LESSON I

THE NATURE AND IMPORTANCE OF ECONOMICS

TOPICS
1. The Nature and Importance of Economics
2. What is Economics?
3. The Fundamental Economic Problems
4. Types of Economic Systems
5. The Economic Resources
6. Economic Goals

LEARNING OUTCOMES
At the end of the lesson, student should be able to:
1. Define the basic terms in Economics
2. Discuss the importance of the need to choose
3. Distinguish the different types of economic systems
4. Evaluate the significance of scarcity
5. Differentiate microeconomics from macroeconomics

Figure 1.1 Do You Use Facebook? Economics is greatly impacted by how well information travels through society. Today, social media
giants Twitter, Facebook, and Instagram are major forces on the information super highway. (Credit: Johan Larsson/Flickr)

TOPIC 1: THE NATURE AND IMPORTANCE OF ECONOMICS

Economic activities permeate the lives of individuals in almost every aspect. When a farmer
chooses to grow tomatoes instead of eggplants, he is making an economic decision that may result in
either profits or losses. When a high school graduate chooses to enroll in an education course rather
than science, he is also making a decision that will affect his future financial capability. Since there is
always a possibility of an oversupply of tomatoes and teachers, the economic well-being of the farmer
and the future teacher will always at risk.

Every person makes economics decisions, major or minor, throughout their lives. As only a few
become economically well-off, it may be safely presumed that they are the only ones who made the
right economic decisions. If this statement is true, then that alone would be sufficient reason to study
economics. Economics, however, should not be the concern of individuals only, but also of
organization and institutions including the government. When the Philippine government decides to
make moves to stabilize the value of the peso, for instance, it does so on the basis of an economic
motive. When a school decides to offer course in engineering rather than medicines, it may be doing so
also on the basis of some economic motives.

TOPIC 2: WHAT IS ECONOMICS?

Walstad and Bingham define economics as “a social science concerned with using scarce
resources to obtain the maximum satisfaction of the unlimited material wants of society.”
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 Samuelson and Nordhaus define economics as “the study of how societies use scarce
resources to produce valuable commodities and distribute them among different people.”
Economics, according to Collin, is “the study of production, distribution, selling, and use of
goods and services.”
To McConnell and Brue, economics is a “social science concerned with using scarce
resources to obtain the maximum satisfaction of the unlimited material wants of society.”
Parkin and Bade’s definition refer to economics as “the study of how people use their limited
resources to try to satisfy unlimited wants.”

What the Definitions Indicate

The definitions point out two important factors: scarce resources and unlimited wants
of people. They represent two opposing realities, i.e., resources are just not enough to satisfy people
since wants are unlimited and resources are limited. Since this is so, the concern will now be focused
on how these resources (limited as they are) will be used to satisfy wants to the highest degree
possible.
What Scarcity Means. Scarcity refers to the condition wherein most things that people want
are available only in limited supply. These things, called economic goods, are generally scarce and
must somehow be rationed, whether by price or by some other means.
What is an Economic Good? An economic good is anything, either a physical commodity or
a service, which yields utility and which could command a price if bought or sold in the market.
Examples of economic goods are books, bicycles, residential lot, and medical care.

What Unlimited Wants Mean. Wants refer to “a person’s desires or preferences for specific
ways of satisfying a basic need.” Thus, to satisfy an unsatisfied need, a person wants particular
products and services. A person needs to quench his thirst and wants a glass of water. Another person
needs a job and wants to hire the services of a placement agency. A company needs fully trained
employees and wants to hire the services of a training firm.

The Nature of Economic Choice

Economics is the study of how humans make decisions in the face of scarcity. These can be
individual decisions, family decisions, business decisions or societal decisions. Scarcity means that
human wants for goods, services and resources exceed what is available. Resources, such as labor,
tools, land, and raw materials are necessary to produce the goods and services we want but they
exist in limited supply.

Figure 1.2 Scarcity of Resources Homeless people are a stark reminder that scarcity of resources is real.

If you still do not believe that scarcity is a problem, consider the following: Does everyone
require food to eat? Does everyone need a decent place to live? Does everyone have access to
healthcare? In every country in the world, there are people who are hungry, homeless (for example,
those who call park benches their beds, as shown above and in need of healthcare, just to focus on a
few critical goods and services. Why is this the case? It is because of scarcity. Let’s delve into the
concept of scarcity a little deeper, because it is crucial to understanding economics.

Since wants are unlimited and the resources needed to satisfy those wants are limited, the
economic society is faced with making a choice on which of these wants must be satisfied. The real
problem, therefore, is scarcity.
Scarcity may be defined as “the imbalance between our desires and the means of satisfying
those desires.” Scarcity is a common problem faced by poor and rich societies. No society is so rich to
satisfy all wants of its people.

LINK IT UP
Visit this website (https://stateimpact.npr.org/texas/2013/08/02/how-10-western-cities-are-dealing-
with-water-scarcity-and-drought/) to read about how the United States is dealing with scarcity in
resources.

The Concept of Opportunity Cost

 You will learn quickly when you examine the relationship between economics and scarcity
that choices involve tradeoffs (compromises). Every choice has a cost. If we choose one thing we
must relinquish (give up, release, free) others which, in different circumstances, we would wish not to
have relinquished. Scarcity of means to satisfy given ends is an almost ubiquitous (na nasa sa lahat ng
dako) condition of human nature. Because people live in a world of scarcity, they cannot have all the
time, money, possessions, and experiences they wish. Neither can society.
Economists use the term opportunity cost to indicate what one must give up to obtain what he
or she desires. The idea behind opportunity cost is that the cost of one item is the lost opportunity to
do or consume something else. In short, opportunity cost is the value of the next best alternative. For
Alphonso, the opportunity cost of a burger is the four bus tickets he would have to give up. He would
decide whether or not to choose the burger depending on whether the value of the burger exceeds the
value of the forgone (gave up) alternative—in this case, bus tickets. Since people must choose, they
inevitably face tradeoffs in which they have to give up things they desire to obtain other things they
desire more.
The difference between trade-offs and opportunity cost: Trade-off refers to the decision to pick
an alternative, whereas opportunity cost refers to the value of the forgone alternative.
Opportunity cost refers to the value of the next best alternative of an economic decision.

What is an example of opportunity cost and trade-off?

Trying to decide whether to take the Fourth of July off to spend with your family, or to go to
work and make extra overtime? That's a trade-off. Trade-offs create opportunity costs, one of the
most important concepts in economics. Whenever you make a trade-off, the thing that you do not
choose is your opportunity cost.

A fundamental principle of economics is that every choice has an opportunity cost. If you
sleep through your economics class, the opportunity cost is the learning you miss from not attending
class. If you spend your income on video games, you cannot spend it on movies. If you choose to
marry one person, you give up the opportunity to marry anyone else. In short, opportunity cost is all
around us and part of human existence. In deciding which want to satisfy, the decision-makers must
reckon with opportunities that will be lost when a particular choice is made . When we want to have
more of a good or service, we are actually sacrificing something in exchange. The concept of
opportunity cost now comes under consideration.
Opportunity cost may be defined as “the cost of choosing to use resources for one purpose
measured by the sacrifice of the next best alternative for using those resources.” For example, if a
farmer chooses to send his child to college rather than expanding his farm’s output by 100%, his
opportunity cost is the additional output of the farm. If a person is considering sleeping rather than
choosing the next best alternative, i.e., meeting a friend, then the opportunity cost of sleeping is
meeting a friend.

The Problem of Scarcity

Think about all the things you consume: food, shelter, clothing, transportation, healthcare, and
entertainment. How do you acquire those items? You do not produce them yourself. You buy them.
How do you afford the things you buy? You work for pay. If you do not, someone else does on your
behalf. Yet most of us never have enough income to buy all the things we want. This is because of
scarcity. So how do we solve it?
 Every society, at every level, must make choices about how to use its resources. Families
must decide whether to spend their money on a new car or a fancy vacation. Nations must decide
whether to devote more funds to national defense or to protecting the environment. In most cases, there
just isn’t enough money in the budget to do everything. How do we use our limited resources the best
way possible, that is, to obtain the most goods and services we can? First, we could each produce
everything we each consume. Second, we could each produce some of what we want to consume, and
“trade” for the rest of what we want. Why do we not each just produce all of the things we consume?

Think back to pioneer days, when individuals knew how to do so much more than we do today,
from building their homes, to growing their crops, to hunting for food, to repairing their equipment.
Most of us do not know how to do all—or any—of those things, but it is not because we could not
learn. Rather, we do not have to. The reason why is something called the division and specialization
of labor, a production innovation first put forth by Adam Smith in his book, The Wealth of Nations.

The Division of and Specialization of Labor

The formal study of economics began when Adam

Smith (1723–1790) published his famous
book The Wealth of Nations in 1776. Smith
introduces the concept of division of labor, which
means that the way one produces a good or
service is divided into a number of tasks that
different workers perform, instead of all the
tasks being done by the same person. To
illustrate division of labor, Smith counted how
many tasks went into making a pin: drawing out a
piece of wire, cutting it to the right length,
straightening it, putting a head
on one end and a point on the other, and
packaging pins for sale, to name just a few. Smith
counted 18 distinct tasks that different people
Figure 1.3 Adam Smith. Adam Smith introduced the idea of dividing
performed—all for a pin, believe it or not! labor into discrete tasks.

Modern businesses divide tasks

as well. Even a relatively simple
business like a restaurant divides the
task of serving meals into a range of
jobs like top chef, sous chefs, less-
skilled kitchen help, servers to wait on
the tables, a greeter at the door,
janitors to clean up, and a business
manager to handle paychecks and bills
—not to mention the economic
connections a restaurant has with
suppliers of food, furniture, kitchen
equipment, and the building where it
is located. A complex business like a
large manufacturing factory, such as the
shoe factory, or a hospital can have Figure 1.4 Division of Labor Workers on an assembly line are an example of the
 hundreds of job classifications. divisions of labor

Why the Division of Labor Increases Production

When we divide and subdivide the tasks involved with producing a good or service, workers
and businesses can produce a greater quantity of output. How can a group of workers, each
specializing in certain tasks, produce so much more than the same number of workers who try to
produce the entire good or service by themselves? Smith offered three reasons.
First, specialization in a particular small job allows workers to focus on the parts of the
production process where they have an advantage. People have different skills, talents, and interests,
so they will be better at some jobs than at others. Only those with medical degrees qualify to become
doctors, for instance. For some goods, geography affects specialization. For example, if you live in or
near a big city, it is easier to attract enough customers to operate a successful dry cleaning business or
movie theater than if you live in a sparsely populated rural area. Whatever the reason, if people
specialize in the production of what they do best, they will be more effective than if they produce a
combination of things, some of which they are good at and some of which they are not.
Second, workers who specialize in certain tasks often learn to produce more quickly and with
higher quality. This pattern holds true for many workers, including assembly line laborers who build
cars, stylists who cut hair, and doctors who perform heart surgery. In fact, specialized workers often
know their jobs well enough to suggest innovative ways to do their work faster and better. In many
cases, a business that focuses on one or a few products (sometimes called its “core competency”) is
more successful than firms that try to make a wide range of products.
Third, specialization allows businesses to take advantage of economies of scale, which
means that for many goods, as the level of production increases, the average cost of producing each
individual unit declines. For example, if a factory produces only 100 cars per year, each car will be
quite expensive to make on average. However, if a factory produces 50,000 cars each year, then it can
set up an assembly line with huge machines and workers performing specialized tasks, and the average
cost of production per car will be lower. The ultimate result of workers who can focus on their
preferences and talents, learn to do their specialized jobs better, and work in larger organizations is that
society as a whole can produce and consume far more than if each person tried to produce all of his or
her own goods and services. The division and specialization of labor has been a force against the
problem of scarcity.

Trade and Markets

Specialization only makes sense, though, if workers can use the pay they receive for doing
their jobs to purchase the other goods and services that they need. In short, specialization requires
trade. You do not have to know anything about electronics or sound systems to play music—you just
buy an iPod or MP3 player, download the music, and listen. Instead of trying to acquire all the
knowledge and skills involved in producing all of the goods and services that you wish to consume,
the market allows you to learn a specialized set of skills and then use the pay you receive to buy the
goods and services you need or want. This is how our modern society has evolved into a strong
economy.

ACTIVITY 1.1 REFLECTION PAPER

1. What is scarcity? Can you think of two causes of scarcity?

2. Explain why scarcity leads to tradeoffs.

3. Suppose you have a team of two workers: one is a baker and one is a chef. Explain why the kitchen
can produce more meals in a given period of time if each worker specializes in what they do best than
if each worker tries to do everything from appetizer to dessert.

4. Why would division of labor without trade not work?

5. What could be the opportunity cost (monetary and non-monetary ) of taking an exam in your
economics class instead of attending a Php8,000.00 ticket concert of your favorite boy band/singers?
Assume that the ticket has been pre-purchased.

6. Who among the following has the most opportunity cost, in terms of going to school, would be the
highest ?
a. A student who is working part-time at Jollibee.
b. A famous singer/actor who wants to obtain a college degree.
c. A promising Information Technology student who will command a high salary after graduation.
d. A star athlete in a college team but whose skill is not ready to enter the PBA team yet.

TOPIC 3: THE FUNDAMENTAL ECONOMIC PROBLEM

The basic economic problem may be derived from the above-cited definitions and discussions.
Since resources are not sufficient to satisfy the unlimited wants of people, decisions must be made
with the said constraints in mind. As such, the following questions must be considered:
1. What goods and services must be produced and in what quantities?
2. How shall these goods and services be produced?
3. For whom shall these goods and services be produced?

Decisions on What and How Much to Produce. Human society must come up with answers to the
following questions: Which goods or services must be produced? Out of the many possibilities, shall
we produce rice or weapons today? If we decide on rice, shall it be a limited quantity of high-quality
rice or low-quality rice? Shall it be many consumer goods like bread or many producer goods like
bakery equipment? Shall we produce many financing institutions or many vegetable farms?
Decisions on How Goods and services Shall Be Produced. Society must also make decisions on how
the goods and services shall be produced. Who shall produce them? What resources and

technology must be used? Who will be soldiers and who will be clerks? Will the educational system
consist of government schools alone or a combination of public and private schools? What types of
organizations shall produce goods and services? Will they be privately-owned or publicly-owned?
Decisions on How Goods and services Shall Be Distributed. The society must also resolve the issue
of who shall consume the goods and services produced. Who benefits from the results of economic
activities? How shall the goods be distributed? Shall we have society of a few rich people and many
poor people? Shall we have high-salaried managers and low-salaried workers or vice versa?

TOPIC 4: TYPES OF ECONOMIC SYSTEMS

The distribution of goods and services will depend partly on the availability of resources, the
laws, customs and traditions prevalent in a given society. Distribution shall also depend partly on the
objectives of the economic system the society has adapted. At this point, it becomes important to
present a discussion of the various economic systems.
Economic systems are classified as follows: 1) capitalism 2) communism 3) socialism and 4)
mixed economies.

Capitalism. Capitalism is an economic system mainly characterized by private individuals owning

and operating the majority of businesses that produce goods and services. The decisions on what
goods and services are produced, how they are produced, and how they are distributed are determined
by competition and consumer demand.
Forms of Capitalism. The economic system of capitalism consists of two forms: pure
capitalism and modified capitalism.
Pure capitalism is characterized by the following:
1. All economic decisions are made without government intervention;
2. Competition serves to determine the goods and services needed by society.
3. Competition will determine who will survive in the marketplace.

Modified Capitalism. Under the modified capitalism, the government intervenes and regulates
business to a certain extent.

Rights of Capitalism. Capitalism is vested with basic rights which are as follows:
1. Private property – People have the right to own property, and their heirs have the right of
inheritance. These rights motivate individuals to work and save money to buy property.
2. Profits – People have the right to earn profits and dispose them as they wish.
3. Business decisions – People have right to engage in business and determine how their business
will operate.
4. Choice – People have the freedom to choose what occupation to undertake, where to establish
their residences, what products and services to buy, etc.

Communism. Communism is “a society in which the government owns all nations’ resources.” It is
the economic system that is directly the opposite of the capitalism. The rights of capitalism which are
private property, profits, business decisions, and choices are not allowed under communism. The
decision on what goods and services to produce, how they will be produced, and how they will be
distributed are determined by central government planning. People have no choice of jobs as this is
dictated by the government. It is the government which decides who will be famers and who will be
soldiers, and only the government can own and operate businesses.

Socialism. Under socialism, the government owns and operates the basic industries like
telecommunications, water service, postal service, transport, banking and selected manufacturing
businesses. Private individuals are allowed, however, to own and operate small businesses. The
government determines what goods and services to produced, how to produce, and how they are
distributed. Those not produced by the government are provided by private individuals depending on
consumer demand and resource availability.

Mixed Economies. A mixed economy is one that has elements from more than one economic system.
It contains both private and state enterprises. As no country practiced communism, socialism, or
capitalism in pure form, mixed economies became reality. The practice is actually an attempt to make
use of the best features of an economic system and “mix” these with that of another system. This came
about as a result of the failure of adapted system to produce the required results.

ACTIVITY 1.2 REFLECTION PAPER

1. What type of economic system does your country adhere to? Does it lean heavily towards capitalism
or communism? Explain.
2. Identify the type of economic system described below (Capitalism, communism, or socialism):
a. Nationalism of key industries
b. Limited role of the government
c. Extensive social services financed through high rate of taxation
d. Consumer choices are limited to what government makes available.
e. Output is distributed through a rationing system.
f. All prices are set by the government
g. Prices of basic commodities are regulated.
h. Both private and public sector make economic decisions.
i. Government dictates the type of output that must be produced.
j. Pursuit of self-interest prevails.

3. What is an example of communism?

4. What is the difference between communism and socialism?
5. What is the best definition of communism?
6. What is the difference between capitalism and communism?

TOPIC 5: THE ECONOMIC RESOURCES

The aim of any economic system is to produce the required output of goods and services. To be able to
do so, the following resources are required:
1. Land
2. Labor
3. Capital
4. Entrepreneurial ability

Land. It is one factors of production which include land used for agricultural or industrial purposes
as well as natural resources taken from above or below the soil. Natural resources consist of energy
resources like fossil fuel and geothermal emissions, non-energy resources like gold, diamond, and
limestone, air and water, and many others.
Labor. Labor refers to the basic factor of production which are productive services embodied in
human physical effort, skill, intellectual powers, and others. It consists of human time spent in
production like driving buses, feeding cattle, singing in night clubs, acting in movies, or repairing
household appliances.
Capital. The third basic factor of production which is capital refers to durable goods produced in
order to produce other goods. It consists of building, plant and machinery, roads, computers, ships,
electric guitars, tennis balls, etc.
Entrepreneurial Ability. Land, labor and capital will remain as they are until someone taps them to
produce the required goods and services. Actual production needs the ability of an entrepreneur to
decide on and implement the right combination of the first three factors of production.

The entrepreneur performs the following functions:

1. He organizes production by combining land, labor, and capital to make goods and services;
2. He makes decisions by determining what goods and services to produce and how to produce
them;
3. He bears the risk of his business decisions. He must suffer the consequences of losses if he
fails, but in the same light, he must reap the profits as a reward if he succeeds.
4. He innovates by introducing new products, new technology, and new ways of organizing
business.

TOPIC 6: ECONOMIC GOALS

Every system invented by man presupposes some goals. These include economic systems
which seek to achieve the following goals.
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1. Economic growth – what is desired by society is a higher standard of living which is translated
into the production of more and better quality goods and services.
2. Full employment – there must be jobs for those who are willing and be able to work.
3. Economic efficiency – this is a goal that requires using resources to derive the maximum
benefit for society.
4. Price level stability – the economy should be able to avoid great fluctuations in the general
level prices.
5. Economic freedom – a high degree of freedom to choose what economic activity to undertake
should be afforded the various sectors consisting of executives, workers, and consumers.
6. An equitable distribution of income – the economy must not be made up of a certain group
that is so poor and destitute while other groups wallow in great luxury.
7. Economic security – there should be enough provision for those who are not able to earn
minimal income like the aged, the chronically ill, the disabled, etc.
8. Balance of trade – a balance of trade that is reasonable must be maintained.

DIVISION OF ECONOMICS
Economic theory is conventionally divided into the following:
1. Microeconomics, and
2. Macroeconomics.

Microeconomics. Microeconomics is concerned with “the behavior and activities of specific

economic units – individuals, households, firms, industries, and resource owners.” Examples are the
determination of the price of a single product, or the behavior of a single consumer or business
firm.The central concept of microeconomics is the market.
Macroeconomics. Macroeconomics is that division of economics that deals with “the behavior of the
economy as a whole with respect to output, income, the price level, foreign trade, unemployment,
and other aggregate economic variables.” It views all consumers as a unit, i.e., the consumer sector,
all business as an aggregate unit, i.e., the business sector and all the government agencies as a unit, i.e.,
the government sector. The purpose of such delineation is to explain and predict the structure and
functioning of whole economies.

ACTIVITY 1.3 SELF-CONCEPT QUESTIONS

Which of the following is a microeconomic issue, a macroeconomic issue or not an economic issue at
all? Write your answer.
1. Establishment of more Metro bank branches in rural areas
2. Abu Sayyaf atrocities in Mindanao
3. Holiday economic or observance of long weekend during holidays
4. Increase in gas and petroleum prices by Shell
5. A 2% increase in inflation rate
6. A housewife’s decision on how to allocate budget among family’s needs.
7. Various goods and services
8. A worker’s decision on how many hours to work each week
9. A 7% growth rate in the Gross National Product
10. Escalating crime rate
11. Designing a government policy that will raise the level of employment
12. Tuition fees hike in a University
13. Drug addiction
14. Measuring the impact of tax policies on total consumption spending in the economy
15. Election sorties and campaign

ACTIVITY 1.4 TEST YOUR UNDERSTANDING

1. Residents of the town of San Jose like to consume hams, but each ham requires 10 people to
produce it and takes a month. If the town has a total of 100 people, what is the maximum amount of
ham the residents can consume in a month?
2. A consultant works for Php1,000 per hour. She likes to eat vegetables, but is not very good at
growing them. Why does it make more economic sense for her to spend her time at the consulting job
and shop for her vegetables?
3. A computer systems engineer could paint his house, but it makes more sense for him to hire a
painter to do it. Explain why.

ACTIVITY 1.5 CRITICAL THINKING QUESTIONS

A. Suppose you passed the entrance examination in top three schools you considered for college.
Where will you enroll? To help you pick up the right choice, come up with a set of criteria that will
guide you in evaluating your choices.

Questions:

1. What is your realization of your analysis?

2. How did you apply trade-off and opportunity cost in this scenario?

B. Interview your parents or whoever manage your family’s budget. Use the following questions:

1. How many are you in the family?

2. How many are breadwinners?
3. How does your family earn on a monthly basis?
4. How does your family allocate your income?
5. What does your family do when you run short of budget?
6. What values and skills do your parents teach you to help you become wise decision-maker?

ACTIVITY 1.6 KEY TERMS

Direction; Answer the following questions:

1. Why is the study of economics an important exercise?
2. Give example of opportunity cost?
3. In what ways are capitalism and communism different?
4. Why is the entrepreneur an important economic resource?
5. What economic goals do you think are pursued in the Philippines?
6. What is the distinction between microeconomics and macroeconomics?