least for sometime and moderate
unemployment cannot be cut sharply
without the risk of raising inflation.

98. Definitions
• Unemployment has been defined as a situation in
which persons deserving work cannot find jobs.
• Underemployment is a situation in which laborers
who are working do not render full equivalent
working time either by choice or by inability to find
full-time work.
• On the other hand, inflation is a phenomenon of
rising prices of goods and of the factors of
production – the price increases may vary for
different factors and goods, depending on supply
and demand and other economic factors.

99. Effects of Unemployment and Inflation
• High unemployment rates are a major social
problem. Jobs are difficult to find. The
unemployed suffers a loss in their standard of
living, personal distress, and sometimes lifetime
deterioration in their career opportunities. When
unemployment reaches double-digit percentages
– and even well short of that – it becomes the
number-one social and political issue.

100. When there is inflation, the following are
some of its effects:
1. Debtors and profit-earners
benefit from inflation.
2. People who put their money in
savings accounts in a bank can
earn say, 6 percent per year
interest income.

101. Measures to address inflation
(a)money supply and credit
(b)government spending and
(c)use of taxation

102. Monetary and Fiscal Policy

103. Monetary Policy
The Central Bank
•is principally an institution designed to
regulate the monetary and financial
systems. It has a policy abroad which
serves as the monetary authority. The
central bank provides the staff to
supervise and implement policies
enunciated by monetary authority.

104. The Philippine Financial System
• composed of different institutions serving different
markets and complementing each other in attaining the
process of intermediation, providing a link between
economic units with excess funds and those that use
these funds.

105. Fiscal Policy
• is a collective term for the combined
operation of public expenditure, taxation
and debt.
• The team “public finance” refers in
particular to the subject of financing public
expenditures. Public finance is
appropriately a study of the fiscal system.
The fiscal operations are reflected in the
government budget.

106. Component of national budget
•The national budget for any given year
contains the expenditure for all public
activities. It also lists the source of
financing of these expenditures based
in existing taxes and other sources of
revenues, and includes proposals for
2000 taxation and other forms of
finance.

107. The standard components of a budget
presentation includes the following:
1. Total Revenue
• Taxes in income
• Taxes in international trade
• Exercise and sales taxes
• Other taxes
• Non-tax revenue
2. Current Operation Expenditures
• Personal Services
• Maintenance
• Interest
• Transfer to corporations
• Allotment local governments

108. 3. Capital Outlays
• Infrastructure
• Other capital
• Capitalization (equity contributions)
• Net lending
4. Overall deficit
• Foreign borrowing (net)
• Borrowing from banking system
• Other domestic borrowing
5. Current operation surplus

109. Business Cycles
• refer to long periods of changes in economic activities in
contrast with seasonal cycles, which are reflected in the
changes that may be observed within a given year. The
business cycle has four distinct phases namely:
expansion phase, peak phase, recession phase and
depression phase.

111. Money and Banking
•Money is fundamental in the
function of the economy. It
facilitates the exchange of goods
and services and lessens the
amount of time and effort to carry
out this trade.

112. Functions of Money
(1)a unit of value;
(2)a medium of exchange;
(3)a standard of deferred
payments, and
(4)a store of value.

113. Economists definition of money
1. M1 or General purpose money
• includes currency in circulation (which includes
coins and paper money) and demand deposits
(the standard name given by economists for
checking accounts, because they can be issued
“on demand “ of the bearer).
2. M2 or Broad Money
• includes savings and time deposits. These are
deposits that are very “liquid,” that is, easily
convertible into cash sot that they are much like
money in the sense of checking deposits.

114. Theories on Demand for Money
• 1. Crude quantity theory of money simply -
states that prices are a direct proportion of the
supply of money. This may be written as P = k ·
M;
• where, P is the price level, k is a positive
proportional constant and M, the supply of
money. If P and M are measured as index
numbers with 100 for a given base year and the
value of k is 1/2 , then this theory will say that for
every one percent increase in money supply, the
price level will rise by ½ percent

115. How is k to be interpreted?
•K is a number which is derived from
the concept of “velocity circulations”
V1, This velocity is the rate at which
the supply of money is turning over or
used per year in order to undertake
transactions. Income transactions are
represented in a give year by the
gross national product, GNP.

116. The stock of money is given
by M. The velocity of circulation is defined
as:
•V= PQ/M
•From this, the famous “quantity
equation of exchange” is
derived, which is
•MV=PQ

117. Commercial Banking
• is a business institution that accepts deposits and
lends to borrowers. An important feature of a
commercial bank is that it s depositors normally
keep checking deposits as one of the features of
their services.
• A bank is like an ordinary business enterprise,
backed up by its capital undertaking special
services to its depositors and borrowers. In
exchange for these services, it charges certain
costs. For borrowers, it receives interest
payments. In addition to the bank’s capital,
depositors give the bank its basis for lending.

118. •Banks need to keep only a fraction of
their deposits in reserve. The central
bank regulates what fractions can be
kept as minimum reserves. This
“reserve requirement” is useful also in
the control of the money supply. In
fact, the minimum reserve requirement
is.