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Karl Marx, the father of modern socialism said that socialism is the
lower stage of post-capitalism, and communism as the higher state of post
capitalism.
Basic Economics Problems
1. What goods and services to produce and how much.
2. How to produce the goods and services.
3. For whom are the goods and services.
Economic Systems
It is a set of economic institutions that dominates a given economy.
Capitalism. The factors of production and distribution are owned and
managed by private individuals or corporations. There is private property,
economic freedom, free competition and profit motive.
Communism. It is exactly the opposite of capitalism where the factors
of production are owned and managed by the state. There is no private
property, no free competition, no economic freedom, no profit motive and
presence of central planning.
Socialism. It is the combination of capitalism and communism
Vital Criteria to Judge an Economic System
-Abundance
-Growth
-Stability
-Security
-Efficiency
-Justice and Equity
-Economic Freedom
Goal of Economics
-Economic growth
-Full employment
-Price stability
-Economic freedom
-Equitable distribution of income and wealth
-Economic security
Wage determination
Farm production guide
Maximize profits
Imposition of sales taxes
Elasticity of Supply
It refers to the reaction or response of the sellers/producers to price
change of goods.
1. Elastic supply. A change in price results to a greater change on
quantity supplied. Producers are very sensitive to price like manufacturing
firms.
Indifference Map
Indifference Curves and Budget Line. To maximize welfare, a
consumer will examine his budget and see the furthest indifference curve he
can reach.
The blue line represents the maximum combination of goods you can
buy give your limited budget. The point where the budget line meets an
indifference curve, shows the best combination of goods, given the existing
budget constraint.
The Budget Line
As we have already seen, a consumers choices are limited by the
budget available. Total spending for goods and services can fall short of the
budget constraint but may not exceed it.
Chapter 4 Production
item, or produce a service, will have a clearer picture of how to better price
the item or service and what will be the total cost to the company.
Economies of Scale
Economies of scale are factors that cause the average cost of
producing something to fall as the volume of its output increases.
Economies of scale can be classified into two main types: Internal
arising from within the company; and External arising from extraneous
factors such as industry size.
Economies of Scale occur for various reasons.
1. Specialization and division of labour. In large scale operations
workers can do more specific tasks. With little training they can become very
proficient in their task, this enables greater efficiency. A good example is an
assembly line with many different jobs.
2. Technical. Some production processes require high fixed costs e.g.
building a large factory. If a car factory was then only used on a small scale it
would be very inefficient to run. By using the factory to full capacity average
costs will be lower.
3. Bulk buying. If you buy a large quantity then the average costs will
be lower. This is because of lower transport costs and less packaging. This is
why supermarkets get lower prices from suppliers than local corner shops.
4. Spreading overheads. If a firm merged it could rationalize its
operational centers. E.g. it could have one head office rather than two.
5. Risk Bearing economies. Some investments are very expensive
and perhaps risky, therefore only a large firm will be able and willing to
undertake the necessary investment. E.g. pharmaceutical industry needs to
take risks in developing new drugs.
6. Marketing Economies of scale. There is little point a small firm
advertising on a national TV campaign because the return will not cover the
high sunk costs.
7. The container principle. To increase capacity 8 fold it is necessary
to increase surface area only 4 fold.
8. Financial economies. A bigger firm can get a better rate of
interest than small firms.
9. External economies of scale. This occurs when firms benefit from
the whole industry getting bigger. E.g. firms will benefit from better
infrastructure, access to specialized labor and good supply networks.
Most of the above economies of scale are internal. It means the
economies benefit the firm when it grows in size
Techniques of Production
Labor-intensive. A process or industry that requires a large amount
of labor to produce its goods or services. The degree of labor intensity is
typically measured in proportion to the amount of capital required to produce
the goods/services; the higher the proportion of labor costs required, the
more labor intensive the business.
-All firms are price takers, therefore the firms demand curve is
perfectly elastic.
-There is perfect information and knowledge.
Definition of Monopoly
A pure monopoly is defined as a single seller of a product, i.e. 100% of
market share.
In the UK, a firm is said to have monopoly power if it has more than
25% of the market share. For example, Google share 90% of search engine
traffic.
Problems of Monopoly
Higher Prices. Firms with monopoly power can set higher prices than
in a competitive market.
Allocative Inefficiency. A monopoly is allocatively inefficient because
in monopoly the price is greater than MC. In a competitive market the price
would be lower and more consumers would benefit. A monopoly results in
dead-weight welfare loss indicated by the red triangle.
Productive Inefficiency. A monopoly is productively inefficient
because output does not occur at the lowest point on the AC curve.
Inefficiency. It is argued that a monopoly has less incentive to cut
costs because it doesnt face competition from other firms.
Supernormal Profit. A Monopolist makes Supernormal Profit leading
to an unequal distribution of income.
Higher Prices to suppliers. A monopoly may use its market power
and pay lower prices to its suppliers. E.g. Supermarkets have been criticized
for paying low prices to farmers.
Diseconomies of scale. It is possible that if a monopoly gets too big
it may experience dis-economies of scale. higher average costs because it
gets too big.
Lack of incentives. A monopoly faces a lack of competition and
therefore, it may have less incentive to work at product innovation and
develop better products.
Charge higher prices to suppliers. Monopolies may use their
supernormal profits to charge higher prices to suppliers.
How Monopolies can develop
1.
Horizontal Integration. Where two firms join at the same stage
of production.
e.g. two banks
2.
Vertical Integration. Where a firm gains market power by
controlling different
stages of the production process. A good
example is the oil industry, where the
leading firms produce, refine
and sell oil.
3.
Legal Monopoly. E.g. Royal Mail or Patents for producing a
drug.
Monopolies also need barriers to entry to protect them from new firms
entering the market. Barriers to entry can include brand loyalty through
advertising and economies of scale
Oligopoly
An Oligopoly is an industry dominated by a few firms, e.g.
supermarkets, petrol, car industry e.t.c.
The main features of oligopoly:
-An industry which is dominated by a few firms.
-Example. UK definition of an oligopoly is a five firm concentration ratio
of more than 50% (this means they have more than 50% of the market
share)
-Interdependence of firms, firms will be affected by how other firms set
price and output.
-Barriers to entry, but less than monopoly.
-Differentiated products, advertising is often important
-Most common market structure
Monopolistic Competition
Monopolistic Competition is a market structure which combines
elements of monopoly and competitive markets. Essentially a monopolistic
competitive market is one with freedom of entry and exit, but firms are able
to differentiate their products. Therefore, they have an inelastic demand
curve and so they can set prices. However, because there is freedom of
entry, supernormal profits will encourage more firms to enter the market
leading to normal profits in the long term.
A monopolistic competitive industry has the following
features:
-Many firms
-Freedom of entry and exit
-Produce differentiated products. Therefore firms have inelastic
demand, they are price makers because the good is highly differentiated
-Make normal profits in the long run, but could make supernormal
profits in the short term
-Are allocatively and productively inefficient.
Contestable Market
A contestable market occurs when there is freedom of entry and exit
into the market. Thus in a contestable market, there will be low sunk costs.
(Costs which cant be recovered when leaving the market).
Factors which determine the contestability of a market
When considering the contestability of markets it is important to
consider the different barriers to entry a new firm may face
-Sunk Costs. If Sunk costs are high this makes it difficult for new firms
to enter and leave the market. Therefore it will be less contestable. For
example, if a new firm had to purchase raw materials, that it wouldnt be
able to resell on leaving the market, this may act as a deterrent.
-Levels Of Advertising And Brand Loyalty. If an established firm
has significant brand loyalty such as Coca Cola, then it will be difficult for a
new firm to enter the market. This is because they would have to spend a lot
of money on advertising which is a sunk cost. Even if they spend money on
advertising it may not be sufficient to change customer loyalty to very strong
brands. It depends on the industry, customer loyalty would be fairly low for a
product like petrol because it is quite homogenous. But, for soft drinks
people have greater attachment to their brand
-Vertical Integration. If a firm does not have access to the supply of
a good then the market will be less contestable. E.g. Oil firms could restrict
the supply of petrol to petrol stations, making it difficult for new firms to
enter. If you wish to sell electricity to domestic customers, a big issue is
whether you can gain access to the electricity grid. The national electric grid
is a natural monopoly, but government regulation can make sure firms have
a fair access to the grid. Giving access to different stages of production can
make the market more contestable. (How vertical barriers can restrict
competition)
-Access To Technology And Skilled Labor. For some industries like
car production it is difficult for new firms to have the right technology.
Nuclear power may require skilled labor that is difficult to get. This makes
the market less contestable. If you wished to compete with Google, you may
find it hard to employ the best software engineers because Google pays its
employees a very good wage and is seen as an attractive company to work
for.
-Demand for goods and services. Direct demand and derived demand.
-Productivity.
-Price of factors of production.
The supply curve for the labor market shows how much labor workers
or households will provide at each wage.
There are two alternatives for each households time: leisure and
working at home.
As the market wage changes, decisions concerning work will also
change. There are two effects of a wage change, which work in opposite
directions:
-Substitution effect: If the marginal benefit of leisure or working at
home is higher than the market wage, the household should choose either
leisure or working at home. This means that as the wage rises (falls),
households are more (less) likely to choose the labor market.
-Income effect: As the wage rises (falls), households are less (more)
likely to spend more time in labor market. With a higher (lower) wage, they
can work less (more) to make the same income.
The relative strengths of the income and substitution effects will
determine the shape of the households labor supply curve.
If the substitution effect is stronger, the curve will be upward sloping.
If the income effect is stronger, the curve will be downward sloping.
If the substitution and income effects are equal, the curve will be
vertical.
Most people have a backward-bending labor supply curve, which is
upward sloping for low wages, vertical or nearly vertical at higher wages, and
bends backward with a downward slope for the highest wages.
Market labor supply, on the other hand, is a straight, upward sloping
line. It is not backward-bending because, as a whole, more workers will be
attracted to higher-paying jobs.
Equilibrium
As with other goods, the supply and demand for labor create an equilibrium
wage rate and quantity in the market when they are equal. There are several
possible inefficiencies, which may cause the wage to differ from equilibrium:
-Income tax: Workers pay a tax on their income, and it affects the amount of
time they are willing to work.
-Minimum wage: The government sets in the market a minimum wage, which
firms are forced to pay.
-If the minimum wage is lower than the market equilibrium
wage, then there is no
impact because firms will pay the equilibrium wage.
-If the minimum wage is higher than the market equilibrium
wage, labor supplied will be
higher than labor demanded, and some workers will
be unable to find jobs.
-Discrimination: Firms may choose to hire or set wages based on factors that
are not related to productivity, such as race, age, or gender. Nonprofit maximizing
decisions are inefficient.
firms often have other benefits that offset the higher cost of labor, such as
lower turnover.
Income Distribution
It is the allocation of income among the owners of the factors of
production.
Social philosophers crusaded not only for social and political equality
but also for economic equality.
Rousseau contended that private property is a robbery and it did not
exist in the state of nature.
Babeuf stated that nature has given every man an equal right in the
enjoyment of all goods.
Proudhon claimed that employers robbed laborers by not rendering
them full value of their labor.
Marx claimed that in the process of accumulating wealth for himself ,
they robbed and exploited the worker.
Types of Income Distribution
1. Personal Distribution. Allocation of income among persons or
households. The degree of income inequality among households or families
(shown in the Lorenz curve).
2. Functional Distribution. allocation of income among the factors of
production: land, labor, capital and entrepreneur. The income of the factors
of production are rent for land, wages for labor, interest for capital, and
profits for entrepreneur.
Lorenz Curve
The Lorenz curve is a useful tool used by those interested in statistics
and economics to give a picture of
distribution. Its plots the % of household
income on the vertical scale against the % of
households on the horizontal. An example is
shown right.
The Gini Coefficient is derived from the
same information used to create a Lorenz
Curve. The co-efficient indicates the gap
between two percentages: the percentage of
population, and the percentage of income
received by each percentage of the
population. In order to calculate this you
divide the area between the Lorenz Curve and the 45 line by the total area
below the 45 line eg.
Area between the Lorenz Curve and the 45 line / Total area below the
45 line
The resulting number ranges between:
0 = perfect equality where say, 1% of the population = 1% of income,
and
1 = maximum inequality where all the income of the economy is
acquired by a single recipient.
* The straight line (45 line) shows absolute equality of income. That is,
10% of the households earn 10% of income, 50% of households earn 50% of
income.
* The Lorenz Curve itself shows actual distribution of income. The
further the Lorenz Curve is away from the 45 line, the more unequal is the
distribution of income.
* Lorenz Curves are typically drawn from gross income. Once
disposable income is taken into account, the Lorenz Curve will most likely
move inwards. This is because, as we shall see, the net effect of taxes and
other distributional measures of government is to bring everyones
disposable incomes closer together.
* Those countries where the wealth is in the hands of a few, such as oil
sheikdoms, will have Lorenz Curves extremely bowed.
Lorenz curves may also be drawn to show the extent of inequality in
the distribution of wealth. Such curves are likely to be even further away
from the line of complete equality than are those of the distribution of
income. This is because most people have some disposable income while not
everyone has assets.
Causes of Income Inequality
1.
2.
3.
4.
5.
complete responsibility for any of its liabilities or debts. In the eyes of the
law and the public, you are one in the same with the business.
Advantages of a Sole Proprietorship
Easiest and least expensive form of ownership to organize.
Sole proprietors are in complete control, and within the parameters
of the law, may make decisions as they see fit.
Profits from the business flow-through directly to the owners
personal tax return.
The business is easy to dissolve, if desired.
Disadvantages of a Sole Proprietorship
Sole proprietors have unlimited liability and are legally responsible
for all debts against the business. Their business and personal assets
are at risk.
May be at a disadvantage in raising funds and are often limited to
using funds from personal savings or consumer loans.
May have a hard time attracting high-caliber employees, or those
that are motivated by the opportunity to own a part of the business.
Some employee benefits such as owners medical insurance
premiums are not directly deductible from business income (only
partially as an adjustment to income).
Partnerships
In a Partnership, two or more people share ownership of a single
business. Like proprietorships, the law does not distinguish between the
business and its owners. The Partners should have a legal agreement that
sets forth how decisions will be made, profits will be shared, disputes will be
resolved, how future partners will be admitted to the partnership, how
partners can be bought out, or what steps will be taken to dissolve the
partnership when needed; Yes, its hard to think about a break-up when the
business is just getting started, but many partnerships split up at crisis times
and unless there is a defined process, there will be even greater problems.
They also must decide up front how much time and capital each will
contribute, etc.
Advantages of a Partnership
Partnerships are relatively easy to establish; however time should be
invested in developing the partnership agreement.
With more than one owner, the ability to raise funds may be
increased.
The profits from the business flow directly through to the partners
personal tax return.
Prospective employees may be attracted to the business if given the
incentive to become a partner.
The business usually will benefit from partners who have
complementary skills.
Disadvantages of a Partnership
Partners are jointly and individually liable for the actions of the other
partners.
Profits must be shared with others.
Since decisions are shared, disagreements can occur.
Some employee benefits are not deductible from business income on
tax returns.
The partnership may have a limited life; it may end upon the
withdrawal or death of a partner.
Types of Partnerships that should be considered:
1. General Partnership. Partners divide responsibility for management
and liability, as well as the shares of profit or loss according to their internal
agreement. Equal shares are assumed unless there is a written agreement
that states differently.
2. Limited Partnership and Partnership with limited liability. Limited
means that most of the partners have limited liability (to the extent of their
investment) as well as limited input regarding management decision, which
generally encourages investors for short term projects, or for investing in
capital assets. This form of ownership is not often used for operating retail
or service businesses. Forming a limited partnership is more complex and
formal than that of a general partnership.
3. Joint Venture. Acts like a general partnership, but is clearly for a
limited period of time or a single project. If the partners in a joint venture
repeat the activity, they will be recognized as an ongoing partnership and
will have to file as such, and distribute accumulated partnership assets upon
dissolution of the entity.
Corporations
A Corporation, chartered by the state in which it is headquartered, is
considered by law to be a unique entity, separate and apart from those who
own it. A Corporation can be taxed; it can be sued; it can enter into
contractual agreements. The owners of a corporation are its shareholders.
The shareholders elect a board of directors to oversee the major policies and
decisions. The corporation has a life of its own and does not dissolve when
ownership changes.
Advantages of a Corporation
Shareholders have limited liability for the corporations debts or
judgments against the corporation.
Generally, shareholders can only be held accountable for their
investment in stock of the company. (Note however, that officers can
be held personally liable for their actions, such as the failure to
withhold and pay employment taxes.
Corporations can raise additional funds through the sale of stock.
A Corporation may deduct the cost of benefits it provides to officers
and employees.
Can elect S Corporation status if certain requirements are met. This
election enables company to be taxed similar to a partnership.
Disadvantages of a Corporation
The process of incorporation requires more time and money than
other forms of organization.
Corporations are monitored by federal, state and some local
agencies, and as a result may have more paperwork to comply with
regulations.
Incorporating may result in higher overall taxes. Dividends paid to
shareholders are not deductible from business income; thus this
income can be taxed twice.
Cooperative
An autonomous association of people who voluntarily cooperate for
their mutual social, economic, and cultural
benefit.
There are 5 different types of cooperatives:
Consumer: owned by consumers who buy goods or services from
their cooperative
Producer: owned by producers of commodities or crafts who have
joined forces to process and market their products
Worker: owned and democratically governed by employees who
become co-op members
Purchasing: owned by independent businesses or municipalities to
improve their purchasing power
Hybrid: a combination of co-op types, where people with common
interests band together.
Business Management
Management in businesses and organizations is the function that
coordinates the efforts of people to accomplish goals and objectives by using
GNP.
Households
The primary economic function of households is to supply domestic
firms with needed factors of production - land, human capital, real capital
and enterprise. The factors are supplied by factor owners in return for a
reward. Land is supplied by landowners, human capital by labour, real
capital by capital owners (capitalists) and enterprise is provided by
entrepreneurs. Entrepreneurs combine the other three factors, and bear the
risks associated with production.
Firms
The function of firms is to supply private goods and services to
domestic households and firms, and to households and firms abroad. To do
this they use factors and pay for their services.
Factor incomes
Factors of production earn an income which contributes to national
income. Land receives rent, human capital receives a wage, real capital
receives a rate of return, and enterprise receives a profit.
Members of households pay for goods and services they consume with
the income they receive from selling their factor in the relevant market.
Production function
The simple production function states that output (Q) is a function (f)
of: (is determined by) the factor inputs, land (L), labour (La), and capital (K),
i.e. Q = f (L, La, K)
income (Y), and so on. Spending and income continue to circulate around the
macro economy in what is referred to as the circular flow of income.
The circular flow of income forms the basis for all models of the macroeconomy, and understanding the circular flow process is key to explaining
how national income, output and expenditure is created over time.
GNP is the total value of all final goods and services produced within a
nation in a particular year, plus income earned by its citizens (including
income of those located abroad), minus income of non-residents located in
that country. Basically, GNP measures the value of goods and services that
the country's citizens produced regardless of their location. GNP is one
measure of the economic condition of a country, under the assumption that a
higher GNP leads to a higher quality of living, all other things being equal.
How to compute GNP
If you spend much time listening to politicians or watching financial
news programs on TV or on the internet, youve undoubtedly heard the
terms GDP and GNP. The terms come up in discussions of the economy
or big picture financial matters, and sometimes seem interchangeable. But
what are GDP and GNP, and what is the difference between the two?
Both represent an attempt to measure the total economic output of a
nation during a given period (usually one year), and serve as barometers to
measure both the level and direction of a countrys economic activity.
GDP, or Gross Domestic Product is calculated either by measuring all
income earned within a country, or by measuring all expenditures within the
country, which should approximately be the same.
GNP, or Gross National Product uses GDP, but adds income from
foreign sources, less income paid to foreign citizens and entities.
GNP can be either higher or lower than GDP, depending on whether or
not a country has a positive or negative result from net foreign inflows and
outgo. Though GNP is still calculated, the United States shifted to GDP as its
primary economic measure in 1991, in part because most countries in the
world use GDP to measure the size and direction of their economies. As a
result, GNP numbers are less common than GDP figures.
Both GDP and GNP are complicated, and best summarized in a side-byside comparison:
What is it?
Same as GDP
How its
calculated
Why is it
important?
Same as GDP
Same as GDP
What does it
mean to me?
Same as GDP
What is the
GDP/GNP of the
US?
$15,684,800,000,000 as of 2012
$15,097,083,000,000 as of
2011
Highest/lowest
GDP/GNP in the
world
Per Capita
GDP/GNP
Highest/lowest
Per Capita
GDP/GNP in the
world
Highest: Luxembourg
$107,206 (2012)
Lowest: Democratic Republic
of the Congo $237 (2012)
Highest: United
States
$15,097,083,000,000
(2011)
Lowest: N/A
Highest: Qatar
$87,030 (2011)
Lowest: Democratic
Republic of the Congo
$350 (2011)
$49,922 (2012)
World Rank: 11th
$48,890 (2012)
World Rank: 10th
(Statistical sources: The World Bank GDP By Country, IMF World Economic
Outlook Database, April 2013, Wikipedia, List of Countries by GNI (PPP) Per
Capita )
GNP = C + G + I + NX +NFP
The calculation is explained below:
Consumption (C) is the total consumption by a household. It consists
of the entire consumer spending such as food, clothing etc. The major
component of GNP is consumers' consumption which forms 2/3rd of total
consumers demand.
Goods and services (G) also forms a large part of the GNP after
consumers' consumption. Government purchases consist of expenses
incurred by the government in the form of salaries for employees, Defense
and spending by state and local government for maintenance of
infrastructure etc. One very important thing which should be kept in mind is
transfer payments made by the Government such as unemployment
compensation should not be included.
Investment spending (I) consists of spending which is made by
businesses in order to keep it running and to increase its productivity.
Investment spending should not be confused with purchase and sale of
stocks and bonds. Investment which goes in construction of houses and
building should also not be a part of the Gross National Product.
The net exports (NX) refer to net exports that are the total exports
minus imports. Exports are goods which a country sells to the rest of the
world and imports are goods which a country purchases for rest of the world.
If the imports are more than exports the net exports are negative resulting in
trade deficit and if the exports are more than imports then there is a positive
net exports resulting in trade surplus. A trade deficit reduces a country's GNP
and is not a healthy sign for an economy and on the other hand trade surplus
results in positive gross national product and is a healthy sign for an
economy.
Net factor payments (NFP) refer to the total amount of payments
that a country pays to the rest of the world for inputs used in production of
goods and services minus the payment received from the rest of the world
for providing with inputs for their production of goods and services.
Limitations of GNP
The most commonly used measure for human well-being is GNP. Apart
from the fact that this is distributed unequally within countries, the Human
Development Report 1996 notes the following limitations to GNP as a
measure, which serve to obscure a real picture of the nature of societies:
1. It registers only goods and services exchanged for money. Unpaid
work and work done in the community are discounted. The 1995 report
estimated that GNP excludes, on average, two thirds of womens work and a
quarter of mens.
2. Socially useful work, such as child-care and care of the elderly, is
given equal value to weapons manufacturing and other destructive
industries.
3. Destruction and reconstruction are both counted. Addictive eating
and drinking count in terms of purchase of food and alcohol, and in terms of
the diet industry and rehabilitation. Wars count in terms of weapons
construction, and rebuilding infrastructure and houses afterwards.
4. Environmental degradation, pollution and resource depletion are not
valued or accounted for.
5. Leisure time is not valued.
6. It ignores human freedom. National income accounting puts no
value on freedom, human rights or participation.
Using measurements of life expectancy, education and real income to
create a human development index, the report ranks countries according to
this index rather than GNP. This approach attempts to provide a better
picture of human development and to expand notions of growth.
Consumption
Consumption can be defined in different ways, but is usually best
described as the final purchase of goods and services by individuals. The
purchase of a new pair of shoes, a hamburger at the fast food restaurant, or
the service of getting your house cleaned are all examples of consumption. It
is also often referred to as consumer spending. Many topics in economics
explore how the income of families and individuals affects consumption and
spending habits.
These are likely to remain more or less stable during the short period.
Established behaviour pattern undergoes material change only over long
periods. These factors fundamentally determine the form of the consumption
function (i.e., slope and position of the propensity to consume, the curve).
The objective factors affecting the consumption function are
exogenous, or external to the economy itself. These factors may at times
undergo rapid changes. Thus, objective factors may cause a shift in the
consumption function.
Subjective Factors:
(1) behaviour patterns fixed by the psychology of human nature
(2) the institutional arrangements of the modern social order, and
social practices relating to the behaviour patterns of business firms with
respect to wage and dividend payments and retained earnings, and the
institution controlling the distribution of income.
Human behaviour regarding consumption and savings out of increased
income depends on psychological motives. There are motives which lead
individuals to refrain from spending out of their incomes. Keynes enlists
eight such motives:
1. The Motive of Precaution: The desire to build up a reserve
against unforeseen contingencies.
2. The Motive of Foresight: The desire to provide for anticipated
future needs, e.g., in relation to old age, family education, etc.
3. The Motive of Calculation: The desire to enjoy interest and
appreciation, because a larger real consumption, at a later date, is preferred
to a smaller immediate consumption.
4. The Motive of Improvement: The desire to enjoy a gradually
increasing expenditure since it gratifies the common instinct to look forward
to a gradually improving standard of life rather than otherwise.
5. The Motive of Independence: The desire to enjoy a sense of
independence and the power to do things.
6. The Motive of Enterprise:
The desire to secure a mass de
manoeuvre to carry on speculation or establish business projects.
7. The Motive of Pride: The desire to possess or to bequeath a
fortune.
8. The Motive of Avarice: The desire to satisfy pure miserliness, i.e.,
unreasonable, but insistent abstinence from expenditure as such.
To this, Keynes adds a corresponding list of motives on consumption
such as enjoyment,
short-sightedness, generosity,
miscalculation,
ostentation and extravagance.
Subjective motivations also apply to the behaviour patterns of business
corporations and governmental bodies. In this respect, Keynes listed the
following motives for accumulation:
(a) The Motive of Enterprise:
The desire to do big things, to
expand, to secure resources to carry out further capital investment.
Investment
An asset or item that is purchased with
the hope that it will generate income or
appreciate in the future. In an economic
sense, an investment is the purchase of goods
that are not consumed today but are used in
the future to create wealth. In finance, an
investment is a monetary asset purchased
with the idea that the asset will provide
income in the future or appreciate and be sold at a higher price.
Determinants of Investment
The quantity of investment demanded in any period is negatively
related to the interest rate. This relationship is illustrated by the investment
demand curve.
A change in the interest rate causes a movement along the
investment demand curve. A change in any other determinant of investment
causes a shift of the curve.
The other determinants of investment include expectations, the
level of economic activity, the stock of capital, the capacity
utilization rate, the cost of capital goods, other factor costs,
technological change, and public policy.
Savings
According to Keynesian economics, the amount left over when the cost
of a person's consumer expenditure is subtracted from the amount of
disposable income that he or she earns in a given period of time.
Multiplier-K = Y/I =
The term investment multiplier refers to the concept that any increase
in public or private investment spending has a more than proportionate
positive impact on aggregate income and the general economy. The
multiplier attempts to quantify the additional effects of a policy beyond those
that are immediately measurable.
Accelerator Effect
Paradox of Thrift
The paradox of thrift is an economic theory that states that the more
people save, the less they spend and thus the less they stimulate the
economy.
How it works/Example:
Developed by economist John Maynard Keynes, the paradox of thrift
works this way: Assume everybody receives 1,000 of income. They save
50% (500) and spend the rest (500). This means everybody is spending
500, which supports demand for products, which in turn creates jobs,
encourages entrepreneurship, and generates tax revenue for the
government.
Now let's assume that everybody decides they need to save more for
retirement. They start saving 750 of their 1,000 and spending only 250.
Suddenly, there is a drop in the demand for goods and services. Businesses
can't make a profit, and so they lay off workers, which raises unemployment
and lowers the tax revenue to the government. The unemployed people, who
now are out their income, stop spending altogether, which worsens the
problem even more. The whole thing continues on a downward spiral.
Why it Matters:
Saving is a good thing, but as Keynes theorized, too much of it can
harm the economy. Some level of spending is necessary to maintain a
healthy economy, ensure that people have jobs, and continue providing tax
revenue to the government.
Some critics of the paradox of thrift remind us that savings is often
investinginvesting in companies that use the money to build factories,
expand operations and hire more employees. Accordingly, savings doesn't
necessarily halt the economy.
Unemployment
Simply put, unemployment is a situation in which an individual in an
economy is looking for a job and can't find one. That said, economists divide
unemployment into a number of different categories, since defining types of
unemployment more precisely sheds some light on why unemployment
occurs and what can be done about it.
Voluntary versus Involuntary Unemployment
At a very basic level, unemployment can be broken down into
voluntary unemployment- unemployment due to people willingly leaving
previous jobs and and now looking for new ones- and involuntary
unemployment- unemployment due to people getting laid off or fired from
their previous jobs and needing to find work elsewhere.
Not surprisingly, economists generally view involuntary unemployment
as a larger problem than voluntary unemployment since voluntary
unemployment likely reflects utility-maximizing household choices.
Types of Unemployment
1. Frictional Unemployment
The easiest type of unemployment to explain is known as frictional
unemployment. Frictional unemployment is unemployment that occurs
because it takes workers some time to move from one job to another. While
it may be the case that some workers find new jobs before they leave their
old ones, a lot of workers leave or lose their jobs before they have other work
lined up. In these cases, a worker must look around for a job that it is a good
fit for her, and this process takes some time. During this time, the individual
is considered to be unemployed, but unemployment due to frictional
unemployment is usually thought to last only short periods of time and not
be specifically problematic from an economic standpoint. This is particularly
true now that technology is helping both workers and companies make the
job search process more efficient.
Frictional unemployment can also occur when students move into the
work force for the first time, when an individual moves to a new city and
needs to find work, and when women re-enter the work force after having
children. (Note in the last case, however, that maternity leave doesn't count
as unemployment!)
2. Cyclical Unemployment
It's probably not surprising that unemployment is higher during
recessions and depressions and lower during periods of high economic
growth. Because of this, economists have coined the term cyclical
unemployment to describe the unemployment associated with business
cycles occurring in the economy. Cyclical unemployment occurs during
recessions because, when demand for goods and services in an economy
falls, some companies respond by cutting production and laying off workers
rather than by reducing wages and prices. (Wages and prices of this sort are
referred to as "sticky.") When this happens, there are more workers in an
economy than there are available jobs, and unemployment must result.
As an economy recovers from a recession or depression, cyclical
unemployment tends to naturally disappear. As a result, economists usually
focus on addressing the root causes of the economic downturns themselves
rather than think directly about how to correct cyclical unemployment in and
of itself.
3. Structural Unemployment
There are two ways to think about structural unemployment. One way
is that structural unemployment occurs because some labor markets have
more workers than there are jobs available, and for some reason wages don't
decrease to bring the markets into equilibrium. Another way to think about
structural unemployment is that structural unemployment results when
workers possess skills that aren't in high demand in the marketplace and lack
skills that are in high demand. In other words, structural unemployment
results when there is a mismatch with workers' skills and employers' needs.
Structural unemployment is thought to be a pretty significant problem,
mainly because structural unemployment tends to be largely of the longterm variety and retraining workers is not a cheap or easy task.
4. Seasonal unemployment is, not surprisingly, unemployment that
occurs because the demand for some workers varies widely over the course
of the year. (Pool lifeguards, for example, probably experience a decent
amount of seasonal unemployment.) Seasonal unemployment can be
thought of as a form of structural unemployment, mainly because the skills
of the seasonal employees are not needed in certain labor markets for at
least some part of the year. That said, seasonal unemployment is viewed as
less problematic than regular structural unemployment, mainly because the
demand for seasonal skills hasn't gone away forever and resurfaces in a
fairly predictable pattern.
Full Employment
State of economy in which all eligible people who want to work can find
employment at prevailing wage rates.
Theories of Employment
Classical It states that employment increases at lower wages.
Employers are willing to hire more at lower wages because it is profitable
when there is a lower cost of production.
Keynesian It states that employment is determined by the
aggregate or total demand for good and services. When people, together
with the business and government sectors, purchase more goods and
services, it induces more production and hire more workers.
Inflation
Inflation means a sustained increase in the general price level.
However, this increase in the cost of living can be caused by different
factors. The main two types of inflation are
Types of Inflation
1. Demand Pull Inflation. This occurs when AD increases at a faster
rate than AS. Demand pull inflation will typically occur when the economy is
growing faster than the long run trend rate of growth. If demand exceeds
supply, firms will respond by pushing up prices.
2. Cost Push Inflation. This occurs when there is an increase in the
cost of production for firms causing aggregate supply to shift to the left. Cost
push inflation could be caused by rising energy and commodity prices.
3. Wage Push Inflation. Rising wages tend to cause inflation. In
effect this is a combination of demand pull and cost push inflation. Rising
wages increase cost for firms and so these are passed onto consumers in the
form of higher prices. Also rising wages give consumers greater disposable
income and therefore cause increased consumption. Trades unions were
powerful, this helped cause rising nominal wageswhich is a significant factor
in causing inflation.
4. Imported Inflation. A depreciation in the exchange rate will make
imports more expensive. Therefore, the prices will increase solely due to this
exchange rate effect. A depreciation will also make exports more competitive
so will increase demand.
5. Temporary Factors. The inflation rate can also increase due to
temporary factors such as increasing indirect taxes. If you increase VAT rate
from 17.5% to 20%, all goods which are VAT applicable will be 2.5% more
expensive. However, this price rise will only last a year. It is not a permanent
effect.
Chapter 10 The Philippine Financial System
Necessity of Finance
Money
Functions of Money
Medium of Exchange
Standard of Value
Store of Value
Development of Money in the Philippines
Monetary Standards
Money Supply
Monetary Theory
Credit
Bases of Credit
Social Philosophy of Credit
Banking in the Philippines
Universal Banking
Central Banking
Global Banking
What is Taxation?
It is a mode by which government make exactions for revenue in order
to support their existence and carry out their legitimate objectives. It is the
most pervasive and the strongest of all the powers of the government. Taxes
are the lifeblood of the government, without which, it cannot subsist.
The first known system of taxation was in Ancient Egypt around 3000
BC - 2800 BC in the first dynasty of the Old Kingdom. In Biblical times, tax is
already prevalent. According to Genesis 47:24 : But when the crop comes in,
give a fifth of it to Pharaoh. The other four-fifths you may keep as seed for
the fields and as food for yourselves and your households and your children.
History of Taxation
Earliest taxes in Rome are called as portoria were customs duties on
imports and exports. Augustus Caesar introduced the inheritance tax to
provide retirement funds for the military. The tax was five percent on all
inheritances except gifts to children and spouses . In England, taxes were
first used as emergency measures.
Polo Y Servicio is the forced labor for 40 days , of men ranging from
16 to 60 years of age who were obligated to give personal services to
community projects . One could be exempted from the polo by paying a fee
called falla (which was worth one and a half real) . Bandala is one of the
taxes collected from the Filipinos. It comes from the Tagalog word mandala ,
which is a round stock of rice stalks to be threshed.
Encomienda are large tracts of land given to a person as reward for a
meritorious act. The encomenderos were given full authority to manage the
encomienda by collecting tribute from the inhabitants and govern people
living on it. Tribute was the residence tax during the Spanish times. It may be
paid in cash or kind, partly, or wholly. But in 1884, the tribute was replaced
by the cedula personal or personal identity paper, equivalent to the present
community tax certificate.
That in the 19th century, the cedula served as an identification card
that had to be carried at all times. A person who could not present his or her
cedula to a guardia civil could then be detained for being indocumentado.
Andres Bonifacio and other Katipuneros tore their cedulas in August 1896,
signaling the start of the Philippine Revolution.
The cdula was imposed by the Americans on January 1, 1940, when
Commonwealth Act No. 465 went into effect, mandating the imposition of a
base residence tax of fifty centavos and an additional tax of one peso based
on factors such as income and real estate holdings. The payment of this tax
would merit the issue of a residence certificate. Corporations were also
subject to the residence tax.
Why Tax?
Tax law in the Philippines covers national and local taxes. National
taxes refer to national internal revenue taxes imposed and collected by the
national government through the Bureau of Internal Revenue (BIR) and local
taxes refer to those imposed and collected by the local government. The
1987 Philippine Constitution sets limitations on the exercise of the power to
tax. The rule of taxation shall be uniform and equitable. The Congress shall
evolve a progressive system of taxation. (Article VI, Section 28, Paragraph 1).
The Congress may, by law, authorize the President to fix within
specified limits, and subject to such limitations and restrictions as it may
impose, tariff rates, import and export quotas, tonnage and wharfage dues,
and other duties or imposts within the framework of the national
development program of the Government (Article VI, Section 28, Paragraph
2).
The President shall have the power to veto any particular item or items
in an appropriation , revenue, or tariff bill , but the veto shall not affect the
item or items to which he does not object (Article VI, Section 27, Paragraph
2). The Supreme Court has the power to: review, revise, reverse, modify, or
affirm on appeal or certiorari , as the law or the Rules of Court may provide,
final judgments and orders of lower courts in all cases involving the legality
of any tax , impost, assessment, or toll, or any penalty imposed in relation
thereto (Article VIII, Section 5, Paragraph 2b).
Tax evasion happens when there is fraud through pretension and the
use of other illegal devices to lessen ones taxes, there is tax evasion, underdeclaration of income, and non-declaration of income and other items
subject to tax, Under-appraisal of goods subject to tariff , and overdeclaration of deductions.
Tax avoidance is the legal usage of the tax regime in a single territory
to one's own advantage to reduce the amount of tax that is payable by
means that are within the law. This is the means by which tax payers try to
reduce tax within the means allowed by law. Tax avoidance should me made
in good faith and at arms length, otherwise it will not be regarded as such. A
good example of tax avoidance is the use of the depreciation method in
claiming deductible expenses to lessen the income tax.
for the sale, exchange or other disposition of real property located in the
Philippines, classified as capital assets.
C. Income Taxes - Taxes imposed on the income of the taxpayers
from whatever sources it is derived. Tax on all yearly profits arising form
property, possessions, trades or offices.
D. Excise or License Taxes - Taxes imposed on the privilege,
occupation or business not falling within the classification of poll taxes or
property taxes. These are imposed on alcohol products; on tobacco
products ; on petroleum products like lubricating oils, grease, processed gas
etc; on mineral products such as coal and coke and quarry resources; on
miscellaneous articles such as automobiles.
Under these lies two other taxes: 1.Documentary Stamp Tax - a tax
imposed upon documents, instruments, loan agreements and papers and
upon acceptance of assignments, sales and transfers of obligation and etc. 2.
Value added tax - is imposed on any person who, in the course of trade or
business sells, barters, exchanges, leases, goods or properties, renders
services, or engages in similar transactions.
Tax Exemptions
The Constitution expressly grants tax exemption on certain
entities/institutions such as:
1. Charitable institutions, churches , parsonages or convents
appurtenant thereto, mosques , and nonprofit cemeteries and all lands,
buildings and improvements actually, directly and exclusively used for
religious, charitable or educational purposes (Article VI, Section 28,
Paragraph 3).
2. Non-stock non-profit educational institutions used actually, directly,
and exclusively for educational purposes. (Article XVI, Section 4 (3)).
3. Exempted to tax as stated in the Article 283 of Rules and
Regulations Implementing Local Government Code of 1991 (RA 7160): Local
water districts, Cooperatives duly registered under RA 6938, otherwise
known as the Cooperative Code of the Philippines, Non-stock and non-profit
hospitals and educational institutions, Printer and/or publisher of books or
other reading materials prescribed by DECS (now DepEd) as school texts or
references, insofar as receipts from the printing and / or publishing thereof
are concerned.
Tax Structures
Progressive. A tax that takes a larger percentage from the income of
high-income earners than it does from low-income individuals. Basically,
taxpayers are broken down into categories based on taxable income; the
more one earns, the more taxes they will have to pay once they cross the
benchmark cut-off points between the different tax bracket levels.
Regressive. A regressive tax is one that is inversely proportional to
income the lower the income, the higher the tax in relation to income.
Most regressive taxes are assessed on products and services in which the tax
is a percentage of the cost of the product or service. Hence, when paying the
tax, a poor person pays as much as the wealthy person. The most common
forms of regressive taxes are sales taxes and value added taxes (VAT). The
inequitable effects of a regressive tax is often mitigated by payments to the
poor and by exempting essential products and services, such as food, from
the regressive tax.
Proportional. Proportional taxes apply the same tax rate to any
income level, or for any size tax base. So if Bill earns 50,000 and Jane earns
100,000, and the tax rate is 10%, then Bill will owe 5,000 in taxes while
Jane will owe 10,000. Many state income taxes and almost all sales taxes
are proportional taxes.
Income Taxation
If you were able to make your own Income Tax Return (ITR) because
you fully understand Philippine taxation laws, then good for you. But for the
majority who rely on accountants or their companies to prepare their ITRs,
here is a simple and concise explanation of the income tax law in the
Philippines.
Who are required to file Income Tax Returns (ITR)?
According to the Bureau of Internal Revenue (BIR), the following are
required to submit Income Tax Returns:
Filipino citizens residing in the Philippines receiving income from
sources within or outside the Philippines
Filipino citizens not residing in the Philippines receiving income from
sources within the Philippines
Taxable partnerships
Net Income
For all taxable partnerships, the tax rate is also 32% of the Net taxable
income from all sources.
International Carriers are taxed 2.5% on their Gross Philippine Billings.
For Regional Operating Headquarters (ROHQ), the tax rate is 10% of
Taxable Income.
Here's a step-by-step guide for manual computation. You may also use
the tax calculator below.
Step 1: Determine your taxable income.
To compute your taxable income, follow this formula:
Taxable income = (Monthly Basic Pay + Overtime Pay + Holiday Pay +
Night Differential) - (SSS/PhilHealth/Pag-IBIG deductions - Tardiness Absences)
Let's say Employee A is married with one dependent, and has a basic
monthly pay of P25,000. Based on the tables of government contributions,
Employee A will pay:
table)
own directly or collectively the lands they till, or in case of other farm
workers, to receive a just share on the fruits thereof
- To this end, the State shall encourage and undertake the just
distribution of all agricultural lands, subject to the priorities and retention
limits set forth in the law, taking into account ecological, developmental, and
equity considerations and subject to the payment of just compensation
- The State shall respect the right of small landowners, and shall
provide for voluntary land-sharing
Historical Background
Historically, agrarian-related remedies extended by past regimes and
administrators proved to be totally unable to fulfill the promise of alleviating
the quality of life of the landless peasants. The land laws have invariably
contained provisions that enabled powerful landowners to circumvent the
law, or even use the law to sustain and further strengthen their positions in
power.
Pre-Spanish Era - Land was not unequally distributed before the
Spaniards came to the Philippines. - The notion of private property was
unknown then. - The community (barangay) owned the land.
Spanish Period (1521-1898) - One of the major initial policies of the
governorship of Legazpi was to recognize all lands in the Philippines as part
of public domain regardless of local customs. - As such, the crown was at
liberty to parcel out huge tracts of Philippine lands as rewards to loyal civilian
and military as rewards.
In effect, communal ownership of land gradually and slowly took the
backseat. Private ownership of land was introduced. With this arrangement,
every municipal resident was given his choice of the land for cultivation, free
from tax.
Large tracts of uncultivated lands not circumscribed within a given
municipality were granted by the Spanish monarch to deserving Spaniards.
This kind of ownership became known as the encomienda.
The encomienda system in the Spanish colonies began as a result of
a Royal Order promulgated in December of 1503. By virtue of this Royal
Order, encomiendas were granted to favor Spanish officials and clerics who
were entrusted the responsibility to look after the spiritual and temporal
developments of the natives in a colonized territory.
In return for such a duty, the encomiendas enjoyed the right to have a
share in the tribute ( tributo ) paid by the natives. Legazpi himself had
granted encomiendas to the friars, like the Agustinians in Cebu and Manila.
Almost all the grants that Legazpi extended to the Spanish officials and
friars were confined to what would eventually become the provinces of
Cavite, Laguna, Batangas, and Bulacan.
Much later, in place of the encomiendas, the Spanish authorities began
to group together several barangays into administration units. They termed
these units as pueblos or municipios which were governed by
required the land to be collateral. While the peasant had not paid back his
loan, he paid the landlord rent for the use of his own land.
Another source of land-related conflict by the late 19 th century was
the friar lands. Many farmers questioned the amount of land in grant given
by the Spanish crown to the religious orders (i.e. Augustinians, Dominicans,
Franciscans, and Recollect Orders). Tenants ( inquilinos ) paid tax termed as
canon to the friars.
Philippine Revolutionary Government (1898-1899) - After the
first Philippine Republic was established in 1899, the government of Emilio
Aguinaldo declared its intention to confiscate large estates, esp. the friar
lands.
American Regime (1898-1935) - The Americans, considered by
Filipino revolutionists, as messiahs (liberators from Spanish colonial rule),
finally unmasked their true color. They themselves became the new
colonizers by virtue of the Treaty of Paris (Dec. 10, 1898).
The Treaty of Paris ended the Spanish-American War, and Spain
ceded the Philippines, Guam and Puerto Rico to America.
Despite the apparent desire of the American government to improve
the land-tenure situation of the country, the following land laws and policies
did not help in any way: 1) Treaty of Paris 2) Land Registration Act of 1902 3)
Public Land Act of 1907 4) Cadastral Act of 1907 5) Friar Lands Act of 1907
Commonwealth Era (1935-1946) - The government headed by
Manuel Quezon, passed and implemented the Rice Tenancy Act of 1933 (i.e.
Act No. 4054). - Its purpose was to regulate the share tenancy contracts by
establishing minimum standards.
The Act provided for better tenant-landlord relationship, a 50-50
sharing of the crop, regulation of interest to 10% per agricultural year, and
safeguards against arbitrary dismissal by the landlord. The desire of Quezon
to placate both landlords and tenants pleased neither. By early 1940s,
thousands of tenants in Central Luzon were ejected from their farmlands, and
rural conflict was more acute than ever.
Japanese Occupation (1941-1945) - The Japanese occupation had a
tremendous impact on the agrarian issue. From the ranks of the peasant and
labor organization, and from the merger of the Communist Party of the
Philippines and the Socialist Party emerged the HUKBO NG BAYAN LABAN SA
HAPON (HUKBALAHAP).
The HUKBALAHAP was headed by a charismatic peasant leader, Luis
Taruc . In addition to fighting the Japanese, the Huks also took upon the
cause of the peasant against the landlords who often collaborated with the
Japanese to maintain their dominant position.
Third Philippine Republic a. Roxas Administration (1946-1948) In 1946, Roxas proclaimed the Rice Share Tenancy Act of1933 effective
throughout the country. - R.A. No. 34 of 1946, known as Tenant Act, provided
for a 70-30 sharing arrangements, and regulated share-tenancy contracts.
Comparison chart
Implication
s
Factors
Economic Development
Economic Growth
Measureme
nt
Effect
Relevance
Scope
Economic Development
Economic Growth