Applied Economics Topic 1: Introduction PDF

Ateneo de Davao University Senior High School APPLIED ECONOMICS TOPIC 1 - Revisiting Economics as a Social Science and Economics as an Applied Science; and The Economic Problem WHAT IS ECONOMICS? Eco...

Ateneo de Davao University Senior High School APPLIED ECONOMICS TOPIC 1 - Revisiting Economics as a Social Science and Economics as an Applied Science; and The Economic Problem WHAT IS ECONOMICS? Economics may appear to be the study of complicated tables and charts, statistics and numbers, but, more specifically, it is the study of what constitutes rational human behavior in the endeavor to fulfill needs and wants. Economics has been defined in many ways. It comes from the Greek word “oikanomia” meaning “household management.” Some of these definitions are as follows: 1. According to Fajardo, economics is the proper allocation and efficient use of available resources for the maximum satisfaction of human wants. 2. Samuelson states that economics is the study of how societies use scarce resources to produce valuable commodities and distribute them among different people. 3. Economics, according to Nordhaus, is the science of choice. It studies how people choose to use scarce resources or limited productive resources (labor, equipment, technical, knowledge) to produce various commodities and to distribute these commodities for consumption. 4. Sicat defined economics as a scientific study which deals with how individuals and society in general make choices. 5. Castillo viewed economics as the study of how man could best allocate and utilize the scarce resources of society to satisfy his unlimited want 6. Webster defined economics as a branch of knowledge that deals with the production, distribution and consumption of goods and services. To sum it up, economics covers all kinds of topics, but at the core, it is devoted to understanding how society allocates its scarce resources. Any country has limited resources. Since resources are generally scarce and human wants tend to be APPLIED ECONOMICS | Page 1 of 15 unlimited, economics encounters big problems. The biggest is that these resources are not freely available. At the very core, economics lies the fact of scarcity. Goods are limited, while wants seem infinite. Because resources are scarce, we need to study how society chooses from the menu of possible goods and services, how different commodities are produced and prices and who gets to consume the goods that society produces. IMPORTANCE OF ECONOMICS Many individuals have no clear understanding of what economics is. They don’t even know how it works and how it affects their lives. People just don’t mind what economics can give to them. Actually, every individual cannot isolate himself from economics. This is brought about by the mere fact that his physical existence in this world depends upon economics. People cannot live without production and consumption. Almost always, human activities involve economics. For instance, earning money, buying goods and services, depositing and withdrawing money in the bank, these are all economic activities. Clearly, a good knowledge of economics offers many favorable possibilities. It guides us how to make a living, how to use our money wisely, how to run our business, how to properly distribute our available scarce resources, and how to maximize our profits and consumer’s satisfaction, among other things. With appropriate economic decision and implementation, life for everyone is most likely better. Furthermore, economics is important in order to understand problems facing the citizen and the family; to help the government promote growth and improve the quality of life while avoiding depression and inflation and to analyze fascinating patterns of social behavior. Because economic questions enter into both daily life and national issues, a basic understanding of economics is vital for sound decision-making by individuals and nations. THE NATURE OF ECONOMICS Economics is a Science. A science is a body of systematic knowledge built upon by conscious efforts. Like any other science, its laws and principles are arrived at only after a long series of observations and experimentations. The body of knowledge is made up of different explanations. An explanation of a certain event is called a theory. A theory may become a successful theory if its predictions are confirmed by actual observations APPLIED ECONOMICS | Page 2 of 15 and must gain universal acceptance. Economics is, thus, concerned with accurate appraisal of facts and events about our material life. Economics is classified as a social science because it deals with the study of man’s life and how he lives with other men. Economics is concerned with human beings and his behavior. Obviously, it is interdependent with other sciences like: Psychology, the science that deals with the development of society; Political science, the science of government; Geography, the science that determines the main resources of a region. Likewise, Religion is related to Economics. Religious traditions and belief can discourage or encourage economic development. Economics, as a social science, is the study of the relations between people during the production, distribution and consumption of wealth in human society. In other words, economics is the study of the relationship established in the production and consumption of goods and the transfer of wealth to produce and obtain those goods among people. Economics explains how people interact within markets to get what they want or accomplish certain goals. Since economics is a driving force of human interaction, studying it often reveals why people and governments behave in particular ways. A study of economics can describe all aspects of a country’s economy, such as how a country uses its resources, how much time laborers devote to work and leisure, the outcome of investing in industries or financial products, the effect of taxes on a population, and why businesses succeed or fail. Of the social sciences, Economics has more advantages as a scientific discipline for two major reasons: 1. Economic motives of human beings may be more regular and therefore persistent. They can be more predictable 2. There is more factual information in the form of statistics. This gives a substantial basis for the verification and formation of alternative economic theories. Considering the nature of economics, it is not advisable to solve an economic problem with an economic solution alone. Our economic problems are not purely economics in nature. These are also created by non-economic factors like culture, education, social, and political. APPLIED ECONOMICS | Page 3 of 15 DIVISIONS OF ECONOMICS Economics has five major divisions. These divisions are as follows: 1. Production – This refers to the process of producing or creating goods needed by the households to satisfy their needs. The factors of production are called inputs and the goods and services that have been created are called outputs of production. 2. Distribution – This refers to the marketing of goods and services to different economic outlets for allocation to individual consumers. In monetary terms, this is the allocation of income among persons or households. 3. Exchange – This is a process of transferring goods and services to a person or persons in return for something. At present, the medium of exchange used in the market is money. This means, we can exchange our money with goods and services. 4. Consumption – This refers to the proper utilization of economic goods. However, goods and services could not be utilized unless you pay for it. Hence, we can also say that consumption is spending money for goods and services in order to yield direct satisfaction. 5. Public Finance – This pertains to the activities of the government regarding taxation, borrowings, and expenditures. It deals with the efficient use and fair distribution of public resources in order to achieve maximum social benefits. This means, government programs and projects which are funded by taxes and loans are properly implemented and managed to generate maximum and optimum benefits for all members of society. MACROECONOMICS AND MICROECONOMICS The study of Economics is divided into two branches: Macroeconomics and Microeconomics. Microeconomics Deals with the economic behavior of individual units such as the consumers, firms, and the owners of the factors of production. Such specific economic units constitute a very small segment of the whole economy. Their activities are presented and discussed in detail. For example, the price of rice, the number of workers of a certain firm, the income of Mr. Sajise, the expenditures of PLDT, etc. Microeconomics is also known as the PRICE THEORY. APPLIED ECONOMICS | Page 4 of 15 Macroeconomics Deals with the economic behavior of the whole economy or its aggregates such as government, business and households. An aggregate is composed of individual units. The operation of the various aggregates and their interrelationship is analyzed to provide a profile of the economy as a whole. Macroeconomics is concerned with the discussion of topics like gross national product, level of employment, national income, general level of prices, total expenditures, etc. it is also known as employment and income analysis. Micro and macroeconomics are intertwined, so as economists gain understanding of certain phenomena, they can help nations and individuals make more-informed decisions when allocating resources. The systems by which nations allocate their resources can be placed on a spectrum where the command economy is on the one end and market economy is on the other. The market economy advocates forces within a competitive market, which constitute the “invisible hand” to determine how resources should be allocated. The command economic system relies on the government to decide how the country’s resources would be best allocated. In both systems, however, scarcity and unlimited wants force governments and individuals to decide how best to manage resources and allocate them in the most efficient way possible. However, there are always limits to what the economy and government can do. However, what is true in Microeconomics may not be true in Macroeconomics. For example, a vegetable farmer gets a better harvest. This means more income for him, if all vegetable farmers have increased their harvests; it is not favorable for them. Because more supply reduces the price of vegetables. TOOLS OF ECONOMICS Most economists are engaged in analyzing the present economic situation of the country. Most of these economists use different scientific approaches and utilize different tools to be able to formulate theories and principles. Some of the major tools used by these economists are the following: 1. Logic - It is a science that deals with sound thinking and reasoning. In the process of reasoning, facts and proofs should be presented; otherwise, such reasoning will be clouded by an iota of doubt. With the wise application of logic, one may be able to arrive at a conclusion. APPLIED ECONOMICS | Page 5 of 15  2. Mathematics - It is a science that deals with numbers and their operations. Actually, economics is the most quantifiable discipline among social sciences. It can quantify population, income, national product, aggregate number of firms, etc. Besides, mathematical operations and equations are used in economics in arriving at a conclusion. Mathematics comes hand in hand with economics. Mathematics helps economists solve concrete problems involving numbers, such as how to calculate the profit margin of a firm, what price a company should set to maximize profits, or how to calculate the amount of C02 emissions in the atmosphere. Mathematical tools used in economics include matrix algebra, linear equations, econometric models, optimization and differential equations. The simplest application of mathematics for economic analysis is found in the field of Geometry, a science that explains relationships. 3. Statistics - It is a branch of. mathematics engages with the analysis and interpretation of numerical data. It deals with the process of collecting, tabulating and analyzing data to test the validity of a certain hypothesis. These are facts collected and arranged in an orderly way for study. Through statistics, one may be able to reject or accept an assumption made on a certain phenomenon. Statistics, for example, help economists calculate a nation's GDP or allow them to better configure a manufacturing process to reduce costs. Statistical tools include regression and correlation analysis and calculation of probabilities. ECONOMICS AS AN APPLIED SCIENCE A pure science furnishes tools and applied science works with these tools. Similarly, Economics as pure science, formulates various laws and applied economics applies them in practice in solving various problems. Before economics has been treated as a pure positive science. But recently, applied economics assumed greater importance. As pure science and applied science go hand- in-hand, so Economics is also pure as applied science. The scope of economics means the limits or boundaries of Economics. According to Adam Smith and A.C. Pigou, Economics studies the causes of material wealth. They gave a very narrow scope to the study of economics by limiting it only to those activities relating to wealth. According to Prof. Marshall, "Economics is the study of economic activities of a man. It is only concerned with the wealth-getting and wealth-using activities of a man," APPLIED ECONOMICS | Page 6 of 15 APPLIED ECONOMICS The term 'applied economics' is believed to have started being used nearly 200 years ago, in the writings of French economist and businessman Jean-Baptiste Say (1767-1832) and British political economist, philosopher and civil servant John Stuart Mill (1806-1873). Say wrote about applying the general principles of political economy. In 1848, Mill used the term in his work Principles of Political Economy with Some of Their Applications to Social Philosophy. Applied economics is the study of economics in relation to real world situations, as opposed to the theory of economics. It is the application of economic principles and theories to real situations and trying to predict what the outcome might be. Put simply, applied economics is the study of observing how theories work in practice. Applied economics may be practiced at macroeconomic (the whole, aggregate economy) or microeconomic (analyzing consumers and companies) levels. Applying economics to the status of the economy of a country, households or company helps eliminate all attempts to dress up a situation so that it will seem better or worse than it really is. Only with applied economics can a true and complete picture of an economic situation or theory emerge, so that decision-makers can choose what to do in order to move in the right direction from a current position. Applied economics deals with the application of economic theories and principles to real world situations with the desired aim of predicting potential outcomes. The use of applied economics is designed to analytically review potential outcomes without the "fanfare" associated with explanations that are not backed by numbers. Applied economics can involve the use of econometrics and case studies. Because economics relies on the interpretation of historical events in its theories, applied economics can lead to "to do" lists for steps that can be taken to ensure stability in real world events. Although applied economics uses economic theory and principles, it is itself not a field of economics, such as neoclassical economics or the Austrian school. APPLIED ECONOMICS | Page 7 of 15 Essentially, it is the application of basic assumptions of economics to real-world situations, both isolated and interrelated with sets of current circumstances. Thus, applied economics involves economists taking generally accepted theory and applying those theories to something that is happening in the real world, with an eye toward determining what can reasonably be expected to happen next. APPLIED ECONOMICS’ APPLICATION Applying economic theories to current economic conditions can be extremely helpful for three key reasons. First, applying economics to the status of the economy of a company, a household or a country helps to sweep aside all attempts to dress up the situation so that it will appear to be worse or better than it actually is. From the perspective, applied economics is a powerful tool that enables the true and complete picture to emerge, so that it becomes possible to decide what to do and where to go from the current position. Second, applied economics acts as a mechanism to determine what i can reasonably be taken to improve the current economic situation, each element that is relevant to the contemporary mode of operation of the entity — including the purchase and sale of goods and services, the usage of raw materials and the division of labor within the entity—come into play, Examining each aspect of the current economic condition will often yield sound ideas on ways to maintain aspects that are working at a reasonable rate of efficiency and strengthen areas where the performance is weak. Last, applied economics can teach valuable lessons on how to avoid the recurrence of a negative situation, or at least minimize the impact. Applied economics is all about the application of theory to real-life situations, so the process can help develop an understanding of why a condition took place. This includes reviewing what steps were taken to improve or correct similar situations and how those strategies can be employed to keep the economy flowing in a direction that will preclude a repeat of the undesired situation. THE ECONOMIC PROBLEM Economics is always in the news. Newspapers, television, and the Internet bombard you with information about the economy. The media report on economic issues because they are important in people’s lives. People like you want to know the latest about job opportunities, sales at the mall, the best cellphone model, and other matters that affect APPLIED ECONOMICS | Page 8 of 15 your income, spending, and lifestyle. Economics is concerned with identifying and clarifying the choices one faces now and in the future. Economic Choices Economics is about making choices. You make economic choices every day. You make choices about whether to get a part-time job or focus on your studies., buy a secondhand laptop or save for college, take a home-packed lunch to school or buy from a fast-food restaurant. You already know more about economics than you realize. You bring to the subject a rich personal experience. This experience will help you reinforce your understanding of the basic needs. The Economic Limited Resources Would you like a new car, a nicer home, better meals, more free time, more spending money, or more sleep? Who would not? Even if you can satisfy some of these desires, others keep popping up. Here is the economic problem: Although your wants or desires are virtually unlimited, the productive resources available to help satisfy these wants are scarce. Scarcity creates an economic problem. Scarcity is the condition facing all societies because there are not enough productive resources to satisfy people’s unlimited wants. What must you do in the face of scarcity? Productive resources are limited. Therefore, you cannot have all the goods and services you want; as a result, you must choose some things and give up others. In reality, we see that the means or resources available for satisfying unlimited human wants are scarce compared to their demand. Scarcity of means for satisfying various needs is the central problem of our economic life and it is scarcity that creates the need to make a choice. The scarcity and choice go hand in hand. All the problems like poverty, unemployment, inflation, the balance of payments, slow growth, etc. that a modern economy faces originate from the scarcity of resources. Had resources been available in abundance, had everybody got enough food and shelter, there would not have been any economic problem and, thus, no need to study economics as a subject. However, the truth is that the scarcity of resources exists. The problem existed in all periods. People belonging to the stone age experienced a variety of problems. Modern people also face the problem of scarcity. And the future generation cannot be made free from the problem of scarcity. In all societies and periods choices have to be made to overcome the problem of scarcity. When we talk about society's economic problem, we refer to the overall problem of the scarcity of resources. Irrespective of the economic APPLIED ECONOMICS | Page 9 of 15 system or its nature and stage of development, scarcity of resources forces people to make certain crucial choices if we go to the capitalist and affluent countries of Europe or the post-socialist countries or the less developed mixed economies like India and the Philippines, we find problems of scarcity and choice. Scarcity refers to the tension between our limited resources and our unlimited wants and needs. For an individual, resources include time, money, and skill. For a country, limited resources include natural resources, capital, labor force, and technology. Scarcity is the fundamental economic problem of having humans who have wanted and needs in a world of limited resources. It states that society has insufficient productive resources to fulfill all human wants and needs. Alternatively, scarcity implies that not all of society's goals can be pursued at the same time; trade-offs are made of one good against others. Because all our resources are limited in comparison to all our wants and needs, individuals and nations have to make decisions regarding what goods and services they can buy and which ones they must forgo. For example, if you chose to buy one DVD as opposed to two videotapes, you must give up owning a second movie of inferior technology in exchange for the better quality of the one DVD. Of course, each individual's and nation's values are different, but people and nations, each having different levels of (scarce) resources, form some of their values only because they must deal with the problem of scarcity. So, because of scarcity, people and economies must make decisions over how to allocate their resources. Economics, in turn, aims to study why we make these decisions and how we allocate our resources most efficiently. Opportunity Cost Opportunity Cost - an essential economic concept that refers to the potential value or benefit an individual or business could have gained from choosing an alternative course of action instead of their current choice. In simple terms, it's the cost of forgoing the next best alternative when making a decision. Opportunity cost as an opportunity lost. If you give up an evening of pizza and conversation with friends to work on a term paper, you will never know exactly what you gave up. You know only what you expected. You expected the value of working on that paper to exceed the value of the best alternative. APPLIED ECONOMICS | Page 10 of 15 Opportunity cost varies. Your opportunity cost depends on your alternatives. This is why you are less likely to study on a Saturday night than on a Tuesday night. On Saturday night, the opportunity cost of studying is higher because your alternatives are more attractive than they are on a Tuesday night when there is less to do. What if you go to a movie on Saturday night? You opportunity cost is the value of the best alternative you gave up, which might be attending a basketball game. Studying on a Saturday night might rank well down the list of alternatives for you—perhaps ahead of cleaning your room but behind watching TV. Sunk Cost Fallacy Sunk Cost are costs that have already been incurred and cannot be recovered, regardless of future decisions. The Sunk Cost Fallacy is a cognitive bias that leads individuals to make irrational decisions based on the amount of time, money, or effort they have already invested in a particular endeavor, even when the future prospects for that endeavor are unfavorable. Reasons for Sunk Cost Fallacy Loss Aversion Humans tend to be more sensitive to losses than gains. The pain of losing something (like money or time) is psychologically more significant than the pleasure of gaining an equivalent amount. As a result, people may be reluctant to accept that their initial investment is lost and prefer to continue in the hope of avoiding that sense of loss. The fear of appearing wasteful When individuals have invested resources like time, money, or effort into a project, they may become reluctant to abandon it or cut their losses because they don't want to feel like all their past investment was wasted. Commitment and Consistency People generally value consistency in their decisions and actions. Once they commit to a course of action or project, they may feel obligated to remain committed, regardless of the negative consequences. Changing direction or abandoning the project can feel like admitting failure, which can be psychologically difficult to accept. APPLIED ECONOMICS | Page 11 of 15 Goods and Services Resources are combined in a variety of ways to produce goods and services. Goods – A farmer, a tractor, fifty acres of land, seeds, and fertilizer come together to grow corn. Corn is a good because it is tangible – something you can see, feel, and touch. It requires scarce resources to produce, and it satisfies human wants. A book, the chair you are sitting in, the clothes you are wearing, and your next meal are all goods. Services – Movies, concerts, cellphone service, Internet connections, guitar lessons, dry cleaning, and your next haircut are all services. A service is intangible – that is, not physical – yet it uses scarce resources to satisfy human wants. Rather than say “goods and services” all the time, the term “goods” usually means both goods and services. Factors of Production: Scarcity is a universal condition that exists because there is not enough time, money, or “stuff” to satisfy everyone’s needs and wants. The “stuff” that everybody wants is made out from resources which are referred to as Factors of Production. Land Land is inclusive of all natural resources and not just some random piece of property. Trees, minerals, Fish, water, and plain land are all examples. Land can be divided into two categories, Renewable resources, like trees and chickens are easily replenished. Non renewable resources, like oil and minerals are difficult to replenish. Labor Labor refers to people with their skills and abilities. Labor refers to the effort expended by an individual to bring a product or service to the market. Again, it can take on various forms. For example, the construction worker at a hotel site is part of labor, as is the waiter who serves guests or the receptionist who enrolls them into the hotel. Capital Capital in economics does not refer to money, but to all of the tools, factories, and equipment used in the production process.Capital is the product of investment. Capital are physical assets used to make other goods and services, and investment is the money spent on buying these physical assets. APPLIED ECONOMICS | Page 12 of 15 Entrepreneurship An entrepreneur is a person who combines the other factors of production - land, labor, and capital - to earn a profit. The most successful entrepreneurs are innovators who find new ways to produce goods and services or who develop new goods and services to bring to market. Circular Flow Model The circular flow model is an economic model that shows the flow of money through the economy. The most common form of this model shows the circular flow of income between the household sector and the business sector. Households provide Business Firms with resources. These resources are called Factors of Production, they include Land, Labor, Capital, and Entrepreneurship. Business Firms use these factors of production to provide goods and services to the Households. Business Firms will provide income to the households for using the resources. Households will pay and provide business receipts to the business firms for consuming goods and services. APPLIED ECONOMICS | Page 13 of 15 Monetary Policy Circular Flow The Monetary Policy shows that savings coming from the household sector has a correlation with investments to business firms. Savings from the Household is managed by the Money Market and turned into future investments and these transactions are monitored and manipulated by the Monetary policy. It is key to note that Savings is equal to Investments. APPLIED ECONOMICS | Page 14 of 15  Fiscal Policy Circular Flow The Fiscal Policy shows that payments for taxes coming from the household sector are being used for government Expenditures or projects, these government expenditures will go towards the supply of goods and services that are not provided by the private sector. Payment for taxes are being managed by the government and these transactions are being monitored and manipulated by the Fiscal Policy. It is important to note that taxes is ideally equal to government spendings. REFERENCES AND RESOURCES McEachern, William A., and Burrow, James L., Applied Economics: An Introduction (Senior High School) 2017, Abiva Publishing House Inc., ​ Applied Economics: An Introduction (Senior High School) by William A. McEachen, and James L. Burrow, Abiva Publishing House Inc., 2017 Edition Essentials of Economics by N. Gregory Mankiw South-Western CENGAGE Learning 6th Edition (MAIN LIBRARY) APPLIED ECONOMICS | Page 15 of 15