Unit 1

INTRODUCTION TO APPLIED ECONOMICS

INTRODUCTION TO ECONOMICS
Economics is a field of study that has become increasingly relevant in our
globalized, financialized society. The economy is part of our collective conscious and a
buzzword that links personal finances to big business and international trade deals.
Economics deals with individual choice, but also with money and borrowing, production
and consumption, trade and markets, employment and occupations, asset pricing, taxes
and much more. What then is the definition of economics? One way to think of it is the
study of what constitutes rational human behaviour in the endeavour to fulfil needs and
wants given a world with scarce resources. In other words, economics tries to explain
how and why we get the stuff we want or need to live. How much of it do we get? Who
gets to have more? Who makes all this stuff? How is it made? These are the questions
and decisions that economics concerns itself with.

As an individual, for example, you constantly face the problem of having limited
resources with which to fulfill your wants and needs. As a result, you must make certain
choices with your money – what to spend it on, what not to spend it on, and how much to
save for the future. You'll probably spend part of your pay check on relative necessities
such as rent, electricity, clothing and food. Then you might use the rest to go to the
movies, dine out or buy a Smartphone. Economists are interested in the choices you
make, and investigate why, for instance, you might choose to spend your money on a
new Xbox instead of replacing your old pair of shoes. They would want to know whether
you would still buy a carton of cigarettes if prices increased by $2 per pack. The underlying
essence of economics is trying to understand how individuals, companies, and nations
as a whole behave in response to certain material constraints.

Adam Smith (1723 - 1790), is often considered the "father of modern economics."
His book "An Inquiry into the Nature and Causes of the Wealth of Nations" (1776) was
the first fully elaborated attempt to understand why some nations prospered while others
suffered widespread poverty. He famously argued that individuals working for their own
self-interest could nonetheless create a stable and well-provisioned society through a
mechanism he called the invisible hand of the market.

Smith, however, was not the first to write on economic matters. Other scholars of
what was then known as political economy wrote prior to "The Wealth of Nations," but
Adam Smith was one of the first to identify the unique economic changes that
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accompanied the birth of industrialization and capitalist production. Smith’s work was
followed by David Ricardo’s "Principles of Political Economy and Taxation" (1817) and
later by Karl Marx in "Capital" (1867). Each of these authors sought to explain how
capitalism worked and what it meant for producers and workers in the capitalist system.

In the late 19th century, the discipline of economics became its own distinct field of
study. Alfred Marshall, author of "The Principles Of Economics" (1890) defined economics
as a social science that examines people's behavior according to their individual self-
interests. He wrote, "Thus it is on one side the study of wealth; and on the other, and
more important side, a part of the study of man." In the early 20th century, however, there
was a push toward legitimizing economics as a rigorous science alongside the physical
sciences like chemistry and physics. As a result, mathematical models and statistical
methods were brought to the forefront along with a number of strong assumptions that
are needed to make those models work. For example, modern mainstream economics
makes the assumption that human beings will always aim to fulfil their individual self-
interests. It also assumes that individuals are rational actors in their efforts to fulfil their
unlimited wants and needs. It also makes the claims that firms exist to maximize profit
and that markets are efficient. This school of economics, which has come to dominate
both the academic field of economics as well as the practical application of economic
theory in policy and business, is known as neoclassical economics.

What is 'Scarcity'

Scarcity refers to the basic economic problem, the gap between limited – that is,
scarce – resources and theoretically limitless wants. This situation requires people to
make decisions about how to allocate resources efficiently, in order to satisfy basic needs
and as many additional wants at possible. Any resource that has a non-zero cost to
consume is scarce to some degree, but what matters in practice is relative scarcity.
Scarcity is also referred to as "paucity."

Absolute scarcity: First, it may be that there are simply insufficient quantities of a
resource to meet human needs or wants. We call this absolute scarcity. No matter how
much we look or try to find additional sources, there are none to be had. Lack of food
leads to starvation, lack of water leads to drought, thirst, and crop failure – and starvation.
There simply is no food or water to be had, at least in that particular area.

Relative scarcity: Second, there may be physical quantities of a resource present

but scarcity exists because of problems about supply or distribution. Meeting the demand
for that resource might mean exploiting lower quality resources. For example, food
production may require cultivating lands that are poorly suited to farming, such as on
steep slopes or in very arid areas, requiring a greater effort (more labour) and other inputs
(chemical fertilizers, irrigation) in order to meet the demand. Another example concerns
the exploitation of fossil fuels. When the most accessible and best quality fuels are fully
exploited (e.g., sweet crude from the Middle East or other areas) we may turn to lower
quality fuels (tar sands) to meet our needs.
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 Investors are always faced with options about where they should invest their
money.

Opportunity cost is the cost of a foregone alternative. If you chose one alternative
over another, then the cost of choosing that alternative is an opportunity cost.

The term opportunity cost is often used in finance and economics when trying to
choose one investment, either financial or capital, over another. It is a measure of any
economic choice as compared to the next best one.

For example, there is an opportunity cost over choosing an investment in bonds

over an investment in stocks.

Economic Resources
There are three fundamental types of economic resources: Land, Labor, and Capital

1. Land
Land is an economic resource that includes all natural physical resources like
gold, iron, silver, oil etc. Some countries have very rich natural resources and by utilizing
these resources they enrich their economy to the peak.

Such as the oil and gas development of North Sea in Norway and Britain or the
very high productivity of vast area of farm lands in the United States and Canada. Some
other developed countries like Japan have smaller economic resources. Japan is the
second largest economy of the world but reliant on imported oil.
2. Labor
The human input in the production or manufacturing process is known as labor.
Workers have different work capacity. The work capacity of each worker is based on his
own training, education and work experience.
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 This work capacity is matters in the size and quality of work force. To achieve
the economic growth the raise in the quality and size of workforce is very essential.
3. Capital
In economics, Capital is a term that means investment in the capital goods. So,
that can be used to manufacture other goods and services in future.
Following are the factors of capital:

a. Fixed Capital
It includes new technologies, factories, buildings, machinery and other equipment.

b. Working Capital
It is the stock of finished goods or components or semi-finished goods or
components. These goods or components will be utilized in near future.

c. Capital productivity
New features of capital building, machinery or technology are commonly used to
improve the productivity of the labor. Such as the new ways of farming helps to enhance
the productivity of the agriculture sector and give more valuable jobs in this sector which
motivates people to come out for work.

d. Infrastructure
It is a stock of capital that is used to maintain the whole economic system. Such
as roads, railway tracks, airports etc.
ECONOMICS AS A SOCIAL SCIENCE
Economic is a different science from biology and chemistry as these are physical
sciences. Economics is a social science because it studies human behaviour just like
psychology and sociology. A social science is, broadly speaking, the study of society and
how people behave and influence the world around them. As a social science, economics
studies how individuals make choices in allocating scarce resources to satisfy their
unlimited wants.
MACROECONOMICS AND MICROECONOMICS
There are two branches of economics. These are macroeconomics and
microeconomics.
Microeconomics is the study of the behaviour of the individual units (like an
individual firm or an individual consumer) of the economy.

According to these units, we may see these examples:

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  Firms:
Demand and Supply of commodities & determination of price by a firm
Study of costs of producing a good by a firm
Study of revenue of a firm
Determining producer's equilibrium (cost & revenue)

 Consumers:
Utility of a consumer : satisfaction from consumption
Consumer's Equilibrium

Now, Macroeconomics studies the behaviour of aggregates of the economy as

a whole, ie it deals with the problems faced by the economy as a whole, and not just by
an individual unit.

 Calculation of National Income : GDP, NNP, GNP, GDP PPP etc. Because it
includes income of all the residents of a country, not just one individual.

 Determination of equilibrium level of output and employment :

Aggregate Demand and Aggregate Supply analysis.
Inflation, deflation and controlling the situation
Employment and unemployment

 Monetary Policy :
Money supply
Interest rates

 Fiscal Policy
Government budget : expenditure and income.
Taxes and subsidies.

 Balance of Payment situation.

Factors that affect u individually are studied in Microeconomics and factors that
generally affect everyone in the economy are studied under Macroeconomics.

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 The following table would briefly distinguish macroeconomics vs
microeconomics examples;

Microeconomics Macroeconomics
It deals with the decision making of single It deals with averages and aggregates of
economic variables such as the demand, the entire economy such as national
price, consumer, etc. income, aggregate output, aggregate
savings etc.
It is narrow in scope and interprets the It has a wide scope and interprets the
small constituents of the entire economy. economy of a country as a whole.
It is also known as the price theory It is also known as the income theory
because it explains the process of because it explains the changing levels of
economic resources allocation on the national income of an economy during a
foundation of relative prices of several period of time.
goods and services.
It deals with the flow of various factors It deals with the circular flow of income and
of production from a single owner to a expenditure between different sectors of
single user of those resources. the economy.
It helps in developing policies appropriate It helps in developing policies appropriate
resource distribution at firm level. resource distribution at economy level
such as inflation, unemployment level etc.

BASIC ECONOMIC PROBLEMS OF SOCIETY

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1. What to produce ?
Each and every economy must determine what products and services, and what
volume of each, to produce. In some way, these kinds of decisions should be coordinated
in every society. In a few, the government decides. In others, consumers and producers
decisions act together to find out what the society’s scarce resources will be utilized for.
In a market economy, this ‘what to produce?’ choice is made mainly by buyers, acting in
their own interests to fulfil their needs. Their demands are fulfilled by organizations looking
for profits.

2. How to produce?
This basic economic problem is with regards to the mix of resources to use to
create each good and service. These types of decisions are generally made by
companies which attempt to create their products at lowest cost. By way of example,
banking institutions have substituted the majority of their counter service individuals with
automatic teller machines, phone banking and Net banking. These electronic ways of
moving money, utilizing capital as opposed to labour resources, have decreased the
banks’ production costs.

3. For whom to produce?

This basic economic question is focused on who receives what share of the
products and services which the economy produces. The portion of production which
each person and family can consume is determined by their income. Income is distributed
in line with the value of resources we have to sell.

THREE TYPES OF ECONOMIC SYSTEM

As you probably know, there are countless economies across the world. All of them
are unique in their own way, but they still share a significant number of characteristics.
Thus, we can categorize them into THREE types of economic systems; traditional
economies, command economies, and market economies. All of them rely on a different
set of assumptions and conditions and of course, they all have their own strengths and
weaknesses. We will look at each of them in more detail below.

1. Traditional Economic System

A traditional economic system focuses exclusively on goods and services that are
directly related to its beliefs, customs, and traditions. It relies heavily on individuals and
doesn’t usually show a significant degree of specialization and division of labor. In other
words, traditional economic systems are the most basic and ancient type of economies.

Large parts of the world still qualify as traditional economies. Especially rural areas
of second- or third-world countries, where most economic activity revolves around
farming and other traditional activities. These economies often suffer from a lack of

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resources. Either because those resources don’t naturally occur in the region or because
access to them is highly restricted by other, more powerful economies.

Hence, traditional economies are usually not capable of generating the same
amount of output or surplus that other types of economies can produce. However, the
relatively primitive processes are often much more sustainable and the low output results
in much less waste than we see in any command, market, or mixed economy.

2. Command Economic System

A command economic system is characterized by a dominant centralized power

(usually the government) that controls a large part of all economic activity. This type of
economy is most commonly found in communist countries. It is sometimes also referred
to as a planned economic system, because most production decisons are made by the
government (i.e. planned) and there is no free market at play.

Economies that have access to large amounts of valuable resources are especially
prone to establish a command economic system. In those cases the government steps in
to regulate the resources and most processes surrounding them. In practice, the
centralized control aspect usually only covers the most valuable resources within the
economy (e.g. oil, gold). Other parts, such as agriculture are often left to be regulated by
the general population.

A command economic system can work well in theory, as long as the government
uses its power in the best interest of society. However, this is unfortunately not always
the case. In addition to that, command economies are less flexible than the other systems
and react slower to changes, because of their centralized nature.

3. Market Economic System

A market economic system relies on free markets and does not allow any kind of
government involvement in the economy. In this system, the government does not control
any resources or other relevant economic segments. Instead, the entire system is
regulated by the people and the law of supply and demand.

The market economic system is a theoretical concept. That means, there is no real
example of a pure market economy in the real world. The reason for this is that all
economies we know of show characteristics of at least some kind of government
interference. For example, many governments pass laws to regulate monopolies or to
ensure fair trade and so on.

In theory, a market economic system enables an economy to experience a high

amount of growth. Arguably the highest among all four economic systems. In addition to
that, it also ensures that the economy and the government remain separate. At the same

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time however, a market economy allows private actors to become extremely powerful,
especially those who own valuable resources. Thus, the distribution of wealth and other
positive aspects of the high economic output may not always be beneficial for society as
a whole.

WHY ECONOMIC IS IMPORTANT

Students may ask, “Why do we need to study economics?” To know how important
the subject is, all they need to do is read the front page of the newspapers to see that the
most important news are economic in nature. Watch the news on TV and for sure,
economic news always presents important issues.
Economics will help the students understand why there is a need for everybody,
including the government, to budget and properly allocate the use of whatever resources
are available. It will help one understand how to make more rational decisions in spending
money, saving part of it, and even investing some of it.
On the national level, economics will enable the students to take a look on how the
economy operates and to decide for themselves if the government officials and leaders
are effective in trying to shape up the economy and formulate policies for the good of the
nation.
SCIENTIFIC APPROACH IN THE EMPIRICAL TESTING OF AN ECONOMIC THEORY
Economic is a study that attempts to explain how an economy operates and how
the consumer attempts to maximize his/her wants within limited means. Using tools such
as logic, mathematics and statistics, the students need to approach the empirical testing
of an economic theory in a scientific manner. This scientific approach involves the
following steps:
1. State the propositions or conditions that are taken as given and do not need further
investigation, as the basic starting point of investigation. These propositions will
serve as the premises upon which the theory is established.
2. Observe facts in connection with the activity that we want to theorize.
3. Apply the rules of logic to the observed facts to determine casual relationships
between observed factors and to eliminate facts that are unnecessary and
irrelevant.
4. Establish a set of principles such that formulated hypothesis may be tested as to
whether they are valid or not.
5. Use statistics and econometrics are empirical proof in testing the hypothesis.

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POSITIVE ECONOMIC AND NORMATIVE ECONOMICS
POSITIVE ECONOMICS deals with what is – things that are actually happening
such as the current inflation rate, the number of employed labor, and the level of the Gross
National Product. NORMATIVE ECONOMICS, on the other hand, refers to what should
be – that which embodies that ideal such as the ideal rate of population growth or the
most effective tax system. Positive economics is an overview of what is happening in the
economy that is possibly far from what is ideal. Normative economics focuses on policy
formulation that will help to attain the ideal situation.
MEASURING THE ECONOMY
We always get to read in the newspapers how our economy has grown in recent
years. Before we go into the essence of applied economics, it is beneficial that students
get to learn first how the growth of the economy is actually measured. The national
government is always happy to inform the people that the country’s Gross Domestic
Product (GDP) has grown in rates, much higher than in the previous administration. We
will now go into a short discussion of what the GDP is all about.
The government plans for a better economy from a perspective of what the
economy has been. Shaping the economy’s future is changing past and present
perspectives extended to the future. In particular, looking ahead is grounded on past and
present performance and health of the economy. The heart of the economy is production
whose value measures both resource input and output of people. The interplay of
resources and output tells how well the economy has performed
COUNTING ALL THROUGH GNP
As the mirror of all products, Gross National Product (GNP) is the market value
of final products, both sold and unsold, produced by the resources of the economy in a
given period. Market Value is determined by supply and demand while the economy’s
resources are those belonging to Filipino Citizens and corporations. Not all resources
belonging to the economy are in the economy, like the capital and entrepreneurship that
brought the SM mall to China. Conversely, not all resources in the economy belong to the
economy like the capital and entrepreneurship brought to the country by multinationals
like Nestle and Procter and Gamble (P & G). In addition, the value of final products already
includes the values of its components from the lower production stages. For example, the
price of your leather wallet already includes the value of the leather that in turn includes
the value of animal hide. In the other words, counting the values of products from the raw
material to the intermediate and on to the final production stages, double counts and
overstates the value of the economy’s production. Likewise, the value of any product in a
certain period should no longer be counted in succeeding periods to avoid double
counting and overstatement that can mislead decision – making.

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GNP/GDP: EXPENDITURE APPROACH
Gross national product (GNP) is an estimate of total value of all the final
products and services produced in a given period by the means of production owned by
a country's residents. GNP is commonly calculated by taking the sum of personal
consumption expenditures (C), private domestic investment, government
expenditure(G), net exports (X) and any income earned by residents from overseas
investments (I), minus income earned within the domestic economy by foreign
residents (M). Net exports represent the difference between what a country exports
minus any imports of goods and services.
GNP = C + I + G + X – M
Table 1.1 represents Philippine GNP statistics whose components are classified
by expenditure accounts. Capital Information is Investment by both the private sector and
government that consists of fixed capital and inventory changes. Fixed capital includes
capital goods (buildings, machineries, equipment) while inventory changes are stocks
(unused) for future use from all stages produced in the year. Net Factor Income from
abroad less the factor payments of other countries. Factor payments are for the direct
services of resources like the remittances of our overseas contract workers for labor
export. Likewise, profit remittances to the home countries of multinational companies like
Nestle and Procter and Gamble (P & G) represent our payments for importing their capital
entrepreneurship. These factor payments to other countries represent additional imports
included from our GNP. On the other hand, payments for non-factor services as part of
trade balance are for services using all factors (resources) of production. Profit brought
home by a Filipino construction firm for construction services in Saudi Arabia is an
example of non-factor service export receipt.
Table National Product
(by Type of Expenditure)
In Million Pesos
TYPE OF EXPENDITURE 2011 2012
1. Household Final Consumption
Expenditure
1,779,604 1,926,671

2. Government Final Consumption

275,015 309,368
Expenditure

3. Capital Formation 442,871 469,111

A. Fixed Capital 457,019 511,636
1. Construction 245,819 277,509
2. Durable Equipment 160,781 180,940
3. Breeding Stock &
42,832 44,621
Orchard Dev't
4. Intellectual Property 7,586 8,566
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 Products
B. Changes in Inventories -14,148 -42,525

4. Exports 776,174 822,900

A. Exports of Goods 521,692 535,173
B. Exports of Services 254,482 287,727

5. Less : Imports 857,624 882,221

A. Imports of Goods 708,655 721,634
B. Imports of Services 148,969 160,587

6. Statistical Discrepancy 16,530 -25,016

GROSS DOMESTIC PRODUCT 2,432,571 2,620,813

Net Primary Income from the rest of
792,881 853,682
the world

GROSS NATIONAL INCOME 3,225,451 3,474,495

However, a better indicator of domestic employment opportunities is Gross

Domestic Product. Gross Domestic Product (GDP) is defined as the market value of
final products produced within a country. The resources in the economy include capital
and entrepreneurship belonging to the other countries brought to the domestic company
by foreign businesses. In Table 1.1, GDP is net of GNP after deducting Net Factor Income
from abroad or by deducting factor income from abroad and adding back Factor
Payments to other countries. In other words, a negative sign to Net Factor Income from
abroad changes the sign of Factor Income from abroad from positive to negative and
Factor Payments to other countries from negative to positive. The tables shows that
Household (74%) followed by capital formation (18%) led by the construction industry. In
other words, our economy mostly produces consumer goods and buildings and other
construction structures. The dominance of household consumption reflects households’
propensity to consume more and save less. On the other hand, construction both private
investments by the rich and public capital spending by government largely financed by
borrowings.
Net Inflow = Inflow – Outflow to – Net Inflow = - Inflow + outflow
GNP/GDP: INCOME APPROACH
Another way to account GNP and classify its components is by resource uses and
contributions that make the production stages. As basic factors of production, resources
(land, labor, capital and entrepreneurship) add value to products (e.g, leather) as
processed into higher forms (e.g., shoes). If all payments for resource contributions (rent,
wage, interest, and profit) went to resource owners, GNP would simply be the sum of all
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factor payments from the raw materials to the final product stage. The value of, say
(P1400) is equal to the intermediate product (P600) plus the factor contributions (P800)
that transformed the latter into its final form. Following the arrow directions, the value of
the intermediate product P(600) is from the factor contributions at the intermediate stage
(P400) and the raw material stage (P200). In other words, factor contributions made the
raw material (P100) and the intermediate product (P400) trough the value added by factor
contributions. The same logic applies to the final product whose material purchase is a
product of factor contributions from the lower stages. In conclusion, all products and their
values are the contributions of these essential (basic) factors of production.

Figure. Value Added Flow

Table 1.2 presents the Philippine GNP statistics whose components are classified
by factor contribution of the economy’s producing sectors. The biggest contributor of GNP
is the Service Sector (48%) serving all industries. Next is the import-dependent Industrial
Sector (44%) providing industrial input across sectors. The smallest sector is Agriculture,
Fishery, and Forestry combined 8%, needing import complements to provide for the food
requirements of the population. Net Factor Income from the rest of the world is factor

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income apart from the factor contributions of the sectors. It includes the OFW remittances
and transfer payments from abroad.
Table National Product
(by Factor Contribution)
In Million Pesos
Major Industry Group At Current
Prices
2010 2011 2012
Agriculture, hunting, forestry and 1, 108,718 1,235,012 1,250,616
fishery
Agriculture and forestry 928, 88 1,052,167 1,056,964
Fishing 180,130 182,845 193,652

Industry 2, 932, 279 3,042,060 3,284,508

Mining and quarrying 128,727 143,027 121,435
Manufacturing 1,930,779 2,047,718 2,170,918
Construction 551,230 520,969 618,077
Electricity, gas, and water 321,543 330,346 374,077

Services 4,962,483 5,429,196 6,029,763

Transportation, storage and
communication 586,197 627,255 685,251
Trade and repairs of motor
vehicles, motorcycles,
personal and household
goods 1,563,786 1,695,908 1,868,423
Financial intermediation 622,404 684,088 763,669
Real estate, renting, and
business activities 979,129 1,106,120 1,236,489
Public administration and
defense compulsory social
security 372,304 404,323 455,476
Other services 838,480 912,502 1,020,455

Gross domestic product 9,003,480 9,706,268 10,564,886

Net primary income from the rest of

the world 1,848,952 1,891,937 2,043,843

Gross national income 10,582,432 11,598,205 12,608729

Housing includes real estate and ownership of dwellings.

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ECONOMIC AS AN APPLIED SCIENCE
Applied Economics is the application of economic theory and econometrics in
specific setting with the goal of analyzing potential outcomes. As one of the two sets of
fields of economics (the other set being the core), it is typically characterized by the
application of the core, referring to economic theory and econometrics, as a means of
dealing with practical issues in fields that include demographic economics, labor
economics, business economics, agricultural economics, development economics,
education economics, health economics, monetary economics, economic history, and
many others. John Neville Keynes is attributed to be the first to use the phrase “to
designate the application of economic theory to the interpretation and explanation of
particular economic phenomena.
We should to be improved human welfare among Filipinos by the investigation and
analysis of economic problems in the real world. Applying economic theory in our lives
means trying to address actual economic issues and be able to do something about it.
The concept of scarcity and choice should encourage us as individuals to help in our own
way to provide solutions to the country’s economic problems.
APPLIED ECONOMICS IN RELATION TO THE PHILIPPINE ECONOMIC PROBLEMS
A solid understanding of economic principles and how they are applied in real-life
situations can serve as significant tools to help address the country’s economic problem.
For example, understanding the existence of scarcity can help economics students
analyze how to maximize the use of available resources in order to overcome scarcity.
Knowledge of economic theories such as the Law of Supply and Demand can help in
analyzing why prices are high and what the government can do to help bring down prices.
THE PHILIPPINES’ BASIC ECONOMIC PROBLEMS
Like most other southeast Asian regions, Philippines too has a history of European
colonization. It was a colony of Spain and the USA. The country is now home to multiple
cultures and ethnic groups. It is also looked upon as a perfect example of a 'mixed
economy'. Traditionally, the economy stabilized on the agrarian contributions and the
manufacture of garments, pharmaceutical products, and semiconductors. In the last
decade, electronic exports added to the exports, along with various products obtained by
mining. Though Philippines too suffered in terms of exports, remittances from overseas
Filipino workers, and foreign direct investments, during the 2008 global economic crisis,
there has been steady economic growth in the recent years. However, there are certain
economic problems that cannot be ignored. The following sections list out some of the
economic problems of the Philippines.
In 2012, 10 million Filipinos were either unemployed (three million) or
underemployed (seven million). In October 2013, unemployment rate was 6.5% in

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comparison to 6.8% in 2012. According to the Labor Force Survey, the unemployment
rate was 6% and 6.6% in October 2014 and January 2015, respectively.
Only one-fourth of the Filipinos that enter the labor force are able to find good jobs
in the country, and the rest of them find jobs overseas, leave the labor force, or end up
becoming unemployed/underemployed. Thus, three-fourth of the workers are
unemployed or informally employed, with lack of opportunities to find good jobs. Though
jobs are being generated, there's a need to generate jobs at a much faster rate, to be
able to bring down the unemployment rate. Many of the unemployed individuals are
college graduates. Many wait for job opportunities abroad, and many families depend on
remittances from family members who are staying abroad.
Despite the talk about economic growth, the poverty rates have not changed
significantly since 2006. As per the National Statistical Coordination Board (NSCB),
poverty incidence of the population improved from 26.3 percent in 2009 to 25.2 percent
in 2012.
Even though Philippines is a fast-growing economy, there's been just a minor
decline in the incidence of poverty. Poverty is very much linked to unemployment.
Unfortunately, the growth is restricted to the BPO, retail, and real estate sector, and a
large number of Filipinos remain without jobs. On top of that, natural calamities further
push people below the poverty line. Thus, economic disparity is a common feature. In
general, the gains from higher economic growth have not really trickled down to the poor.
Population explosion is considered as one of the undisputable alarming obstacles
that stand on the path of the less developed countries. These countries produce great
numbers in terms of human resources because the birth rate is much higher than in the
rich countries, but the rate of employment and production in the poor countries is very
low. Definitely this is a very serious problem that the government should never take for
granted.
The Philippines belong to the group of these "less developed countries." And as
we all know, the growth of population in our country is unstoppable. In fact, the Philippine
population is one of the fastest growing countries in the world. It is estimated that 3,000
Filipino babies are born every day, 100,000 every month, or one million a year to round
up the figures. There are more babies being born today than there were in the 1970s.
There will be more babies born 20 years from now than the number of babies that are
born this day. In this lies the problem: at first, the babies need milk, diapers and vitamins.
But the trouble is, babies grow up. And when they do, they need education, which requires
more school structures; they need food, clothing, houses, jobs, etc. These are basic
needs that must be filled. Providing them creates a large number of problems that demand
the fullest utilization of the nation's resources.

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ASEAN ICON
Lee Kuan Yew GCMG CH SPMJ (16 September 1923 – 23 March 2015),
commonly referred to by his initials LKY, was the first Prime Minister of Singapore,
governing for three decades. Lee is recognised as the nation's founding father, with the
country described as transitioning from the "third world to first world in a single
generation" under his leadership.
After attending the London School of Economics, Lee graduated from Fitzwilliam
College, Cambridge University, with double starred-first-class honours in law. In 1950, he
became a barrister of the Middle Temple and practised law until 1959. Lee co-founded
the People's Action Party (PAP) in 1954 and was its first secretary-general until 1992,
leading the party to eight consecutive victories. After Lee chose to step down as Prime
Minister in 1990, he served as Senior Minister under his successor, Goh Chok Tong until
2004, then as Minister Mentor (an advisory post) until 2011, under his son Lee Hsien
Loong. In total, Lee held successive ministerial positions for 56 years. He continued to
serve his Tanjong Pagar constituency for nearly 60 years as a Member of Parliament until
his death in 2015. From 1991, he helmed the 5-member Tanjong Pagar GRC, and was
returned unopposed for a record five elections.
Lee campaigned for Britain to relinquish its colonial rule, and eventually attained
through a national referendum to merge with other former British territories to
form Malaysia in 1963. But racial strife and ideological differences led to its separation to
become a sovereign city-state two years later. With overwhelming parliamentary control
at every election, Lee oversaw Singapore's transformation from a stagnant British crown
colony with a natural deep harbour to an Asian Tiger economy. In the process, he forged
a system of meritocratic, highly effective and incorrupt government and civil service. Many
of his policies are now taught at the Lee Kuan Yew School of Public Policy.
Lee eschewed populist policies in favor of pragmatic long-
term social and economic measures. With meritocracy and multiracialism as governing
principles, Lee made English the common language to integrate its immigrant society
and to facilitate trade with the West, whilst mandating bilingualism in schools to preserve
students' mother tongue and ethnic identity. Lee's rule was criticised, for curtailing civil
liberties (public protests, media control) and bringing libel suits against political
opponents. He argued that such disciplinary measures were necessary for political
stability, which together with rule of law, were essential for economic progress.
On 23 March 2015, Lee Kuan Yew died of pneumonia, at 91. In a week of national
mourning, 1.7 million residents and guests paid tribute to him at his lying-in-
state at Parliament House and at community tribute sites around the island.

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Test
I. Classify the following topics. Write MI if it falls under Microeconomics; MA, if it falls
under Macroeconomics
1. The inflation rate in the Philippines in the last quarter of 2013 was
4.8%.
2. A P340-billion deficit in the Philippine budget is expected in the year
2015.
3. Price of Toyota vehicles are predicted to go up in December.
4. Garlic prices in the past months have rises because producers hoarded
their suppliers in their bodegas.
5. Unemployment rate has dropped because of the increase in the
number of OFW’s.
6. In the past year, Coca Cola was named the fastest selling product in
the market.
7. Rental on land could not be increased by landowners because of the
Rent Control Law.
8. Prices of apples and grapes tend to increase during the Christmas
season.
9. The Philippine economy grew at the rate of 5.8% in 2013.
10. Philippine congress passed the Value Added Tax Law of strengthen
the Philippine tax system.

II. Describe the type of economic system characterized in each of the following
sentences.
1. Prices are based on demand and supply.
2. The government decides on what goods should be produced.
3. Ancient methods are used in deciding what goods to produce.
4. People enjoy freedom of choice in arriving at decisions on what to buy.
5. People have no freedom of choice in arriving at decisions on what to
buy.
6. Economy is stagnant, making use of practices in the olden times.
7. Economy is backward because no new technology or production
methods are introduced.
8. It is most democratic form of economic system
9. People’s preferences are reflected in the prices they are willing to pay
in the market.
10. It exists in primitive and backward civilizations.

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III. Identify which resources is referred to by the following words.
1. Entertainers 9. Minerals
2. Forests 10. Marine resources
3. Teachers 11. Technology
4. Production equipment 12. Engineers
5. Call center agents 13. Business proprietor
6. Factories 14. Building
7. Lawyer 15. Nurses
8. Doctors

IV. Answer the following questions

1. Whys is economics deeply rooted in the concept of scarcity?
2. In what ways is applied economics important in tackling economic issues or
problems of the country?
3. What are the approaches used in computing the country’s GNP?
4. What is the difference between microeconomics and macroeconomics?
5. .What is economics?

V. Activities.
1. Cut out a news item that is related to any economic issue. In the classroom, guided
by your teacher, decide if the issue is related to scarcity. If so, why and how?
2. On the board, using a pie chart, show your regular allowance for the week and
how you budget this for your school and personal expenses.
3. Talk to the person who prepares the household budget for the family, it could be
your mother or your father. Make a list of all basic expenses for one month. Then
ask the budget in percentage for each of these expenses.
4. If facilities in the school permit, with the teacher go online with the students. Visit
the data.gov.ph and in the space that says search data here, type in Philippine
National Budget for 2015. Print out a copy of the budget. Based on the budget,
determine what expenditure are the government’s top priorities, and then the
expenditures which are the least priorities. Make use of debates, research work,
and panel discussion to deepen understanding of the national budget.
5. If you were to advise the President of the Philippines on how to cope with the
issues on poverty and unemployment to improve the lives of the Filipino people,
what would you know tell him and why?

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 Unit 2:
APPLICATION OF DEMAND AND SUPPLY

THE MARKET
A market is an interaction between buyers and sellers of trading or exchange. It is
where the consumer buys and the seller sells. The goods market is the most common
type of market because it is where we buy consumers goods. The labor market is where
workers offer services and look for jobs, and where employers look for workers to hire.
There is also the financial market which includes the stock market where securities of
corporations are traded.
The market is important because it is where a person who has excess goods can
dispose them to those who need them. This interaction should lead to an implicit
agreement between buyers and sellers on volume and price. In a purely competitive
market (similar products), the agreed price between a buyer and seller is also the market
price or price for all.
DEMAND
It is logical for people to expect an increase in the demand for bathing suits, ice
cream, suntan lotion, and umbrellas during summer. During the typhoon months, people
may start buying raincoats, boots, and cold medicines. In June, when the school year
starts, demand for textbooks, school supplies, and uniforms normally go up. Valentine’s
day cause demand for flowers and chocolates to surge. We can therefore see that in
various seasons of the year, demand for certain type of goods will increase. On the other
hand, demand for rice, fish, salt, and milk tends to be consistent all year.
Demand is the willingness of a consumer to buy a commodity at a given price. A
demand schedule shows the various prices.
A demand function shows how the quantity demanded of a good depends on its
determinants, the most important of which is the price of the good itself, thus, the
equation:
Qd = f(P)

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 This signifies that the quantity demanded for a good is dependent on the price of
that good. Presented in Table 2.1 is a hypothetical monthly demand schedule for vinegar
(in bottles) for one individual, Maria. The quantity demanded is determined at each price
with the following demand function:
Qd = 6 – P/2
Hypothetical Demand Schedule of Maria for Vinegar (in bottles)
Price per bottle Number of Bottles
P0 6
2 5
4 4
6 3
8 2
10 1

At a price of P10 per bottle, Maria is willing to buy one bottle of vinegar for a given
month. As price goes down to P8, the quantity she is willing to buy goes up to two bottles.
At a price of P2, she will buy five bottles. There is a negative relationships between the
price of a good and the quantity demanded for that good. A lower price allows the
consumer to buy more, but as price increases, the amount the consumer can afford to
buy tends to go down.
The demand curve is a graphical illustration of the demand schedule, with the price
measured on the vertical axis (Y) and the quantity demanded measured on the horizontal
axis (X). The values are plotted on the graph and are represented as connected dots to
derive the demand curve. The demand curve slopes downward indicating the negative
relationship between the two variables which are price and quantity demanded.

Figure Hypothetical Demand Curve of Maria for Vinegar (in bottles) for One Month

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 The downward slope of the curve indicates that as the price of vinegar increases,
the demand for these good decreases. The negative slope of the demand curve is due to
income and substitution effects.
Income effect is felt when a change in a price of a good changes consumer’s real
income or purchasing power, which is the capacity to buy with a given income. In other
words, purchasing power is the volume of goods and services one can buy with his/her
income. If a good becomes more expensive, real income decreases and the consumer
can only buy less goods and services with the same amount of money income. The
opposite holds with a decrease in the price of a good and increase in real income.
Substitution effect is felt when a change in the price of a good changes demand
due to alternative consumption of substitute goods. For example, lower price encourages
consumption away from higher-priced substitutes on top of buying more with the budget
(income effect). Conversely higher price of a product encourages the consumption of its
cheaper substitutes further discouraging demand for the former already limited by less
purchasing power (income effect).
THE LAW OF DEMAND
After observing the behaviour of price and quantity demanded in the above
schedule, we can now state the Law of Demand. Using the assumption ceteris paribus,
which means all other related variables except those that are being studied at the moment
and are held constant, There is an inverse relationship between the price of a good and
the quantity demanded for that good. As price increases, the quantity demanded for that
product decreases. The low price of the good motivates the consumer to buy more. When
price increases, the quantity demanded for the good decreases.
NON-PRICE DETERMINANTS OF DEMAND

The five determinants of demand are:

1. The price of the good or service.

2. Prices of related goods or services. These are either complementary (purchased
along with) or substitutes (purchased instead of).
3. Income of buyers.
4. Tastes or preferences of consumers.
5. Expectations. These are usually about whether the price will go up.

For aggregate demand, the number of buyers in the market is the sixth determinant .

Demand Equation or Function

This equation expresses the relationship between demand and its five determinants:

qD = f (price, income, prices of related goods, tastes, expectations)

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 It says that the quantity demanded of a product is a function of five
factors: price, income of the buyer, the price of related goods, the tastes of the consumer
and any expectation the consumer has of future supply, prices, etc.
Price. The law of demand states that when prices rise, the quantity of demand falls. That
also means that when prices drop, demand will grow. People base their purchasing
decisions on price if all other things are equal.
The exact quantity bought for each price level is described in the demand
schedule. It's then plotted on a graph to show the demand curve.
If the quantity demanded responds a lot to price, then it's known as elastic demand.
If the volume doesn't change much, regardless of price, that's inelastic demand.
The demand curve only shows the relationship between the price and quantity. If
one of the other determinants changes, the entire demand curve shifts.
Income
When income rises, so will the quantity demanded. When income falls, so will
demand. But if your income doubles, you won't always buy twice as much of a particular
good or service. There's only so many pints of ice cream you'd want to eat, no matter how
wealthy you are. That's where the concept of marginal utility comes into the picture. The
first pint of ice cream tastes delicious. You might have another. But after that, the marginal
utility starts to decrease to the point where you don't want any more.
Prices of related goods or services
The price of complementary goods or services raises the cost of using the product
you demand, so you'll want less. For example, when gas prices rose to P180 a gallon in
2008, the demand for Hummers fell.
Gas is a complementary good to Hummers. The cost of driving a Hummer rose
along with gas prices.
The opposite reaction occurs when the price of a substitute rises. When that
happens, people will want more of the good or service and less of its substitute. That's
why Apple continually innovates with its iPhones and iPods. As soon as a substitute, such
as a new Android phone, appears at a lower price, Apple comes out with a better product.
Then the Android is no longer a substitute.
Tastes
When the public’s desires, emotions or preferences change in favor of a product,
so does the quantity demanded. Likewise, when tastes go against it that depresses the
amount demanded. Brand advertising tries to increase the desire for consumer goods.
For example, Buick spent millions to make you think its cars are not only for older people.
Expectations
When people expect that the value of something will rise, they demand more of it.
That explains the housing asset bubble of 2005. Housing prices rose, but people bought

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 more because they expected the price to continue to go up. Prices increased even more
until the bubble burst in 2006. Between 2007 and 2011, housing prices fell 30 percent.
But the quantity demanded didn't grow. Why? People expected prices to continue falling.
Record levels of foreclosures entered the market due to the subprime mortgage crisis.
Demand didn't increase until people expected future prices would, too.
Number of buyers in the market
The number of consumers affects overall, or “aggregate,” demand. As more buyers
enter the market, demand rises. That's true even if prices don't change. That was another
reason for the housing bubble. Low-cost and sub-prime mortgages increased the number
of people who could afford a house. The total number of buyers in the market expanded,
which increased demand for housing. When housing prices started to fall, many realized
they couldn't afford their mortgages. At that point, they foreclosed. That reduced the
number of buyers, driving down demand.
SHIFTS OF DEMAND CURVE
A shift in demand means at the same price, consumers wish to buy more. A
movement along the demand curve occurs following a change in price.

Movement along the demand curve

A change in price causes a movement along the demand curve.

Figure Change in Price

A shift in the demand curve occurs when the whole demand curve moves to the right or
left. For example, an increase in income would mean people can afford to buy more
widgets even at the same price.

The demand curve could shift to the right for the following reasons:

 The good became more popular (e.g. fashion changes or successful advertising
campaign)
 The price of a substitute good increased.
 The price of a complement good decreased.
 A rise in incomes (assuming the good is a normal good, with positive YED)
 Seasonal factors.

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Evaluation higher price causes movement along and later shift

If there is an increase in the price of petrol, there would be a movement along the
demand curve, and a smaller quantity would be bought. However, there is likely to be
only a small fall in demand because demand for petrol tends to be quite price inelastic.

Figure: Change in Price

However, in the long term, the demand curve may shift to left as well because people
respond to the higher price by looking for alternatives, for example, they buy an electric
car and so no longer need petrol.
SUPPLY
Demand showed us the side of the consumers and their reactions to changes in
price and other determinants. We now look at the side of the supplier
Supply refers to the of quantity of goods that a seller is willing to offer for sale. The
supply schedule shows the different quantities the seller is willing to sell at various prices.
The supply function shows the dependence of supply on the various determinants that
affect it.
Assuming that the supply function is given as: Qs = 100 + 5P and is used to
determine the quantities supplied at the given prices.

Table: Supply Schedule of Domeng for fish in One Week

Price of Fish (per Kilo) Supply (in kilos)
P20 200
40 300
60 400
80 500
100 600

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 As can be seen in Table 2.2, the relationship between the price of fish and the
quantity that Domeng is willing to sell is direct. The higher the price, the higher the quantity
supplied. When plotted into a graph, we obtain the supply curve

Figure. Supply Curve of Fish of Domeng for One Week

We derive a supply curve is upward sloping, indicating the direct relationship

between the price of the good and the quantity supplied of that good.
THE LAW OF SUPPPLY
After observing the behaviour of price and quantity supplied in the above schedule,
we can now state the Law of Supply. Using the same assumption of “ceteris paribus”
(other things constant) there is a direct relationship between the price of a good and the
quantity supplied of that good. As the price increases, the quantity supplied of that product
also increases. The high price of the good serves as motivation for the seller to offer more
for sale. Thus, when price increases, the quantity supplied of the good increases since
the seller will take this as an opportunity to increase his/her income.
NON-PRICE DETERMINANTS OF SUPPLY
In the above analysis, the only factors that are vary are price and quantity
demanded. However, in real life, supply is influenced by factors other than price. These
factors are assumed constant for the purpose of simplifying the study of the relationship
between price and the quantity supplied.
If the assumption of ceteris paribus is dropped, non-price variables are now
allowed to influence supply. These non-price factors are cost of production, technology
and availability of raw materials and resources. These non-price determinants can cause
an upward or downward change in the entire supply of the product, and this change is
referred to as a shift of the supply curve.

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SHIFTS OF THE SUPPLY CURVE
Just like in the case of demand, there are also movements along and shifts of the
supply curve. In the curve, what we see are changes in the quantities supplied due to
different prices of fish. These changes are reflected on a single supply curve and are
changes from one point to another profit on the same curve. This is referred to as a
movement along the supply curve. The reason for a movement along the supply curve is
the change in the price of the good. Once supply increases due to a non-price
determinant, the entire supply curve will shift to the right to reflect an increase, or to the
left to reflect a decrease.
The supply function will allow now read: S = f(P,C,T,A,R), where the supply (S) of
a good is a function of the price of that good (P), the cost of production (C), technology(T),
and the availability of raw materials and resources (AR).
As a non-price determinant, the cost of production refers to the expenses
incurred to produce the good. An increase in cost will normally result in a lower supply of
the good even when the price will not change since the producer has to shell out more
money to come up with the same amount of output. With the same budget and a higher
cost, the producer will only produce a smaller amount of the good, and therefore, the
supply of the good in the market will decrease. This is reflected in a rightward shift of the
supply curve from S1 to S2.
Technology is another significant non-price determinant of demand. The use of
improved technology in the production of a good will result in the increased supply of that
good. On the other hand, the use of obsolete or improper technology in production will
result in a downward shift of the supply curve from S1 to S2.
Another possible non-price determinant supply than can cause an upward shift of
the curve from S1 to S2 is through improved availability of raw materials and resources.
Since more resources can be used to produce a bigger output of the good, then supply
increases.

Figure. Rightward Shift in the Market Supply Curve for Fish in Quinta Market for One
week

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 The leftward shift of the curve of fish due to change in a non-price determinant.
For example, the effect of an increase due to an improved technology in catching fish
leads to a rightward shift to the supply curve to S2 which means the suppliers will sell
more fish for the same price.

DEMAND AND SUPPLY IN RELATION TO

THE PRICES OF BASIC
COMMODITIES
MARKET EQUILIBRIUM
If the forces of demand and supply operate together, we can show how price is
determined in a market economy. Alfred Marshall, a British economist, defined the law of
Demand and Supply
Equilibrium is the state of balance when demand is equal to supply. The equality
means that the quantity that sellers are willing to sell is also the quantity that buyers are
willing to buy for a price. As a market experience are willing to transact. The price at which
demand and supply are equal is the equilibrium price. Market equilibrium is attained at
the point of intersection of the demand and supply curves.

Figure.Market Demand and Supply Curves for Fish in the Quinta Market for One Week
The price of a good in the market is the equilibrium price. It is the price at which
the quantity demanded is equal to the quantity supplied. This is how most commodities
in the market are priced by their producers or sellers.
DETERMINATION OF MARKET EQUILIBRIUM
Market Equilibrium is attained when the quantity demanded is equal to the quantity
supplied.
Assuming that the demand function for Good X is : Qd = 60 – P/2 and the spply
function for Good X is : Qs = 5 + 5P
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 Applying the equations, we derive the following demand and supply schedules
given the following prices:
Demand Schedule of Price Good X Supply Schedule of Good X
P0 60 5
2 59 15
4 58 25
6 57 35
8 56 45
10 55 55
12 54 65
14 53 75
16 52 85

Equilibrium quantity is attained where Qd = Qs

Equilibrium quantity is 55 since quantity supplied and quantity demanded are both
55 at the price of P10, which is the equilibrium price.
Example of Determination of Market Equilibrium
Assume a demand and a supply function as the following:
P = 50 – 2Qd (Demand) P = 20 + 4Qs (Supply)
Where:
P = price Qd = demand Qs = Supply in thousands
The demand curve is downward sloping with the negative slope – 2 while the
supply curve is upward sloping with positive slope 4. At equilibrium, the price at which
buyers are willing to buy a certain volume is also the price at which sellers are willing to
sell the same volume. Thus, for the same price, buyers are willing to buy while sellers are
willing to sell the same volume. To compute equilibrium Price (P) and Quantity (Q), we
have to equate the demand and supply functions, as follows:
50 – 2Qd = 20 + 4Qs
At equilibrium, P = 40 and Q = 5 as illustrated by the demand-supply schedule and
graph below.

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 Figure.Demand-Supply Graph
Assume a demand and a supply functions, as follows:
P = 50 – 2Qd (Demand) P = 20 + 4Qs (Supply)
P = price Qd = Demand 4Qs = Supply in thousands
Table 2.3 Demand-Supply Schedule
D S P
48 24 1
46 28 2
44 32 3
42 36 4
40 40 5
38 44 6
36 48 7
34 52 8
32 56 9
30 60 10

APPLICATION OF DEMAND AND SUPPLY IN RELATION TO HOUSING

SHORTGAGE
With close to 100 million Filipinos, limited land area, and shortage of funds to build
houses for all the Filipino families, the country continues to suffer from a shortage in mass
housing that is expected to reach 6.5 million units by 2030, Profriends President and CEO
Guillermo Choa told reporters in a briefing in Makati City. (Danesa O. Rivera, GMA News
October 2, 2014). Housing Shortage has been perennial problem in the country with
accumulated backlog of about 3.92 million units from 2001 to 2011. (Source: Subdivision
and Housing Developers Association (SHDA).
Housing in the country is a problem evident because of the rapid growth of
Philippine population. More people will mean a higher demand for housing. The supply of
houses is less than existing demand for them since more and more Filipinos are added
to the population annually. There seemingly a lack of government priority to build homes
for the homeless. Filipinos are see putting up shanties and makeshift homes in the
streets, under bridges, close to the railroad tracks, and near creeks, which proves to be

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dangerous since these overflow during typhoons and inundate the areas, causing risk to
the lives of the poor who have no other choice as to where they should live.
Hardly does housing grow faster than population to decrease the housing backlog.
It is the poor who suffer an increasing backlog to decent housing due to the increasing
population.

Figure.Housing and Population

There is obviously an excess of demand compared to supply housing even among
ordinary Filipinos. Buying and owning one’s home is always the dream of every Filipino
family but it is expensive to build a house in the country. Since many Filipinos are middle-
or low-income earners, they cannot afford the high cost of housing. Prices or real estate
and construction materials are even on the rise although with a significant decrease in
July, 2017.

Figure. Philippine Average Construction Cost

Other people who dream of owning their own house may opt to borrow money from
financial institutions such as banks. They may apply for what we call real estate loans to
buy their dream houses. They may also borrow from the state-owned Pag-IBIG Fund if
they are regular contributing members of the fund.
Real estate loans are hard to come by for middle- and low-income earners and
have a long process of application. In addition, banks need to charge high interest rate
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that is a burden on the borrower. An additional difficulty is that interest on loans is usually
high and even if the first year interest rates are low, these rates are subject to an upward
adjustment usually on the second year and onward, depending on the market rates.
The option for those who cannot afford to buy houses is to rent them from the
owners paying on a monthly basis. But there are laws on rent such as the one sponsored
by former Senator Joey Lina that tend to protect and favour the renters. This has led to
reluctance on the part of owners to rent out their property, thus further limiting housing
opportunities for the Filipino.
Rent control is a type of intervention that affects prices. Rent control is equivalent
to the setting of a price ceiling on the rent.

Figure. Demand and Supply Curves for Housing

The ideal situation is at the point where the demand and supply curves intersect
otherwise called market equilibrium. The government can intervene by setting rent
control that is equivalent to a price ceiling. It indicates the homeowners cannot set the
rent higher than the price ceiling. set by the government. However, if price ceiling is set
below this equilibrium point, homeowners will be motivated to rent out their property such
that supply will decrease and this will result in an excess of demand over the supply of
housing, making it even more difficult for people to buy their own houses.

ELASTICITIES OF DEMAND AND SUPPLY

Elastic, unitary and inelastic refer to the price elasticity of demand, a calculation
that determines how price sensitive the market is for specific goods. That relationship
between price and demand determines whether the demand for the product is described
as elastic, inelastic or unitary. Inevitably, some products are more price sensitive than
others.

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1. Elastic Demand
When a change in demand is greater than the change in price, the demand for the
product or good is said to be elastic. When a product is elastic, slight changes in price
lead to huge changes in the demand for the product. Many goods and services that not
necessity items are usually highly elastic. To determine the elasticity of the demand for a
product, the percent change in quantity is divided by the percent change in price. When
this equation is calculated, the answer reveals a product’s elasticity. If the answer to the
equation is equal to or greater than one, the product is considered elastic.

2. Inelastic Demand
Inelastic refers to the change in demand being less than the change in price on the
product or good. Products considered inelastic are typically products people consider
necessities. Changes in prices do not change the demand for the product very much.
When the elasticity equation is calculated, goods that are considered inelastic have an
answer that is less than one.

3. Unitary Demand
Goods that are considered unitary in terms of elasticity are goods that result in no
effect in demand even when prices change. There are few goods ever considered unitary,
but products such as medicine or utilities can sometimes reach this point. No matter what
prices are charged, people find a way to purchase the goods, regardless. Companies
selling goods that are unitary often make large profits because people consider these
goods a necessity above all other goods.

Elasticity of Demand
There are three types of elasticity of demand that deal with responses to a change
in the price of the good itself, in income, and in the price of a related good, which is a
substitute or a complement.
Price of Elasticity of Demand

1. Arc price elasticity:

It is slightly different from the price elasticity as defined above. We have seen that
price elasticity is given as

Here, changes in demand and price are taken to be proportionate changes to their
original levels, Q1 and P1 respectively. If the points are separated by a larger distance on
the demand curve, it is customary to express the change in demand and price as a
proportion of their average values rather than of their original values.

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2. Point price elasticity:
Point price elasticity refers to the price elasticity at a point on the demand curve.
In other words, it accounts for the price elasticity of demand in the close proximity of the
point, that is, proportionate change in demand in response to an infinitesimally small
change in price at the point.

𝑸𝟐 − 𝑸𝟏 𝑷𝟐 − 𝑷𝟏
𝑬𝒑 = ( )÷( )
𝑸𝟏 𝑷𝟏

Price elasticity is important to the seller since it gauges how far demand can
change relative to price. The price elasticity of demand measures how far consumers are
willing to buy a good especially when its price rises reflective of the economic, social, and
psychological forces shaping consumer preference.

Income Elasticity of Demand

Income Elasticity of Demand (YED) is the responsiveness of demand when a
consumer’s income changes. It is defined as the ratio of the change in quantity demand
over the change in income.

YED is useful for governments and firms to help them decide on what goods to
produce and how a change in overall income in the economy affects the demand for their
products, i.e., whether it’s inelastic or elastic.

Income Elasticity of Demand can be positive or negative. This depends on the type
of good. A normal good has a positive sign, while an inferior good has a negative sign.
For example, if a person experiences a 20% increase in income, the quantity
demanded for a good increased by 20%, then the income elasticity of demand would be
20%/20% = 1. This would make it a normal good.

Cross Price Elasticity of Demand

Cross Price Elasticity of Demand (XED) is the responsiveness of demand for
one good to the change in the price of another good. It is the ratio of the percentage
change in quantity demanded of good x to the change in the price of Good Y. In business,
Cross Elasticity of Demand is important because it will help determine whether or not it is

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a good move to increase or decrease prices or to substitute one product for another for
revenue.
There are three types of cross price elasticity of demand: substitute goods,
complimentary goods and unrelated products.

A. Cross Elasticity of Demand for Substitutes

When the cross elasticity of demand for product A relative to a change in the price
of product B is positive, it means that in response to an increase in the price of product
B, the quantity demanded of product A has increased. An increase in the price of product
B means that more people will consume A instead of B, and this will increase the quantity
demanded of product A.

Substitutes will always have a positive Cross Price Elasticity or greater than zero.

B. Cross Elasticity of Demand for Compliments

When the cross elasticity of demand for product A relative to the change in the
price of product B is negative, it means that the quantity demanded of A has decreased
relative to an increase in the price of product B. An increase in the price of B will reduce
the quantity demanded of A.

Compliments will always have a negative Cross Price Elasticity or less than zero.

C. Cross Elasticity of Demand for Unrelated

These are goods that show no relationship. Unrelated goods will always have a
Cross Price Elasticity of Demand = 0

PRICE ELASTICITY OF SUPPLY

With regard to supply, price elasticity of supply determines whether the supply
curve is steep or flat. A steep curve signifies a high degree of elasticity or ability to change,
while a flat curve indicates an inability to change response to a change in the price of the
good. Goods that are easy to produce have elastic supply while those which need a long
time to produce and which are hard to make have inelastic supply.

MARKET STUCTURE
After looking at the basic principles of demand and supply, it will be also helpful to
learn about the market structures in which sellers can operate. Each structure will be
described in terms of the nature of the product being sold, the number of buyers and
sellers in the market, and the ease of entering or exiting the market. Market structure
refers to the competitive environment in which buyers and sellers operate.

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 Competition is rivalry among various sellers in the market. As students, we are
familiar with the word competition. We are exposed to competition in school; spelling
bees, quiz bees, and sports fest. On the television, we watch beautiful girls from all over
the world compete for the Miss Universe of Miss World title. We see how the various
teams of the PBA compete win the championship.
The market is a situation of diffused, impersonal competition among sellers who
compete to sell their goods and among buyers who use their purchasing power to acquire
the available goods in the market.
There are varying degrees of competition in the market depending on the following
factors:
1. Number and size of buyers and sellers
2. Similarity or type of product bought and sold
3. Degree of mobility of resources
4. Entry and exit firms and input owners
5. Degree of knowledge of economic agents regarding prices, costs, demand, and
supply conditions.
PERFECT COMPETITION
Perfect competition describes a market structure where competition is at its
greatest possible level. To make it more clear, a market which exhibits the following
characteristics in its structure is said to show perfect competition:

1. Large number of buyers and sellers

2. Homogenous product is produced by every firm
3. Free entry and exit of firms
4. Zero advertising cost
5. Consumers have perfect knowledge about the market and are well aware of any
changes in the market. Consumers indulge in rational decision making.
6. All the factors of production, viz. labour, capital, etc, have perfect mobility in the
market and are not hindered by any market factors or market forces.
7. No government intervention
8. No transportation costs
9. Each firm earns normal profits and no firms can earn super-normal profits.
10. Every firm is a price taker. It takes the price as decided by the forces of demand and
supply. No firm can influence the price of the product.

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IMPERFECT COMPETITION
Imperfect competition is a competitive market situation where there are many
sellers, but they are selling heterogeneous (dissimilar) goods as opposed to the perfect
competitive market scenario. As the name suggests, competitive markets that are
imperfect in nature.

Imperfect competition is the real world competition. Today some of the industries
and sellers follow it to earn surplus profits. In this market scenario, the seller enjoys the
luxury of influencing the price in order to earn more profits.

If a seller is selling a non identical good in the market, then he can raise the prices
and earn profits. High profits attract other sellers to enter the market and sellers, who are
incurring losses, can very easily exit the market.
We shall discuss:

1. Monopoly
A monopoly exists when a single firm that sells in the market has no close
substitutes. The existence of a monopoly depends on how easy it is for consumers to
substitute the products for those of other sellers.
Consumers tend to have a bad image of a monopoly. The fears that monopolies
tend to jack up prices of their good since consumers have no choice and cannot buy the
good from any other seller. Because of the absence of competition, there is also the
danger that consumers will suffer from poor quality of the good and poor service delivered
by the monopolist.
Monopoly can exist for the following reasons:
 A single seller has control of entire supply of raw materials
 Ownership of patent or copyright is invested in a single seller
 The producer will enjoy economics of scale, which are savings from a large range
of outputs
 Grant a government franchise to a single firm.
While a monopoly enjoys a lot of power in the market, it actually does not have
unlimited market power because it faces indirect competition for consumers’ money for
all goods
Monopolist’s quantity of output will be lower to enable him to set the price higher.
Because of this, to prevent abuses, there is need for stricter government laws.
A monopoly can easily exist when there are barriers to entry that may cause other
firms to stay out of the market instead of entering and competing with firms already there.

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The reason could be due to legal barriers like government restrictions, patents and
copyrights.
Because it is the only supplier in the market, the firm is free to determine is output
level and its price. Once the firm determines its output level, it also determines its price;
it is thus a price setter. Once the firm determines its price, it also determines its output
level that will enable it to maximize its profits.
The monopolist faces a downward-sloping demand curve; meaning, the lower the
price, the higher the quantity that will be bought by the consumer.
2. 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 can 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.
This market combines some characteristics of perfect competition and monopoly.
Its key characteristics are:
a) a blend of competition and monopoly
b) firms sell differentiated products, which are highly substitutable but are not perfect
substitutes;
c) many sellers offer heterogeneous or differentiated products, similar but not
identical and satisfy the same basic need;
d) changes in product characteristics to increase appeal using brand, flavour,
consistency, and packaging s means to attract customers;
e) there is free entry and exit in the market that enables the existence of many sellers;
and
f) it is similar to a monopoly in that the firm can determine characteristics of product
and has some control over price and quantity.
The firm under monopolistic competition faces a downward-sloping demand curve.
This means that it can sell more by charging less and can raise price without losing all
customers. As such, the firms in this market are given room to set different prices by their
product differences. In other words,, a firm can set a higher price because it has
something different to offer its buyers.
The firm tends therefore to engage in non-price competition. This refers to any
action a firm takes to shift the demand curve for its output to the right without having to
sacrifice its prices. This may include better service, product guarantees, free home
delivery, more attractive packaging, better locations, and advertising. The firm can either
sell more by charging a lower price or it can even raise its price without losing all of its
customers because it has the capacity of developing loyalty among its customers. Hence,
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firms in this market structure are price setters. However, the demand curved faced by the
firm is more elastic than the demand curve faced by a monopolist.
3. Oligopoly
An oligopoly is a market structure in which a few firms dominate. When a market
is shared between a few firms, it is said to be highly concentrated. Although only a few
firms dominate, it is possible that many small firms may also operate in the market.
Its characteristic are:
a) action of each firm affects other firms; and
b) interdependence among firms.
These strategically interacting firms try to raise their profits by colluding with each
other raise prices to the detriment of consumers. Just take a look at the oil industry.
Producers of oil from all around the world can manage to raise prices by agreeing with
each other on what prices to charge the consumers. Thus, countries that use a lot of oil
have no choice but to buy from these producers at high prices.
Oligopolies may exist due to the existence of barriers, which may include
economies of scale, reputation of the sellers, and strategic and legal barriers such as the
grant of patents/franchise, loyal following of costumers, huge capital investments and
specialized input, and control of supply of raw materials by a few producers.
Cooperative behaviour on oligopoly usually takes the form of price-fixing or output-
setting agreements such as the one maintained by the OPEC (Organization of Petroleum
Exporting Countries)
SIGNIFICANCE OF THE MARKET STRUCTURE
The type of market in which the business operates will determine the amount of
market power or control the business owner will enjoy. Greater market powder means a
greater ability to control prices, differentiate the products one offers for sale, thus, leading
to opportunities for more profits.

SUPPLY- DEMAND AND THE PHILIPPINE

LABOR MARKET
After learning about the workings of demand and supply and how these forces
affect the market, we will now focus on how the forces of demand and supply, the theory
and principles, can help in analyzing Philippine economic problems.

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LABOR SUPPLY, POPULATION GROWTH, AND WAGES
The people of a country are very important as a resource used in the production
of goods and services. Population is the source of labor supply although not all of a
country’s population are part of the labor supply. In the Philippines, the labor supply, also
known as the labor force, refers to the portion of the population, 15 years old and over
who are willing and able to work, including those who are actively seeking work but have
not found work and those who are employed. There are likewise other people who are
excluded from the labor force such as full-time housewives or househusbands, full-time
students, those who are physically and mentally disabled and therefore cannot work, as
well as those who do not wish to work and are not actively seeking for work.
The country’s labor supply is vital to the economy, since their contribution to
production of goods and services determines the value of the country’s Gross Domestic
Product. In 2014, as of April, Philippine labor force was reported at 41.6 million, with an
estimated 38.7 million total employed persons in July 2014, translating into an
employment rate of 93%. Of this number of employed people, 60% were males and the
largest number of employed persons consisted of the age group 25 to 34 years with
26.4% of the total employed. Fifty percent of employed persons were in the services
sector. Laborers and unskilled workers comprised one-third of the employed persons.
Wage and salary workers were registered at 57.5%
Full-time workers are those who work for 40 hours or more while part-time workers
work for less than 40 hours.
In April 2014, full-time workers comprised 59.3 percent of the total employed.
Employment growth in large enterprises in Metro Manila continued to be positive
at 1.02% during the fourth quarter of 2014 but this reflected a marked slowdown
compared with the same quarter of the previous year at 3.22%. The country’s labor force
grew by an average of 2.5% or an addition of 962, 000 persons in 2014. This placed the
total working population in the active workforce at 40.1 million. The figure corresponds to
a higher labor force participation rate (LFPR) of 64.4% than 63.9% in 2013.
The 2014 average annual employment data showed positive note, employment
level grew by 2.8 compared to 2013 – a net gain or employment generation that exceeded
one million. Employment was boosted by robust growth in industry (4.1%) together with
a sustained growth in services (3.1%) and modest recovery in agriculture (1.7%). Both
the rates of unemployment and underemployment eased slightly from the previous year.
Employment growth in 2014 was largely driven by the rise in part-time employment (9.1%)
alongside the increase in the number of self-employed persons and unpaid family
workers. The country’s labor force grew by an average 2.5% or an addition of 962, 000
persons in 2014. This placed the total working population in the active workforce at 40.1

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million. The figure corresponds to a higher labor force participation rate (LFPR) of 64.4%.
than last year’s 63.9 %.(“Labor Force Survey” NSO 2015)
PHILIPPINE POPULATION
Let us now look at the Philippine population statistics in order to relate population
growth to the growth of our labor supply and to the demand for goods and services. This
will also help us analyze why the prices of basic commodities have been increasing.
The Philippine census is an official account of the population of a certain local
administrative unit in the Philippines. The population is enumerated every 5 years.
The population of the Republic of the Philippines reached more than 100 million
people in 2014, registering an increase of 2.0% versus the previous year. The population
of the Philippines represents 1.38% of the world’s total population. The distribution of
Philippine population among the 3 biggest regions.

Figure. Distribution of Philippine Population, (2013)

(Source: National Statistic Office)

Table. Summary of Projected Population, by Five-Year Interval

Philippines:2000 – 2040(Medium Assumption)
Year Both Sexes Male Female
2000 76,946,500 38,748,500 38,198,000
2005 85,261,000 42,887,300 42,373,700
2010 94,013,200 47,263,600 46,749,600
2015 102,965,300 51,733,400 51,231,900
2020 111,784,600 56,123,600 55,661,000
2025 120,244,500 60,311,700 59,912,800
2030 128,110,000 64,203,600 63,906,400
2035 135,301,100 67,741,300 67,559,800
2040 141,669,900 70,871,100 70,798,800

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 Let us now look at the population statistics and see how our population growth
over the years has affected the Filipino’s quality of life. We can see that from 2000 to
2005, which are the census years, population increased by approximately 8 million
Filipinos. In 2005 to 2010, the increase was approximately 9 million Filipinos. From 2010
to 2015, it is estimated that the close to 9 million Filipinos will be added to the total
population. It is logically to say that more Filipinos mean more mouths to feed; thus,
demand for products and services will naturally increase. If the supply of these goods
does not increase as fast as the demand, their prices will naturally increase. Housing,
school buildings, health care, and food may no longer be sufficient to meet the needs of
the growing population. In Table 2.5, we see that while population has been increasing,
the rate of growth of population has however been declining, and is expected to decline
further over the next 5 years.
Table. Average Annual Growth Rates, Philippines: 2000-2040
Year Growth Rate
2000-2005 2.05
2005-2010 1.95
2010-201 1.82
2015-2020 1.64
2020-2025 1.46
2025-2030 1.27
2030-2035 1.09
2035-2040 0.92

Another significant population demography is the age distribution. In Table 2.6, a

comparison is made between sex and age distribution in 2010 and the projections for
2015. A close look at the table shows an almost equal distribution of males and females
in both 2010 and 2015, with males exceeding females by a very small margin.

Table.Distribution of Philippine Population by Age and Sex, 2010 and 2015

Age Both Sexes 2010 Bothe 2015
Male Female Sexes Male Female
Total 94,013,200 47,263,600 46,749,600 102,965,300 51,733,400 51,231,900
0-9 10,984,800 5,619,400 5,365,400 11,386,600 5,828,500 5,558,100
5-14 10,370,300 5,289,200 5,081,100 10,950,900 5,595,100 5,355,800
10-19 9,801,500 5,006,300 4,795,200 10,343,600 5,269,700 5,073,900
15-24 9,603,300 4,900,900 4,702,400 9,757,800 4,978,600 4,779,200
20-29 8,857,500 4,478,600 4,378,900 9,544,900 4,865,300 4,679,600
25-34 7,892,000 3,940,800 3,951,200 8,795,500 4,439,500 4,356,000
30-39 7,001,500 3,474,900 3,526,600 7,842,700 3,910,200 3,932,500
35-44 6,008,400 3,013,200 2,995,200 6,942,200 3,439,600 3,502,600
40-49 5,442,300 2,737,600 2,704,700 5,924,800 2,962,400 2,962,400

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 45-54 4,702,100 2,376,700 2,325,400 5,330,100 2,669,800 2,660,300
50-59 3,931,600 1,974,500 1,957,100 4,554,700 2,285,500 2,269,200
55-64 3,050,800 1,521,500 1,529,300 3,747,900 1,860,500 1,887,400
60-69 2,307,800 1,122,800 1,185,000 2,843,700 1,392,700 1,451,000
65-74 1,559,300 735,700 823,600 2,055,900 973,200 1,082,700
70-79 1,189,400 533,700 655,700 1,305,700 593,200 712,500
75-84 700,500 298,500 402,000 904,200 384,000 520,200
80+ 610,100 239,300 370,800 734,100 285,600 -----

What is interesting in this table is how Philippine population is distributed among

age groups. It can be seen that in 2010, more than 21 million of total population fell under
the age group of 0 to 4 and 5 to 9. These are very young children who normally go to
school, do not work, and therefore depend on their parents for their subsistence and living
requirements. This translates to a high dependency ratio on the productive members of
the population. Then we have the older retired age group of 65 year old to 80+ numbering
a little over 2 million. These people who may not have adequately prepared financially for
their retirement will add to the dependency burden on the productive members of the
population.
It is thus important to study population in terms of age distribution, to see how
much of the population is made up of the age group that can join labor supply and
therefore contribute to income generation and production of goods. This will mean less
dependency on the part of the very young and the old members of the population. Relating
this to the concept of demand and supply, one can analyze that big proportions of
dependent members of population contribute to increased demand without the capacity
to contribute to supply of goods and services. This can lead to a shortage of social
services, housing, schooling, health care, and transportation. The high demand is also a
reason for increasing commodity prices.
THE PHILIPPINE WAGE SITUATION
Usually, when Labor Day is celebrated in the Philippines on May 1, labor unions
and organizations clamor for wage increases. The government protects the workers
through the imposition of minimum wages. But workers always claim that these minimum
wages are not enough for their substance. Let us take a look at the minimum wages in
the National Capital Region.

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Table. Current Minimum Wage
National Capital Region (NCR)
as of April 4, 2015
(in Pesos)
Sector/Industry Basic Basic New COLA New
Wage Wage Basic Minimum
Increase Wage Wage
Rates
Non-Agriculture P451.00 P15.00 P466.00 P15.00 P481.00
Agriculture(Plantation and P410.00 P15.00 P429.00 P15.00 P444.00
Non Plantation)
Private Hospitals with bed P414.00 P15.00 P429.00 P15.00 P444.00
capacity of 100 or less
Retail/Service P414.00 P15.00 P429.00 P15.00 P444.00
Establishments employing
15 workers or less
Manufacturing P414.00 P15.00 P429.00 P15.00 P444.00
Establishments regularly
employing less than 10
workers

The above minimum wage apply in the NCR. Minimum wages in the other regions
in the Philippines are lower depending on the cost of living in the specific regions or sector.
The setting of minimum wages by the government assures protection for workers
that they are not underpaid by employers, and gives the guarantee of a sufficient income
to meet their basic needs.
LABOR MIGRATION AND THE OVERSEAS FILIPINO WORKERS
Another distinct feature of Philippine labor is the growth of labourers whom we call
the OFWs or Overseas Filipino Workers. Primarily because of a high unemployment rate
in the country, currently at 6.4%, Filipinos have started to find work in the countries, In
addition to this, migration is also affected by wage gaps among countries: Because wages
are higher in the United States and other more developed economies, Filipino teachers,
engineers, doctors, nurses and other health professionals and technical workers have
opted to migrate. So, even if the supply of doctors in the country may be limited, because
of the higher wages abroad, some doctors prefer to migrate and work in foreign countries.
In 2014, there were 2, 320, 000, registered OFWs.

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Table. Distribution of Overseas Filipino Workers by Sex and Region (2014)
Region Number (In thousands)
Both Sexes Male Female
Philippines 2,320 1,149 1,170
National Capital Region 10.5 12.5 8.6
Cordillera Administrative Region 2.2 1.6 2.91
I - Ilocos Region 8.2 6.4 9.9
II - Cagayan Valley 6.7 3.9 9.5
III - Central Luzon 15.5 18.6 12.4
IVA - CALABARZON 17.9 20.7 15.1
1 IVB - MIMAROPA 2.1 2.5 1.6
V - Bicol Region 3.4 3.3 3.6
VI - Western Visayas 8.6 8.4 8.7
VII - Central Visayas 6.5 8.8 0.4
VIII - Eastern Visayas 1.1 1.2 1.1
IX - Zamboanga Peninsula 2.6 2.3 2.9
X - Northern Mindanao 3.4 3.3 3.6
XI - Davao Region 2.7 1.5 3.9
XII - SOCCSKSARGEN 4.6 2.3 6.9
Caraga 2.0 1.8 2.1
Autonomous Region in Muslim 1.8 1.0 2.7
Mindanao

Scattered all over the world, our overseas Filipino workers have been hailed ad
our modern-day heroes, contributing to the growth of the economy and sending millions
of dollars to their families back home in the Philippines. The lack of jobs in their native
land, and the low wages for whatever jobs are available are the main reasons Filipinos,
both male and female, try to find work in foreign countries. Oversupply of workers has
resulted in low-wage levels. Insufficient jobs in relation to the available labor supply has
also led to these low-wage levels since workers compete among each other for these
limited job openings. Those unwilling to work at these low-wage levels look for greener
pastures, which they find in foreign countries. They do a wide variety of jobs:
professionals, health workers, caregivers, engineers and construction workers,
entertainers, and teachers.

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SUPPLY – DEMAND AND PHILIPPINE
ECONOMIC PROBLEMS
THE PHILIPPINE PESO AND FOREIGN CURRENCIES
Trading with other countries is also an important economic activity that impacts on
the economy. Selling locally made products, called exports, means we earn dollars as
payment for these goods bought by foreign buyers. In the same manner, we buy goods
from other countries, and these are imports. When we trade with other countries, we need
a common currency to use to pay for goods we buy from them and for them to pay us for
goods we sell to them. When we travel to foreign countries, we may bring peso or the US
dollar, then convert them into the local currency of the country which we visit. For
example, we convert our dollars into baht when we go spending in Thailand, to rupees in
India, euros in Spain and other European countries, and yen in Japan. This is why we
need conversion rates and these are based on the existing foreign exchange rates.
The rate of conversion of the Philippine peso to a foreign currency is reflected in
the exchange rate. If we have pesos that we need to convert into dollars, we need to
know the current exchange rate. These rates are dependent on the working of demand
for and supply of the currency in the market. For example, if the US dollar is demand, the
price of the dollar will increase and will be reflected in a higher exchange rate in favor of
the dollar, which means one will need more pesos to buy dollars.
Table. Peso – Dollar/Euro Exchange Rates
Bangko Sentral ng Pilipinas
Treasury Department

Reference Exchange Rate Bulletin

Country Unit Sym Euro U.S Dollar Phil. Peso
bol Equivalent
I. CONVERTIBLE CURRENCIES WITH BANGKO SENTRAL
1 UNITED STATES DOLLAR USD O.929195 1.000000 44.412000
2 JAPAN YEN JPY 0.007802 0.008396 0.372900
3 UNITED POUND GBP 1.387289 1.493000 66.307100
KINGDOM
4 HONGKONG DOLLAR HKD 0.119876 0.129011 5.729600
5 SWITZERLAND FRANC CHF 0.971555 1.045588 46.436700
6 CANADA DOLLAR CAD 0.762073 0.820143 36.424200
7 SINGAPORE DOLLAR SGD 0.688344 0.740796 32.900200
8 AUSTRALIA DOLLAR AUD 0.724236 0.779423 34.615700
9 BAHRAIN DINAR BHD 2.465363 2.653224 117.835000
10 KUWAIT DINAR KWD
11 SAUDI ARABIA RIAL SAR 0.247779 0.266660 11.842900
12 BRUNEI DOLLAR BND 0.685804 0.738062 32.778800
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 13 INDONESIA RUPIAH IDR 0.000072 0.000078 0.003500
14 THAILAND BAHT THB 0.028679 0.030864 1.370700
15 UNITED ARAB DIRHAM AED 0.252980 0.272257 12.091500
EMIRATES
16 CHINA YUAN CNY 0.149950 0.161376 7.167000
17 KOREA WON KRW 0.000855 0.000920 0.040900
18 EUROPEAN EURO EUR 1.000000 1.076200 47.796200
MONETARY
UNION

The table lists the various currencies into which the Philippine peso is convertible.
The most commonly traded currency in the world is the US dollar. Before the United
States economy experienced economic recession in 2008 to 2010, the dollar had a very
high value in the market. In the Philippines, the dollar was at its highest when we needed
P55 to buy one dollar. If the exchange down to the level P44 to P45 per dollar. This
is likewise the effect of the workings of demand and supply in the market. When the
supply of a currency increases, its value tends to decrease and we pay a lower price for
it. When the demand for a foreign currency increases, its value will increase and we pay
a higher price for it.
HOUSING SHORTAGE AND THE REAL ESTATE BOOM IN THE PHILIPPINES
Demand and supply also play an important role in the Philippine real estate
situation. In the late 1990s, during the Asian financial crisis, construction hit low levels in
the Philippines. Some high profile construction projects were abandoned and demand for
housing was at low level. Some real estate companies even had to close. This was the
effect of decreased demand for construction projects.
However, as soon as the Asian countries recovered from the crisis, the
construction sector also started to recover. High-rise condominium buildings and
townhouses started to bloom in the metropolis. In Metro Manila, we still continue to see
new buildings rising. The real estate boom currently being experienced in the country may
also be traced to the booming Business Process Outsourcing (BPO) sector in the country.
With the rising number of BPOs in the metropolis, there is a need to put up offices, which
also means an increase in the demand for commercial spaces. And with more employees
working in these offices, some moving from the province to Metro Manila, there is also a
rise in the demand for residential spaces.

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 Table shows occupied housing units in order to give us an idea of demand for
housing in the country.
Table 2.10. Total Number Occupied Housing Units
in the Philippines by Census Year, 1960 to 2010
Decennial Census Total Population
(in thousand)
1960 4,435.2
1970 5,668.8
1980 7,919.9
1990 11,161.7
2000 14,891.1
2010 19,715.7

The residential market in the country continues to grow because of Filipinos who
pursue their dream of owning houses. Rich people continue to have more options, with
new housing available at the Fort in the Global City in Taguig, as well as in Alabang, in
Makati, Quezon City and Parańaque.
The increase in residential demand may also be traceable to the OFW sector, with
remittances allowing their families back home to buy more affordable houses. Office
buildings and high-rises to continue sprout all around us. We se numerous construction
sites, developers try to meet the backlog in housing for Filipinos. Promotion of housing
developers is so aggressive, we walk around the malls and their agents come up to us
with beautiful brochures informing us of available condominiums or townhouses with
financing made easy, and with light terms for the buyer.
RENT AND PRICE STRUCTURE
The layman’s concept of rent is payment for the use of land or buildings belonging
to others. It is the compensation made to the owner land or building. From the point of
view of economics, rent refers to a payment made to or for a factor of production over
and above the amount expected by its owner. Economic rent is the positive difference
between the actual payment made for a factor of production (such as land, labor, or
capital) to its owner and the payment level expected by the owner, due to its exclusivity
or scarcity. Economic rent exists due to market imperfections; there would be no need for
payment for rent. Henry George(2014) describes the concept of rent in economic as
follows:
“In the economic meaning of rent, payments for the use of any of the products
of human exertion are excluded, and of lumped payments for the use of
houses, farms, etc., only the part is rent which constitutes the consideration for
the use of the land. The part that is paid for the use of buildings or other
improvements is properly interest as it is consideration for the use of capital.”
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 In short economic rent is any unearned income.
SAVINGS AND INVESTMENT

Saving and investment are necessary to build the future. Savings is to investment
as food is to the body nourishment process. As food and the nourishment process sustain
body growth, so do savings and investment to the growth of the economy’s productive
capacity. But saving calls for giving up the present in order to build up and, therefore,
invest for a future. Saving and investment are not only the concern of business but also
of households and government.
Investment is defined as building up the capital stock for more future production
and consumption. But the cost of investment is saving is defined postponed consumption
at present. Behind the use of money as exchange medium are the real activities of
savings and investment, which are clearly seen in the households that produce of their
own consumption (e.g., subsistence farmer). Say, a rice farmer wants to produce a
surplus and sell it in the marketplace to provide for his family’s other needs. To realize
this, he builds an irrigation canal from the river (investment) for planting and harvesting
even during the dry months. But this form of investment calls for giving up some weeks
of planting resulting in foregone consumption (savings) in exchange for greater
consumption from the production surplus in the future.
However, the use of money as exchange and credit medium can maximize savings
and investment. While one constantly saves money for future use, another one spends
on investment even before accumulating savings by borrowing. One can borrow and
repay against future accumulated savings. The credit systems through its intermediaries,
like banks link savers and investors who are not the same persons. Thus, this access
encourages savings to maximize its allocation for investment.
Even government borrows the savings of households and business to spend on
capital accumulation. Capital takes the basic forms of machineries, equipment, and
buildings and construction. While business builds additional factories that also create
employment, households continuously accumulate fixed assets like houses and cars for
more services. On the other hand, government invests in physical infrastructures like
roads and bridges to encourage business activities. All these capital accumulations

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redound to bigger productive capacity to sustain household consumption. The economy’s
capital information (investment) has always been greater than savings since government
investment is also financed by taxes and at times, foreign borrowings.

Figure. Savings and Investment as % Gross Domestic Product (2015)

RENT

The problem of unaffordable decent housing is the problem not so much of the
middle class as the poor due to poverty. Typical middle-class household members pitch
in to afford decent housing rental and eventual ownership. But the poor cannot afford
decent housing at all, let alone they are not convincing enough for housing loans without
formal employment and paying capacity. Lacking skills, they are self-employed (e.g.,
construction workers). Thus, they land-to-mouth without employment record that could
otherwise entitle them to the social benefits provided by the government. Thus the poor
squat on other people’s lands or rent squatter housing in subhuman living condition they
can only afford.
The poor spend more than their meagre income to make both ends meet.
Nonetheless, they can hardly provide even for their basic needs, which include housing.
A typical poor family spends on food and practically nothing on housing and other
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consumer items. Thus poverty has isolated the poor to live in slum areas crowding in
shanties they do not even. Even in worst condition are those at the bottom thirty percent
(30%) of family income earners who are the poorest of the poor as they live below poverty
line. Much less could they provide even for food consumption that many live in the streets
and other public places. In contrast, even the middle class can afford some savings and
provision for their other needs.

Figure. Family Income Expenditure (2012)

Figure. Family Expenditure Distribution (2009)

(Bottom 30% of Family Income Groups)

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 Figure. Family Expenditure Distribution (2009)
All Family Income Groups

MINIMUM WAGE
The problem of inadequate wage is intertwined with the problem of unemployment.
Both problems stem from the lack of jobs for our large labor force. The excess labor
supply due to lack of jobs at Point A reduces wage from W 1 to W 0 at point B. Yet, the
resulting increase in labor demand (L0 – L1) is not enough to employ excess labor (L0 –
L1) simply because jobs are not enough. Therefore, wage is more inadequate and
unemployment rate is higher as more and more people cannot find jobs that have become
scarcer; Reconstructing, more excess labor decreases wage and increase the number of
unemployed even more.
But the relatively few employers can exploit many who badly need jobs all the
more. For this reason, the government mandates a minimum wage to protect workers.
Employers force helpless workers to accept a wage even lower than W0 at Point C. Thus,
government mandates a wage no lower than W 0 at point B to at least prevent further
exploitation of workers. In other words, employers are banned from paying wages below
the minimum standard set by government. Yet, most wages are still below the minimum
standard due to lack of enforcement. On other hand, total enforcement may not be
possible with the millions of employers the government has to watch for violations.

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 Figure. Labor Supply-Demand

500
450
400
350
300
250 Average Wage
200 Minimum Wage
150
100
50
0
Agriculture Industry Service

Figure. Daily Average – Minimum Wage Comparison (2013)

In the long run, it is creating more jobs that will empower workers to readily find
employment and demand higher wages. A higher demand curve raises employment
beyond L2 and Wage to W 2 at Point D. For after all, minimum wage legislation is just
government’s control tool to prevent further exploitation of workers. Making it a long-run
solution to the wage and unemployment problems will only make labor more costly
resulting in less hiring and more unemployment at Point A.

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TAXES

We pay taxes for government to provide public goods and services that empower
and enable individuals and institutions alike (e.g., school, business corporation) to pursue
their dreams. One example of a public good is farm access road for farmers to transport
their produce to the cities for the needed cash income. Another example is the public
school system to educate children of poor families out of poverty. On the other hand, an
example of a public service is resorting peace and order in war-torn areas in Mindanao
by the armed forces and police that all can resume normal life. Another example is the
regulation of business permits by the City Hall to prevent industrial overcrowding, which
can dampen the incentive to do business. In other words, we pay taxes for government
to provide a better place where we can exercise our freedom securely, and progressively.
But taxes are yet out burden even as we ultimately benefit from the public goods
and services we get in return. Taxes can dampen the incentive to do business for the
benefit of society as they can eat up profit. An example is the usual profit tax that diverts
investment from new and vital products (e.g., cancer drugs) to those who need less of
(restaurants). Pioneering businesses need some tax reliefs in the early stage of market
exposure when profit is still lean. Taxes can also distort saving, investment, and
consumption as income earners shift to substitutes to avoid the tax burden. An example
is the high tax on interest income, which drives income earners to put their savings instead
in individually lucrative but socially unproductive real assets like jewelries, idle lands, and
the like. Ideally, tax benefit is maximized as its burden is minimized.
The main issue that hobbies the government to maximize tax benefit while
minimizing its burden is the shortfall of tax collections due to corruption. The Philippines
is one of the lowest in tax collections and thus, government spending (as % of GDP) even
in Asia. As tax collection has even declined through the years, the budget deficit
(spending over tax revenue) has correspondingly worsened. What is worse is the
government borrows from the public to make up for the deficit and stretch government
spending. Ultimately, repayment of public debts by drawing on the government budget
only crowds out spending especially on the more important public goods and services.
Shortfalls of tax revenues and government spending can mean less road maintenance,
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books for the public schools, medicals services, and medicines for the poor, to name a
few. On top of the shortfalls, corruption misallocates spending on the not-so-important
from the more important public goods and services (e.g., road beautification instead of
free medical services for the poor).

Figure. Tax Revenues as % of GDP

Figure. Government Budget Performance (% of GDP)

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Test
I. A. Using the following demand function, solve for the demand schedule of consumer.
Randy given the following prices for bottled water.
Qd = 60 – P/2
Prices QD
P0
2
4
6
8
10
12
14
16

 Based on this table, construct a demand curve for Randy

B. On the other hand, for Robin, a seller of bottled water in the market, the supply
unction is given as:
Qs = 5 + 5P
Prices Qs
P0
2
4
6
8
10
12
14
16
 Construct the supply curve of Robin and put it in a graph with Randy’s demand
curve
 Assuming that Robin is the only seller and Randy is the only buyer in the market,
identify the equilibrium price and quantity.

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II. Answer the following questions
1. What are the key words that contrast savings and investment?
2. What is investment for?
3. How does the government investment complement private investment?
4. What is savings to investment?
5. What condition prevents the poor from affording decent housing?
6. Why do they lack even the credibility to borrow money from lending institutions (e.g.
banks) for housing?
7. Why do the poor spend more than what they earn?
8. What is their spending pattern from the foregoing?
9. What are taxes for?
10. What good are the foregoing for society?
11. What are the distorting effects of taxes and why?
12. What are the distorting effects to society of shortfalls of tax collection?
13. What depresses wages and creates unemployment?
14. What conditions employers to exploit workers even more?
15. What can be a lasting solution to the problems of inadequate wage and
unemployment?

III. Activities
1. The class will be divided into five groups. Each groups will be assigned to get a one
year, month – to – month exchange rates of the Philippines with :
Group 1: The British Pound
Group 2: The Japanese Yen
Group 3: The Euro
Group 4: The Taiwanese dollar
Group 5: The Malaysian ringgit
In class, compare the findings of all the groups. Identify the currencies which had
more or less stable exchange rates and then those whose exchange rates
changed more frequently. For the second group of currencies, find reasons for
the frequent changes in the rates.
2. Research on the dollar to peso exchange rate from the time of the presidency of
Diosdado Macapagal to the presidency of Nonoy Aquino. List down the rates over
the years and try to find reasons for abrupt increases or even decreases in the
exchange rate.
3 . What difference would make if your parents did not save? What consumption have
you sacrificed in terms of consumption in order to save on your weekly allowance?
What were you able to buy with your accumulated savings? What is now the benefit
of savings for and investing in those purchases?
4. Assume that your family’s budget is only P200 a day. Figure out with the help of your
mother what it can buy. How much can you set for a monthly rental or housing loan
repayment with the foregoing budget? Imagine the kind of house your family can
afford to rent with the amount in the foregoing. How do you compare this house with
what you see in the slum areas?
5. Repeat question 4 assuming this time the daily budget is much less at P100.

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6. Assume that your family’s budget is equal to the minimum wage of P490 a day.
Figure out with the help of your mother what it can buy. How much is left for house
rental, medical services, tuition, etc.? is the budget enough to make both ends meet?
is your family better off with its actual budget as compared with the minimum wage?
Again, ask your mother how she allocates your family budget. How much do you
think a family should earn to provide for at least, the most basic needs (e.g. food,
housing)?
7. Ask your parents how much taxes they pay annually. Figure out with their help what
they could otherwise buy with said amount.
8. Enumerate 5 common public goods and services government provides with the
taxes we pay. Are the benefits of these public goods and services worth the taxes
your parents pay? Explain

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Unit 3:
INDUSTRY AND ENVIRONMENTAL
ANALYSIS: BUSINESS OPPORTUNITY
IDENTIFICATION

PRINCIPLES, TOOLS, AND TECHNIQUES

A business is just a small portion of an industry. It is undertaking by a person or a
group of person who are partners, or a stockholders who own a juridical entity known as
corporation. Its main objective is to earn profit for the owners. An industry, on the other
hand, is the aggregation of the different businesses engaged in the same line of
undertaking. For example, Celine is a business firm that is part of the country’s shoe
industry.
For a reason to put up a business, it is essential that an industry analysis first be
made. Commonly used is a system known as the SWOT analysis, which lists the
strengths, weaknesses, opportunities, and threats that the business faces
BUSINESS ORGANIZATION
From a legal point of view, there are four ways to form a business:

1. Sole Proprietorship. The vast majority of small businesses start out as sole
proprietorships. These firms are owned by one person, usually the individual who has day-to-day
responsibility for running the business. Sole proprietorships own all the assets of the business
and the profits generated by it. They also assume 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 owner’s personal tax return
 The business is easy to dissolve, if desired.

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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 owner’s medical insurance premiums are not
directly deductible from business income (only partially as an adjustment to
income).

2. 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.

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Types of Partnerships that should be considered:

a. 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.

b. 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.

c. 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.

3. 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 corporation’s 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.
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4. Cooperative. A cooperative is an entity organized by people with similar needs to
provide themselves with goods or services or to jointly use available resources to improve
their income.
Cooperative members have an equal say in decision- making with one vote per
member regardless of number of shares held, there is open and voluntary membership
and surplus earning is returned to the members according to the amount of their
patronage.

SMALL, MEDIUM, AND LARGE SCALE BUSINESS

It is also important to study the classification of business as to the size based on
the worth of the business assets. In the Philippines, total assets for micro business are
worth below P1, 500, 001. For the small business, total assets are from P1, 500, 001 to
P15, 000, 000. Medium business has the total assets from P15, 000, 001 to P60, 000,
000. Any business with assets in excess of P60, 000, 000 is considered large scale.
For any form of business organization, the business must be registered with the
appropriate government agencies. In the case of sole proprietorship and partnerships,
100% must be owned and capitalized by Filipinos. For corporations, at least 60% f the
outstanding capital stocks must be owned by Filipino citizens. Business activity conducted
may be within major sectors of industry, services, practice of profession, or operation of
tourism-related business and agri-business.

TOOLS IN EVALUATING A BUSINESS

According to guide developed by North Carolina’s Small Business and Technology
Development Center, the key factors that must be considered in analyzing the industry
are the following:
1. The geographic area which your business will cater to. Is it limited to local areas?
Or will it cover a region, the entire country, or even the international market?
2. The size and outlook of the industry. What trends can be identified?
3. Description of the product.
4. The buyers have to identify. Who are your target customers?
5. The regulator environment. Are the local, national laws that will restrict the
business? One needs to identify government regulations specific to the chosen
industry.
6. The need to identify the leading businesses in the industry, and to provide
company information on the most successful businesses that you will be up
against.
7. Factors that will affect the growth of the business.

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THE SWOT ANALYSIS
SWOT analysis (or SWOT matrix) is a strategic planning technique used to help
a person or organization identify the Strengths, Weaknesses, Opportunities,
and Threats related to business competition or project planning.[1] It is intended to
specify the objectives of the business venture or project and identify the internal and
external factors that are favorable and unfavorable to achieving those objectives. Users
of a SWOT analysis often ask and answer questions to generate meaningful information
for each category to make the tool useful and identify their competitive advantage.
Strengths and Weakness are frequently internally-related, while Opportunities and
Threats commonly focus on environmental placement.

 Strengths: characteristics of the business or project that give it an advantage over

others.
 Weaknesses: characteristics of the business that place the business or project at a
disadvantage relative to others.
 Opportunities: elements in the environment that the business or project could exploit
to its advantage.
 Threats: elements in the environment that could cause trouble for the business or
project.
SWOT analysis aims to identify the key internal and external factors seen as
important to achieving an objective. SWOT analysis groups key pieces of information into
two main categories:

1. Internal forces

The strengths and weaknesses actually refer to the internal forces, and
these are the resources and experiences readily available to the business
proponent. Usually include as internal forcess are:

a) financial resources such as money and sources of funds for

investment;
b) physical resources, such as the company’s location, facilities,
machinery, and equipment
c) human resources consisting of employees;
d) access natural resources, trademarks, patents, and copyrights; and
e) current processes, such as employee programs, department
hierarchies and software systems ,sales and distribution
capabilities, marketing programs, etc.

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 2. External forces — the opportunities and threats presented by the environment
external to the organization. These may include:

a) economic trends including local, national and international financial

trends, developments in the country’s stock market, reforms in the
banking system, growth of the Gross Domestic product;
b) market trends, such as new products or technology or evolving
buyers’ profiles, including changes in tastes and lifestyle behaviour;
c) national and local laws and statutes as well as political, environment,
and economic regulations;
d) demographic characteristics of the target market such as the age,
the gender, the culture of the costumers;
e) relationship with suppliers and co-owners; and
f) competitive threats

Before an owner can plan for its business’ future, he/she must first evaluate the
business by identifying and analyzing internal and external resources and threats. The
SWOT analysis is a tool that can help a proponent by enabling him/her to identify and
assess the internal and external forces that can affect the business. When used properly
and regularly, this can serve as guide for the company to attain success. It is guide to
prepare for a new venture, design business strategies, and identify areas of change and
reform. When used properly, the business owner can anticipate problems, including
possible solutions and take advantage of identified opportunities. The owner can
maximize its strengths and attempt to cut out its weaknesses.
The table presents a SWOT analysis template that can be used as a guide to
identify the strengths, weaknesses, opportunities, and threats.
STRENGHTS WEAKNESSES
 Government incentives  Difficulty of organization
 Low capital requirements  Costly set-up
 Market acceptance  Possible pollution problems
 Experienced leaders  Lack of training of workers
OPPORTUNITIES THREATS
 Project may replace imported good  Entry of competitors
available in the market  Time consuming production
 Will improve employee welfare processes
 Improved company reputation  Opposition from residents in the
community.
Table. SWOT Analysis Template

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PORTER’S FIVE FORCES OF COMPETETIVE POSITION ANALYSIS
Porter's Five Forces of Competitive Position Analysis were developed in 1979 by
Michael E Porter of Harvard Business School as a simple framework for assessing and
evaluating the competitive strength and position of a business organisation.

This theory is based on the concept that there are five forces that determine the
competitive intensity and attractiveness of a market. Porter’s five forces help to identify
where power lies in a business situation. This is useful both in understanding the strength
of an organisation’s current competitive position, and the strength of a position that an
organisation may look to move into.

Strategic analysts often use Porter’s five forces to understand whether new
products or services are potentially profitable. By understanding where power lies, the
theory can also be used to identify areas of strength, to improve weaknesses and to avoid
mistakes.

Figure. Porter’s Five Forces of Competitive Position Analysis

The five forces are:

1. Supplier power. An assessment of how easy it is for suppliers to drive up prices. This
is driven by the: number of suppliers of each essential input; uniqueness of their product
or service; relative size and strength of the supplier; and cost of switching from one
supplier to another.

2. Buyer power. An assessment of how easy it is for buyers to drive prices down. This is
driven by the: number of buyers in the market; importance of each individual buyer to the
organisation; and cost to the buyer of switching from one supplier to another. If a business
has just a few powerful buyers, they are often able to dictate terms.

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3. Competitive rivalry. The main driver is the number and capability of competitors in
the market. Many competitors, offering undifferentiated products and services, will reduce
market attractiveness.

4. Threat of substitution. Where close substitute products exist in a market, it increases

the likelihood of customers switching to alternatives in response to price increases. This
reduces both the power of suppliers and the attractiveness of the market.

5. Threat of new entry. Profitable markets attract new entrants, which erodes
profitability. Unless incumbents have strong and durable barriers to entry, for example,
patents, economies of scale, capital requirements or government policies, then
profitability will decline to a competitive rate.

IMPORTANCE OF PORTER’S FIVE FORCES ANALAYSIS

The Porter’s Five Forces Analysis is a significant tool for organizations to
understand the factors affecting profitability in a specific industry and can help to form
decisions on whether or not to enter a specific industry, whether or not to increase a
capacity in a specific industry, and also for developing competitive strategies.
Under this theory, a business becomes more attractive, the greater the suppliers
power to drive prices up, the less the buyer’s power to drive prices down, the less the
number of competitors in the market, the more differentiated the product or service is ,the
less the substitutability of the products for similar goods, and the more difficult it is for new
entrants to participate in the market. (Chartered Global Management Accountant 2015)

INDUSTRY ANALYSIS
In a book published by the Development Academy of the Philippines, How to
Prepare Feasibility Studies, it includes an industry analysis of the following important
factors.
COMPETITION. Who are the major businesses in the industry? Are there locations
close to your proposed business? Have they been long existing or still new entrants?
What is the market share of each of these businesses? It is very important that you know
your competitors and be ready for them. Your aim is to win their costumers, convince
them to buy from you instead, and remain as loyal customers.
CUSTOMERS. Who will you sell your product to? The target market must be
identified. Who exactly will buy your products? What income groups? What age brackets?
What gender? What career groups? What type of people will you cater to, based on their
preferences, lifestyles, and buying habits?
SUPPLIERS. Every retail business suppliers from whom one can source raw
materials, intermediate products, or even the finished goods one intends to resell.
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 A business may need one or more suppliers. It is important to develop suppliers
who are reliable in terms of the quality of what they supply and their dependability in
coming up with the things you order from them. With modern technology, one can easily
go online and shops for suppliers look at reviews made by the other retailers to determine
who the reliable ones are. The yellow pages of the telephone directories are also a good
source of suppliers’ stores and names. The person intending to put up a business must
ask around for prices in order to be more competitive with other sellers in the market.
A business owner can buy directly from the manufacturers. This will be the
cheapest source since there are no middlemen involved. However, this is only
recommended if the supplier’s location is convenient and will not involve expensive
delivery costs.
Another alternative is to buy from distributors. They are wholesalers of brokers who
buy in big quantities from manufacturers, add a mark-up to their purchase price and sell
to retailers. Their prices are higher but they can sell in small quantities, which the
manufacturers would not normally do.
A third source of goods is through imports. Some businessmen go to nearby
countries to buy their goods or raw materials there. There is advisable if the prices abroad
are relatively cheaper and no heavy import duties will raise the prices and make the goods
less competitive in the country and when transport costs are not excessive.
It is important to maintain good relationships with one suppliers; they are the key
to one’s continued access to goods and to raw materials that will be needed for the
business.
SUBSTITUTE. Substitutes are goods that can be in place of another. These are
goods that may, even if partly, satisfy the same needs of a consumer such that the
consumer may use one instead of another. For example, margarine can be a substitute
for butter or wheat bread for white bread. Some goods are close substitutes while others
are not. Pepsi Cola may be a very good substitute for Coca Cola, but not everybody will
be willing to switch brands because they have developed a taste for a particular cola. This
is why manufacturers try to differentiate their products from their competitors so that the
customers will develop product loyalty for their brand. We know that Safeguard and Dove
are both bath soaps, yet we can distinguish one brand from another, and we have our
own preferences.
The more differentiated a products is, the greater the edge of its manufacturer
because this can convince the customers to buy their product instead of that of the
competition.

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A GUIDE TO INDUSTRY ANALYSIS
An industry analysis guide developed by North Carolina’s Small Business and
Technology Development Center (SBTDC) can help in making an analysis of one’s
business industry.
The key factors to be considered in analyzing your industry identified by the
SBTDC are:
1. Geographic Area – identify the area whether local, regional, nationwide. or
international.
2. Industry (as to size) – worth in pesos and number of firms, trends and
developments and future outlook.
3. Product – describe the product as to physical attributes and characteristics, and
its uses
4. Buyers – describe target costumers as to age, income group, geographical
locations, and occupations; include consumers demographics such a
population/household size, sex, race, ethnicity, family status, housing status, etc.,
may also include psychographics such as lifestyle information, tastes,
preferences, and buying habits
5. Regulatory Environment – should include government laws and regulations that
apply to the business.
6. Company Information – make a list of the most successful business in the industry
7. A brief history of the industry – when it started and how it developed
8. Factors that affect growth of the industry – such as migration of population from
rural to urban areas
9. Trends in sales over recent years – show actual sales in the industry over the past
5 years
10. Current operational/management trends within the industry, which are standard
practices prevalent among the firms
11. The types of marketing strategies prevalent within the industry
12. Competitor information – include the location of competitors and how long have
they been in business and their market share
ENVIRONMENTAL ANALYSIS. The other analysis that has to be done is an analysis
of the environment in which the business will operate. This means an evaluation of the
possible or probable effects of external forces and conditions on the survival and growth
of the business.

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ECONOMIC FORCES
This involves a look at economic factors such as income of the people, specifically
the target market, economic conditions such as inflation, recession, prosperity, demand,
and supply in the market.
PHYSICAL ENVIRONMENT
This includes a look at the population size, the geography of the place where
business will be located, land distribution, climate, and in today’s global warming situation,
whether or not the area is prone to flood or earthquake.
POLITICAL FACTORS
The type of government, the stability and strength of the government, and good
leadership are factors that can be an advantage to a business.
CULTURES AND LIFESTYLES
It is important to study cultural practices such as fiestas, celebration of the
Christmas seasons, trends and consumption patterns, as a means to identify the goods
and services that will fit into these celebrations and spending behavior.
COMPETITION’
This is something that needs to be studied. As already mentioned above, the
degree of competition in the market and the extent and strength of competition are all
very vital in determining the success or failure of a business.

THE CIRCULAR FLOW OF ECONOMIC

ACTIVITY
To further guide the students on how the market works, this section describes the
various economic activities that take place in an economy. This is referred to as the
circular flow which is defined as the flow of activities of household and firms in a circular
direction. Let us start with the first illustration.
THE SIMPLE FLOW OF GOODS AND SERVICES
Goods and services flow from the firms as producers, to the households as
consumers, in a clockwise direction. On the other hand, households as resource owners
provide firms as producers with resource use such as labor rendered, capital lent or
invested, land rented to producers, and entrepreneurial skills. These resources flow from
the households to the firms also in clockwise direction. It is the use of these resources
that enables the firms to produce the goods and services delivered to the households.
The flow of products and resources are the physical flows in the economy.
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 The flipside to the physical flow is the money payment flow. Household pay and
firms earns revenues in exchange for the goods and services received and provided,
respectively. Revenue revenues flow counter clockwise from the households to the firms
as payments for the goods and services received by the former. Likewise, firms pay and
households earn factor income for the use or resources provided to the former. Factor
income payments counter flow from the firms to the households for resources provided
by the latter.
For as long as households are willing to consume, producers continue to produce
goods and services for the households using the resources provided by the latter. As the
physical flow continues, so is the money payment flow in exchange for products and
resources, the physical flow continues in clockwise direction in exchange for money
payment flow in the counterclockwise direction.

Figure. The Circular Flow

A closer look
Among the firms, there is also the product flow up the production stages, that is
from the raw material to the intermediate good and on to the final good for consumption.
Opposite the product flow is the money payment flow in exchange for product delivery
down the production stages from the consumer, that is, to the final then to the intermediate
and on to the raw material stage (broken arrows.
Raw materials are unprocessed goods like raw materials, logs, and wheat, which
are extracted from their sources and do not undergo any process of production.
Intermediate goods are semi-processed goods that are not ready for final use by the
consumer, such as leather, cloth, and steel, which have undergone some processing but
need to go through additional processing before they can be actually used. These are
supplied to final good firms of conversion into goods in their finished stage. Final goods

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are goods that are ready for direct consumption such as refrigerators, dresses, or pants.
These final goods are then sold to consumers for their use.
The figure magnifies the production side of the circular flow diagram. Goods flow
up the production stages to the consumers in return for payments trickling down the
production stages for their inter-stage product flows.

Figure. Intra-Production Payments Flows

Another form of physical flow is the flow of resources from the households to the
business firms. The households is the source of resources used by the raw material firm,
the intermediate good firm, and the final good firm. In the flow, it can be seen that the
household provides resources to the raw material, intermediate good and the final good
firms use in the production of goods.

Figure. Resource-Production-Payment Flow

In return for the use of the resources, the three types of producing units make
money payments to households (broken arrows). This is now a financial flow since it
involves the payment of money to the resource owners. Money is now paid by the various
firms to the households as payment for the resources they provide. Much less does

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forestry contribute to output as it will take decades to revegetate our vastly denuded
forests?
INDUSTRIAL SECTOR
The Industrial Sector supposedly processes raw materials from agriculture,
fishery and forestry into intermediate products that are further processed into final
products. For example, local makers of wallet and bags produce the final products by
processing the intermediate product of leather which is manufactured from the animal
hide extracted by agriculture. Within the industrial sector itself, local cement
manufacturers produce the product by heating limestone mixed with clay from the
quarrying industry for use in the construction industry. The lead industries in resource use
and output are manufacturing and construction as they respectively account for 65% and
20% of sectoral production(NCSB 2009).
SERVICE SECTOR
The Service Sector produces the intangibles supporting and complementing
production in the other sectors as well as among its own industries. For example, the
transport industry brings input and output among the other industries. Reliant on its
activity is the trade industry that takes on the complementary role of marketing their
produce. The single biggest industry in resource use and output is trade as it accounts
for 29% of sectoral production(NCSB 2009).

COMPETITIVENESS AND EFFICIENCY

The fair ranking of the Philippines in world competitiveness means that the
country’s industries are yet on their way from the factor-driven to the efficiency-driven
stage. In the Global Competitiveness Report 2013 – 2014 of the World Economic Forum
(WE), the country ranked number 58 among the 148 countries on its list. Factors allowing
the free flow of products and resources are already in place such as institutions,
infrastructure, stability, and basic education and health. However, our industries have yet
to attain the efficiency enabled by higher education/skills, technological readiness, and
product/labor market competition. For example, we have yet to design and produce the
first Filipino car (include engine, transmission) following in the footsteps of countries like
Malaysia and China. Much less are we even close to the innovative stage driven business
sophistication and innovative ideas. This stage cuts across standards to produce
sophisticated products like the electric-powered cars of Japan and the United States. The
outlines what makes a country’s industries globally competitive and responsive to both
local and global needs.

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 Figure. Factors for Global Competitiveness Index

As the country’s industries struggle to attain efficiency toward the government’s

vision of sophisticated innovation, they do so with those in the rest of the world. The
Philippines still lags behind her neighbors in East Asia in labor efficiency alone. Reflective
for her global competitiveness, much less is the country attractive to host foreign
businesses serving regional markets. According to said competitiveness report,
prominent among the problematic factors for doing business in the Philippines are
inadequate infrastructure, corruption, inefficient government bureaucracy, policy
instability, crime rate, tax rate, and restrictive labor regulations.

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 Figure Labor Efficiency of ASEAN Countries in 2009

The country’s producing sector also struggle with one another as they compete
for the use of local resources (e.g., labor). The least efficient is Agriculture, Fishery, and
Forestry combined while the most efficient is industry. While Agriculture, Fishery, and
Forestry combined employs one third of local labor for production, it only contributes one
tenth to the country’s total output. In contrast, Industry has almost twice as much share
on output (27%) as it has in employment (16%). In between in Service which has a slightly
greater share in output (63%) than in the employment (53%). The figure shows the
comparative efficiencies of the country’s main producing sectors.

Figure. Sectoral Share Output (2013)

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 Figure. Sectoral Shares Employment (2013)

Figure. Sectoral Productivity (2008)

AGRICULTURE AND FISHERY
In a global setting these industries are the least competitive despite the country’s
natural resources mainly due to human factors affecting efficiency. The uncontrollable
nature (e.g., typhoons, drought, etc.) occasionally disrupts production and causes
damage to crops. But socio-economic and governance factors explain more why the
country’s agriculture lacks the technology, skills, market competition, and even credit
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enabling efficiency to be at least self-sufficient in food. The figure shows that rice
production – the leading crop of agriculture – is even short of consumption. Unlike fishery
and livestock, agriculture is more exposed to both natural and human factors with its
longer production cycle involving land cultivation and nurturing what nature grows.

Figure. Contribution of Local Production to

Local Consumption (2008)( in Percent)
In particular, inadequate socio-economic and public infrastructure coupled with
liberalized trade smother agricultural efficiency of the know-how, resources, and
competitive environment to at least meet local consumption. Small-scale farming – the
foundation of agriculture – is limited to take advantage of size and access to technology,
skills, credit, and marketing networks. Most farms (63%) are micro in scale with an
average size of 2.2 hectares (List of Establishments, NSO 2009). Also, the continuous
conversion of agriculture lands for industrial use and settlement even threatens to
decimate the number of farmlands left. Let alone the almost one-half of irrigable lands
(44%) is not irrigated yet (World Development Indicators, “World Bank 2006”). On top f
the limitations of size, inadequate infrastructures (roads, transport, and storage) hamper
the free flow of products and input between farms and markets. On the other hand, trade
liberalization (e.g., tariffs) has overwhelmed local production that is yet too weak to stand
up to foreign competition as of rice from China, Thailand, and Vietnam. The Philippines
have the lowest yield per hectare of rice land and per person among ASEAN countries.
Thus, we import cheaper rice to supplement local production although the latter has been
accelerating to decrease the former.

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 Figure. Average Palay Yield Among
ASEAN Countries
(In Metric Tons Hectare)

Figure. Average Palay Production per Person among

ASEAN Countries,
Average fro 2008 – 2010 (In Kilogram Per Person

The same socio-economic and governance factors limit efficiency in the fishery
sector that it can hardly produce a surplus for export. Like in agriculture, fishing activities
are micro in scale confined to municipal fishing and aquaculture (List of Establishments,
NSO 2009). Municipal fishing by small shore crafts while aquaculture is culturing and
growing fish in the controlled environment of mostly small fishponds. These industries

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jointly and equally account for the bulk (71%) of fishery production (Bureau of Agricultural
Statistics, Department of Agriculture 2013). In contrast, commercial fishing accounts for
a little over one-third of mostly exportable fishery production (39%) by big corporations
using big vessels that are instrument-navigated in deep sea. On top of size limitations is
the inadequacy of road, transport, and storage facilities to preserve and market the
perishable product in order to fetch more competitive prices. Likewise, industrial and trade
policies have even made fuel – a critical input – more costly especially for the motorized
bancas of small municipal fishermen. Going back to, fish supply, mostly from the
municipal and aquaculture industries, is just enough to meet local consumption needs
(100%). The weakness of these industries deprives the small fisherman of the income
opportunity to produce a surplus of high-valued species for export.
MANUFACTURING
In spite of the liberalization f foreign investment and trade, the manufacturing
industry is hardly competitive even in the ASEAN region due to limitations of size and
structural support. Likewise, these limitations smother manufacturing efficiency especially
of the technology and skills to grow and complete in a global context. Almost all (89%)
manufacturing establishments are micro in scale with limited access to competitive
opportunities similar to agriculture and fishery (NSO 2008). These light enterprise
produce consumer goods-mostly (86%) food manufacturers – contributing the bulk (55%)
of manufacturing output using low technology and skills (NSCB 2012). Lacking
government support to deepen technology and production, the fewer enterprises of much
larger scale are into the final productions stages of electronics, machineries, chemicals,
petroleum, and garments. In the absence of intermediate (middle) product industries, they
are the most that we can have – import-dependent and without much need for technology
and skills. Thus, they do not contribute much to the economy in terms of output and jobs.
The same lack of government support fails to challenge micro enterprises to grow toward
higher technology and creativity levels. As in agriculture, even local enterprise of larger
scale are still to stand up of foreign investment and trade competition induced by
liberalization policies.
TRADE AND TRANSPORT
In spite of being the top grosser (34%) of the biggest sector that is service, the
trade industry supported by the transport industry is also handicapped by the limited size
of its establishments. Almost all (92%) are micro in scale engaged in retail trade the
contributes almost one – half (46%) to total trade (Census of Philippine Business and
Industry, NSO 2012). However, the transport industry has a fair majority (73%) of micro
business mostly engage in land transport and transport support services (e.g.,
maintenance). Land Transport accounts for almost one – half (46%) of all transport
services while transport support services accounts for bulk (52%) of industry output. On
top of limitation size, thirty percent (30%) of trade establishments crowd in Metro Manila
serving only thirteen percent (13%) of the country’s population. But crowding more in the
same National Capital Region are more than one-half (56%) of transport establishments
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in the country. On the other hand, less crowded are thirteen percent (13%) of trade and
eight percent (8%) of transport establishments in nearby CALABARZON (Cavite, Laguna,
Batangas, Rizal, and Quezon) industrial zone serving fourteen percent (14%) of the
country’s population (Census, NSO 2010). At any rate, even businesses in this industrial
zone are near support industries in the Metro Manila where one-third (30%) of
manufacturing establishments are also based.
INTERNATIONAL TRADE
Assembled electronic products top the country’s exports (40%) dominated by
manufacturers reflective of the country’s waning agriculture sector (Philippines Statistics
Authority, Foreign Trade Statistics 2013). The assembled parts are imports from
subsidiaries in the global networks of the same multinational corporations (e.g., Intel,
Texas Instrument). These electronic parts are also the country’s leading imports (22%)
followed by minerals, fuels, machineries and equipment, and the like. Almost all imports
are semi-final and final manufacturers in the absence of intermediate product industries.
As already mentioned, electronics products hardly contribute to local output and
employment being import-dependent and without much need for technology. Unlike their
counterparts in other sectors, their assembly plants are mostly found in the
CALABARZON industrial zone where support industries in manufacturing and trade are
also moving into.
TOURISM
Tourism is an emerging industry as expenditure of foreign tourists on related
services such as hotels and restaurants transport and entertainment grew by twenty –
nine percent (29%) in 2012. Gaining importance as an industry, it contributed six percent
(6%) to the gross output of the economy (NSCB, Tourism Statistics 2012). It is also figured
as the third leading exports of the country after electronics and miscellaneous services,
which include business process outsourcing (26.9%). Most tourists prefer hotels for
accommodation (80%) and cars for transport facilities (42%). Most also prefer restaurants
(68%) and avail of Internet access (51%) in accommodating establishments. In addition,
establishments concentrate operation in Metro Manila, Western, and Eastern Visayas as
most preferred tourist destinations. However, the industry mostly composed of micro
enterprises (90%) is yet to grow to its fullest potential. The country lags behind even in
the ASEAN region as a tourist destination with a minimum share (5%), in total arrivals
contrast to Singapore (16%), Malaysia (30%), and Thailand (24%). Thus, it is also lags
behind in tourist arrivals per 100 population even in the ASEAN region.

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 Figure . Tourist Arrivals per 100 Population (2011)
SMALL BUSINESS OPPORTUNITIES
Small farmers and fisherman can tap urban consumer markets and distribution
centers with cooperative efforts to minimize the limitations of size and inadequate farm-
to-market facilities. They can engage in the cooperative activities not only of
sharing/collectively owning resources to preserve freshness or delay perishability of
goods at lower cost. Collectively, they can also gain direct and faster access to market
networks to command higher product prices as well as cheaper production input. Let
alone that they can access credit for expansion on collective aredibility. However, more
government provisions of farm-to-market infrastructure like concrete road network can
boost the efficiency of cooperative market activities even of farmers and fishermen in the
hinterland.
The country’s growing population also affords cooperating micro enterprises in the
manufacturing, trade, and transport of new consumer markets for growth and expansion.
More micro manufacturers of light consumer products can find new markets in growing
industrial and urban areas like CALABARZON, away from overcrowded Metro Manila.
Complementary and support industries are already gravitating toward these growing
centers, let alone concentration of government infrastructure and services promoting
market efficiency. Thus, new micro trade and transport enterprises can complement or
support the growing number even of light manufacturers moving to these growth centers.
To minimize limitations of size, micro enterprises can form associations for inter- industry
coordination and timely availability of services. In addition, manufacturer’s association
can improve market access on competitive terms. But more government provisions of
physical infrastructure like concrete road network can greatly improve said inter-industry
coordination and market access.

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 In the tourism, micro businesses can help to maximize tourist arrivals and
destinations with timely support and substitute services for big establishments
strengthened by cooperative efforts. Can transport services can support hotel
accommodations while loading houses with restaurants can serve as substitutes in the
latter’s absence. Micro enterprises can also form associations for timely coordination with
big establishments and complementation among themselves. For the meantime, tourism
and related services can concentrate operation in major tourist destinations such as Metro
Manila and Western and Eastern Visayas. However, better road networks can pave the
way for the development of other tourist destinations and services, which include
transport.

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Test
I. Answer the following questions.
1. Distinguish between a business and an industry.
2. Why is competition an important factor that has to be studied before putting up a
business?
3. When you decide on putting up a business, how do you choose the market that you
should cater to?
4. What is the level of Philippine industrial development according to the World
Economic Forum (WEF)?
5. Contrast this current stage with the highest development stage that our country can
aim for.
6. Compare a sectoral contributions to output with sectoral shares in employment. How
does the comparison indicate the relative efficiencies of the different sectors
(agriculture, industry, and service)?
7. What are micro establishments constrained to take advantage of in contrast to large
scale establishments?
8. What farm – to – market facilities do small farmers and fishermen need and why?
What would they miss out if these facilities were inadequate?
9. In what way do rice farmers lose to imports from neighboring countries?
10. Why do local manufacturers mostly consisit of consumer items produced without
much need for technology and skills?
11. Why are large scale manufacturers, only engaged in the final stages of the
production?
12. What are the disadvantages of manufacturing establishments operating outside of
Metro Manila and the CALABARZON industrial zone?
13. Why is it disadvantage of trade and transport services to overcrowd in urban
centers like Metro Manila?
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14. Why do the country’s electronic exports hardly add value and employment to the
economy?
15. What can micro enterprises collectively do with their cooperative actions and
associations.
II. Activities.
1. The class will be divided into five groups. With the teacher’s guide, each group
should suggest a business that they want to put up. Each group should then
justify their choice of business. Each group will discuss among the members
the environment that should be studied in terms of the location they decided to
choose. based on the environmental analysis, the group members should
identify all the factors need to be studied in the specific environment/location.

2. Think of new product you would want to introduce in the market. It can be a
good already being sold but which you can innovate and improve, or it could
be something really new that you yourself conceptualized. Describe that
product in terms of design, composition as to materials used, product use or
application, and its attributes which you believe are unique in that product.

3. Observe and talk the small producers/sellers in your barangay (farmers,

fishermen, or vendors cottage industries). What other market opportunities do
they see and for what purpose and what product. What can they collectively do
when they form an association and for what goals? What kinds of government
support do you think they need for what specific activities? What can your
barangay and city/municipal government can do to support these small
producers/sellers and for what specific projects and products. How would you
conduct your business if you were one of the owners of a small – scale cottage
industry?

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 Unit 4:
SOCIO – ECONOMIC IMPACT STUDY

THE THEORY OF CONSUMER BEHAVIOR

Consumer Theory describes how consumers make decisions on what to buy.
Consumption refers to the use of goods and services to satisfy human wants directly.

THE UTILITY FUNCTION

A consumer aims to maximize the satisfaction he/she derives from the use of a
good or a service. Utility is the term used for satisfaction. Utility is something intangible.
As such, it is not easy to measure. Quantifiable goods are subject to measurement, they
can be expressed in numerical values. In order to make it easy to understand to concept
of utility, we shall assume that it is measurable units, which we shall called utils. A util is
one unit of satisfaction.
The utility function shows the relationship between utility and consumption. In
equation form, it is U = f(C), which simply stated: utility is a function of consumption. Also,
to be more specific, utility for the consumption of goods X and Y can be expresses as: U
= f (X, Y).
Important measures of utility are: Total Utility and Marginal Utility: Total Utility
refers to the combined utility derived from consuming certain units of a good. Marginal
Utility refers to the additional utility derived from consuming an additional unit of the good.
Let us study the following utility schedule of consumer Marvin.
Table . Hypothetical Utility Schedule of Marvin for Chocolate Candy
Quantity of Consumption Total Utility Marginal Utility
1 8 8
2 15 7
3 21 6
4 26 5
5 30 4
6 33 3
7 35 2
8 36 1
9 36 0
10 35 -1

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 Let us study Marvin’s utility schedule for chocolate candy. When he eats the first
bar, he gets a utility of 8. The second bar gives him a utility of only 7. We see that while
his total utility increases with each additional chocolate bar, the additional utility becomes
less and less. The satisfaction he derives from each additional unit starts to diminish.
Notice that upon eating his ninth bar, his total utility does not change at all, which means
that there is no additional utility derived from the ninth. That is why marginal utility at 9
units of consumption is equal to zero. Look at what happens as he consumes the tenth
bar. Instead of increasing, the total declines and marginal utility is even negative. Are
there physical manifestations of a negative marginal utility? Physical discomforts such as
an upset stomach, dizziness, and indigestion are signs that instead of adding to one’s
utility, the consumption of the additional unit of the good has resulted in the decrease of
total utility derived.
The above situation illustrates the Law of Diminishing Marginal Utility. The law
states that as additional units of a good are consumed, the additional utility derived from
each additional unit tends to diminish. The reason for this behaviour is the satiation of
human wants. Man’s wants can be fully satiated at a given time. That is why owners of
Vikings, Dad’s, or Buffet 101, do not lose money even if people are free to eat all they
can. At some point, they will simply give up eating because their wants have been
satisfied.
SIGNIFICANCE OF CONSUMER BAHAVIOR IN BUSINESS
The consumer is the person who buys the product business offers for sale. It is
therefore imperative that we get to please the consumer, so he/she will buy from us
instead of from our competitors and also that once he buys from us he will be loyal to us
and not buy from other sellers of the same product. Knowing how consumer satisfaction
is maximized will help a business in always keeping the consumer’s welfare the topmost
priority.

THE PRODUCTION THEORY

Production refers to the use of economic resources to create goods and services
that will be used to satisfy human wants. In this chapter, we will focus on the behavior of
the producer in an attempt to maximize output. The theory of production is an analysis of
the input-output relationship. The term input refers to the resources used to produce
goods and services. Output refers to the product created as a result of the combination
of input in the production process.
Production function is an equation showing the maximum output of a commodity
that a firm can produce per period of time with each set of input. Input and output are
measured in physical rather than monetary units.

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Output = f(input)
The production function is represented in the equation:
O = f(i)
Where O stands for output and i stands for input. To be more specific, output
depends on the quantity of land, labor, and capital available. Thus:
O = f(Ld, Lb, C)
The production function contains the functional relationship between output and
the basic factors of land, labor, and capital. These basic factors complement each other
as they are used in the production of goods and services.
Output produced is measured in three forms:
 Total Product (TP) is the combined production of several units of a given
input.
 Marginal Product (MP) is the additional output produce by an additional
unit of the input and is equal to ∆TP/∆i.
 Average Product (AP) refers to the average contribution per unit of input
and is equal to TP/i

Let us illustrate the values of the three forms of output by studying the following
table. Let us assume that the variable input is labor measure in man hours and is
combined with fixed of capital and land.

Table. Production Schedule for Output X with Variable Labor Input

Quantity of Labor Total Product Marginal Product Average Product
Input
1 10 10 10
2 22 12 11
3 37 15 12.3
4 55 18 13.8
5 69 14 13.8
6 77 8 12.8
7 80 3 11.4
8 81 1 10.1
9 81 0 9
10 90 -1 8

Let us study the behaviour of the different product values as the quantity of labor
input increases. Initially, we see that the addition of additional labor input leads to a
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proportionally greater increase in total product or output (TP). This results in increasing
values of MP and AP and corresponds to labor input and from 1 to 4. As more input of
labor are added, Total Product continues to increase but already at a decreasing rate.
This happens from the 5th to the 9th input of labor. Here, the Marginal Product and Average
Product already show decreasing values. Upon the addition of the 10 th input of labor, the
Marginal Product is now negative.
The stage where Total Product is increasing at a fast rate is the stage of increasing
returns. Here, Marginal Product and Average Product are both increasing.
When Total Product is increasing at a slower rate and Marginal Product and
Average Product are both decreasing, we have the stage of diminishing returns.
When Total Product decreases and as a result Marginal Product is negative, we
enter the stage of negative returns.
The production behaviour above leads us to the Law of Diminishing Marginal
Returns. It is in reference to the diminishing values of MP. The law states that additional
output starts to diminish at a certain point as additional units of a variable input are
combined with or more fixed input. The reason for this behavior can be traced to the
constraints faced because of the fixed resources that are used in complement with the
variable input, which in this case, is labor.
SIGNIFICANCE OF PRODUCTION THEORY IN BUSINESS
As we already learned, a business is engaged in providing goods and services to
customers with the goal of making profits. Although some businesses are engaged in
retailing goods that they bought from producers, many businesses produce the goods
that they sell. It is therefore important for the business proprietor to be aware of the
production behaviour that will maximize output with limited quantities of output available
to him/her. This is in turn will help maximize profits for the enterprise.

SOCIO-ECONOMIC IMPACT OF A BUSINESS

Today, putting up a business is not just all about profits. It is also concerned with
consumer welfare, job creation, environment issues, uplifting the quality of life, and
contributing to the economy. Let us now look at how a business can impact the consumer,
the suppliers and the investors, the government, and households.
IMPACT ON THE CONSUMER
A new business, especially one that is innovative and focused on bringing some
new product or service to the market, is always welcome to the consumer who is looking
value for his money. If the new business is selling a product that ahs close substitutes in
the market, then the owner of the business will try his best to win the consumers away
from the existing sellers by offering something that will benefit the buyers.

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 How can the new business accomplish this? One good way is to innovative the
product come up with the new features that are not found in the existing competing goods.
This can be in the form of a better appearance, a new venture feature or ingredient or a
new convenient way of making the product available. A new business therefore means
new products or services available to the buyers, giving them more choices.
Since the new seller will try to attract buyers, another strategy that could be
adopted is to improve the quality of the good making it a notch higher than those already
being sold in the market. Although this may mean high prices for better quality goods, this
could cater to a market that is more after quality than low price.
Initially, as a business starts, the seller may make the product available at
introductory prices lower than the other substitutes in the market. This will definitely be
an advantage to the price conscious buyers who have limited budgets.
As long as a new business can provide, new goods and services, better quality of
goods and more options, the consumer can benefit from it. But if a business comes up
with a low quality good and does not provide the consumer value for his money, then this
business will have a negative impact on the market.
IMPACT ON SUPPLIERS AND INVESTORS
A new business will also provide opportunities for suppliers and investors. If a new
construction company is set, up, then this opens up opportunities for the other businesses
that will supply them their needs, tools, wood, cement, steel, paints, nails, screws, and
decorators. May suppliers will now get a chance to sell to the newly established business,
which means income for them.
Demand for the goods provided by the suppliers will increase. These suppliers will
now need to produce more of them and they will need to hire more workers who will earn
wages from being employed. More capital will be needed to invest in the production of
these tools and materials, generating again income for the economy. Investors get to earn
returns on their investments, with capital flowed back into more investments and
generating more income for the economy, thus, leading to economic growth.
IMPACT ON THE GOVERNMENT
The government will also benefit from the establishment of new businesses,
through revenues earned on fees collected from them an on taxes imposed on the
incomes of the businesses.
Before a business can be set up, it has to meet requirements to start opening.
First, the business owner has to apply to start its business. Licenses have to be obtained.
Organizational fees to be paid. On the municipal level the local government earns
revenue from these fees and licenses. This means money added to their local budget to
provide social services to the community, for the development of the company, to pay

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salaries of local officials and workers, to maintain peace and order and to subsidize public
schools.
On the national level, the government gets to impose taxes on the incomes earned
by the businesses. Employees hired by these businesses also have to pay personal
income taxes to the Bureau of Internal Revenue (BIR). For employed workers, these
taxes are regularly withheld by their employers and remitted on the BIR.
These taxes revenues fuel development because they are used by the government
for national activities and for budget allocations for its programs. The national government
has revenues to finance its projects, to pay government officials, to build schools, to
improve the military, to promote peace and order all over the country, to build housing for
the poor, and to provide health services and improved welafare programs for the people.
A more detailed study of the government will follow in the succeeding sections of
this chapter.
IMPACT ON HOUSEHOLDS
New Businesses mean employment opportunities for the Filipinos. Those who
have jobs but are earning low-wages may find better paying jobs with the new companies.
Unemployed workers looking for work may have the chance of being employed by these
companies. The pool of unemployed workers will definitely decrease. Being employed will
enable them to buy their basic needs and even some luxuries. This means that their
quality of life and their standard of living will improve.
Acquisition of wealth and assets can now follow both for the business owners and
the employees they hire. Profits earned by the owners can be invested back into the
business for expansion, or some can be withdrawn by the owners which they can use to
buy new cars or new houses. Success stories on television shows feature rags-to-riches
stories of entrepreneurs who used to be very poor, but with hard work and persistence,
were able to make their businesses succeed, enabling them to send their children to good
expensive schools, building big houses, and buying two or more cars housed in their
garage. The owners, because of their success, manage to acquire wealth and buy assets
which are fruits of their hard work.
With the growing focus on preserving the environment for future generations,
businesses also get to contribute their share. So-called green structures for buildings are
means used to prevent further damage to the environment. Instilling the value of recycling
and reusing of resources among employees and family members may also become the
advocacy of these businesses. Spreading information on the dangers of global warming
may be promoted by the business owners. Thus, businesses become instruments for
society to have a better place to live in.

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IMPACT ON THE COMMUNITY
Corporate Social Responsibility (CSR) has become a growing trend among
businesses today. As a result of this, corporations and even small businesses have
increased their focus on projects that provide scholarships to poor but deserving students,
allocating budgets for housing for low-income families such as participation in programs
like the Gawad Kalinga, environmental protection including tree planting, elimination of
pollution, and other environment related programs. Communities benefit from business-
sponsored activities that include sport fests and wellness programs, livelihood projects,
micro financing, and even medical and dental missions

SOCIO-ECONOMIC AND GOVERNMENT

IMPACT ON BUSINESS

GOVERNMENT IMPACT ON BUSINESS

While the government increasingly spends on socio-economic services to improve
business condition, size and inadequate infrastructure and support services limit the
growth opportunities of micro enterprises. Declining debt payments to local and
international debtors have given way to more spending on services like road development
and education. On the other hand, size limits business access to technology, credit and
market networks in the absence of government support and services (Chapter 3). On top
of the limitations of size, poor road conditions and inadequate support industries further
limit production and marketing by adding cost to doing business. Poor road condition
increases transport cost and the risk of perishability especially of agricultural and fishery
products. High costs of electricity and real estate acquisition increase production cost
especially of manufacturers. Other difficulties in doing business in the country are high
taxes, costly registration, and bureaucratic corruption. Foreigners and foreign companies
face the same obstacles in developing local operation and marketing. The Philippines, as
well as Indonesia, has the highest costs of electricity and the real estate acquisition in the
ASEAN region. It also has the highest tax rate on additional income negating investment
incentives and further increasing cost of registration from bureaucratic red tape or delay.
Thus local enterprises especially those of micro scale are yet weak to face competition
from imports and foreign investments from the liberalization policies of the 1990s.

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 Figure. National Budget (2013)

Figure. Electricity Cost (US$ per Kilowatt Hour)(2004)

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 Figure. Real State Acquisition Cost (US$ per Square Meter)

Figure. Tax Rate (%) on Additional Income (1999)

HOUSEHOLD IMPACT ON BUSINESS

Although the country’s population is still young with a majority (68%) aged below
29 years old, it is gradually becoming older with declining fertility and mortality rates. More
than one-third (35%) aged 15 to 34 years old are given to sophisticated consumption.
One-third (33%) aged up to 14 years old are children needing grow up care and only
seven percent (7%) aged to 60 years old and above need elderly support. But as fertility
rate (children per woman) is declining, so is the proportion of children needing growing
up care (below 15 years old). For example, fertility dropped from six (6) in 2000 to three
and one-half (3.5) in 2010 while the percentage of children up to age 15 years old
correspondingly dropped from thirty-seven percent (37%) to just thirty-three percent
(33%). Also as mortality rates of all ages dropped from 2000 to 2010, life expectancy
correspondingly increased from 67 to 71 years old with one-half of the population not
younger than 23 from 21 years old on 2000. Fast forward, the National Statistics Office

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(NSO) forecasts elderly population to increase to almost ten percent (10%) in 2023 from
just seven percent (7%) in 2010.
However, the declining purchasing power of wage has marginalized the
consumption of said age groups in at least forty percent (40%) of families. Coupled with
inadequate wage, unemployment has also trapped more than one-fourth (26%) of families
in poverty. A typical family hardly saves and spends most income on food (43%) and
housing, utilities, and fuel (21%).The fifure shows that only a pittance (8%) is spent on
education and health. Thus, the Philippine has the lowest rate (% on income) of savings
mostly corporations even in the ASEAN region (Chapter 2). Due to limited purchasing
power of income, many Filipino consumers have become price sensitive and are only
able to afford cheap but shoddy items. Low quality characterizes local products especially
manufacturers that are largely food items. Low-quality consumption can mean inadequate
care for the young (below 15 years old). and the elderly. Also, as non-essentials are
crowded out of the budget, so is sophisticated consumption especially of the youth (15 –
34 years old). In the end, some micro businesses may be crowded out of the market in
view of limited consumer demand due to inadequate income.

Figure. Population in 2010 (by Age Group)

Figure. Real Wage Index

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 Figure. Unemployment and Poverty

Figure. Annual Family Expenditure (2012)

TRADE AND CAPITAL MOVEMENTS

The external sector shapes the foreign exchange market (foreign currency inflow-
outflow) through its trade, capital movements, and financial flows. Trade includes factor
payments such as remittances from overseas contract workers and profit remittances of
foreign companies to their home countries. Capital movements include both short- and
long-term foreign investments in the country and Filipino investments abroad. Financial
flows involve international debts and loans and their repayments.
Foreign currency (largely in dollars) inflow less outflow payments define the
Balance of Payment (BOP) of the economy. Foreign currency receipts from abroad
(inflows) eventually sell for pesos while foreign currencies for payments to other countries
(outflows) are brought with pesos. From the viewpoint of the economy, a BOP surplus
means that more foreign currencies are being sold for pesos than those being bought
with pesos. Likewise, a BOP deficit means that less foreign currencies are being sold for
pesos than those being bought with pesos.

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 Figure. Foreign Currency Flows and the Economy

As part of its regulatory function, the government through the Central Bank
competitively buys and sells foreign currencies in the foreign exchange market to balance
supply and demand and stabilize the exchange rate. The Central buys foreign currency
surpluses with pesos and sells them for pesos to fill the shortfalls in times of deficit in
order to stabilize the foreign exchange market. From Point A, the Central Bank buys
(demand shift D1 and D2) the excess supply of foreign currency (F1 – F2 from supply shift
S1 to S2). Thus, buying this excess supply maintains exchange rate E 1 and foreign
currencies bought and sold (supply = demand) F1 at point A. Conversely, the Central
Bank can sell foreign currency reserves (supply shift S0 to S1) to fill the shortage (F1 to F0
from supply shift S1 to S0) to likewise restore equilibrium at point A.

Figure. Foreign Exchange Market

The economy’s is yet to go deeper into more technology – based stages that it
imports the capital and final goods even including consumer items that it could otherwise
produce. But it only exports raw materials and some consumer items using low
technology (e.g., garments). Local manufacturing which largely produces light
manufactures (low technology) of food and other consumer items can hardly stand up to

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imported competitive products. Machineries and electronics exports are simply products
from their imported components assembled locally by transnational corporations. As
mentioned in Chapter 3, electronics exports hardly contribute to local output and
employment being import-dependent and without much need for technology.

Figure. Imports by Major Commodity Group Q1 2014 (Percent Share)

Figure. Exports by Major Commodity Group Q1 2014 (Percent Share)

As the country exports little but imports much, it spends more but hardly earns
foreign (largely dollars). What buoy the foreign currency market are net capital inflows
(foreign investment, loans) that offset trade deficits (imports exceed exports) resulting in
mostly BOP surpluses. Nonetheless, foreign exchange rate (pesos to foreign currency) is
relatively high making peso imports costly while exports are becoming more competitive
with more peso profit margin for the same dollar price. Unfortunately, local production can
hardly fill in for costly imports as handicapped by limited scale, access to technology and
government incentive against the backdrop stiff import competition. On the other hand,
they have to contend with higher cost of doing business due to costly capital and material
products. Thus, local business engage in low technology production and trade that
includes cheap and shoddy imports of consumer items.

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 Figure. Real Exchange Rate
Further stifling the foreign currency market is the decline of its exchange rate
against rising local prices (inflation) that makes the peso overvalued against the dollar in
recent years. The increasing value of the pesos together with the other Asian currencies
against the weakening dollars stems from capital flows avoiding the recession in the U.S.
and Europe and finding opportunities in Asia. The resulting decline of the real exchange
rate (exchange rate divided by price index) has two (2) implications. Imports are becoming
cheaper relative to local goods while exports are becoming less competitive with less
peso profit margin for the same dollar price. Much less are exports competitive as our
neighbors and rivals (Malaysia, Thailand, and Indonesia) have successfully reversed their
exchange rate conditions to make their exports more competitive. In turn, cheapening
imports with less competitive exports further fans foreign currency demand relative to
supply to keep the exchange rate high. Despite Central Bank’s intervention to minimize
fluctuations by buying and selling dollars, the peso – dollar exchange rate is still above
forty (40) pesos. Thus, imports dependent economy is still costly while exports continue
to lose price competitiveness.

Figure. Year – to – date Appreciation/Depreciation of

Asian Currencies against US Dollar
(in percent, as of end – March 2014)

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HERFINDAHL – HIRSCHMAN INDEX (HHI)
As a final note to help guide the proponents of a business proposal in choosing
what type of industry to enter, the use of the Herfindahl – Hirschman Index – HHI would
be useful since it helps the proponent identify markets are highly competitive and
saturated and those markets with high market concentration.
The HHI is a commonly accepted measure of market concentration. It is calculated
by squaring the market share of each firm competing in a market, and then summing the
resulting numbers. Market share is equal to the Revenue of the Firm/Revenue of the
Industry and is actually a percentage. However, the whole numbers of the market share
are used to compute the HHI.
The HHI number can rage from close to zero to 10, 000. The HHI is expressed as:
HHI = M2 of Firm 1 + MS2 of Firm 2 + MS2 of Firm 3… + MS2 of Firm n.
The closer a market is to being a monopoly, the higher the market’s concentration
(and the lower competition). If, for example, there was only one firm in an industry, that
firm would have 100% market share, and the HHI would equal 10,000 (1002), indicating
a monopoly. Or, if there were thousands of firms competing, each would have nearly 0%
market share, and the HHI would be close to zero, indicating nearly perfect competition.
This means the market highly competitive and is characterized by the existence of
numerous competitors.
Results of the HHI would indicate the following:
 HHI below 100 indicates a highly competitive market.
 HHI below 1 000 indicates an unconcentrated market
 HHI between 1 000 to 1 800 indicates moderate market concentration.
 HHI greater than 1 800 indicates high market concentration.
The business proponent should therefore seek to enter an industry where HHI is
greater than 1 800 since the market is not characterized by too many firms.

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Test
I. Answer the following questions.
1. Why are the business still handicapped by inadequate infrastructure services
despite government’s increasing spending on the same?
2. How does size affect business in both the short and long run?
3. How do inadequate infrastructure and industry support services affect business in
both the short and long run?
4. What are the other obstacles and their specific effects to doing business?
5. What are the indicator(s) that the country’s population is still young? What is the
consumption preference of the young?
6. Yet, why do we say that the country’s population is gradually aging?
7. Why has household consumption been marginalized through the years?
8. How has declining purchasing power changed the household consumption pattern?
9. What is the effect of the foregoing on business competition and why?
10. In our country why do imports usually exceed exports?

II. Activities

1. Discuss how SM impacts positively on the community and the country.

2. Form a group and choose a business whose owners are well known for their
advocacies. Report on these advocacies in the classroom.

3. Interview a typical mother or housewife in a low – income community on how she

budgets the income of her family. Further ask if said family budget can still provide
for some amenities (e.g., cellphone load, DVDs) and if so, how much and what
kind. Look around the said community and find the kind and number of micro
enterprises serving its consumer needs. Identify their market problems and figure
out what you would do if you were in their shoes.

4. Look for successful small business in your neighbourhood. Interview the owner,
find out the reasons for putting up the business, the problems encountered, and
the reasons for putting up the business, the problems encountered, and the
reasons for its success.

5. Observe and talk to the small producers/sellers in your barangay (farmers,

fishermen, and vendors cottage industries). Is there any lack of public
infrastructure facilities that limits their operation? How has this inadequacy limited
their business activities and profit? What support services do they lack and how
has this limited their business activities and profit? Have they experienced
registration and licensing delays and how have they limited their business activities
and profit? What are the possible ways to explore to minimize or even avoid the
aforementioned impact?

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6. Identify at least 10 goods that you always consume at home. How many are
imported from our neighbor (e.g. China, Thailand) and produced locally? Find
locally made consumer goods that compete with these imports. If you can find at
least one or two, compare their prices and quality. What will happen to the peso
price of these imported consumer goods should the exchange rate continue to
decrease in absolute values, that is, if the peso appreciates in value? Explain.
What will happen to the remittances converted to pesos of our overseas contract
workers (OCW) under the scenario of peso depreciation? Explain.

7. Research on business opportunities. Look for a business where the industry is not
yet saturated with so many firms. You can apply the Herfindahl – Hirschman Index
discussed in the chapter. Once you have identified a business, prepare a business
proposal.

The business proposal should include the following.

a) A description of the good or service to be offered;

b) Target market of your product;
c) Proposed location and reason for the choice of this location;
d) Long – term objectives of the business;
e) Estimated capital requirements;
f) Sources of capital
g) Form of business organization: Sole proprietorship, Partnership, or
Corporation;
h) Suggested pricing of the product
i) Mode of promotion or advertising used;
j) Technical requirements: Machine, Building, Tools needed; and
k) Socio – economic Impact: Positive Effects of the Project and Negative
Effects of the Project

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