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INTRODUCTION

Why should business students study economic policy?

To align business and investments with economic policy;
To make informed business decisions based on the economic environment defined by policy.

Economic Policy
Being informed of fiscal policy would benefit businessmen and suppliers that deal with
government

Monetary Policy
Bangko Sentral ng Pilipinas (BSP) hiked key interest rates since August 2014: borrowing rates
from 3.75 to 4 and lending rates from 5.75 to 6 in 1Q 2016.
http://www.bsp.gov.ph/monetary/mon etary.asp
The Fed began tapering quantitative easing (QE) in mid-2013. This would lead to higher interest
rates and tighter monetary policy
http://www.breitbart.com/Big- Government/2014/08/26/Oil-Prices- Melt-as-Fed-s-QE-Shrinks
Terminology
Economics the efficient allocation of scarce resources. What? How? For whom?
Political economy the role of power in economic decision making.
Development economics the efficient allocation of resources in the context of economic, social,
political & institutional mechanisms, both private & public.
Clinical economics & the individualistic approach to development economics (Sachs, 2004)
Economic policy any action taken or not taken by the public sector [including national & local
governments, Bangko Sentral ng Pilipinas (BSP)].

The Evolution of Development Economics

1950/1960s
Traditional the capacity of a national economy to generate and sustain annual increases in its
GNP of 5-7%.
Other indices:
o Economic levels and growth rates of real per capita GDP;
o Non-economic social (casual reference) literacy schooling health conditions &
services provision of housing

1970/1990
New View in 1970s
High growth with little improvements in the conditions of the bottom 40%
Development was redefined as the reduction or elimination of poverty, inequality &
unemployment
In the 1980/early 90s growth rates turned negative for many debt-stricken LDCs.
o Human Development (UNDP) expanding the choices people have to live the lives they
value (SO:http://hdr.undp.org/hd) by building the following capabilities:
I To live long & healthy lives To be knowledgeable To be able to participate

2000 to 2015
UNs Millennium Development Goals (MDG):
Eradicate extreme hunger & poverty Universal primary education Promote gender equality &

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empower women Reduce child mortality Improve maternal health Combat HIV/AIDS,
malaria Ensure environmental stability Develop a global partnership for development.
In 2015, UN drafted Agenda 2030 contained the post-2015 Sustainable Development Goals
(SDGs).

2016 Onwards
Progress in MDGs by 2015 called for extended global efforts through the UNs Agenda 2030 -
Sustainable Development Goals (SDGs)
Expanded the goals to be 17 SDGs:
Sustainable Development Goals

Objectives of Development
Availability of life-sustaining goods: food, health, shelter & protection
Raise levels of living: higher incomes, more jobs & better education;
Expand the range of social & economic choices.

Elements of Development
Human resources: population control & quality of human capital;
Natural resources: conservation;
Capital formation: increase domestic saving rate;
Technological progress: learning-by-doing

Alternative Models for Development: Political Economy Perspective

Command economy
Market economy (Washington consensus)
Mixed or managed-market approach

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II. REVIEW OF MACROECONOMICS

Macroeconomics:the study of the economy as a whole
Most monitored macroeconomic statistics:
1. Gross Domestic Product (GDP) is the economys total income; the total expenditure on an economys
output of goods & services.

2. Consumer Price Index (CPI) measures the level of prices; measures the current cost of a basket of
goods and services (i.e. food, clothing, transportation; ranges from 265-700 items).
AccordingtothePSA,theCPI2013=134&CPI2014=139.5, in 2006 prices. Headline inflation rate of 4.1%.

3. Unemployment Rate the percentage of the labor force that is unemployed.

Instruments:
Fiscal policy: government action or inaction
o Taxes: direct, indirect;
o Expenditures: national budget;
o Regulation (or deregulation)

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Monetary policy: BSP

o Open market operations;
o Reserve requirement;
o Discount rate

Terminology
GDP the market value of all final goods and services produced w/in an economy in a given
period of time.
o the sale of used goods is not part of GDP;
o an increase in inventories increases GDP
o is a flow variable.
Real vs. Nominal GDP nominal GDP current market values; real GDP constant prices.
The GDP deflator measures the price of output relative to its price in the base year:
GDP deflator = Nominal GDP/ Real GDP
Can measure GDP in two ways:
o use the value (prices) of final goods;
o use the value added approach (Ex. bakery)
The inflation rate is computed as the percentage change of CPI.
National Income Accounts : GDP = C + I + G + NX (NIA identity)
Consumption (C): goods & services bought by the household. That is:
I Nondurable goods: food & clothing;
I Durable goods: cars, television, computers;
I Services: medical & dental check-ups, spa treatments.
I
Investment (I): goods & services bought for future use. That is:
I Business fixed investment: plant & equipment;
I Residential investment: new house; inventory.
I
Government purchases (G): goods &services bought by national & local governments including
Transfer payments to individuals (i.e. social security and welfare benefits). However, these
are not part of GDP since transfers simply redistribute existing income;
Military equipment, highways, basic health & education services.

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Net exports (NX): exports less imports

National Income Accounts: GDP = C + I + G + NX

Net domestic product (NDP):
NDP = GDP depreciation
National Income (NI) is total income received by land, labor and capital:
NI = NDP Indirect taxes
Disposable Income (DI)
a. NI direct taxes net business saving
b. DI = a + transfers from government

In a closed economy, with no G & NX:

S I and I S
If =+&=+, then SI

T
Even in an open economy with G & NX, I S: I = I + X
T
where: I - total investment
I gross private domestic investment
X net foreign investment (= net X)

T P G
S =S +S
T
where: S - total saving
P
S private saving
G
S government saving (=T-Exp)

T P G T
I =I+X=S +S =S

III. AGGREGATE SUPPLY AND AGGREGATE DEMAND (AS-AD)

Questions to be answered
What determines national income (aggregate supply)?
Who receives income from production?
Who buys the output of the economy?
What equilibrates the demand for and supply of goods & services?

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Aggregate Supply
What determines the total production of goods & services?
AS: the total production of goods and services in an economy, GDP.

Aggregate Supply: Factors affecting GDP

Factors of production:
o Capital, K: set of tools a worker uses; and,
o Labor, L: time people spend working.
o These are assumed to be fixed and fully-employed in the short-run
Production function: represents the available technology which determines how much Y is
produced given K, L and the pattern of wage prices in the economy.
Y = F(K,L)

Aggregate Supply: Production function

Characteristics:
o If only 1 input changes there will be diminishing returns;
o If all inputs change there are three kinds of returns to scale:
a. Constant returns to scale, CRS;
b. Increasing returns to scale, IRS;
c. Decreasing returns to scale, DRS.

Aggregate Supply:National income distribution & factors of production

How is national income distributed among factors of production?
Assumptions: (1) Perfect competition, PC; (2) firms maximize profits

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1. Demand for factors of production with fixed supply:

Factor prices are determined by demand;
Follows the law of diminishing marginal product;
A firms demand for labor depends on

2. Demand for factors of production with flexible supply. Rewrite AS fn. as:

Factors affecting AS are:

o Real wage ( ) indirect affect via production function;
o Capital () and technology () both direct (through the production function) and
indirect (through the ) effects are positive

Aggregate Supply:The supply of factors of production

How do factors of production supply their services?
Labor supply:
o Involves a labor-leisure choice;
o Depends on the substitution and income effects;
o Also depends on the real wage level;
o Curve is upward sloping.

Labor supply, depends on:

Substitution effect: ; Income effect:
I Income tax affects labor supply
I Empirically in Sweden as tax rates increase, labor supply decreases.
I Backward bending labor supply curve