1.

Economic Models
We use economic models so that discussions will be much simpler
We use economic models to identify the importance of this discussion
a. Circular Flow Diagram

Circular Flow Diagram

- A schematic representation of the organization of a specific economy

- Answers the questions:
how does the economy work?
how does the peso flow through households and firms in a specific economy?
INSIDE FLOW
i. There are 2 participants in the market, namely the Households and Firms. There are 2 types
of markets, namely markets for Goods and Services and markets for Factors of Production.
ii. For firms to produce goods and services, they will need factors of production (or inputs
for production).
iii. Factors of production (Land, Labor, and Capital), owned by households, will enter the
market of Factors of Production, and will be used by firms for them to produce goods and
services.
iv. The produced goods and services will be present in the markets for Goods and Services
where consumers/households buy and consume the services.
OUTSIDE FLOW
i. Households spend their money to buy and consume goods and services from the markets
of Goods and Services.
 ii. Spending done by the households will be translated as the revenue earned by the firm
iii. Revenue earned by the firm will be used to pay for the wages, rent, and profit.
iv. The revenue used by the firm will later on be translated as the income earned by the
households.
v. The income that the households receive will be used to buy goods and services.

Circular Flow Diagram more specific

- A fully organized economy includes the government, foreign sector, and financial institutions
are added, which makes the diagram more realistic
i. Relationship between the foreign sector and businesses: we export goods and services to
the rest of the world, and in return, countries import goods and services to our country.
ii. Relationship between financial institutions and households: banks make use of savings for
investing and to grant loans to borrowers.
Why is it important to keep money in banks?
SCENARIO #1: There is a lack of money supply in the bank because everyone is
hoarding their money. The government will then increase money supply in the
market. Then suddenly, everyone spends their money so there will be
hyperinflation, therefore there will be problems in managing the money.
SCENARIO #2: There is inflation over time. Your 100 pesos now can buy you 5
candies but after 10 years, your 100 pesos can buy you 2 candies. When you put
your money in the piggy banks, it does not grow since there is no interest. It is
really important to keep money in banks and invest to avoid problems in the future
concerning inflation.
 Stock Markets and Mutual Funds
SCENARIO #1: Stock markets are very volatile, meaning it changes rapidly and
massively. As a risk lover, say for example you will bet 15,000 pesos in a basketball
game. As a risk averse, you go for mutual funds. There is a positive relationship
between the risk and the return-of-investment (ROI). The higher the risk, the higher
the ROI. The lower the risk, the lower the ROI. The risk of mutual funds is relatively
lower compared to stocks, meaning the ROI is lower BUT it is more stable. This is
why it is important to determine ones risk appetite.
iii. Relationship between the government and households: the government collects money
and at the end of the day, households will expect the government to provide goods and
public services.
b. Production Possibilities Frontier

- Graph that shows all possible combinations of outputs that the economy can possibly produce
given the available factors of production and production technology.
- Encounters 4 economic concepts: efficiency, tradeoffs, opportunity costs, and economic growth.
SCENARIO #1: Based on the graph, what would be the best (ideal) point for the Philippine
economy to produce?
Not D: it is beyond the frontier, meaning the economy cannot produce that level (check
definition: emphasis on the word AVAILABLE). D is not FEASIBLE, it is unattainable.
Not B: it is below the frontier, the resources have not been maximized. B is INEFFICIENT.
EFFICIENCY: Either points A or C (no 2 points at the same time). The point has to be on a line for
it to be considered efficient.
TRADEOFF (giving up something to get something else): From C to A, you give up 2000 units of
computers but you gain 100 units of cars. From A to C, you give up 100 cars to gain 200 units of
computers.
 OPPORTUNITY COST (measuring how much you have to give up to obtain an item): The slope
measures the opportunity cost. The steeper the slope, the higher the opportunity cost.
ECONOMIC GROWTH: With economic growth, there will be a shift in the PPF that would then
enable the economy to reach point D.

2. Branches of Economics
- Many subjects are studied on various levels
- There are 2 subfields:
MICROECONOMICS
Households and firms make decisions and interact in the market
Individual units
MACROECONOMICS
A bigger scale of discussion
Aggregate: how EVERYONE in the economy interact
Inflation, unemployment, and economic growth

3. An Economist as a Scientist vs. Policy Advisors

SCIENTIST: if economists are trying to explain the world; economists are trying to understand how
the world works
POLICY ADVISOR: when economists are trying to change the world
o Positive statements: descriptive; laying down facts
o Normative statements: what ought to be/what ought to be done; subjective prescriptive
statements
1. An increase in minimum wage will cause a decrease in employment among the least skilled
POSITIVE
2. The income gains from a higher minimum wage are worth more than any slight reductions
in employment NORMATIVE
It is subjective because of the phrase worth more because whats more worthy for
one person may not be worthy to another.