CONTEMPORARY ECONOMIC ISSUES

FACING THE FILIPINO ENTREPRENEUR

I. Investment and interest rate
II. Rentals
III. Minimum wage
IV. Taxes
INVESTMENT AND INTEREST RATE
INVESTMENT: A DETERMINANT OF INCOME
 Investment
– is a process of building up capital stock, or the expenditure which
determines the income and production in the economy.
– also refers to the value of machinery, plants, and buildings that are
bought by firms for production purposes
– investment is the capital expenditure on the purchase of physical assets
such as plant, machinery, and equipment (also known as fixed
investment) and stocks (also known as inventory investments)
 Investment Expenditure
– investment expenditure means capital spending.
– it is mainly derived from accumulated savings and other sources
external to the circular flow; it does not come from current income and
consumption.
WHY IS INVESTMENT ESSENTIAL TO THE ECONOMY?
 Why is investment essential to the economy?
– Current business income serves current business needs.
– The surplus may not be sufficient to finance even a fraction of
investment spending. Instead, a business may borrow the savings of the
economy, which households likewise do, e.g., for housing construction.
– Investment, therefore, requires that a portion of current consumption be
forgone (i.e., saved) to free up resources which can be used to finance
investment.
INVESTMENT IS CLASSIFIED INTO TWO TYPES:
1. FIXED INCOME INVESTMENT
– Investors are aware that there are risky investment options. For
investors who are averse to risk fixed income investments are the
best option since these investments are guaranteed to have a lower
risk of losses.
– Fixed income investments (FIIs) are investments that provide fixed
periodic sources of income over a certain period of time
– examples:
1. government securities like treasury bonds, treasury bills and notes
2. corporate bonds (which have higher interests compared to
government securities)
3. special deposit accounts offered by the Bangko Sentral ng Pilipinas
(BSP)
4. foreign currency time deposits
INVESTMENT IS CLASSIFIED INTO TWO TYPES:
2. VARIABLE INCOME INVESTMENT
– are forms of investment that are suitable for risk tolerant
individuals.
– in VIIs, returns are not fully guaranteed and money or resources
invested may also not be fully recovered. The reason for this is that
the returns from variable income investments are strongly
influenced by economic situations and the behavior of financial
markets.
– examples:
1. business ownerships in the form of equities
2. company stocks
3. investment fund shares that have a high level of liquidity since they
can be easily converted to cash
INVESTMENT AND INTEREST RATES
 Investments and Interest Rates
– interest rates play a key role in increasing capital stock, which in turn
affect investments.
– there is a negative or inverse relationship between investment and
interest rate.
 the higher the interest rate, the lower the quantity of investments; the lower
the interest rate, the higher the quantity of investments
WHAT IS INTEREST RATE? WHAT IS ITS ROLE IN INVESTMENTS?
 In economics, interest is used in two ways.
1. It can be the price of the credit, which is often referred to as loanable funds
2. It can also be the return that the capital earns as an input in the production
process
 Interest rate represents the cost of using or borrowing money.
 Loanable funds refer to the amount of money lent out by a lender to a
borrower, for which the borrower will pay an interest rate to the lender for
the use of that fund.
 Interest as the return on capital can be illustrated in the case of a printing
press owner who decides to buy additional equipment which costs
Php10,000.
– After a year, he earns Php1,000 for using the equipment in his business. The Php1,000 is
equivalent to a 10-percent interest rate on the capital which is the equipment.
– In this case, interest is the return earned by the capital as an input in the production process.
MARKET FOR LOANABLE FUNDS

 Figure 5.1 shows the market for loanable funds where the demand is the amount of funds that firms and individuals will
borrow at a given interestrate.
 A downward sloping demand curve indicates low interest rates, which means that borrowing money is quite cheap. When
the cost of borrowing is low; more people are encouraged to avail of loans.
 The supply curve is the amount that individuals wish to save. It is upward sloping since individuals get a higher return on
their money when interest rates are high, and they are thus willing to save more.
INVESTMENT DEMAND CURVE

 Interest rates affect the level of production of investment goods. A change in interest rates results in a change in investment
demand.
 The rate at which a borrower pays for the money that is borrowed is usually influenced by macroeconomic conditions such as
inflation-which reduces the purchasing power of capital-and money supply. This relationship is best described by the
investment demand curve.
 A change in the interest rate causes a movement along the investment demand curve as shown in Figure 5.2.
DETERMINANTS OF INVESTMENTS
 Fluctuations and changes in interest rates have a significant influence on
investments.
 Determinants of investments
1. Future expectations – reflect plans to change production capacity. As expectations
change, anticipating future returns from investments, the investment demand curve
shifts to the right. On the other hand, if there are expectations of lower profits, the
investment demand curve shifts to the left.
2. Level of Economic Activity – When GDP is high, the level of production increases. This
boosts demand for capital and encourages higher investments. When household
incomes increase, consumption also goes up, which further leads to a rise in
aggregate demand.
3. Technological Change – With changes in technology, demand for capital will have to
increase in order to keep up with these important developments.
4. Public Policy – Public policies in the form of granting incentives to firms can
significantly affect the demand for capital, thereby increasing investments.
Investment tax credits and tax holidays can encourage investments in a country.
RENTALS
RENTALS
 Rent
– It is typically refers to the use of property for a certain amount
– It is the price paid for the use of land and other natural resources or
factors of production that is in fixed supply.
– Rent has been traditionally associated with land, which is a fixed factor
of production.
 The concept of economic rent applies to economic factors, not just
land.
 Economic rent is a payment in excess of opportunity costs. According
to David Ricardo, an influential British classical economist in early
1800s, rent is a surplus of revenue over cost, which arises due to
differences in the level of usability of the land.
 The scarcity of land becomes the concept of rent.
WHAT RENT ON LAND?
 Rent on Land
– Land is one of the most common type of investments aside from owning
shares, cash, and securities.
– In order to analyze how the price for the use of land is determined, we
must look at the supply of land and its level of demand.
– Since the supply of land is perfectly inelastic, the level of demand is what
determines the rent on land.
– Since supply of land is fixed, demand becomes the determinant of rent.
– Aside from renting the land out, the owner of the land can also opt to
sell the land at a higher price to earn a profit.
HOW IS THE DEMAND FOR LAND DETERMINED?
 Economic rent also relies on productivity differences.
 Several determinants indicate the productiveness of the land:
a. Products grown on the land
 The location attribute of the land can also be considered for its demand
b. Prices of other resources which are combined with the land
 City areas have higher land rents than remote areas with difficult access
to transportation and communication.

Note:
A person keen on investing on land must realize that there are also risks to watch out
for. For one, it takes a long time to sell such property, which means money is not easily
realized.
WAGES
DETERMINANTS OF MARKET WAGE RATES
 A basic principle of economics is the notion that the price or value of goods, services, and
even resources, such as labor, is determined by the behavior of demand and supply.
 Labor Demand
– The demand for labor is similar to the demand for a good, and thus generally
follows the law of demand.
– The wage, which is the price of labor, is plotted in the y-axis of the graph, and the
quantity of labor, which can be expressed by the number of employment available
in the market, is plotted in the x-axis.
– Similar to the law of demand, when the price if labor increases, the related
quantity of labor decreases, which makes the price of labor inversely related to
the quantity of labor. This means that employers will hire more people when
wages go down.
 Labor Supply
– It follows the principle of the law of supply, which says that if the price of labor
increases, then the supply of labor also increases, and vice versa.
– As wage increases, more people will enter the labor market and compete for
higher-paying jobs. But if wages decline, there will be fewer people looking for
jobs and competing for these lower wages.
WHAT IS MARKET CLEARING?
 When the labor demand and supply meet at a certain wage and
quantity of workers, an equilibrium is reached. This point of
equilibrium is called the market clearing.
 It is where firms may hire an employee at the existing wage rate and
people who would like to have that wage rate would be able to doso.
 However, as this is a competitive labor market, even though there is
an identified market clearing, employers and employees may leave
the labor market, as firms may want to pay lower wages or workers
may wish to earn higher wages.
EQUILIBRIUM WAGES
 When jobs are safe and easy, we can assume that the wages they pay
are average. Most People want to have such jobs.
 As the job becomes more difficult and dangerous, workers naturally
require a higher wage to do such work.
 Compensating Differential is the difference in wages that arise to
offset the nonmonetary characteristics of different jobs
 People who work in coal mines or on night shifts usually receive a compensating
differential to make up for the unpleasant nature of the job.
EQUILIBRIUM IN A COMPETITIVE LABOR MARKET
 In a perfectly competitive labor market, firms and workers are free to enter
and exit the market. This makes the equilibrium allocation of workers to
firms efficient.
 How the workers fit the firm maximizes the total gains that workers and
firms accumulate by trading with each other.
 A competitive equilibrium leads to an efficient allocation of resources.
EQUILIBRIUM IN A COMPETITIVE LABOR MARKET

 Figure 5.3 shows the intersection of the labor supply and the labor demand in a competitive market.
 The x-axis represents the employee hours while the y-axis represents the wage level.
 The demand curve gives the total number of employee hours that firms in the market demand at that wage, while the supply
curve shows the total number of work hours that agents in the economy allocate to the market at any given wage level.
MINIMUM WAGE
 Minimum wage is the lowest allowed
wage paid to workers by virtue of
legislation and government policies.
 This is a form of government
intervention to alleviate poverty and
income inequality in terms of rendering
job services.
 The effects of minimum wages may in
principle differ between industries in
which employers do and do not have
control over the wage rates they pay for
the labor of a given skill and application
 Minimum wage is set primarily to
protect workers from abusive
employment practices.
 A decent minimum wage is actually a
useful tool in addressing wide disparities
in wage distribution.
TAXES
TAXES
 Taxes are the lifeblood of the government.
– Without taxes, the government will not be able to provide services to its
people, such as public works, health, education, defense and police
protection, and social services.
– Hence, taxation is necessary for the government to be able to finance its
expenditures.
 Taxation is the act of levying tax so that the sovereign, through its
law-making body, can raise income to defray the necessary expenses
of the government.
– It is an inherent power of the state to demand enforced contributions
from the people for public purposes .
– Hence, tax is a levy imposed by the government on the income, wealth,
and capital gains of persons or businesses, on spending on goods and
services, and on properties.
TAXES
 Taxes are used by the government for a variety of purposes
a. raising revenue to cover government expenditures on the provision
of social services such as education, health, and public infrastructure
as well as the salaries and benefits of public servants;
b. as an instrument of fiscal policy in regulating the level of total
spending (or aggregate demand) to stabilize the economy;
c. altering the distribution of income and wealth;
d. controlling the volume of imports into, and sometimes exports of
certain goods out of, the country.
TYPES OF TAXES
TYPES OF TAXES
1. Direct taxes are taxes levied by government on the income and wealth
received by households and businesses to raise government revenue and to
act as an instrument of fiscal policy.
a. Individual income taxes are taxes that are levied on households. These are taxes on
particular persons
b. Corporate income taxes are taxes on businesses. Take note that corporations are
legal entities that assume an independent personality. Thus, if a corporation earns
a profit, it must pay a corporate income tax. This is considered direct tax.
1. Indirect taxes are taxes levied by government on goods and services to
raise revenue and to act as an instrument of fiscal policy. Observe that
these are not taxes on people but on goods and services that people
purchase and consume.
a. Value-added tax (VAT) are taxes included on goods and services
b. Excise taxes are taxes included on certain products
TYPES OF TAXES
3. Progressive taxes are taxes that place greater burden on those best able to
pay and put little to no burden on the poor.
 The best example of a progressive tax is the individual income tax
 For most taxpayers today, the more they earn, the higher percentage they pay
for tax
 In terms of the average tax rate, people in higher income brackets pay a
substantially higher average tax rate than those in the lower brackets.
4. Proportional taxes are taxes that place an equal burden on the rich, the
middle class, and the poor. In other words, taxes are levied at a constant
rate as income rises.
5. Regressive taxes are taxes that fall more heavily on the poor than on the
rich. Under this taxation structure, taxes are levied at a decreasing rate as
income rises.
 This form of taxation takes a greater proportion of tax from a low-income
taxpayer than from a high-income taxpayer.
 Indirect taxes such as the VAT or excise taxes on certain products are regressive
when taken as a proportion of total net income.
BASIC PRINCIPLES OF TAXATION
 The basic principles of taxation refer to key concepts that guide
governments in designing and implementing an equitable taxation
regime. These basic principles are generally referred to as Adam
Smith's Canons of Taxation. These include:
1. Adequacy. Taxes should be just enough to generate revenue required
for the provision of essential public services like health, education, and
national defense and police protection.
2. Broad basing. Taxes should be spread over as wide as possible to all
sectors of the population or economy to minimize individual tax
burden.
3. Compatibility. Taxes should be coordinated to ensure tax neutrality and
meet the overall objectives of good governance.
4. Convenience. Taxes should be enforced in a manner that facilitates
voluntary compliance to the maximum extent possible.
BASIC PRINCIPLES OF TAXATION
 Basic principles are generally referred to as Adam Smith's Canons of Taxation.
5. Earmarking. Tax revenue from a specific source should be dedicated to a specific
purpose only when there is a direct cost-and-benefit link between the tax source and
the expenditure, such as the allocation of motor users’ tax for roadmaintenance.
6. Efficiency. Tax collection efforts of the government should not cost an inordinately
high percentage of tax revenues.
7. Equity. Taxes should equally burden all individuals and entities in similar economic
circumstances.
8. Neutrality. Taxes should not favor any one group or sector over another and should not
be designed to interfere with or influence individual decision-making.
9. Predictability. The collection of taxes should reinforce their inevitability and
regularity
10. Restricted exemptions. Tax exemptions must only be done for specific purposes (e.g.,
to encourage investment) and within a limited period.
11. Simplicity. Tax assessment and determination should be easily understood by an
average taxpayer
END OF PRESENTATION
ACTIVITY: IMAGINE YOUR SELF AS AN ENTREPRENEURS,
CONSIDER BUILDING A BUSINESS.

GUIDED QUESTIONS:
1. WHAT KIND OF ENTERPRISE DO I NEED TO BUILD?
2. WHAT RISKS AND SACRIFICES DOES SUCH AN
ENTERPRISE DEMAND?
3. CAN I ACCEPT THOSE RISK AND SACRIFICES?
4. SETTING A STRATEGY: HOW WILL I GET THERE?
5. IS THE STRATEGY WELL DEFINED?