IHM11H Applied Economics Module 7 PDF

**MODULE 7** **APPLIED ECONOMICS** **Part 3 Introduction to Macroeconomics: Chapter 7 Macroeconomics Fundamentals** 1. Macroeconomics - The Role of Government - Reasons for Economic Growth - The Circular Model - International Trade Practices and Polices **\ Learning Objectives** 1....

**MODULE 7** **APPLIED ECONOMICS** **Part 3 Introduction to Macroeconomics: Chapter 7 Macroeconomics Fundamentals** 1. Macroeconomics - The Role of Government - Reasons for Economic Growth - The Circular Model - International Trade Practices and Polices **\ Learning Objectives** 1. **To understand the role of government in terms of the macroeconomics.** 2. **To know the product possibilities curve.** 3. **To comprehend the reasons for Economic growth.** 4. **To understand the Circular Model** 5. **To know the international trade practices and policies.** Role of Government Circular Model -------------------- -------------------------------------------- Economic Growth International trade practices and policies **Introduction** **What is macroeconomics all about?** **Generally, people would associate it to anything having to do with money and how to make as much as possible. Others claim that it deals with making choices and facing trade-offs. Still others associate it with government fiscal and monetary policies and how they can best help a country\'s economic health. Of course, macroeconomics covers all these and other aspects of the economy like aggregate production, general prices of goods and services, employment, among others.,** **The real purpose of macroeconomics is its ability to explain how we can optimally use our resources in order for us to achieve the highest standard of living possible. Several definitions of macroeconomics have been formulated. For our purposes, however, a good definition that macroeconomics is the study of how we can best increase our country\'s wealth given the available resources we have like our land, labor, and capital and how these resources are transformed by entrepreneurs into final goods and services which we ultimately consume to satisfy our needs and wants. Wealth in this definition includes tangibles like cars, houses, appliances, condominiums, etc. as well as intangibles like more leisure time, cleaner air, etc.** **There is quite disagreement over how a country should go about achieving the optimum amount of wealth. Some economists advocate a great amount of government involvement, price controls, active monetary policy, etc. Others, on the other hand, believe that government involvement should be minimal and limited to tasks related to defending individual rights, national defense and security, maintenance of peace and order, etc. Many, however, believe that a combination of moderate government involvement and private initiatives is ideal in achieving the highest standard of living.** **There are also various opinions about the role of profits, consumer spend-ing, saving, capital formation, minimum wage, foreign investment, taxation and government spending, public debt, etc. in our economy. Then, there is the question of burden thus, the question of taxing goods and services or income and profits to equally distribute the wealth of our country. Moreover, there is the question of whether to encourage spending (and discourage saving) to stimulate our country\'s economic growth. Likewise, the question of unions increasing the welfare of the labor sector is present.** **In-text Activities** **The Role of Government** **The Philippines is a mixed economy with a substantial amount of government involvement in the form of direct government spending, taxation, regulation, and monetary policies. Economic conditions were not always like this though as changes in economic policies happen every now and then depending upon the economic situation brought about by national and international economic conditions.** **After the Philippines gained her independence after World War Il from the United States in 1945, the country experienced a dramatic change in economic beliefs about the role of the private sector and the government. Subsequently, the role of the government in our country (as well as in many other countries of the world) has increased considerably at the end of the war. Central banks, in particular, took control of the monetary system; labor unions supported by government legislations gained more influence; social programs, such as social security and health insurance were deemed necessary; new deal types of government spending to artificially create jobs when the economy is slowing down became commonplace; and to fund the growing government expenses and the exponentially growing number of government employees, taxes to income and goods and services skyrocketed. Public borrowings (both domestic and foreign) became the \'in thing\' among developing and developed countries that do not meet target revenues needed to support government spending.** **Before we delve into the question as to whether the increased role of the government of the Philippines and other countries has been beneficial, let us take a look at some fundamental macroeconomic concepts about the economy and the way it works.** **Reasons for Economic Growth** **We noted in the above discussion that increases in a country\'s capital stock and advances in technology lead to economic growth. How does a country achieve significant increases in capital goods and advances in technology?** **Let us look at increases in capital stock first.** **Capital goods (like machinery, equipment, factories, etc.) are produced just like any other consumer goods such as cars, televisions, and food. At one point in time (that is, given fixed amounts of resources and technology), assuming full-employment condition, more capital goods can be produced only at the expense of producing other goods. Thus, in a two-good economy, more capital goods are produced when fewer consumption goods are produced say 500 tractors and 350 tons of rice. In Figure 8.1, we are moving from the lower right to the upper left of the curve, for instance, from point A to point 8 or point C.** **Advances in technology occur because of inventions and innovations in producing goods and services. Inventions and innovations take place when entrepreneurs have incentives to produce more efficiently and minimize their costs. When lower costs lead to higher profits and greater rewards, entrepreneurs are motivated to continue to improve the production process. Countries that allow entrepreneurs to keep all or most of these rewards (by limiting taxation and government involvement) have been observed to experience greater rates of technological growth.** **In any case, the economy will experience growth thus its production possibility curve will shift outward. For as long as more new capital goods are produced and/or new technology is/are utilized in the production of goods and services, the expansion of the economy will continue. On the other hand, the economy will not grow if capital goods and/or technology is/are lacking.** **The Circular Flow Model** **The dynamic market economy creates continuous, repetitive flows of goods and services, resources, and money. The circular flow diagram, shown in Figure 7.1, illustrates the flow of resources and output from households to businesses, and vice versa. Observe that in the diagram we group private decision makers into businesses and households and group markets into the resource market and the product market.** **Figure 7.1 Circular Flow Model** **Figure 7.1 illustrates the flow of resources and payments for their use as well as the flow of goods and services and payment for them. Thus, the household sector sells resources to and buys products from the business sector while the business sector buys resources from and sells products to the household sector.** **The upper half of the circular flow diagram represents the resource market: the place where resources or the services of resource suppliers are bought and sold. In the resource market, households sell resources (i.e., land, labor, capital) and businesses buy and use them in the production of goods and services. Households own all economic resources either directly as workers or entrepreneurs or indirectly through their ownership of business corporations. They sell their resources to businesses, which buy them because they are necessary for producing goods and services. This is represented by the inner arrow from the household sector going to the business sector. The funds that businesses pay for resources are costs to businesses but are flows of income in the form of wage, rent, interest, and profit to the households. This is represented by the outer arrow from the business sector going to the household sector. Productive resources therefore flow from households to businesses, and money flow from businesses to households.** **The lower half of the model represents the product market: the place where goods and services produced by businesses are bought by and sold to the households. In the product market, businesses combine the resources owned by the households (i.e., land, labor, capital) to produce and sell goods and services. This is represented by the inner arrow from the business sector going to the household sector. In return, the households receive income from selling their resources to the businesses. Consequently, the households use the (limited) income they have received from the sale of resources to buy goods and services that the businesses produced in the form of consumption expenditure. This is represented by the outer arrow from the household sector going to the business sector. The monetary flow of consumer (household) spending on goods and services yields sales revenues for businesses. Businesses compare those revenues to their costs in determining profitability and whether or not a particular good or service should continue to be produced and sold.** **The circular flow model depicts a complex, interrelated web of decision making and economic activity involving businesses and households. For the economy, it is the circle of life. Businesses and households are both buyers and sellers. Businesses buy resources and sell products. Households buy products and sell resources. As shown in Figure 7.1, there is a counterclockwise real flow of economic resources and finished goods and services and a clockwise money flow of income and consumption expenditures.** **International Trade Practices and Policies** **THE NEED FOR TRADE** **If we look around us, we will see many items we use which are imported from abroad or which have components imported abroad. The books we read, the food we eat, the watches we wear, the buses we ride on, the radio we listen to, the TV sets from which we watch our favorite programs, the movies we see --- many of these things come from abroad or if they are produced here, have parts or components produced abroad.** **\"No man is an island.\" We cannot afford to close our doors from the influences of other countries and other people. If the Arab countries, specifically Saudi Arabia, all of a sudden cut their oil imports to us, our factories would grind to a halt, our buses and cars would stand still, our gas-fired electric plants would not supply us with electricity. In other words, our economy would be paralyzed. If suddenly, we cut our exports to other countries, our sugar plants would have to reduce their production drastically, our coconut farmers and producers would receive significantly less income, our copper and gold mines would have to close shop, our factories which produce semi-conductor devices must stop production. In other words, the income we receive from exports would be drastically reduced and unemployment would rise.** **People who isolate themselves from outside influences miss out on many developments that happens outside their environment. Take a look at our own primitive tribes like the Aetas, the Mangyans, and the Tasadays. They have backward economies simply because they had unwittingly isolated themselves from outside influences.** **We learn from other people in the same way that they learn from us. The countries of the world develop to a great extent on their ability to interrelate with one another and make good use of one another\'s strengths.** **Commerce, communication, and trade have brought countries of the world closer together. We import some of the goods that other countries produce, and, in turn, we export to other countries some of the goods they desire. In this way, interdependence benefits nations. The growth of nations in the world is very much a function of this interdependence.** **Is There a \"World Economy\"** **With the growing interdependence of nations, a \"world economy\" started to exist.** **Through time, this interdependence has become more and more pronounced. It exists because no country today is self-sufficient and all must participate in international trade.** **For one, Philippine economic development depends to a great extent on imports.** **The Philippine economy is a highly import-dependent economy. We have been used to putting up finishing plants, which would require the importation of raw materials to process. This can be shown on the following table which shows the percentage share of imported raw materials to the gross value of our production.** **On a worldwide scale, poor and rich countries, capitalist and socialist alike, exist in global economic web. If there is a bad coffee crop in Brazil, the price of breakfast will go up in Vienna and Warsaw. If there is a harvest failure in the Soviet Union, the American farmers will alter their sowing plans. If the price of crude oil is raised in the Middle East, the pinch will be felt in Boston and Manila.** **This situation applies not only to raw materials, but to other sectors of the world economy as well. The inflation which much of the world is now suffering originated in the economies of developed countries, About 90 percent of the world\'s scientists live in developed countries and technology is one of their main exports. Banks and insurance companies, airlines and shipping companies all tie the world together.** **The result of this interdependence, and it is a growing one, is that no country can set its domestic economic policy without regard to global trends. The sooner we realize this phenomenon, the better it is for us and for the rest of the world.** **Trade as a \"Primary Instrument of Development\"** **Trade is called a \"primary instrument of development\" because this has been its proven role throughout history. Human societies have changed and grown from the stone age to the present by sharing ideas and technologies, and when done peacefully, this has mainly been through trade.** **After the industrial revolution, trade became even more important for several reasons.** **The first was the speed at which science and technology developed the means to create wealth; knowledge itself became a tradable commodity.** **Another reason was the growing investment necessary to transfer and use the cumbersome technology of the industrial age. Trade provided the means for non-in-dustrial societies to earn the surplus wealth necessary to pay for the creation of modern societies.** **The third reason was the social impact of trade in bringing traditional cultures in contact with new ideas, technologies, and goods, thus preparing them for the larger adjustment necessary for industrialization.** **MERCANTILISM** **An international economy could not exist until there were nations. In the Western World, the sixteenth and the seventeenth centuries were the era of the rise of the modern nation-state. During these times, a movement called \"mercantilism\" was born. Many of the concepts and even some of the policies that originated in that period continue to influence thought and action today.** **What is Mercantilism** **Mercantilism is a political-economic movement originating in the period 1500-1750 whose paramount goal of nationalpolicy is to make the nation rich and powerful the means of which consisted mainly in the protection of domestic industry and the regulation of trade.** **In 1500, western Europe probably had population between 55 and 60 million. Most of these people earned a meager living tilling the soil, either as serfs on the landed estates of the nobility or as independent peasant farmers. Probably 80 to 90 percent of them were so occupied. Of the remainder, most were employed as craftsmen, shopkeepers, or servants of the relatively small number of nobles, higher clergy, and well-to-do merchants who enjoyed ample incomes and who held the reins of political and economic power.** **Society was thus preponderantly agrarian. Only four cities had attained a population of close to or slightly above 200,000: London, Paris, Naples, and Milan. Six had a population of about 100,000; Antwerp, Amsterdam, Lisbon, Seville, Rome, and Palermo. There were relatively many towns of a few thousand to 40,000 or 50,000 population, but even these were widely scattered.** **Trade** **Because most people had an income sufficient only to provide the bare needs for food, clothing, and shelter, trade in the fifteenth century was confined mainly to the towns and the immediately surrounding countryside. The sixteenth century, however, saw a steady increase in the intra-European trade in luxuries. In the North European trade, the Dutch, by developing efficient, specialized ships, and by opening up new fisheries, greatly expanded their herring catch and trade in salted herrings.** **Vasco da Gama\'s discovery of the ocean route to Indian and the Spice Islands via the Cape of Good Hope (1498) enabled Portugal, and later Holland, to rival and then displace Venice in trade with these areas. For da Gama\'s achievement meant that commerce was no longer confined to the Mediterranean galleys of Venice, to the camel caravans of the Near East, and to the pack trains winding their way northward over the Alps. Now commerce could take to the high seas in vessels of increasing size, at a diminishing cost of operation.** **The discovery of the Americas was soon followed by the Spanish conquest of Mexico and Peru. From their art treasures and mines flowed a swelling stream of gold and silver that bulwarked Spain\'s power for over a century. But the Spanish economy remained backward; for supplies for its growing American colonies, Spain had to depend increasingly on purchases from other European sources.** **With the consequent seepage of the precious metals into the rest of Western Europe, prices rose steadily if somewhat irregularly, while wages lagged behind. The mild but steady inflation continued until about 1650, sustaining profits and stimulating both the accumulation of capita and the growth of trade. And beginning early in the sixteenth century, colonial expansion in North America by the English, Dutch, and French added another dimension.** **TRADE PRACTICES AND POLICIES** **Philippine exports have been the main dollar earner of the country. In recent years, it has contributed about fifty percent of total dollar receipts of the country.** **The concept of interdependence which we discussed earlier applies only within an economy but also among economies. There are goods produced by other countries that we desire to have, and there are goods produced in our country that are desired by other countries. If we want foreign goods,\"states-side goods\" to be exact, we have to import them. Importation of goods means that we have to have currency to buy them.** **We cannot use our Philippine peso to buy foreign goods. We need dollars to import goods or to buy goods from foreign sources.** **In international economic relations, importers and exporters accept international currencies that they can trust. Thus, for international transactions, they would readily accept the dollar, the English pound, the Japanese yen, the German deutsch-mark, and even the Saudi Arabian rial. It so happens that the owners of the currencies just mentioned are among the most prosperous nations on earth. Currency is like a personal check. A check authentically signed by Mr. Enrique Zobel of the Ayala Corporation is much more acceptable than a check signed by an ordinary Mr. Juan de la Cruz.** **We need dollars for economic growth. We need dollars to import the goods our industries need. It is a fact that a great part of our equipment, machinery, raw material requirements for our local production are imported from abroad.** **Exports** **Exports are goods or merchandise that we sell to other countries to earn dollars.** **These dollars that we earn will later be used to buy goods we need from abroad. The faster the growth of exports, the more goods and services we can purchase from abroad.** **In the recent years, earnings from exports have constituted about 50 percent of total dollar receipts of the country.** **Imports** **The dollars we earn through exports and other sources are used mainly to import goods and services we need. Most of our imports are composed of industrial and manufactured items.** **A big chunk of our import payments is composed of electronics, mineral fuels.** **References** Refer to the references listed in the syllabus of the subject **LEARNING ASSESSMENT : Macroeconomic Fundamentals** **Economic Model Illustration** **Direction:** Illustrate, discuss and give at least two (2) examples in the circular flow model using the following: \*Household \*Businesses \*Resource Market \*Product Market \*Buy Resources \*Sell Resources \*Sell Products \*Buy Products \*Consumption Expenditures \*Wages and Salaries \*Rent \*interest \*Profit \*Labor \*Capital \*Entrepreneurship \_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_