Basic Terms in Economics

Good – is anything which yields satisfaction to someone. It is anything used to satisfy a person’s wants
and desires.

Classification of Goods

1. Consumer goods – which yields direct satisfaction directly just like softdrinks and food.
2. Capital goods – used in production of other goods and services.
3. Essential – used to satisfy the basic needs of man.
4. Luxury goods- goods that man may do without, but are used to distribute to his comfort and
well being.
5. Economic – is a good which is both useful and scarce
6. Free – good is so abundant that there is enough of it to satisfy everyone’s needs without
anybody paying for it.

Economic Resources
1. Land – refers to all natural resources which are given by and found in nature and are, therefore
not man-made.
2. Labor – any form of human effort exerted in the production of goods and services.
3. Capital – refers to man-made goods used in production of goods and services.
4. Entrepreneur – is the person who combines other economic resources for use in production of
goods.

The Need to Choose

Scarcity – refers to the limitations that exist in obtaining all the goods and services that people want.

Three Fundamental and interdependent economic problems.

1. What to produce and how much?

2. How shall goods be produced?
3. For whom shall goods be produced?

Types of Economic System

1. The Traditional Economy – this is basically a subsistence economy. A family produces everything
that it consumes. Decisions on what, how and for whom to produce are made by referring to
the traditional manner of doing thing.
2. The Command Economy – in this type of economy, means of production are owned by the
government. Its decisions are arrived at by planners or government men who dictate what, how
and for whom to produce/
3. The Market Economy – The basic characteristics of this economy is that resources are privately
owned and decisions are made by the people themselves.

The Philippine economy is a mixed economy since it applies a mixture of the three forms of
decision-making. However, it is more market oriented rather than command or traditional.

Society’s Technological Possibilities

Inputs – refer to the commodities or services used to produce the good and service.

Existing technology is used to combine these different inputs. It consists of land, labor and capital.

The Tools of Economic

1. Logic – he has to learn how to apply logic in order to enable him to reason out properly and to
draw conclusions.
2. Statistics – to describe quantitatively human behaviors and to serve as empirical evidence in the
testing of hypothesis.
3. Mathematics – to conceptualize and quantify economic principles.
 Positive science – means it deal with what it is.
Normative – deals with what should be.

Scientific approach can be outline in the following stages.

1. Observation – An analyst should be able to recognize conditions, behaviors and events in the
environment.
2. Definitions and Assumption – the analyst should describe the specific uses of the study and the
peripheral conditions which affect the economic behaviors which are being studied.
3. Deductions – These are hypothesis or theories presented for empirical validations.
4. Empirical Testing – Deductions have to be tested as to their validity and correctness.

MACROECONOMICS

- Covers all these and other aspects of the economy like aggregate production, general prices of
goods and services, employment and others.
- Real purpose is its ability to explain how we can optimally use our resources in order for us to
achieve the highest standard of living possible.
- Study of how we can best increase our country’s wealth given the available resources we have
like our land, labor and capital and how these resources are transformed by entrepreneurs into
final goods and services which we ultimately consume to satisfy our needs and wants.

Important Terms:

1. Aggregate Demand – A schedule or curve which depicts the total quantity of output that is
demanded a various price levels.
2. Aggregate Supply – A schedule or curve which depicts the total quantity of output that is
supplied at various price levels.
3. Business Cycles – Fluctuations in real GDP which recur and last for periods of two years or more.
4. Nominal GDP – The market value of all final goods and services produced in the domestic
economy during a one year period measured at current prices.
5. Peak – The point which economic activity stops expanding and begins to decline.
6. Potential GDP – the maximum output a domestic economy can produce without putting upward
pressure on the price level.
7. Real GDP – The market value of all final goods and services produced in the domestic economy
during a one year period measured with constant prices; real GDP is nominal GDP corrected for
inflation.
8. Recession – A period of time in which real GDP is declining.
9. Trough – The point at which economic activity stops declining and begins to increase.
10. Compensation of employees
- The largest of the national income accounts. It comprises mainly of income earned from wages,
salaries and certain supplements paid by firms and government to suppliers of labor.
11. Rental Income of Persons
- Source of income is from rent and royalties received by property owners who permit others to
use their assets during a period of time.
12. Profits
- Includes those earned by self-employed proprietorships and partnerships who simultaneously
run their businesses and the same time pay themselves of labor services rendered to their firms.
13. Net Interest
- Household both receive and pay interest. Person who make loans to businesses earn interest
income.
14. Indirect taxes
- Are levied as a percent age of prices of goods and services sold, therefore become part of the
revenue received by firms.
15. Depreciation
- To reconcile the above accounts with GDP requires adding the consumption of fixed capital.
Consumption of fixed capital is an estimate of the depreciation of capital.
The Role of Government

The Philippine is a mixed economy with a substantial amount of government involvement in the form of
direct government spending, taxation, regulation and monetary policies. After the Philippines gained her
independence after World War II from the United States in 1945, the country experienced a dramatic
change in economic beliefs about the role of the private sector and the government.

The role of government in our country has increased considerably at the end of the war:

- Central banks took of the monetary system;

- Labor unions supported by government legislation gained more influences;
- Social programs such as social security and health insurance were deemed necessary;
- New deals types of government spending to artificially create jobs when the economy is slowing
down became commonplace;
- To fund the growing government expenses and the exponentially growing number of
government employees, taxes to income and goods and services.

The Production Possibilities Frontier

- Represents outcome or production combination that can be produced with a given amount of
resources.
- is a curve depicting all maximum output possibilities for two goods, given a set of inputs
consisting of resources and other factors.
- The PPF assumes that all inputs are used efficiently.
- the production possibilities of two commodities when resources are fixed.
- Measures the efficiency in which two commodities can be produced together, helping managers
and leaders decide what mix of commodities are most beneficial

Pareto Efficiency

- Is a concept named after Italian economist Vilfredo Pareto that measures the efficiency of the
commodity allocation on the PPF.

Reasons for Economic Growth

- Increased capital e.g investment in new factories and investment in infrastructure

- Increase in working population
- Increase in labor productivity
- Discovering new raw materials
- Technological improvements to improve the productivity of capital and labor

The Circular Flow Model

The dynamic market economy creates continuous, repetitive flows of goods and services, resources and
money.

Wages and salaries, rent,

interest, profit
RESOURCE MARKET
Labor, land, capital
Entrepreneurial ability

BUSINESSESS HOUSEHOLDS
-buy resources - Sell resources
- sell products - Buy products

Goods and services

PRODUCT MARKET
Consumption services
This figure illustrates the flow of resources and payments for their uses as well as the flow of goods and
services and payments for them. Thus, the household sector sells resources to and buys products from
the business sector while the business sector buys resources from and sells products to the household
sectors.

Important Concepts and Definitions

Nominal vs Real Values

Nominal Values – (nominal prices, earnings, wages or interest rates) refers to the peso value of the
prices, earnings, wages or the absolute value of the interest rates.

Real Values – are always values in comparison or relative to other related economic variables.

Positive vs. Normative

Normative economic statement is someone’s opinion of value judgment about an economic issue. Such
a statement can never be proven.

Example of positive economic statement related to macroeconomics:

1. The national deficit this year breached the P280 billion mark
2. When the value of the dollar falls, the Philippine products imported into the United States
become more expensive.

Example of normative statements related to macroeconomics:

1. The government should raise taxes and lower government spending to reduce budget deficit.
2. We need to try the value of the peso in order to discourage the importation of Japanese goods
into this country.

National Income Accounting

A. GNP Accounting: Meaning, Purpose and Limitations

1. Meaning

GNP – Gross National Product is defined as the market value of all final products produced by
the resources of the economy during a specified period of time.

Three Important limitations to zero in on the identification of final products.

1. The definition excludes products not produced by the resources of the economy as imports.
2. The definitions includes those products that can no longer be used for higher stages of
production and therefore have reached the highest level of transformation using the economy
resources.
3. The third limitation is time and the definition eliminates from the aforementioned those not
produced by the economy within the period of time accounted.

2. Purpose and Limitations

Economic Planning and Policy Making – require a measure of aggregate economic activities and an
identification of their structures.

GNP reflects the value of the economy’s production since it also includes the value of products from the
lower stages of production. In addition, GNP show the structure of production according to end use and
factor contributions.
 A. GNP Accounting: Expenditure Approach
1. Framework

This approach identifies the final products according to the principles and classifies them
according to end use such as consumption, government. Investment and rest of the world
otherwise known as exports.
Investment – consists of capital goods and inventories.

The following equation shows the framework of the approach,

GNP = C + I + G + (X - M)

GNP = Gross National Product

C= Consumption
I = Investment
G = Government Spending
X= exports
M= Imports
(X-M) = net factors
NFY= Net Factor Income

Statistical Discrepancy – is a theoretical account used to even out the practical differences
between the figures arrived at by the two alternative approaches to GNP accounting.

Sample Given
C = 169 m
I = 131 m
G = 145 m
X = 17 m
M = 12 m
SD= 6 m
NFY= 25 m

B. GNP Accounting: Income Approach

Three essentials features which are the pillars of the approach

1. The direct payments of the producing units to the resource owners represent the latter’s
direct contributions to production otherwise known as factor contributions.
2. The additive values of the production in the whole production process result from the direct
contribution of resources owners in every production stage to transform products or inputs
to higher forms.
3. The approach has a built in mechanism to exclude imports and previously produced
inventories but include currently produced inventories.

Applications
Any practical difference is evened out by the theoretical account of Statistical Discrepancy in the
expenditure approach.
In essence, taxes are also classified as factor contributions since they should have otherwise
been part of factor payments if without taxation. On the other hand, Capital Consumption
Allowance otherwise known as Depreciation represents payments to the resource owners for
the consumption of capital goods in the production process and likewise considered as a factor
of contribution.
 The approach also includes Government Income from Property and Entrepreneurship since the
government enterprises concerned are part of the production system and produces private
goods and services.

In principle, the government assumes a business role and becomes a factor contributor only in
essential areas where private enterprises creates a vacuum. On the other hand, subsidies are
excluded since they only bloat profits and product values and do not entail production and
factor contributions.

PY = Incorporate of Person
CY= Corporate Income
GY = Government income from capital
NI = National Income
IT = Indirect Tax
S = Subsidies
DA= Depreciation allowance

Formula

NI = PY + CY + GY

GNP = NI + (IT-S) + DA

Personal Income

- Is income earned by persons or households.

PI = NI – (S + T + GI) + TP

Where:

PI – Personal Income
NI – National Income
S – Undistributed Profits or Corporate Savings
T – Corporate Taxes
GI – Government Entrepreneurial Income
TP – Transfer Payments

Disposable Income and Consumption

Disposable Income (DI) is personal income available for consumption as it exludes personal taxes.
On the other hand, consumption is equal to Disposable Income less savings.

DI = PI – PT
C = DI - PS

Therefore:
C = PI –PT –PS

Where:
DI – Disposable Income
C – Consumption
PI – Personal Income
PT – Personal Taxes
PS – Personal Savings
 Consumption and Savings

National Income as reflected in the value of production or personal economic income which the
firms pay to the households in exchange for factor contributions.

A. Basic Concepts of Consumption

Consumption – is the act of using goods and services to satisfy human wants. In a broad sense,
consumption is not the monopoly of households since businesses and the government also use goods
and services to attain some ends.

Factors of Consumption

1. Framework

Personal consumption is household’s realized demand to satisfy current needs. However, one
should not be misled to the conclusion that demand factors are the only direct determinants of
consumption.

2. Taste or Preference

Taste or preference depends on how the products satisfy one’s desire. A change in collective
attitude can change aggregate taste or preference, consumption, and marginal propensity to
consume. However, a change in the relative taste or preferences of the population according to
consumption behavior can also alter aggregate consumption with the same income./

3. Population

Population size also determines consumption needs and therefore affects consumption
expenditures with a given income.

An increase in household size with income and other factors as constant may decrease the
propensity to consume and increase savings at the expense of essential items in the
consumption basket.

4. Income

The level of income can increase with more infusions in the circular flow. On the other hand,
income distribution among consuming unit of different propensities to consume also
determines aggregate consumption. Therefore, income re-distributed in favor of those with
higher propensity to consume increases the level of aggregate consumption assuming other
factors as constant.

5. Price Level

Individual product demand in inversely proportional to price due to change in purchasing power
and substitution with other product. On the aggregate, consumer seek the best mix in the
consumption of available products through substitution given a certain level of aggregate
income, price and purchasing power.

6. Innovation and Promotion

Innovations and promotions can expand the line of consumer’s choice and extend the influence
of demand factors on consumption and propensity to consume income.

On the other hand, promotions and advertising serve as media of introducing new products in
the market which create demand and consumption. In addition, they also give information
about existing products to guide consumers in attaining a better mix of items in the
consumption basket.
 7. Engel’s Law and the Compositional Change in Consumption Expenditure.

A German economists by the name of Ernest Engel in the 19th century found relation between
the level of family income and the composition of its consumption spending. His research shows
that as the family income level rose, the proportion to total income of essential items like food
increased, while non essential items like education and recreation followed the opposite trend.

Engel’s Law – implies that changing the relative importance of items in the consumption basket
depends on how consumers spend additional income. Spending more additional income for
higher needs like education increases their share in total consumption and income at the
expense of essential items like food which follows the opposite.

GROSS DOMESTIC PRODUCT

- Refers to the market value of all final goods and services produced domestically in a
given period of time.

Real GDP vs Nominal GDP

Nominal GDP – the value (current price) of final goods and services produced within a
country for a specific period of time.

Nominal GDP = Price x Quantity

Hypothetical Data for Nominal GDP

Year Quantity Price Nominal GDP

2005 150 15
2006 130 35
2007 125 50
2008 120 60
2009 110 75

Real GDP – is the value ( at constant price ) of final goods and services produced within a country for a
specific period of time.

Real GDP = Nominal GDP x 100

Price Index

Price index – is the ratio of the price of the current year and the price of the base year multiplied by 100.

Base year – point of reference from which constant price of quantity of goods and services are taken.

Price Index = Price of the current year x 100

Price of the base year

Year Price Index Nominal GDP Real GDP

2005 100 2,250
2006 233 4,550
2007 333 6,250
2008 400 7,200
2009 500 8,250