lecture in taxation

Principles of Economics with Agrarian Reform Law and Taxation (Soc Sci 223IT/323CT)

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CHAPTER 1 FUNDAMENTAL CONCEPTS OF ECONOMICS

What is economics? We might not consciously know its definition but it affects our daily lives

nevertheless.

Adam Smith, considered the Father of Economics, defines economics as an inquiry about the nature and causes of the wealth of nations. According to Feliciano R. Fajardo, economics is the proper and efficient use of available resources or the maximum satisfaction of human wants. Felilia M. Ronan and Robert R. Amores view it as a science that allocates scarce resources to satisfy unlimited human wants.

Cristobal M. Pagoso and his co-authors define it as a discipline that concerns with the production, distribution and use of material goods and services. Sociologists look at it as a social science because it deals with the study of human behavior.

Sicat considers it as a scientific study that deals with how individuals and how the society generally makes

choices.

Economics as a Science

Since it is a systematic and organized body of knowledge, we can also say that it is also a science. As a science, it follows an orderly procedure of gathering data, analyzing facts and drawing conclusions from those existing phenomena. Just like other fields, there is a need to analyze and scrutinize data. Other disciplines perform experiments to determine the application and effectiveness of such principles and theories. Chemistry, for instance, conducts an experiment to determine the number of molecules present in water. And from this proved that water is a compound composed of two molecules of hydrogen and one molecule of oxygen. The finding is quantifiable and verifiable. But unlike chemistry, however, economics is an applied, not an exact science.

Economics as a Social Science

Like psychology, it deals with people’s interaction with others, an interaction that affects the utilization of material resources. It will be of an advantage then to a student of economics to look at the field as it relates to other fields such as science, sociology, anthropology and others.

Economics , encompassing these fields, involves that hard-to-measure human motivation which is perpetually changing. A voluminous pile of information and statistics are involved in this study. These are at times best captured graphs, charts, statistical and general purpose tables as well as mathematical equations. When economics theories and principles are utilized, this becomes applied economics.

Key Concepts

Economics (oikononia), is a branch of social science that deals with the study of scarce resources, its allocation and its utilization to satisfy the unlimited human wants and needs.


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Social Science is the study of society or its constituting parts through the scientific method of observation, hypothesis, analysis and experimentation. Allocation is the process of choosing among competing ends among available resources to acquire a higher degree of satisfaction Utilization is the process of property managing the scarce resources. Every available resource has its own utility. Util is the assigned unit of measuring utility. Division of Economics

Economics is divided into two branches:

Macroeconomics studies the aggregate level of economic activity, such as the total level of output, the level of national income, the total level of employment and the general price level for the economy viewed as a whole. It deals with total private expenditures, total investments, total government expenditures, and total imports and exports of goods and services. It seeks the causes and cures for unemployment , inflation, and balance of payments. Microeconomics, on the other hand, studies the economic behavior of individual decision-making units such as consumers, resource owners and business firms. It deals with how an individual consumer spends his income to maximize satisfaction, how a business firm combines resources of factors of production to maximize profits and how the price of each commodity and each type of resource is determined by demand and supply. It studies how these individual decisions are affected by different forms of market organization. Economics aims to develop theories, principles, and models which are abstractions and generalization of reality that can be applied in resolving or alleviating specific problems and in furthering the realization of society’s overall goals. The goal is to develop policies that might prevent or correct such macroeconomic problems as inflation and unemployment, and microeconomic problems as poverty, population explosion, pollution and urbanization. Some of the difficulties in studying economics are:

a. Our preconceived notions about the causes and cures of economic problems are often either completely wrong or partially wrong and misleading;

b. The economic terminology to which we are exposed in newspapers and popular magazines is sometimes emotionally loaded;

c. The definitions of economic terms in such a way that they are clearly at odds with the definitions held by most people in everyday speech;

d. The assumption that “what is true for the individual or part is necessarily also true for the group as a whole” (this is called fallacy of composition);

e. The assumption that simply because one event precedes another, the first is necessarily the cause of the second (this is known as post hoc fallacy or ergo propter hoc fallacy).

Example 1. Economic conditions greatly affect all of us throughout our lives. They affect us when we seek food, clothing, shelter, and a myriad of goods and services which we associate with a comfortable or affluent standard of living. All the headline-grabbing issues of the day – inflation, unemployment, defense spending, poverty and equality, government deficits, government regulation of business and the rest – are economic conditions that affect us all. It is practically impossible in today’s complex world to be a responsible citizen without some grasp of economic issues and principles.


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SCARCITY

The Problem of Scarcity

Economic resources are scarce or in limited supply in every society. We have only limited amount of resources which can be put in use in the production of goods and services. Quantities of arable land, mineral deposits, capital equipment, and labor (time) are all limited; that is, they are available only in finite amounts. Because of the scarcity of productive resources and the constraint this scarcity must use its scarce resources as efficiently as possible to produce the goods and services most wanted by society. Economic resources (factors of production) which refer to all natural, human and man-made resources which are used in the production of goods and services, are the following:

1. Land refers to all natural resources – all gifts of nature – which are usable in the productive process such as arable lands, mineral deposits, forests , and water resources. The owner of land receives rental income from the users of land.

2. Labor refers to all of the physical and mental talents of men and women which can be used to produce goods and services such as teacher, economist, accountant, mechanist, nurse, typist, retail clerk and others. Labor receives wages or salaries.

3. Capital refers to man-made goods used in producing services such as tools, machinery, equipment, building, and transportation networks. The term “capital” being defined does not refer to money which is available for use in the purchase of machinery, equipment, and other productive facilities. Because money produces nothing; hence, it is not to be considered as an economic resource. Real capital – tools, machinery, and equipment – is an economic resource; money or financial capital is not. The factor payment for capital is interest income.

4. Entrepreneur is a person who sets up a firm by combining land, labor, and capital to supply a good or service that he thinks society wants. Entrepreneur hopes to make profit – normal profit- which is the amount that is left behind after all allocations to the other economic resources have been made.

Because of the problem of scarcity, we have to economize or use our economic resources as efficiently as possible. If resources were not scarce or limited, there would be no need to economize or use them efficiently and so there would be no need to study economics. Example 2.

In economics, we deal with economic resources, and economic goods and services to stress the crucial fact that they are scarce and therefore command price rather than being free. Scarcity is the limitation that exists in employing resources for the satisfaction of human wants and needs. It arises because human wants tend to multiply in number while the resources to satisfy these wants tend to be limited. It simply connotes that human wants always exceeds available resources. The rich and the poor alike face the same predicament. For example, Miles wishes to be a certified nurse; however her family cannot send her to a university. The national government wants to spend a budget for livelihood programs, education and health care; but it cannot financially raise more than what it wants. These are examples of scarcity of time resources, capital resources and the like.


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OPPORTUNITY COST

Opportunity cost is the forgone alternative of a product or service. In the process of choosing, one can derive a benefit for the one he has chosen. Establishing one’s priorities is important in the process of decision making so one chooses the alternative that will give the higher level of satisfaction. Everyday endeavors entail opportunity cost. The tardiness of attending classes will always cost one to miss lectures. Anita decided to watch Smallville so she did not finish her assignment. Abraham accepted the chance of going abroad so he lost his chance for a college diploma. All these are situations where trade-off and opportunity cost exist. One has to critically analyze choices that will have the least sacrifice but the greater benefits.

RESOURCES

Resources are anything that can give direct satisfaction to human needs and wants. Learning the

holistic view of resources can be more meaningful by using the concept of mapping below.

Resources can be classified into

God created resources man-made resources

Reasons for resources to be scarce

Classified into skills divided into tangible resources are

Resources

Natural Resources Human Resources Physical Resources

Depletion Death/Productivity Depreciation

Forest Resources

Land/ Mineral

Marine Resources

White Collar Jobs

Blue Collar Jobs

Inventions

Innovations


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“complementing effect of the resources” One resource cannot be fully utilized without the other.

Depletion is the process of natural deterioration of the available resources over time. The severity of deterioration is due to the excessive demand for production and consumption and to replenish them will take months/years. To some natural resources, no amount of time can brim them back if fully exploited. Depreciation is the process of wear and tear of a physical resource pr capital. For example, the utility of a new car today will not be the same 10 years from now. Practice Task!

1. Give one specific example of wherein you will observe how resources complement each other? Do

you believe that all are important and have the same degree of significance? 2. What are some examples of services rendered by blue-collar jobs? By white- collar jobs? Why is one

superior to the other? 3. Prove the statement: 80 million Filipinos are said to be scarce.

PRODUCTION POSSIBILITY FRONTIER

Production Possibility Frontier (PPF), is an economic model that describes the economy’s capability to optimize the use of resources faced by scarcity. The economy can choose combinations of product quantities based on the principle of what is needed and beneficial for the period of time. This model assumed that the production is not a one shot deal, therefore the economy knows its needs and wants. The PPF concept will also cater the concept of trade-offs.

Food for all 24 • a • b 21 • c 18 15 • d 12 •h 9 •g 6 •e 3 f PPF2 0 •

3 6 9 12 15 PPF1 machinery


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Figure 1

Production Possibility Frontier of Masikap Economy (Hypothetical Data)

Possibility Food for all machinery

a 24 and 0

b 22 and 6

c 20 and 9

d 15 and 12

e 5 and 15

f 0 and 16

Table 1

The table lists the possible output that the Masikap Economy can produce. Masikap Economy is capable of combinations a, b, c, d, e, and f. Refer to the graph. Any point along the PPF curve signifies possible alternatives the economy can produce between food and machinery. Unattainable outputs are points outside the PPF. The rightward shift of the PPF curve signifies growth attained over a period of time (PPF1 to PPF2). Table 1 shows that our economy can either produce 24 units of food and 0 machinery (point a), 22 units of food and 6 units of machinery (point b), 20 units of food and 9 units of machinery (point c), 15 units of food and 12 units of machinery (point d), 5 units of food and 15 units of machinery (point e), 0 food and 16 units of machinery (point f). At alternative a, our economy would be devoting all its resources to the production of food. At alternative e, all available resources would be devoted to the production of machinery. Both of these alternatives are clearly unrealistic extremes; any economy typically strikes a balance of dividing its total output between capital and consumer goods. Moving from f to e, e to d and d to e, show that we have to give up 1 unit of machinery, 3 units of machinery, 3 units of machinery, etc. 5, 15, 20 to produce units of food respectively. Thus, as we produce more food, we incur higher and higher costs in terms of machinery foregone. This is so because we b In Figure 1the data of Table 1 is represented graphically as the production possibilities curve. Figure 1 shows that each point on the production possibilities curve represents some maximum output of any two products. Society must choose which product-mix it desires: more machinery means less food, and vice-versa. As we move down form point a to point f we incur rising costs in food production. A point inside the production possibilities curve (such as g) implies that the economy is not utilizing all of its available resources and/or not using the best technology available to it. A point outside (such as g) cannot be reached within the resources and technology available. The law of diminishing marginal returns is explicit when Masikap Economy wants to produce additional unit of food, the economy as to give up units of guns. Therefore, increase production of one commodity decreases the opportunity to produce the other goods. This is true because of the scarcity of resources. Production Possibilities A production possibilities schedule or table shows the different combinations of two commodities that society can produce by fully employing all its resources with the best technology available. There are several assumptions: efficiency – the economy is operating at full employment and achieving full production; fixed resources – the available supplies of the factors of production are fixed; fixed technology – the technology does not change at some specific point in time; and the fixed products – there are only two products instead of the innumerable goods and services actually produced.


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Production possibilities schedule or table also includes how much of one commodity must be given up in order to produce more of a second commodity. When it is graphed, we get the production possibilities curve or transformation curve. Since resources are not equally efficient in the production of both commodities, for each additional unit of a commodity we produce, the more we must give up of the second commodity. Thus, we generally face increasing costs of production.

ECONOMIC METHODOLOGY In the study of economics, students should be able to carefully distinguish between two types of statements: statements about what is and statements about what ought to be. Critical thinkers must be able to contrast statements and how these bring meaning to an idea. Positive economics shows casualty of two variables. It is consistent to what we observe in the world, be it true or false. Normative economics presents matters of opinion. It dwells won making judgments and inferences on an idea or thought. For examples:

a. the subject on taxes collected by government. Positive Economics: The efficient collection of taxes increases government funds to 20%. Normative Economics: To deliver the best public services, government should sustain the collection.

b. the deteriorating environment Positive Economics: The improper disposal of urban wastes increases health risks among urban residents. Normative Economics: Massive public education recycling urban wastes should be instituted.


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CHAPTER 2 THE ECONOMY

Economic Sectors In an economy, decision makers are vital to address how wants and needs will be satisfied. These institutionalized sectors vary in their economic participation and these are:

a. Households – the owners of the factors of production and the consumers of the final goods and services. The source of manpower for labor force is basically the main function of this sector.

b. Business firms – the producers of intermediate and final products. This sector is directly involved in most production activities.

c. Government/Public Sector – is composed of local and national government agencies responsible for the provision of basic services for the economy. It facilitates the transfer and collection of public funds.

d. External sector – refers to any foreign country who has opened direct economic transaction with the local economy. Economic relationships are primarily the trading and the investing activities.

Economic Processes and Economic Questions Regardless of what economic system and economy adopts, there are fundamental questions important for the economy to answer to sustain and to improve mechanisms in doing the economic processes of production, distribution and consumption. Economic Processes are classified into: Production is an economic process of employing available resources to produce goods and services for human consumption. Fundamental questions under this process would be: Every society, regardless of its political organization, must answer five fundamental questions. These are: “what is to be produced,” “how much is to be produced,” “how is it to be produced,” “who is to receive it,” and “how should the system be adapted to change.”

1. What is to be produced refers to the kinds and quantities of goods and services to be produced. Scarcity dictates that the economy should prioritize needs among wants in the production of goods and services. Improper and wasteful use of resources must be avoided.

2. How much is to be produced refers to what level or degree the available resources should be

utilized in the production process. He quantity of good and services should be meet the needs of today and preserve the resources for future consumption.

3. How is it to be produced refers to the combination of various resources and the techniques to use in

production. The means or technique to be used in the actual production activity could be labor intensive or capital intensive.

4. Who is to receive it refers to how to divide up what has been produced among consumers in the

economy. Domestic and foreign markets demand for products and services that an economy is capable of producing. Hence, the core of the question is whose needs are to be satisfied?


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5. How should the system be adapted to change refers to how the economic system can make significant reallocations of resources in order to preserve efficiency in their use. These questions arise only because resources goods and services are scarce. Emergence of methods, technology and attitudes in production would bring impact to the future stake of the economy’s potentials.

Example: Philippine society must somehow decide how many hectares of land to be permitted for real estate development, how many cars to build, how many schools to construct and teachers to train, how much food to produce, how much medical services to provide, and how many defense goods to acquire. In producing these goods and services, it must determine which of the many techniques and factor combinations available are to be used. It must determine whether these goods and services would be distributed or shared among the various economic units which comprise the economy. Distribution is an economic process of allocating produced goods and services for the domestic and foreign economies. Fundamental questions to be considered are the following:

1. How will the produced goods and services be distributed among the number of inhabitants? 2. How will be the owners of the resources be compensated by the use of such resources? 3. How does the economy allocate the available resources for future consumption?

Consumption is the final intake or use of allocated goods and services. Since most of the products entail

monetary equivalent, exchange or the use of money will take place prior to consumption.

Fundamental questions that must be addressed are the following:

1. How will the people avail of the basic goods and services when prices are unpredictable? 2. How do consumption patterns differ among consumers? 3. How does the degree of demand influence the pressure on supply for goods and services?

Economic Good Versus Free Good

Free goods and services that can be demanded without the need for a monetary exchange. While exchange goods are scarce, that the demand for those goods require monetary exchange. CIRCULAR FLOW OF GOODS AND SERVICES The circular flow in final goods and services model illustrates how the transfer of goods and services can be facilitated through the linkages with the different sectors comprising the economy. All sectors configure to maintain and sustain the exchange activity. Here, we will observe how the economy can attain the maxim that total leakages must equal total injections. The Circular Flow in a Two-Sector Model. No Saving Economy Initially, it is assumed that the economy is composed of only two sectors: households and businesses are the sole producers of goods and services and production occurs by hiring the factors of production (land, labor, capital, and entrepreneur) owned by the households. These assumptions are presented in Figure 1 as a circular flow. Households receive money income by selling services of productive factors to the businesses. The households use their entire money income to purchase the output of the businesses. On the other hand,


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businesses obtain money income by supplying goods and services to the households. The businesses spend all their revenues or receipts to pay for the productive factors owned by the households.

Two-Sector Model: Money Incomes (Factor Payments) (Rents, Wages, Interests, profits)

***RESOURCE MARKET *** Supply of Factors of Production

Supply of Goods and Services ***PRODUCT MARKET *** Consumption Expenditures

(Purchase of Goods and Services)

Figure 1

The upper half of the diagram is called resource markets wherein businesses are on the demand side and households are on the supply side. The lower half of the diagram in the product markets where households are on the buying or demand side while businesses are on the selling or supply side. Therefore each unit buys or sells. The circular flow model shows a complex and interrelated task of decision making and economic activity. Resource Market is the exchange of the final goods produced by the business firms. In this market, the households are the sellers of the product inputs (resources) and the firms are the buyers. Product Market is the exchange of the final goods produced by the business firms. Here the sellers are the business firms while households act as buyers. The clock-wise flow (direction of arrows) presents the flow of resources while the counter-clockwise flow illustrates the movement of money or income flow. Savings results from the household and the business firm intentions to keep a portion of the income earned from the sale of resources and produced goods. Savings reduces the money income to be used as payment for resources and consumption expenditure. In the circular flow it is treated as a leakage for the activity creating distortions to the cycle. The economy will be at equilibrium when financial institutions make savings available to the households and the business firms in the form of investment. Investment is the process of increasing the current capital goods to produce more goods and services. Thus, investment is an inflow to the circular flow.

Households Business Firms

Investments

Financial Investments

Savings


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The two-sector model equilibrium is at the point that savings (leakage) is equal to investment (inflow). The manipulations involved in controlling the behavior of saving and investment are defined under Monetary policy of the country. Figure 2 presents two identities implicit in the circular flow of Figure 1. Households’ receipt of money income equals the value of output for the businesses. The revenues for businesses equal households spending.

Money Income = Value of Output

Aggregate Spending = Revenue of Firms

Figure 2

By introducing a behavioral assumption into the circular flow, the theory of money income is devised. Suppose that the businesses produce only as long as they receive revenues equal to their disbursement of money income. By assumption, the level of money income (and therefore, the value of output) depends upon the aggregate spending. Practice task 1.

a. Why do households save part of their income? Describe the effects of saving to the circular flow? b. Interest is the payment for the use of capital. How do interest rates influence the households’ and

business firms’ willingness to save? c. At what level of interest rates would households and business firms be willing to invest?

The Circular Flow in a Three-Sector Model The government can tax and spend. Figure 3, it can be noted that taxes depend upon the value of output reduce the money flow to the households. It can also noted that tax receipts , if not spent, are leakages in the circular flow. The circular flow of money depends upon households’ intention to consume, businesses’ intention to invest and governments’ plan to tax and spend.



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Three-Sector Model: Money Incomes Factors of Production

Output of Goods and services Consumption Expenditures

Figure 3 The three-sector model examines the equilibrium condition of the economy with the presence of the government. Here savings and taxes (leakages) must equal the investments and government expenditures (injections) to sustain the equilibrium conditions. In reality, the processes involved are not really that easy to manage. Taxes are generally all forms of contributions collected by the government from households and business firms upon the consumption and use of the resources. The government’s major source of income comes from the income of households and the sales receipts of the business firms. Taxes curtail the money income of households and business firms and reduce their capacity to buy and produce. Government in return must use and spend money collected for public/general consumption. Fiscal policy maintains the balance between taxes and public expenditures. Practice Task 2:

a. Explain why taxes reduce the households’ and business firms’ capacity to consume? b. What are some of government expenses? c. Taxes abate households’ and business firms’ ability to consume. If government will not collect

taxes, how can it necessarily provide services to the economy?

Four-Sector Model Import, like tax and savings, is a leakage in the circular flow. Imports do not remain in the circular flow therefore they constitute outflows or withdrawals. Export like spending and investment is an injection in the circular flow. Exports retrieve funds for the circular flow through the receipts of the sales of the products to the rest of the world. The circular flow showing these withdrawals and injections may be drawn as in Figure 4.


Investment

Banks

Savings

Government Expenditures

Government

Taxes


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In an open economy, the fourth sector is described as the rest of the world. The term connotes the presence of other countries engage in trading of goods and services. The circular flow of goods and services will be at its equilibrium by balancing the imports (leakage) with the exports (injections). The payments for the goods purchased outside the economy are money outflows. The imbalance produced by importation of the goods from other countries can be corrected through exports. Exports are injections from the sale of goods to external sector. It increases the money income in the circular flow. Trade policy upholds the balance of imports and exports.

Money payment flow Factor input flow Resource Market Product Market

Final goods/services flow Consumption expenditures flow

Figure 4

Practice task 3: Why are some goods classified as imported?

a. Give specific examples. b. Give some valid reasons why the economy needs goods coming from other countries. c. Why are exports considered as an injection to the circular flow?

Total leakage = Total injection Saving Investment Taxes Government Expenditures Imports Exports Leakages are outflows from the circular flow of goods and services. Injections are inflows to the circular flow of goods and services.


Investment

Banks

Savings

Government Expenditures

Exports

Government Rest of

The World

Taxes

Imports


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ECONOMIC SYSTEM

Economic System is the configuration of all institutions/sectors in the economy. It organizes its citizens into productive activities. It facilitates ways and mechanisms on how resources can be allocated and how owners of resources can be compensated. It also formulates processes on how the economy can sustain development. Type of economic system and its characteristics:

1. CAPITALISM In this model, the factors of productions and distribution are owned and managed by private individuals or corporations. Also known as market economy, free enterprise economy and it follows the laissez faire policy. Laissez faire is a French word which means “let alone policy or leave it alone.” No government intervention in the market. The following are the characteristics :

a. Presence of religion (belief in God) b. Private property c. Economic freedom d. Profit motive e. Free competition f. Absence of central planning

Market economy is characterized by the use of system through which individual decisions and preferences are communicated and coordinated in responding to the Five Fundamental Economic Questions. In such a system, each participant is motivated by his own selfish interest; each economic unit seeks to maximize its income through individual decision making; and there are many independently acting buyers and sellers of each product and resource of the existence of competitive conditions.

2. COMMUNISM The factors of production and distribution are owned and managed by the state. It is the exact opposite of capitalism also known as command economy or classless society. The essential characteristics of communism are:

a. Absence of religion b. No free competition (government is the sole source of central planning) c. No economic freedom d. No profit motive

Command Economy is characterized by public ownership of virtually all property resources and collective determination of economic decisions through central economic planning. The division of output between capital and consumer goods is centrally decided as is the allocation of consumer goods among the citizenry.

3. SOCIALISM

This is the combination of capitalism and communism. The major and strategic industries are owned and managed by the state the while minor industries belong to the private sector. Examples of major industries are mining, transportation and production of essential products. Minor industries include production of non-essential products such as toys, toothbrush, cakes, chocolates, candies.

4. TRADITIONAL

This is characterized by a system in which the production method, exchange , and the distribution of incomes are all sanctioned by custom. In this system, technological change and innovation are closely constrained because they may clash with traditional and threaten the social order. Economic activity is secondary to religious and cultural values and society’s desire to perpetuate the status quo. A subsistence economy where one produces only the things he need


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CHAPTER 3 MARKET STRUCTURES

Market Structure is the configuration of a market or industry, specifically in terms of the number of firms in the market and the competitiveness of each firm. In theory, the term market connotes the general condition under which buying and selling are conducted. It is any given arrangement that facilitated the transfer or exchange of goods and services of factors of production. Market is the place where you can buy the goods and services you want, where buyers and sellers transact. The prices of these goods and services are determined by “forces” in the market. And this is where a market structure comes in, or the competitive environment wherein buyers and sellers arrive at a price in exchanging goods and services deemed mutually beneficial. Market control is the ability of a firm to determine the price and the quantity of the goods sold. The number of competitors engaging in the market serve as the force which determine price and exchange opportunity. Market deregulation and privatization are two examples of government policies with the goal of inducing competitiveness. Deregulation entails the lifting of laws that restrict or limit specific decisions made by industries. Privatization is the return of a government firm to private administration. SIX KINDS OF MARKET STRUCTURE

1. Perfect Competition 2. Monopolistic Competition 3. Monopoly 4. Oligopoly 5. Duopoly 6. Monopsony

BASIC MARKET STRUCTURES 1. Perfect Competition 2. Monopolistic Competition 3. Monopoly 4. Oligopoly

TWO EXTREME MARKET STRUCTURES

1. Perfect Competition 2. Monopoly

MARKET STRUCTURES KNOWN AS IMPERFECT COMPETITION

1. Monopoly 2. Monopolistic Competition 3. Oligopoly

THE DIFFERENT MARKET STRUCTURES

Perfect and Pure Competition. This is a kind of market model in which:

1) there are many buyers and sellers of a product; 2) the product is homogenous; 3) there is perfect mobility of resources; and


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4) economic agents have perfect knowledge of market condition.

Monopolistic or Differentiated Competition This is a kind of market model in which:

1) there is a large number of sellers acting independently; 2) products are differentiated. Ex. softdrinks, toothpaste; 3) there is limited control of price; 4) entry or existence in the industry is rather easy in the long run; 5) there is aggressive non-price competition in product quality like extensive advertising to promote the

products of the sellers. Monopoly This is the kind of market model in which:

1) a single firm sells a product; 2) the product that is produced has no close substitute or is unique. Ex. NAPOCOR; 3) the monopolist dictates the prices; and 4) entry into the industry is very difficult (as evidenced by the fact that there is a single firm in the

industry).

Oligopoly This is the kind of market model in which:

1) there are few sellers or firms that dominates the market; 2) products are identical and homogenous or they are differentiated. Ex. computers, cars, washing

machines; 3) there is price agreement among the producers to protect their own products; 4) the entry into the industry is possible, but it is not easy because it requires big capital for production.

It is also very difficult to compete with existing firms because these are already well-established; 5) there is a strong promotion and advertising techniques used among those who produce

differentiated products.

Duopoly This is the kind of market model wherein there are only two sellers in the market.

Monopsony This is the kind of market model wherein there is only one buyer. Ex. Government.

ILLUSTRATION OF MARKET STRUCTURE

CHARACTERISTIC MARKET STRUCTURE NUMBER OF SELLER NATURE OF PRODUCT

DIFFERENTIATION

ABILITY TO ENTER

AND EXIT IN

INDUSTRY

DEGREE OF CONTROL

OVER PRODUCT

PRICE

PROMOTION (NON-

PRICE COMPETITION)

EXAMPLE

1.Perfect or pure

competition

Vey large number of

sellers

Product is identical Very easy to enter

and exit

No control over

product price

No competition

regarding the

quality, advertising and the like

Basic need like rice,

sugar, and the like

2.Monopolistic

competition

Large number of

seller acting

Products are

differentiated

independently

Existence in the

industry is easy in

the long run

Limited control over

product price

Need extensive

advertising to

promote the

product

Softdrinks,

toothpaste and the

like

3.Monopoly One seller Product is

unique/mo close substitute

Very difficult and it

is situational

Great control over

product price

May or may not

engage in promoting the

product

National Power

Corporation (NAPOCOR)

4. Oligopoly Few sellers Products are To enter in industry Has control over Strong promotion Car, washing


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identical and

homogenous

is possible but not

easy

product price and advertising machine, computer,

etc.

5. Duopoly Two sellers ---- Not easy to enter Less control but possible

Need promotion and advertising

------

6. Monopoly Many sellers but

there is only one

buyer

Uniform Very difficult to

enter

Great control over

product price

Need promotion Services

Table 1

MONOPOLOST ACTIVITIES IN MAXIMIZING PROFITS

(How they aarived & imposed price on the product) COMPUTATION WHEN COST OF PRODUCTION IS FIXED Price Per Qty Qty sold Total Receipts Cost Per Qty Total Cost Monopoly

Profits

P 6.00 500 P 3,000.00 P 2.30 P 1,150 P 1,850.00

5.60 610 3,416.00 2.30 1,403 2,013.00

4.70 725 3,407.00 2.30 1,450 1,957.00

4.20 850 3,570.00 2.30 1,955 1,615.00

3.50 1,280 4,480.00 2.30 2,944 1,536.00

2.60 1,350 3,510.00 2.30 3,105 405.00

Table 2

DEFINITION OF TERMS Price per Quantity – known as the testing price of monopolist Quantity Sold – the total number of quantity purchased based on the given price Total Receipt – the equivalent amount of the quantity sold or the total revenue that a monopolist receives based on the given price. Where there is a single price, TR is the price average quantity sold Cost per Quantity – the amount of money spent for each unit of commodity Total Cost - the total expenses from all the quantity that has been produced & sold in the market. The sum of fixed costs & variable cost Monopoly Profits - the amount earned by the monopolist after they less the amount spent from the product FORMULA:

a) Total Receipts = Price per quantity x Quantity Sold b) Total Costs = Cost per quantity x Quantity Sold c) Monopoly Profits = Total Receipts - Total Costs d) If Q, sold is not given,

Quantity Sold = Total Receipts / Price Per Quantity e) If Cost per Quantity is not given

Cost per Quantity = Total Costs/Quantity Sold


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COMPUTATION WHEN COST OF PRODUCTION IS NOT FIXED (INCREASING COST)

Price Per Qty Qty sold Total Receipts Cost Per Qty Total Cost Monopoly Profits

P 6.00 500 P 3,000.00 P 2.30 P 1,150.00 P 1,850.00

5.60 610 3,416.00 2.45 1,494.50 1,921.50

4.70 725 3,407.00 2.60 1,885.00 1,522.50

4.20 850 3,570.00 3.10 2,635.00 935.00

3.50 1,280 4,480.00 3.50 4,480.00 0

2.60 1,350 3,510.00 3.65 4,927.50 (1,417.50)

Table 3

(DECREASING COST)

Price Per Qty Qty sold Total Receipts Cost Per Qty Total Cost Monopoly Profits

P 6.00 500 P 3,000.00 P 2.30 P 1,150.00 P 1,850.00

5.60 610 3,416.00 2.15 1,311.50 2,104.50

4.70 725 3,407.00 1.85 1,341.25 2,066.25

4.20 850 3,570.00 1.75 1,487.50 2,085.50

3.50 1,280 4,480.00 1.10 1,408.00 3,072.00

2.60 1,350 3,510.00 1.00 1,350.00 2,160.00

Table 4

ANALYSIS: Since a monopolists’ main aim is to maximize profits, he test thee market how far he can go by offering different prices acceptable to the market. Under the computation when cost of production is fixed the monopolist sells the product at price P5.60 with the highest profit of P2,013. Under the computation when cost of production is not fixed (increasing cost), the monopolist sells the product at price P5.60 with the highest profit of P1,921.50. Under the computation when cost of production is decreasing, the monopolist sells the product at P3.50 with the highest profit of P3,072.00. Note: Under the different level of computation, it is always fall on P5.60 price of product with the highest profit except decreasing cost. It doesn’t mean that this will happen always. Different response of consumers, cost of product and price are the components to determine the highest profits. The example as you see in the computation is exceptional.


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CHAPTER 4 DEMAND AND SUPPLY ANALYSIS

This chapter will show how prices of goods and services are determined through supply and demand. These prices, in turn, will be based on the amount or quantity of goods and services available in the market. We shall look into the forces that influence the supply and demand levels. MARKET The market is where goods and services are brought. A place where buyers and sellers transact. Such transaction signals the exchange of goods and services between buyers and sellers. But aside form these two players, Government plays a role in determining the final price either by setting a ceiling or instituting other price mechanism policies. DEMAND Demand refers to people’s willingness to buy a particular product. The desirability and eagerness to buy can also constitute a potential, realizable demand. The number of buyers is determined by a product’s price reasonableness. If consumers find prices of bananas, for instance, too stiff, they would go for other fruits or other food substitutes. THE LAW OF DEMAND A demand schedule is a table which shows the various amounts of a product which the individual is willing and able to purchase at various alternative prices during some specified period of time. The graphic representation of the demand schedule is the demand curve. The demand curve slopes downward (from left to right) because the individual will buy more of a commodity at lower prices. This reflects he Law of Demand which states that as the price of a commodity decreases, all other things being constant, the corresponding quantity that the individual will be willing to buy increases. The negative slope of the demand curve shows that price and quantity are inversely related. That is, the lower the commodity price, the greater the quantity demanded per unit of time. This conforms to our everyday experience as consumers and is the result of the substitution and income effects. As the price of a commodity falls, the individual substitutes this commodity for another in consumption (substitution effect), or he is able to buy more of it with the same money income (income effect). Quantity demanded refers to the various amounts of a good which buyers are willing and able to buy, at all possible alternative prices, other things being equal. The sum of the demand curves of all individuals in the market for a commodity gives the market demand curve for the commodity. As the price of a commodity decreases – with other things held equal – quantity increases. And as price increases, again other things remaining constant, demand decreases. People are more willing to buy more or less. FACTORS THAT INFLUENCE DEMAND A demand schedule ( a demand curve in graph) shows various quantities of goods and services buyers are willing and able to purchase at different market prices. It is determined by factors such as: Income. When income increases, people are able to buy more. Population. As the population grows, demand for goods and services increases.


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Taste and Preference. Assuming prices are constant, people go more for the goods they prefer by their tastes and biases. Price Expectation. When the people anticipate price increase, demand for its product increases. Price of Related Goods. When a product’s price increases, people shift to its substitutes, thus known as goods.

Hypothetical Market Demand Schedule For Meat Per Day in National Capital Region (Manila)

Price of Meat per Kg Quantity Demanded in Kgs.

45 90,000

50 85,000

55 80,000

60 75,000

65 70,000

70 65,000

75 60,000

Table 1

Table 1 shows the prices of meat are inversely related to the quantity demanded for meat. When the price of meat is P45.00, the demanded for meat is pegged at 90,000 kgs. When the price increases to P75.00 (with P30 increases in price per kg.) the quantity demanded for meat is 60,000 or 30,000 kgs. Less.

Hypothetical Market Demand Curve for Meat (Per Day in Manila)

1A

Figure 1A

0

10000

20000

30000

40000

50000

60000

70000

80000

90000

100000

1 2 3 4 5 6 7

Price of Meat per Kg

Quantity Demanded in Kgs.


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Note: An excess demand or a supply shortage exists when the quantity demanded exceeds the quantity supplied. SHIFT IN THE DEMAND CURVE THROUGH THE CHANGES OF DIFFERENT FACTORS THAT DETERMINE DEMAND

1. Income Income – demand curve shifts to the left in income – demand curve shifts to the right

2. Population Demand curve shift to the right

3. Taste and Preference In taste and preference – demand curve shifts to the left

In taste and preference – demand curve shifts to the right

4. Price Expectation If people expect the price of sugar will increase next week, demand curve in the current week will shift to the right. If people expect the price of sugar will decrease next week, demand curve at the current week will shift to the left.

5. Price of Related Goods

An increase in price of a commodity can cause a shift in the demand curve for another product. Given the increase in the price per kilogram of orange and decrease in the price per kilogram of dalanghita, buyers are likely to buy dalanghita instead of orange. In this case, the demand for orange will shift to the left, while the demand for dalanghita will shift to the right. Eaxmple 1

Price per kilo Quantity Demanded by one individual (kilos per mo.)

Quantity Demanded in the market (kilos per mo.)

Alternative Point

20 7 700 A

18 7.5 750 B

16 8.5 850 C

14 10 1000 D

12 12 1200 E

Table 2

Table 2 gives an individual’s demand schedule and the market demand schedule for vegetable. Assume that there are 100 identical individuals in the market. The table shows that at the high price of P20 per kilo, 7 kilos of vegetable per month will be bought by one individual and 700 kilos will be bought by the 100 individuals in the market (point A. If the price were lower, say P16 per kilo, each individual would buy 8.5 kilos per month; 850


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would be bought by the market as a whole (point C). At the low price of P12 per kilo the individual will purchase 12 kilos per month, while the market purchases 1200 (point E). Note that the lower the price, the greater the quantity demanded by the individual and the market. P Individual’s Demand Curve p Market Demand Curve 20 • 20 • 18 • 18 • 16 • 16 • 14 • 14 • 12 • 12 • 10 D 10 D 8 8 6 6 4 4 2 2 Qd Qd 2 4 6 8 10 12 200 400 600 800 1000 1200

Figure 2

Figure 2 shows that if the price of vegetable is P20 per kilo (measured along the vertical axis), the individual will purchase 7 kilos of vegetable per month measured along the horizontal axis, in the left panel of Figure 2) and the market will purchase 7 kilos (point A in the right panel), etc. Note that both demand curves are negatively sloped (i.e. slope downward to the right) indicating that at lower prices, the quantities demands are greater. Change in Quantity Demanded A change in quantity demanded designates the movement from one point to another point – from one price quantity combination to another – on a fixed demand curve. The cause of a change in the quantity demanded is a change in the price. Example In Table 2, a decline in the price asked by the suppliers of vegetable from P20 to P18 will increase the quantity of vegetable demanded from 700 to 750 kilos. In Figure 2, the movement from point A to point B on curve D is a change in quantity demanded. Change in Demand A change in demand refers to a shift in the entire demand curve either to the right (an increase in demand) or to the left (a decrease in demand). The consumer’s state of mind concerning purchases of the commodity has been altered. The cause of a change in demand is a change in one or more of the determination demand. The determinants of demand are (factors that shift the demand curve):

1. Change in consumer tastes and preferences. Favorable change in the consumer tastes and preferences – possibly prompted by advertising or fashion changes – will mean that more will be demanded at each price; that is, demand will increase.


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2. Change in number of buyers. An increase in the number of buyers in a market brought about perhaps by population growth or by improvements in transportation will constitute an increase in demand. Few consumers will reflect by a decrease in demand.

3. Change in consumer income. For superior or normal goods (such as appliances, jewelries, meat, etc.) a rise in income will cause an increase in demand and the demand for normal goods will decline in response to a fall in income. For inferior or “poor man’s” goods (such as sardines, galunggong, etc.), a rise in income will cause a decrease in demand.

4. Change in the prices of related goods. A decline in the price of eyeglasses reduces the demand for contact lenses (substitute goods); a reduction in the price of cars increases the demand for tires (complementary goods).

5. Change in price expectations. Consumer expectations of higher future prices increase the demand because the consumer will buy now in order to beat the anticipated price rises. Expectations of falling prices decrease the current demand for the commodity because the consumer will postpone buying till the price have lowered.

Determinants of Demand:

a. The price of complementary good d. expected future prices b. The price of substitute goods e. population c. Income f. taste and preference

Movement Along the Demand Curve (change in Qd): Decrease if: Increase if: Price/unit Price/unit P1 A1 P0 A0

P0 A0 P1 A1

D D Qd Qd Qd1 Qd0 Qd0 Qd1

Figure 3 Figure 4 Shifts in the Demand Curve (Change in D): Decrease if: Increase if: The price of a substitute falls The price of a substitute rises The price of a complement rises The price of a complement falls Income falls Income rises The price of a good is expected to fall The price of a good is expected to rise In the future in the future The population decreases The population increases


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Price/unit Price/Unit A1 A0 A0 A1

P0 P0 D1 D0

D0 D1

Qd Qd Qd1 Qd0 Qd0 Qd1

Figure 5 Figure 6 Shifts in Demand Shifts in Demand Situation: Decrease in the number of buyers Situation: increase in consumers’ income

Figure 2 shows the changes in the demand for vegetable. P D2

D0

D1

Figure 7 Qd

A change in one or more of the determinants of demand – consumer tastes and preferences, the number of buyers, consumer income, the prices of related goods, or prices expectations – will cause a change in demand. An increase in demand shifts the demand curve to the right, as from D0 to D2. A decrease in demand shifts curve to the left as from D0 to D1. Practice Task 1: Indicate the following:

a. Change of demand/ (increase, decrease) Quantity demanded

b. movement of demand (along the curve, shift to the right or shirt to the left)

c. relationship to demand (direct, indirect) given the situation and product.

A. Prepaid cellphone 1. Price of cellphone is expected to increase

a. Increase b. Shift of demand to the right c. Direct

2. Increase in the price of prepaid cellphone a. Decrease


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b. Along the demand curve c. Indirect

Graph and show the movement or shifting of the demand for product Tape (cassette). SUPPLY The supply points to the willingness of a producer to ,manufacture goods. The higher the price, the more he is willing to produce. THE LAW OF SUPPLY As prices increases, quantity supplied also increases; as price decreases, quantity supplied also decreases. Again, Ceteris Paribus or assuming other things are equal. Other things being equal (ceteris paribus), the higher the price (p), of a good, the greater is the quantity supplied, (Qs) SUPPLY DETERMINANTS: Price of Goods. The increase in price of goods especially raw materials decreases the supply of finished goods in the market. An increase in the prices of goods increases the cost of producing further goods. Cost of Production. The higher cost of raw materials and other factors of production, the lesser supply of produced goods in the market. However, when the supply of raw materials increase, the manufacturer tend to hoard their processed products in the market to gain profit. Availability of Resources. The supply of goods in the market depends on the availability of resources. More economic market resources that offer production means more supply of goods in the market. Conversely, less supply, less goods. Number of Producers and Sellers. The more the producers and sellers, the more likelihood of a bigger supply. The fewer these players, the lesser the goods’ supply. Technological Advancement. The more important and advanced technology is used in a production of goods, the more supply there is in the market. Taxes. The higher the taxes imposed by Government, the lesser production and thus less supply of goods in the market. Higher tax can discourage people to engage in production as it restricts earnings and increases cost of production. Subsidies. Government determines what industries to promote by, among others, providing subsidies to favored businesses. Weather. Climate affects a products level of supply particularly those of agricultural goods. Drought expectedly decreases rice supply.

Price of meat per kg Quantity demanded in kgs

45 60,000

50 65,000

55 70,000

60 75,000

65 80,000

70 85,000

75 90,000


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Table 3

Table 3 shows the price per kgs. of meat is directly related to the quantity supplied per kg. of meat. /when the price of meat is P75, quantity supplied for meat is 90,000 kgs. When the price decreases to P45 (with P30 decrease in price per kg.). the quantity demanded for meat is 60,000 or with a reduction of 30,000 kgs. A graphical interpretation of this demand schedule is presented in Figure 3A.

3A Figure 3A

Table 3A shows that the prices per kgs of meat is directly related to the quantity supplied per kg of meat. When the price of meat is P75, quantity supplied for meat is 90,000 kgs. When the price decrease to P45 (with P30 decrease in price per kg.), the quantity demanded for meat is 60,000 or with a reduction of 30,000 kgs. A graphical interpretation of this demand schedule is presented in Figure 3. SHIFT IN THE SUPPLY CURVE THROUGH THE CHANGES OF DIFFERENT FACTORS THAT DETERMINE SUPPLY

1. Price of Goods

- in price of goods – supply curve shifts to the left

- in price of goods – supply curve shifts to the right

2. Cost of Production

- In cost of production – supply curve shifts to the left

- In cost of production – supply curve shifts to the right

3. Availability of Resources

- In availability of resources – supply curve shifts to the right

- In availability of resources – supply curve shifts to the left

0

10000

20000

30000

40000

50000

60000

70000

80000

90000

100000

1 2 3 4 5 6 7

Price of meat per kg

Quantity demanded in kgs


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4. Technological Advancement

- in technological advancement – supply curve shifts to the right

- In technological advancement – supply curve shifts to the left

5. Number of Producer

- In number of producers – supply curve shifts to the left

- In number of producers – supply curve shifts to the right

6. Taxes - in taxes - supply curve shifts to the left

- In taxes – supply curve shifts to the right

7. Subsidies

- in subsidies – supply curve shifts to the right

- in subsidies – supply curve shifts to the left

8. Weather

- Good weather – supply curve shifts to the right - Bad weather – supply curve shifts to the left

GOVERNMENT INTERVENTION Government intervention in pricing mostly apply to agricultural products whose prices can be unstable. Price Ceiling – the legally established maximum price set by Government. Price Floor – the legally established minimum price set by Government, If the market price falls to the support level, farmers can sell any amount they wish to the government. Thus, government defines the framework when to intervene.

SUPPLY A supply schedule is a table which shows the various amounts of a product which a producer is willing and able to produce and make available for sale in the market at different prices during some specified period of time. The graphic representation of the supply schedule is the supply curve. This usually slopes upward (from left to right) because higher prices must be paid to induce the producer to supply more of the commodity. This reflects the Law of Supply which states that as price rises, the corresponding quantity supplied rises; as price falls, the quantity supplied also falls.


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The supply curve is usually positively sloped indicating that a producer will supply more of a commodity only at higher prices. This results because producer usually faces increasing production costs. Quantity supplied refers to the various amounts of a good which sellers are willing and able to sell in the market, at all possible alternative prices, other things being equal. There is a positive relationship between the price and the quantity supplied. The sum of all the individual producer’s supply market curves for a commodity gives the market supply curve of the commodity. Example

Price per kilo Quantity Supplied By one producer (kilos per mo.)

Quantity Supplied In the market (kilos per mo.)

Alternative Or Point

20 130 1300 F

18 105 1050 G

16 85 850 C

14 70 700 H

12 60 600 I

Table 4 P Individual’s Supply Curve p Market Supply Curve F 20 • S 20 • S 18 • 18 • G 16 • 16 •C 14 • 14 • H 12 • 12 I • 10 10 8 8 6 6 4 4 2 2 Qs Qs 20 40 60 80 100 120 200 400 600 800 1000 1200

Figure 8 Figure 9 Table 4 gives an individual producer’s supply schedule and the market supply schedule for vegetable. Assume that there are 10 identical producers in the market. The values of Table 4 are plotted in Figures 8 and 9. They show that at a low price of P12 per kilo, each producer will supply only 60 kilos of vegetable per month, for a total of 600 kilos by the 10 producers in the market (point I). If the price were higher, say P16 per kilo, each producer would supply 85 kilos per month for a market total for 850 kilos (pt C). At the high price of P20 per kilo, each producer would supply 130 kilos for a market total of 1300 (pt F). Note that to induce producers to supply greater quantities, higher price must be paid. Thus, the supply curves are positively sloped (i.e. they slope upward to the right). CHANGE IN QUANTITY SUPPLIED A change in the quantity supplied refers to the movement from one point to another point on a stable supply curve. The cause of such a movement is a change in the price of the specific product under consideration. Example


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In Table 4 a decline in the price of vegetable from P20 to P18 decreases the quantity of vegetable supplied from 1300 to 1050. In Figures 8 & 9 the movement from point F to point G on curve S is a change in the quantity supplied. CHANGE IN SUPPY A change in supply is indicated by the shifting of entire supply curve. An increase in supply shifts the curve to the right; a decrease in supply shifts it to the left. The cause of a change in supply is a change in one or more of the determinants of supply. The determinants of supply are (factors that shift the supply curve)

1. Change in technology. Technological advancement will increase supply while a deterioration of technology will cause a decrease in supply.

2. Change in the costs of production. An increase in the costs of production will cause a decrease in supply while a decrease in the costs of production will increase supply.

3. Change in taxes and subsidies. An increase in taxes and a decline in subsidies will decrease supply while a decrease in taxes and increase in subsidies will increase supply.

4. Change in prices of other goods. A decline in the price of eyeglasses increases the supply of contact lenses (substitute goods); a reduction in the price of cars decreases the supply of tires (complementary goods).

5. Change in price expectations. Expectations of higher prices may induce the producers to withhold their products from the market, causing supply to decrease. Expectations of lower prices will make producers to sell more at present causing supply to increase.

6. Change in number of suppliers. As more firms enter an industry, the supply will increase while as firms leave an industry, the supply will decrease.

Figure 10 shows the change in the supply for vegetable. S1 S2 S3

P

Figure 10 Qs

A change in one or more of the determinants of supply – technology, costs of production, taxes and subsidies, prices of other goods, price expectations, or number of suppliers – will cause a change in supply. An increase in supply shifts the supply curve to the right, as from S1 to S2. A decrease in supply shifts the supply curve to the left, as from S0 to S1.


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Quantity supplied. Qs of a good is the amount that producers plan to sell in a given period of time at a particular price. Supply Schedule

Point Price per unit, P (in pesos)

Quantity Supplied, Qs (per piece)

A 2.00 4

B 4.00 7

C 6.00 12

D 8.00 16

E 10.00 20

F 12.00 25

Table 5 Price /unit S

12 • F 10 •E

8 •D The Supply Curve

6 •C

4 •B

2 •A 5 10 15 20 25 30 35 Qs Figure 11 Determinants of Supply:

a. The price of complementary goods d. expected future prices b. The prices of the factors of production e. the number of supplies c. The prices of substitute goods f. technology

g.Taxes and subsidies

Movement along the Supply Curve (Change in Qs): Decrease if: Increase if: The price of goods fall The price of the goods rises Price / Unit Price /Unit S S P0 • A0 P1 • A1 P1 • A1 P0 • A0 Qs Qs Qs1 Qs0 Qs0 Qs1


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Shift in the Supply Curve (Change in S): Decrease if: Increase if: The price of a factor of production to The price of a factor of production Produce the goods increases used to produce the goods increases The price of a substitute in production rises The price of a substitute in production falls The price of a complement in production falls The price of a complement in production rises Price / Unit Price /Unit S1 S0 S0 S1 P0 • A1 A0 P0 • A0 A1 Qs Qs Qs1 Qs0 Qs0 Qs1 Shift in Supply with a decrease in Shift in Supply with the used of the number of sellers modern technology Sample Exercises on Supply Indicate the following:

a. Change in supply (increase, decrease) b. Movement of supply (along the curve, shift to the right or shift to the left) c. Relationship to supply (direct, indirect) given the situation and product)

A. Automobiles (import)

1. Robotic production plants lower the cost of producing cars a. Increase b. Shift of supply to the right c. Indirect

2. Increase in the government ad valorem taxes on imported automobiles a. Decrease b. Shift of supply to the left c. Indirect

Graph the following situations showing the movement or shifting of supply.


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CHAPTER 5 MARKET EQUILIBRIUM

Key Concepts: Equilibrium occurs when the quantity demanded is equal to the quantity supplied. That is at a certain agreed price, sellers and buyers would be willing to produce and to buy. Market Schedule: (Tickets for Mr. Pure Energy’s Concert)

Price (in pesos)

Quantity Demanded (Per Piece)

Quantity Supplied (Per Piece)

300 1,000 100

500 700 300

800 500 500

1,000 400 800

1,200 200 1,200

Surplus (excess supply) exists when the quantity supplied exceeds the quantity demanded at the current price. In this condition, market prices are above the equilibrium price. Shortage (excess demand) exists when quantity demanded is greater than quantity supplied at a current price. Market prices are graphically situated below the equilibrium price. Equilibrium Point is the intersection of the supply and demand curves for the product. Price 1200 • •S surplus 1000 • • equilibrium 800 • equilibrium point, e price, Pe 600 • • 400 shortage • • D 200 200 400 600 800 1000 1200 Quantity Equilibrium Quantity, Qe Market equilibrium – mutual agreement between producer and consumers, that is whatever will be produced by the producers the same amount of goods will be consumed by the consumers at a given price. Changes in Equilibrium: When supply and demand curves shifts, the equilibrium price and quantity change. This is brought about by the non-price determinants of demand and supply.


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Example 1: High population, High D; Low cost of production, High S; Constant Market price S0

Price/Unit S1

A0 Pe • • A1

D1

D0 Quantity, Q Qe0 Qe1

Example 2: Low Income, Low D; High use of technology, High S; low Market Price S0

Price/Unit Pe0 • Ae0 S1

Pe1 • Ae1 D0

D1 Quantity, Q Qe0 Price floor and Price Ceiling The government is sometimes treated as a third actor in a market. The role of the government can be evaluated through the price setting mechanisms. Some sellers who want to increase the production of goods and services sometimes cannot afford to defray additional expenses as part of their production cost. Government agencies enact laws to regulate the prices of their products. Floor price is the minimum price set on a particular good or service. The aim is to help producers sustain production. This price is usually set above the equilibrium of the price level existing in an open market. There are goods and services which buyers consider basic. These goods and services sometimes need government control on prices set in an open market. Ceiling price is the maximum price set on a particular good or service. The aim of this market interference is to help consumers purchase the product. The price is usually set below the equilibrium price. This can create shortage of supply of the particular product.


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Market Equilibrium A market reaches an equilibrium when the quantity demanded equals the quantity supplied and these are no internal forces precipitate change. Equilibrium will occur where the demand and supply curves intersect, that is, where the buying intentions of consumers are consistent with the selling intentions of the sellers. The equilibrium price and the equilibrium quantity of a commodity are determined by the market demand and supply of the commodity. The equilibrium price is the price at which the quantity of the commodity that consumers are willing to purchase over a given period of time exactly equals the quantity producers are willing to supply.

At higher prices, the quantity demanded falls short of the quantity supplied and the resulting surplus will push the price down toward its equilibrium level. At price below the equilibrium price, the quantity demanded exceeds the quantity supplied and the resulting shortage will drive the price up toward the equilibrium level. Thus, the equilibrium price, once achieved, tends to persist. The Price Mechanism and the Philippine Mixed Economy We have seen that the equilibrium price and quantity of a commodity are determined at the intersection of the market demand and supply curves of the commodity. This helps determine “what” commodities and “how much” of each are produced. The equilibrium price and quantity of each factor of production are determined at the intersection of the market demand and supply curves of the factor. These factor prices help determine “how” businessmen should combine factors of production to minimize production costs. Factor prices also determine “for whom” goods and services are produced. In our country, activists criticize the price system by pointing out that: it leads to an unequal distribution of income – some live in luxury while others live in poverty. It cannot ensure continued employment of labor and other resources. Some firms restrict output and raise prices. And, prices often reflect only private concerns rather than social costs and benefits of education, medical services, etc. The government is trying to overcome the criticisms by implementing the following : it redistributes income from the rich to the poor through progressive taxation (i.e. the rate of taxation is greater on higher incomes than on lower incomes) and other programs for the poor; it devises economic policies to eliminate or reduce unemployment and/or inflation; it seeks to regulate firms’ pricing and service policies to protect the consumers; and, it also tries to reduce the discrepancy between private costs and benefits on one hand, and social costs and benefits on the other hand through taxes and subsidies, thus, it taxes private firms and subsidies education and public services like social services, medical services, defense, infrastructures, etc.


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Chapter 6 Elasticity Concepts

Price elasticity refers to varying levels of responses to a consumer’s buying choices as affected by a change in price.

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