econo midterm

8/2/2019 ECONO Midterm

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Market Structures and Price-Output Determination

The various market structures are represented by four basic market models. Theseare theoretical frameworks for existing firms and industries in the real world. Suchmarket models describe the characteristics of the various market structures.However, some enterprises do not exactly fit the characteristics of any of the marketmodels. In other words, the market models are not the complete replica of realities.But such market models are imported because they help us understand the real worldwhere the market system is the principal element of the economy.

Firms and industries play a vital role in our economy. They always seek ways ofreducing costs of production and of improving the quality of their goods andservices, especially in a competitive market. However, in the process of interplaybetween the forces of supply and demand, the happy balance between business profitand consumer satisfaction has always remained a big problem. In most cases, thesatisfaction or interest of the consumers has been ignored due to self-interest ofproducers or sellers, and because of inherent market imperfections. For instance, incase of monopoly the position of the consumers is very weak. The monopolistusually dictates his price. And even in a market situation where there are manyproducers or sellers, the latter can agree together to forge a common price. Thuseliminating price competition among themselves in order to attain their self-interests

-more profits per unit of their output.

In view of the scarcity of resources, firms and industries should strive to maximizetheir employment and production. It is their responsibility to pursue economicefficiency as their objective. Economic efficiency is the relationship between input(factors of production) and output (goods and services produced by the factors ofproduction). However, within the social contest of the economy of the poorcountries, economic efficiency is not the main issue. The first and most importantgoal of the economic system should not be economic efficiency but social equity.This refers to the fair allocation of the productive resources like land, capital andmanagement among the members of society.

The market system allocates goods and services through the mechanism of demandand supply. The members of society obtain their goods and services. in the market onthe basis of their ability and willingness to buy. Some say that the market system orprice system is more efficient than the government in allocating goods and services.But in countries where productive resources are not fairly distributed, only the veryfew rich get most of the goods and services in the market. Hence, there is a need forthe government to participate in allocation function of the market system to protectthe interest of the poor.

Basic Market Models

1. Perfect/ pure type

a. perfect or pure competitionb. pure monopoly

2. Imperfect/non-pure type

a. monopolistic competitionb. oligopoly

Market Models Defined

Pure competition - is a market situation where there is a large number of independentsellers offering identical products.Pure monopoly - refers to a market situation where there is only one seller or

producer supplying unique goods and services. A one-buyer market situation isknown as monopsony.

Monopolistic competition - pertains to a market situation where there is a relativelylarge number of a small producer or suppliers selling similar but not identicalproducts.

Oligopoly - is associated with a market situation where there are few firms offeringstandardized or differentiated goods and services. Such definition is not precisebecause oligopoly includes a wider range of market structures than the other threemarket models. On the other hand, a few buyer market situation is called oligopsony.Characteristics of Market Models

Pure Competition

1. There is a large number of independent sellers.2. Products are identical or homogeneous. Examples are farm products like

rice, corn, fruits, vegetables, etc.3. No single seller and no single buyer can influence the change in market

price of a product. There are thousands of sellers selling millions ofidentical products. In case a firm or one seller millions of identical products.In case a firm or one seller decides to reduce its supply even up to 99percent, the total supply in the market is not affected. The supply of oneseller is negligible. Therefore, he cannot change the market price. Likewise,if he sells his goods at a lower price than the prevailing market price, his

goods are bought in just a few minutes. But the market price remains. Onthe other hand, if he offers his goods at a higher price than the market price,he cannot sell his goods. The rise or fall of market price is due to changes intotal demand or supply.

4. It is easy for new firms or sellers to enter the market and for existing firmsor sellers to leave the market. There are no significant barriers like legal,financial, or technical requirements. For example, a vegetable vendor is freeto sell in the market. She only pays the market fee. In case, she is no longerinterested in her small business, she is also free to leave the market.

5. There is no non-price competition like advertising, sales promotion, orpackaging. There is no need for such non-price competition because theproducts are identical which means they have the same features. Forinstance, even if the advertise rice, egg plant, pr tomatoes, it has no effect


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on buyers. They just purchase such products even from one who has notadvertised.

Pure Monopoly

1. There is only one producer or seller.2. Products are unique in the sense that there are no good or close substituteavailable. Most public utilities supplying water, electric and telephone service aremonopolists. Example, MERALCO, PLDT and MWSS.

3. The monopolist makes the price. Since he is the only supplier, he can reduce hisoutput in order to increase his price. Or he can increase his supply if this means anincrease in his total profit.4. It is extremely difficult for new firms to enter the market. There are severalformidable barriers like very big capital and very keen competition. The existingmonopolist is an established giant in the industry. There are also natural monopolieswhich refer to existing goods or services in which competition is not practical orprofitable. Most public utilities enjoy natural monopolies. These are grantedexclusive franchises by the government. For example, it is not practical andconvenient for several electric, water, or telephone companies to operate at the sametime in a community. There would be many electric wires and posts and diggings. InMetro Manila, we have only one water supply company, and yet we are greatly

inconveniences by its endless diggings.

PRODUCTION

What is Production?

In the ordinary language, the term "production" means raising of crops or making ofa physical goods in factories. For example, if you make ice cream, you will say thatyou have produced ice-cream (a goods). But from the point of view of Economincs,you have not produced any new thing in the form of ice-cream, rather, you havechanged the form of milk, sugar, cream, etc., and thus have created the utility.According to Marshall, "Man does not produce physical (material) goods; but whenit is said that he produces material goods, in fact, he only creates the utility. Even thescientist also agree that " Matter can neither be created nor destroyed." Thus in

Economics, the word "production" is used to imply creation or increasing the utilityof a good so that its value is increased.Definition

(1) "Production may be defined as the creation of utiities " - Anatol Murad(2) "Production is the process that creates utility in goods."-A.H. Smith(3) "Production is the creation of value in commodity."- Thomas(4) "Production is the creation of economic utility"- Ely(5) "Production means an increase in the value of a commodity"- Nicholson(6) "Production is any actitvity which adds to the value of a nation's supply of goodsand services."- M.J Ulmer(7) "Prodcution may be defined as the process by which inputs may be transformedinto output." -Robert Awh.

Difference between Consumption and Production

Generally, production and consumption are considered to be altogether contrary anddifferent activities.Consumption is the use of utility whereasproduction is creation of utility.In fact, their difference is not so fundamental. Both these are two different aspects ofthe same activity. For example, when a carpenter makes a chair, he performs an actof production by increasing the utility of log of wood. But at the same time, he hasalso consumed the log of wood by using its utility. Thus, two aspects of the same

activity are production and consumption. According to Prof. Mehta., "When theutility of a good is used for the direct satisfaction of want, it is called consumption,and its use for the indirect satisfactions of want is called production.

Methods of Creation of Utility

Production or creation of utility can be made by the following methods:(1) Form Utility : If by changing the form of a good, capacity to satisfy wants iscreated in it, it is called the form utility. Changing of wheat in the form of biscuit,changing of wood into furniture are the examples of the form utility. Rebisco orJacinto Steel Company or factories changing the raw materials into goods create theform utility.(2) Place Utility: Utility is also created by changing the place of goods. It is also

called place utility. Collecting of the sand from the river-bank and transporting it tothe construction site or, transporting the coal to different parts of the country fromthe coal-mines are the examples of place utility. A transporter, railways, shippingcompanies, and airways create place utility. So, the function of transportingcompanies is called production.(3) Time Utility: If by an act of storage for a good for some time its utility increases,it is called time utility. Storing oranges, apples and other fruits in the cold storagesuntil their crop season is over and their prices increase, is the example of time utility.Thus the activities of traders, who make the stock of a commodity, can also be calledproduction.(4) Service Utility: If the service of a man satisfies our want, it is called serviceutility. A professor's teaching in a class, a lwayers pleading a case, a tailors

stitching a shirt, is the examples of the creation of service utility. Therefore, aprofessor, lawyer or a tailor is also the producers.(5) Possession Utility: If the change of possession of a good increases its utility, it iscalled the possession utility. The utility of a sewing machine is not so great for adealer in sewing machines as it is for a tailor. The utility of the machine increases bythis change of possession. It will be called possession utility. Since traders orretailers are the creators of this utility, their activity is also called production.(6) Knowledge Utility : When the utility of a good increases by increasing people'sknowledge about that goods, it is called knowledge utility. For example, we come toknow about the qualities of Samsung LED, Cream Silk conditioner or Colgatetoothpaste through advertisements. We make greater demand for these goods. Thus,advertisers also help production by creating knowledge utility.


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Thus, in order to know whether a man is a producer or not, it is to ensure whether anincrease in utility or value is made by the work done by that man or not. It isessential that the work-done by anyone must create or increase utility.

Factors of Production

You want to produce wheat. For the production of wheat, you require land, workers,tractor, tube well, seeds, pesticides, favorable climatic conditions and fertilizers, etc.All these are called the means of production or inputs. With the help of these, we get

the output or production." The sources of services which enter into the process of production are calledfactors of production. The factors are broadly classified as land, labor, capital andentrepreneur."- M.J. Ulmer.1. Land- is an original gift of nature. It includes the soil, rivers, lakes, ocean,mountains, forests, mineral resources, and climate.2. Labor- is an exertion of physical and mental effort of individuals. This applies notonly to workers, famers, or laborers but also to professionals like accountants,economist, or scientists.3. Capital - is a finished product which is used to produced other goods. Examples ofcapital goods are machines as far as economics is concerned. In finance and tolaymen, capital refers to money. However, money is a medium of exchange. It

cannot produce goods. It can only buy goods. This is just an exchange betweenmoney and the corresponding units of goods.4. Entrepreneur- is the organizer and coordinator of the land. labor and capital.

Agents of production and their Income

In economic, the agents of production are those persons who are owners of thesefactors or resources. In other words, these are the persons by whom the supply offactors is made. Agents of production are also four(i) Landlord : He is the owner of land. His income is called rent.(ii) Labourer: he is the owner of labour. His income is also wages.(iii) Capitalist: he is the owner of capital. His income is called Interest.(iv) Organizer or Entrepreneur. He is the owner of organization. His income iscalled wages or salary or profit.Agents of production also be different persons, and at the same time, one man canalso be the master of several resources; for example, a carpenter who makes furniturehimself as his own shop, investing his own capital, will be called landlord, laborer,capitalist, organizer, organizer and entrepreneur-- all in one.

Importance of Production

Production has great importance for every man or country. The Mangoes andBananas are from among the rich people of Philippines because they make a lot ofproduction. America or Japan are from among the richest countries of the world andare known as Big producers of a good number of items in the world. So, theeconomic progress of a country and the economic welfare of the people depend uponthe volume composition and price of production and its distribution. The importanceof production can be judged by the following facts:

Basis of Consumption:

For the satisfaction of our wants, all of us wish to consumer goods like ice cream,shirt, television, scooter, etc., and other services. The quantity, quality and variety ofconsumption goods is made possible only when their production is made availableand at moderate prices. Thus, the major basis of the consumption of the people of acountry is the production of various goods and services in that country.

Basis of Economic Development

We will be able to make the economic development of our country at a faster ratewhen the production of producer-goods, such as, machines, electricity, raw material,chemicals, etc., is made on a large scale. More production of machines and rawmaterial, etc., will lead to more production of the consumer goods, like cloth, sugar,scooter, etc., Increase in the quantity of production will provide employment to morepeople, create income and remove unemployment in the process of economicdevelopment.

Basis of Economic Welfare :

Increase in the economic welfare of a country takes place when people's standard ofliving improves; there is an increase in per capita income; almost all the people ofthe country get more necessaries of a superior quality than before and at a fair price.

Thus, the quantity and quality of production and their availability to all are the majorbasis of economic welfare.

Basis for Economic Planning:

The main basis of the formation of economic plans, such as the Five Year Plans ofIndia is the fixation of the targets of production of different goods. The success offailure of a plan is assessed on the basis of the achievement compared to itsproduction targets.

Basis of Trade:

The volume of the internal and external trade of every country depends only on thevolume of its production. If the production is high, greater increase in the volume oftrade will take place.

Basis of Government's Income:

A major basis of the income of the government of every country; e.g: Philippines, isthe taxation on production. These taxes are in the form of Sales Tax, Customs Duty,Excise Duty, etc. If the production is high, the income received through these taxeswill also be high. The government should use this income for the economic andsocial progress of the public.

Production Function

Production is the creation of goods and services to satisfy human wants. The factorsof production are called the inputs of production, and the goods and services thathave been created by the inputs are called outputs of production. The factors ofproduction are classified as fixed factors (fixed input) and variable factor (variable


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input).A fixed factor remains constant regardless of the volume of production. Thismeans whether you produce or not, the factor of production is unchanged. Examplesare land capital. For instance, in a one hectare rice field, you can employ 24, or 6farmers to cultivate it. One hectare of land is still one hectare whether only 20 cavansor 40 cavans of palay are harvested. In the case of a machine - let us say hollowblock machine - it can produce 10 units or 50 units of hollow blocks a day. Still, it isone machine. In fact, even if there is no production, the machine is still there. In thecase of a variable factor, it changes in accordance with the volume of production. No

production means no variable factor. More production means more variable factors.Example is labor and entrepreneur. More laborers are needed when there are moreworks to do. If there is no job to perform, a laborer is not needed.The process of transforming both fixed and variable inputs into finished goods andservices is called theory of production. The quantity and quality of goods andservices being produced depend on the state of technology. Obviously, moderntechniques of production are more efficient than primitive technology. For example,the United States and Japan apply modern technology in rice farming. As a result,they can harvest about 300 cavans of palay per hectare. The underdevelopedcountries can only harvest an average of 40 cavans. Such technical relationshipbetween the application of inputs (factors of production) and the resulting maximumobtainable output is known as production function.

Law of Diminishing Returns

The law of diminishing returns is also known as the law of diminishing marginalproductivity. It is a basic law of economics and technology. The law states that whensuccessive units of a variable input (like farmers) work with a fixed input (like onehectare of land), beyond a certain point the additional product (output) produced byeach additional unit of a variable, input decreases.The validity of the law of diminishing returns is based on two assumptions. Thesuccessive units of a variable input should be identical, and the same technology isapplied . For example, the case of 10 farmers who work in a 1 hectare rice field, theyshould have the same efficiency. That is, they are all industrious and strong. Also,they use the same type of technology. If the first 5 farmers applied primitivetechnology while the remaining ones used modern technology, naturally additionalproducts do not decrease. In the same manner, if the first 5 farmers are lazy while theremaining ones are very industrious, then additional products produced by the latterdo not decline. In fact, there would be an increase.It is noted that in the work combination of variable input and fixed input, total outputand additional output (or marginal product) increase up to a certain point. Beyondthis point, the rate of increase of total product declines, and later on total productdecreases as more units of a variable factor are employed. In the case of marginalproduct, it also diminishes beyond a certain point until it reaches negative returns asmore variable inputs are added.

Cost Categories

The burden sustained in order to perform a certain activity, to carry out a certainproduction, to achieve certain goals.In a balance sheet, costs raise commercial liabilities to be settled. They should not beconfused with money outflows.By contrast, in economics, most formal models ignore this distinction between costsand payments.1. Actual costs refer to real transactions, whereas opportunity costs refer to the

alternative taken into consideration by decision makers who might want to choosethe line of activity which minimize the costs. From an external point of view, it isdifficult to ascertain which are the alternatives considered.Discretionary costs are not strictly necessary for current production but correspond tostrategic goals (e.g. improving the firm's image through an advertising institutionalcampaign).2. Production costs

Given a specific product version, production costs are usually classified according totheir responsiveness to different levels of production attained.Fixed costs are simply not responsive to production levels.If there are only fixed costs, the total costs follow this rule:Variable costs grow with higher levels of production (proportionally or not). If there

are only variable costs, at zero production the total costs will be zero. Total costs willfollow for instance this rule:

3. Total costs are the sum of all costs. By dividing the total costs by the quantityproduces, one gets the average costs: how much a unit of production costs ("unitcost").Average costs can be directly compared with price to compute profitability: if theprice is higher than average cost, the production is profitable.Total profits will be given by multiplying the average profit with the quantityproduced and sold. Identically, total profits can be obtained as total revenues lesstotal costs.The relationship between total revenue and total costs depending on the productionlevel is analyzed by the so-called "break-even analysis".4. Average cost - This is also called unit cost. It is equivalent to total cost divided byquantity.AC = TC/Q5. Marginal cost - is the additional or extra cost brought about by producing oneadditional unit. It is obtained by dividing change in total cost by change in quantityMC = TC/Q6. Explicit cost - This is also called expenditure cost. These are payments to theowners of the factors of production like wages, interests, electric bills, and so forth.7. Implicit cost - Another term for this cost in non-expenditure cost. The factors ofproduction belong to the users. So, they do not pay. You do not pay rent to your ownland.8. Opportunity cost - Is a foregone opportunity or alternative benefit. For example,the superpowers are spending more than $1 trillion dollars a year for the arms race.Such amount is more than enough to erase global poverty from the face of the earth.


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Major Forms of Business Organizations

1.1 Single or sole proprietorship.

It is a form of business organization which is owned by one person. The ownerpersonally manages his business. Most of our business operations (including thosewhich are not registered) belong to single proprietorship. Examples are retailers,market vendors, barber, tailors, and so forth.The advantages of single proprietorship are:

1. It is easy to organize. Financial capital is small, and registrations requirements are

not difficult do not even bother to apply for a license.2. The single proprietor is the boss. He makes the decisions, and enjoys substantialfreedom of action. Possibilities of conflicts or quarrels are minimized.3 . The owner acquires all the profits from his business This gives him moreincentives to make his business grow.On the other hand, the disadvantages of a single proprietorship are:

1. In general, the financial resources of a single proprietorship are not enough totransform the business into a large-scale enterprise. Considering its small asses andhigh mortality rate, banks are reluctant to grant big loans to single proprietorshiptype of business organizations.2. Benefits of specializations in business management are not present in small-scaleproprietorship. There is only one manager. In not a few cases, the owner is the only

employee.3. The owner has unlimited liability. This means the owner of the business risks notonly the assets of his small enterprise, but also his other personal assets like his pieceof land, bank deposits, and other personal properties which are not part of hisbusiness. In case of loss, such assets are subject to financial claims by creditors.

1.2 Partnership

It is a form of business organization in which two or more persons agree to own andoperate a business. The partners agree to combine their resources (money. materialsand management). They also share their profits and losses. However, there are"silent" partners. They only provide the financial capital but they do not participatein the management. There is also the "industrial" partner. He does not contributemoney to the business organizations but he is responsible for the management.The advantages of partnership are:

1. It is also easy to organize like the single proprietorship. Legal red tape isconnection with its registration is not much.2. Better management because of the presence of more participants in the operationsof the business.3. Possibility of bigger resources than the single proprietorship exists. Financialinstitutions may extend bigger loans to such business organization considering thecombined resources of the partners.The disadvantages of partnership are:

1. Conflicts or quarrels between or among the partners regarding the management orpolicies of the business are likely to crop up. In fact, under Filipino style, somepartners cheat their other partners in matters of profits or expenses.

2. It lacks stability. The death or withdrawal of one partners dissolves thepartnership. To continue its operation, a complete reorganization is needed.3. Like the single proprietor, the partners are also subject to unlimited liability,except the limited partners. Such partners liabilities are only confined to their shareof capital contribution in the form of cash or property.

1.3 Corporation.

It is a legal entity, distinct and separate from the individuals (stockholders) who own

it. The Corporation Code states "Corporation is an artificial being created byoperation of the law, having the right succession and the powers, attributes, andproperties expressed authorized by law or incident to its existence." Only naturalpersons are qualified to be incorporators. They must not be less than 5 but not morethan 15, all of legal age, and a majority of whom are residents of the Philippines.Each incorporator of a stock corporation must be an owner of at least one share ofthe capital stock.The advantages of corporations are:

1) A member has a limited liability. In case the corporation becomes bankrupt, onlythe capital contributions of the members are affected. The other personal propertiesof the stockholders of a corporation are excluded from financial claims of creditorsof the corporation.

2) It has the most effective means of raising money capital for its operations, byselling stocks and bonds. Stocks are certificates of ownership while bonds arecertificates of indebtedness. There are financial institutions which specialize inhelping a corporations sells its securities (stock and bonds).3) It has a permanent existence. The life-span of a corporation is 50 years, andsubject to renewal for another 50 years. The death or withdrawal of some officersand members does not affect the existence of the corporation. The corporation caneasily get officers or managers from inside or outside the organization. Transfer ofcorporate ownership may take place anytime through the sale of stocks.The disadvantage/s of a corporations are:

1) Corporations face one major disadvantage: The government levies an extra tax oncorporate profits. For an unincorporated business, any income after expenses is taxedas ordinary personal income. The larger corporation is treated differently in thatsome of its income is doubly taxed- first as corporate profits and then as individualincome on dividend.2) There is a sharp division between those who own the corporation and those whoare involved in its business operations. There is potential for conflict betweenowners, who want a fair return on their investment, and management, which isconcerned with using profits to maintain or upgrade production facilities. There is agreater potential for conflict between workers and management, as each looks to itsown self-interest in the workplace.3) Specialized decision making is sometimes a time-consuming and complex processas proposals, changes in policies, and so on pass through layers of management.4) Corporations are the most difficult type of business to form. A corporation mustform a board of directors, draft its articles of incorporation, adhere to strict guidelinein the issuance of stock, and so on. The rules and regulations for forming


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corporations vary from state to state, but most follow the provisions outlined in theModel Business Corporation Act.5) Corporations are subject to a double taxation of corporate profits. Corporateprofits are first subject to the corporate income tax, a progressive tax on corporateprofits.Multinational Corporations

Among Filipino corporations, family corporations are still dominant. The othercorporations are owned mostly by very close friends. It has been noted that many of

these Filipino corporations are conservative in their business operations. This meansthey are not very responsive to innovations, and they are not risk-takers like theAmerican, European and Japanese corporations.However, the whole Philippine economy has been dominated by giant corporationswhich do not belong to Filipino citizens. Such situation exist in many other lessdeveloped countries like those in Africa and Latino America. The most famous ofthese big corporations. They control production, financing, processing, andmarketing of all essential goods all over the world. Examples of their products areoil, drugs, fertilizers, soft drinks, beauty soaps, cars, toothpastes, insecticides,veterinary medicines, and so forth.International business was primarily an international trade at the start. That is,industrial countries imported raw materials from the agricultural countries, and thenexported the finished products to the agricultural countries. Some years later,international finance and investment developed. The rich countries granted financialloans to the poor countries. Such investments were strictly financial in nature, andinvolved the flow of funds through banks, investment companies, and governments.Emergence of Big International Companies

As the start of the 20th century (1900), some big companies emerged in internationalbusiness. Their subsidiaries managed overseas operations. Such subsidiaries weretreated as appendages to the parent company, and functioned chiefly as exportagencies. The headquarters of these subsidiaries were located (and still at present) inthe home country like the United States, Great Britain, or France. The warehouses,service offices, and sales agencies have been located in foreign countries like thePhilippines, Brazil or Nigeria.Shortly after the last global war, the management of international companies wasrestructured in response to the needs of international business operations. Vice-presidents for international operations were appointed. They performed liaisonworks with the various subsidiaries engaged in international manufacture and trade.During the 1960s , a global corporation evolved. Its foreign operations wereintegrated into a single organizational structure. This is the multinational ortransnational corporation. It is a corporation which maintains its headquarters in onecountry (rich country) but performs productions, marketing, finance, and personalfunctions within many other countries (mostly poor countries).

1.4 Cooperative.

Presidential Decree No. 175 defines a cooperative as "only organizations composedprimarily of small producers and consumers who voluntarily join together to formbusiness enterprise which they themselves own, control and patronize." A small

producer is an individual who provides (or together with his family) the primarylabor requirements of his business enterprise, or one who earns at least fifty percentof his gross income from his labor. The government in its effort to promote theorganization of more cooperative throughout the country has extended several powerand privileges (like tax exemptions) to cooperatives. Such business organizationshave become famous in Europe, United States, Japan, Canada, Israel and otherprogressive countries. Cooperative has been very effective in improving the socialand economic conditions of the poor people are in said countries. In the Philippines,

the most successful community credit union is found in San Dionisio, Paranaque,Metro Manila. It is the biggest of its kind on Asia. It started in 1961 with only 28members and P380 capita. Today, it has more than P60 million assets and about15,000 members (including special depositors who are the minor children of themembers).Similarities between a cooperative and a corporation are:

1. Factors of production are privately owned and managed.2. Both depend on business efficiency to survive in a competitive market.3. Their activities and operations are both regulated and supervised by thegovernment.4. Both enjoy a reasonable degree of economic freedoms.Differences between a cooperative and a corporation are:

1. A cooperative is for service while a corporation is for profit.2. Membership in a cooperative is open and voluntary while in a corporationmembership is only for wealthy relatives and friends.3. Government in a cooperative is democratic. It is one man one vote and no proxyvoting. In the case of a corporation, it is one share one vote, and more shares morevotes. It is the rule of the minority (richer members).4. Savings or nets profits are refunded to the members of a cooperative on the basisof their individual patronage while in a corporation, profits are distributed to thestockholders on the basis of number of their shares.

Macroeconomics

Every time we read a newspaper. we encounter terms like the inflation rate, GrossDomestics Product(GDP), GDP growth rate, unemployment rate, interest rate,foreign debt, budget deficit, exchange rate, balance of payments, and the like. Quiteoften, writer describe the trends in these in theses variables and attempt to explainhow observations of these variables came about. This type of analysis falls withinthat branch of economics known as macroeconomics.Macroeconomics is the study of the economy in the aggregate. It examines howeconomic agents as a whole respond to changes in the economic environment. It alsostudies how their actions feedback on the economy.

Macroeconomics is concerned with three broad questions. These are:

a) How do we explain changes in the inflation rate?b) How do we explain changes in the aggregate output?c) How do we explain unemployment?


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With these questions, we are concerned with the identifying the determinants ofthese important variables. We are also interested in explaining how these variablesare linked to each other.While the questions above seem simple enough, the answers are not. In fact, thereare quite a number of, sometimes conflicting, answers to these questions. Perhaps, itis in, macroeconomics that the old adage asking ten economists yields elevendifferent answers" fits perfects. Perhaps, the existence of competing explanations inmacroeconomics lies in the fact that we still know very little about how an economy

as a whole operates.

National Income

The income of the nation is measured by the total earnings of the factors ofproduction owned by its citizens of by the total market value of all final goods andservices produced by its citizens. Such earnings or market value of final goods andservices are estimated on a yearly basis. Such measurements reflect the performanceof the economy. These indicate whether the national economy is progressing orregressing. For instance, if the national income is bigger this year than in theprevious year and that last year's national income was bigger in the previous years,then it can than be said that the economic performance of the country has beenimproving during the last few years. However, if it is a reverse situation, then thenational income has been experienced by many poor countries. Their populationgrowth rate is greater than their production rate. Furthermore, the numerous civilwars and droughts in Africa have brought a plunge to the national economies of not afew African countries.Countries usually show their achievements by economic indicators like grossnational product (GNP), per capita income (PCI), or per capita(GNP) .Suchmeasurements also classify the economic class of countries whether these are highlydeveloped, intermediate, or less developed. The reference point is the per capita(GNP) or per capita income (PCI) of the United States. All countries, whose nationalincome or PCI are withing the range of the PCI of the United States, are classified ashighly developed countries, Those whose incomes are far below that of the UnitedStates are considered less developed countries.

Definition of Terms

Gross national product (GNP)- is the total market value of all final goods andservices produced by citizens in one year.National Income - is the total income of the factors of productions in one year or thetotal payments received by citizens in one year. GNP has greater value than nationalincome because the latter is equivalent to total cost of production.Per capita income (PCI) - is income per head.PCI =National income_____________PopulationPer capita GNP = Gross national product__________________

Population

Gross domestic product - is the total market value of all final goods and servicesproduced within the territories of a country in one year. Incomes derived frominvestments or wealth in foreign countries are excluded. In the case of GNP, theincomes of the citizens earned from abroad are included. In a country whoseeconomy is dominated by multinational corporations or foreigners, the GDP isbigger than GNP. This is the actual situation in many less developed countries.Money GNP- is the value of GNP at current price or market price.

Real GNP - is the value of GNP in terms of the number of goods and servicesproduced.Real GNP = Money GNP_________Price Index x 100Final goods and services - are those which are sold for the last time, and these arenot for further processing or manufacturing. Example is bread. Flour is not a finalproduct. It is used for making bread. It is referred as intermediate product.Disposable income - is personal income less personal taxes.

Ways of Calculating National Income

Income approach

Wages+Rents+Interest+Profits____________= National income+ Indirect taxes less subsidies+ Depreciation_____________= GNPProduct or Expenditure Approach

Household consumption expenditures+ Government purchases of goods and services+ Gross domestic investment of business firms+ Net exports (if value of imports is greater than exports , it is minus)________________________________= Gross national product= Capital consumption allowances (depreciation)= Net national product= Indirect business taxes= National incomeIndustrial Origin Approach

Agriculture, fishery and forestry+ Industrya. mining


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b. manufacturingc. constructiond. electricity, gas and water+ Service sectora. transportationb. tradec. financed. service= Gross Domestic Product- Factor income from the rest of the world= Gross national product- Net indirect taxes- Depreciation__________________________= National Income

Depreciation and Indirect Business Taxes

Depreciation is an allowance for capital goods like machines which have been"consumed" in the process of production. A machine depreciates not only because ofthe use through time but also as a result of obsolescence or calamities like fire andflood. Such machines loses its value and must be replaced in order to sustainproduction.In most machines, their useful life is more than one year. Since national incomeaccounting covers a period of one year, the actual expenditures for such machinesand their useful life do not have the same length of time. The productive life of themachine maybe 5 or even 10 years but the expenditure in the purchase of themachine has been included in one year national income accounting. Therefore, toavoid understatement of total income during the year of purchase of the machine andoverstatement of total income for succeeding years, a depreciation cost is allocatedevenly over the useful life of the machine. For example, if the useful life of themachine is 5 years, its costs is P10,000 and its junk value is P200, its yearlydepreciation value is computed:10,000 200

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In the case of indirect taxes, these include general sales taxes, excises, businessproperty taxes, license fees, and custom duties. An indirect tax is a tax imposed bythe government on products sold by businessmen. To make up for the money thatthey have to pay to the government, businessmen merely increase the prices of theirproducts. Thus, the burden of the tax is shifted to the buyers of the products. In otherwords, the businessmen pass on to the consumers the tax imposed on them by thegovernment.Taxes are used to finance the programs and projects of the government. In estimatingnational income, the services rendered by the government are included. Hence, the

tax element is included in the value of output under government services rendered.Likewise, the value of the products sold by businessmen contains an element of taxin the form of higher price (indirect tax). To restate briefly, tax was included once inthe price of goods sold in the market, and again included in the form of governmentservices funded by taxes. In this case in the market, and gain included in the form ofgovernment services funded by taxes. In this case , there is double counting in thecalculation of national income. To get national income, depreciation and indirectbusiness taxes are deducted from GNP which is the market value of final goods.National income is the factor value of goods which refers to the total cost ofproduction or factor payments like wages, rents, interest and profits.

Double Counting

The value of goods and services must be counted only once. To avoid doublecounting, only the value of the final goods and services are included. The value ofthe intermediate goods which constitute the value of the final products is excluded.For example, the market price of an executive table is P10,000. This is reflected inthe GNP as P10,000. The cost of the paint, ply wood, nails, lumber, labor, profit, andother costs that are incurred in the production of the table are excluded. Otherwise,there is double counting. It would be P20,000 which is not true.Nevertheless, there is an alternative wayof estimating value of the final product.This is called the value-added method. The value added to the total value of theproduct at every stage of production is totaled. The result is equal to the value of thefinal product. However, it is much easier to count only the final products than theintermediate goods like the nails, paint, and so forth. Here is a simple illustration ofvalue-added method:

Bread.....................20 centavosFramer....................10 centavosBaker.....................15 centavosRetailer..................20 centavosFarmer....................10 centavos (initial value)Baker......................5 centavos (value added)Retailer...................5 centavosAlso nonproductive transactions are excluded like purely financial transactions(social security payments, welfare payments, veterans payments, student'sallowance from parents, government subsidies, and the buying and selling of stocksand bonds..Such transactions do not directly involved current production. Some ofthese incomes were earned some years ago, and the others are just transfer ofownership. Clearly , the beneficiaries do not contribute to current production. Toinclude these in the present GNP accounting would be double counting because suchincomes have been included in previous years and others are already counted in thecurrent year. For example, the income of the student's father which is P40,000 isincluded in 1994 GNP. The sum of P7,000 is the total student's allowance for 1994.If this allowance is counted fir 1994 GNP, then it is an overstatement because suchamount came from the income of his father. Another kind of transaction which is notincluded in the GNP is resale transaction. If the second hand sales are included, then


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it is double counting. For example, a hollow-block machine is produced this year.The value of this machine is included in this year's GNP. If this is double counting.Take note that GNP measures all produced in 1994 are measured in the 1994 GNPeven if some of these are not sold in the same year. Therefore, such unsold productsshould not be included in the 1995 GNP. These were not produced in the said year.

GNP Record of the Philippines

GNP statistics indicate the economic conditions of our country in a given year. Sucheconomic conditions become bad due to several factors, like political instability,natural calamities, rebellion, social problems and other destabilizing elements. Forinstance, our 1984 GNP posted as negative 6 percent. This was the lowest economicgrowth rate in the whole Asian and Pacific region. Such negative growth rate wascaused by assassination of former Senator Benigno Aquino, Jr. street demonstrationsand crony capitalism.

Consumption

Consumption is the amount of money spent on goods and services which yielddirect satisfaction. It is the biggest of the major components of expenditures onoutput. when we buy food or pay the services of a doctor, it is consumption.However, the purchase of a bond which generates an income in the future does notproduce direct satisfaction. Thus, its purchase is not considered consumption. Thatpart of income which is not consumed is called savings.Income = Consumption plus saving

Y = C+S

s = Y-C

Factors Influencing Consumption

1. Distribution of national income. When there is a very uneven distribution,income is largely concentrated in the hands of a very small portion of the population.Individuals with big incomes are proportionately big savers. Hence, savings increaseat the expense of consumption. On the other hand, if there is a very even distribution,the concentration of the bulk of aggregate income is in the hands of individuals withmoderate incomes. This group does not save much. As a result, consumption tends tobe greater than saving.2. Rate of interest. People tend to save more at a higher interest rate. However, ifincome-earning assets yield more incomes, then people are encourage to purchasesuch assets. Thus savings decrease.3. The desire to hold cash. Such needs for cash for personal or business reasonsreduce consumption and raise saving.4. Price level. When prices are high (inflation), people spend more amounts ofmoney. This decreases saving.5. Population. More people means more consumption. More people have to buymore goods and services.6. Income. Higher income results to more consumption.7. Taxes. More taxes reduce disposable income. This decreases consumption.

8. Attitudes and values. There are individuals who are thrifty or extravagant.Evidently, these factors influence consumption or savings.

Consumption Function

Consumption function is the functional relationship between income andconsumption. The aforementioned factors influencing consumption all contribute tothe level of consumption of individual. However, all other things being constant,consumption primarily depends on income. Any change in consumption is due tochange in income in most cases. Such relationship between income and consumptionis analyzed in two ways, One is the average propensity to consume (APC). This isthe fraction of all income spent on consumption. The formula is: C/Y.The other one is the marginal propensity to consume (MPC)

This is the ration of the increase in the consumption to to the increase in income thatcaused it. The formula is: C/Y. In both ways, if consumption is equal to income, theanswer is 1(based on the formula). if consumption is less than income, the answer isless than one. But if consumption is greater than income, then it is more than 1.Is it really possible for consumption to exceed income? Note that under the equationof Y = C+S, it appears that C can not be higher than Y. The answer is it it possible,but under the short run consumption function. An individual can spend more than hisincome by using his past savings or by borrowing. A nation can also do the same.Like the Philippines, it is spending more than what it is getting from taxes and othersources of income. This had been made possible because of foreign loans. However,in the long run, it is no longer possible for a man or nation to consume more than itsincome because savings are already exhausted, the loans have to be paid. If not, thenborrowers also exhaust their credit.

Investment

Investment is expenditure on new capital goods. Capital goods are produced goodswhich are used to produce other goods. Investment plays a very vital role in theeconomy because it creates more employment, production and consumption. Clearly,more investment means more national income or gross national product. Investmentis the most fickle component of expenditure. Such behavior is generally assumed tocause economic fluctuations. There are several factors which affect investment.However, the decision to invest is based largely on expected profits.

Paradox of Thrift

The economy is in equilibrium when saving equals desired investment. According tothe classical writers, the economic growth of society depended on capital formation.In order to accumulate capital, it was first necessary for society to save forinvestment funds. In short, the classical economists believed that more saving wasgood because more funds would be available for investment. However, John MynardKeynes disagree with such economic theory. He said the attempt of consumers tosave more will reduce saving. This is the paradox of thrift.We have been taught that thrift is always a good virtue. If one individual saves alarge part of his income for his future use, it is likely good for him. But if allindividuals in a society save, then there is a big decline in consumption. This greatly


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reduces the demand for goods and services. So, production is cut down, togetherwith the number of workers. This results to more unemployment and reduction ofincome. Since aggregate or total income falls, then total saving also falls - or evenzero saving. Evidently, what is good for the individuals is not good for all.However, it is good to save during boom and inflation. Being thrifty is likely toreduce the rate of inflation. Likewise, during full employment (when all productiveresources are fully used, it is good to save - both from the position of the individualand that of society. Because if we consume all our resources, nothing is left forcapital formation. Under condition of unemployment, more savings means lessconsumption. And this leads to the downfall of the economy - less investment, lessemployment, less production, and less income.

Summary

1. The sum total of all factor payments is the national income. This is the total costsin the production of goods and services by citizens of a country in one year.2. The total market value of all final goods and services produced within the territoryof a country in one year is known as gross domestic product. While those producedby citizens, inside and outside the country, is the gross national product.3. There are three ways of estimating national income: income approach, product orexpenditure approach, and industrial-origin approach. NEDA is responsible for thenational accounting.4. To avoid double counting, only the value of the final goods and services arecounted. Non-productive transactions are excluded like students' allowance, pensionsand those for resale to avoid double counting. GNP measures all current productionswhether the products are sold or not. What is produced during the year is counted forthat year.5. Consumption is the amount of money spent on goods and services which yielddirect satisfaction. It is determined by income distribution, rate of interest, price,population, and income, among other things.6. Investment is expenditure on new capital goods. Its major determinants are ROIand IR. As long as ROI is greater than IR, there is investment. The otherdeterminants are population, price, technology, government policies, and peace andorder.7. When investment is greater than saving, there is an expansion of economicactivities. Conversely, there is contraction of economic activities.

econo midterm

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