The document summarizes key concepts from economics as taught by Dr. Villamor Vital. It discusses how economists view the basic competitive model of the economy with firms competing for customers using price and consumers competing using price. It also covers how market economies provide incentives through prices, profits, and property rights. The document provides examples of opportunity costs, marginal costs and benefits, and production possibility frontiers to illustrate economic trade-offs. It defines key terms like sunk costs and discusses using graphs to understand economic relationships.

1. Thinking Like anThinking Like an
EconomistEconomist
Lecture by Dr. Villamor VitalLecture by Dr. Villamor Vital
Professor, Economic AnalysisProfessor, Economic Analysis
Asian Social InstituteAsian Social Institute
July 11, 2007July 11, 2007

2. Basic Competitive Model of theBasic Competitive Model of the
EconomyEconomy
 Firms compete for customers, usingFirms compete for customers, using
priceprice
 Consumers compete, using priceConsumers compete, using price
 Assumptions:Assumptions:
1.1. How consumers behave – rationalHow consumers behave – rational
2.2. How firms behave – profit maximizingHow firms behave – profit maximizing
3.3. How markets behave – competitiveHow markets behave – competitive

3. Incentives & Information: Prices,Incentives & Information: Prices,
Property Rights, & ProfitsProperty Rights, & Profits
 Market economies provide information andMarket economies provide information and
incentives throughincentives through pricesprices,, profitsprofits,, &&
property rightsproperty rights..
 Prices – most willing & able to pay;Prices – most willing & able to pay;
scarcity indicator; consumers adjust.scarcity indicator; consumers adjust.
 Profits – motivates producers/sellers.Profits – motivates producers/sellers.
 Wages – must provide incentives to work.Wages – must provide incentives to work.
 Private property & property rights – use &Private property & property rights – use &
dispose/sell as the owner sees fitdispose/sell as the owner sees fit

4. Incentive-Equality Trade-offIncentive-Equality Trade-off
 Some persons performSome persons perform
better than othersbetter than others
 Incentives for betterIncentives for better
performers result inperformers result in
higher total output, buthigher total output, but
creates inequality.creates inequality.
 Are there societies whereAre there societies where
there are no incentivesthere are no incentives
for good performance? Isfor good performance? Is
there equality here?there equality here?

5. When Property Rights FailWhen Property Rights Fail
 Ill-defined property rights: The GrandIll-defined property rights: The Grand
Banks storyBanks story
 Restricted Property RightsRestricted Property Rights
 Entitlements as Property Rights – e.g.Entitlements as Property Rights – e.g.
right to occupy an apartment for liferight to occupy an apartment for life

6. The Grand Banks StoryThe Grand Banks Story
Fish are a valuable resource. Not so long ago, the areaFish are a valuable resource. Not so long ago, the area
between Newfoundland and Maine, called the Grandbetween Newfoundland and Maine, called the Grand
Banks, was teeming with fish. Not surprisingly it was alsoBanks, was teeming with fish. Not surprisingly it was also
teeming with fishermen, who saw an easy livelihoodteeming with fishermen, who saw an easy livelihood
scooping out the fish from the sea. Since there were noscooping out the fish from the sea. Since there were no
property rights, everyone tried to catch as many fish asproperty rights, everyone tried to catch as many fish as
they could. A self-interested fisherman would rationallythey could. A self-interested fisherman would rationally
reason that if he did not catch the fish, someone elsereason that if he did not catch the fish, someone else
would. The result was a tragedy: the Grand Banks waswould. The result was a tragedy: the Grand Banks was
overfished, to the point where not only was it not teemingoverfished, to the point where not only was it not teeming
with fish, but commercial fishing became unprofitable.with fish, but commercial fishing became unprofitable.
Today Canada and the United States have a treatyToday Canada and the United States have a treaty
limiting the amount of fish that fishermen from eachlimiting the amount of fish that fishermen from each
country can take from the Grand Banks, and gradually,country can take from the Grand Banks, and gradually,
over the years, the fish population has been restored.over the years, the fish population has been restored.

7. Rationing (alternative to the priceRationing (alternative to the price
system)system)
 Def: When individuals get less of a goodDef: When individuals get less of a good
than they would like at the terms offeredthan they would like at the terms offered
 RationingRationing
– By Queues – to those willing to wait in lineBy Queues – to those willing to wait in line
(Phil. Examples: gov’t. rolling stores, relief)(Phil. Examples: gov’t. rolling stores, relief)
– By Lotteries – fair but inefficient (Lotto, PCSO)By Lotteries – fair but inefficient (Lotto, PCSO)
– By Coupon – e.g., military gas couponBy Coupon – e.g., military gas coupon
(National Defense College), BSP rice coupon(National Defense College), BSP rice coupon

8. Opportunity Sets & Trade-offsOpportunity Sets & Trade-offs
 Opportunity set – the group of availableOpportunity set – the group of available
optionsoptions
 Constraints – limit choice & define theConstraints – limit choice & define the
opportunity set, usually, time and money.opportunity set, usually, time and money.
 Budget constraints – limited by moneyBudget constraints – limited by money
held (say, for a Worker)held (say, for a Worker)
 Time constraints – time limit (say, for aTime constraints – time limit (say, for a
billionaire)billionaire)

9. Budget Constraint: Figure 2.1Budget Constraint: Figure 2.1
0
2
4
6
8
10
12
14
0 1 2 3 4 5 6
B1
D
E
F
B2

10. Figure 2.2 Time constraint: OpportunityFigure 2.2 Time constraint: Opportunity
set for watching TV vs. Other Activitiesset for watching TV vs. Other Activities
0
4
8
12
16
20
24
28
0 4 8 12 16 20 24
Hours spent watching TV
Hours
spent on
all other
activities
Time constraint
D

11. More on Thinking Like anMore on Thinking Like an
EconomistEconomist
 Production Possibilities FrontierProduction Possibilities Frontier
– Trade-offsTrade-offs
– Efficient CombinationEfficient Combination
– Diminishing ReturnsDiminishing Returns
 Opportunity CostsOpportunity Costs
 Marginal Costs and BenefitsMarginal Costs and Benefits

12. Figure 2.3 The Guns & ButterFigure 2.3 The Guns & Butter
Trade-offTrade-off
0
20
40
60
80
100
120
0 40 70 90 100
Guns (Millions)
Butter (Millions of Tons)
F
C
B
A
G
Society’s production possibilities frontier
The production possibilities curve reflects diminishing returns.

13. Figure 2.4 The Wheat & CornFigure 2.4 The Wheat & Corn
Trade-offTrade-off
60,000 150,000
200,000
150,000
C
B
A
Firm’s production
possibilities curve
This production
possibilities curve shows
that as wheat production
increases, it becomes
necessary to give up
larger and larger amounts
of corn. Or, to put the
same point a different
way, as corn production
falls, the resulting
increase in wheat
production gets smaller
and smaller. Point A
illustrates an inefficient
outcome, falling inside the
opportunity set.

14. Table 2.3 Diminishing ReturnsTable 2.3 Diminishing Returns
Labor inLabor in
cornfieldcornfield
(no. of(no. of
workers)workers)
Corn outputCorn output
(bushels)(bushels)
Labor inLabor in
wheat fieldwheat field
(no. of(no. of
workers)workers)
WheatWheat
outputoutput
(bushels)(bushels)
1,0001,000 60,00060,000 5,0005,000 200,000200,000
2,0002,000 110,000110,000 4,0004,000 180,000180,000
3,0003,000 150,000150,000 3,0003,000 150,000150,000
4,0004,000 180,00180,00 2,0002,000 110,000110,000
5,0005,000 200,000200,000 1,0001,000 60,00060,000

15. Costs in terms of Trade-offsCosts in terms of Trade-offs
 An opportunity set like the budget constraint, theAn opportunity set like the budget constraint, the
time constraint, or the production possibilitiestime constraint, or the production possibilities
curve specifies the cost of one option in terms ofcurve specifies the cost of one option in terms of
another.another.
 Operating on the constraint or curve, it isOperating on the constraint or curve, it is
possible to get more of one thing only bypossible to get more of one thing only by
sacrificing some of another.sacrificing some of another.
 The “cost” of one more unit of one good is howThe “cost” of one more unit of one good is how
much you have to give up of the other.much you have to give up of the other.

16. Costs in terms of trade-offs: BudgetCosts in terms of trade-offs: Budget
Constraint (Cont’d.)Constraint (Cont’d.)
E.g., trade-offs based onE.g., trade-offs based on relative pricerelative price,,
ratio of the prices of CDs and DVDs,ratio of the prices of CDs and DVDs,
wherewhere Price of CD = $10,Price of CD = $10,
Price of DVD = $20.Price of DVD = $20.
Then relative price = $20/$10 = 2. ForThen relative price = $20/$10 = 2. For
every DVD one gives up, one can buy 2every DVD one gives up, one can buy 2
CDs.CDs.

17. Trade-offs along the ProductionTrade-offs along the Production
Possibilities FrontierPossibilities Frontier
E.g. Figure 2.3: Point A is the choice whereE.g. Figure 2.3: Point A is the choice where
40 million guns and 90 million tons of40 million guns and 90 million tons of
butter are produced.butter are produced.
The trade-off can be calculated byThe trade-off can be calculated by
comparing points A and B. Society cancomparing points A and B. Society can
have 30 million more guns by giving up 20have 30 million more guns by giving up 20
million tons of butter.million tons of butter.

18. Opportunity CostsOpportunity Costs
 Include not only what you paid to acquireInclude not only what you paid to acquire
a good or enjoy an activity, but alsoa good or enjoy an activity, but also
 What that amount paid could otherwiseWhat that amount paid could otherwise
buy andbuy and
 Time you used up in the activity which youTime you used up in the activity which you
could have used for anothercould have used for another
 Examples: Manny Pacquiao & Gerry theExamples: Manny Pacquiao & Gerry the
Utility Man; Atty. Mel’s decision not toUtility Man; Atty. Mel’s decision not to
have a second wife; Vince’s internet date.have a second wife; Vince’s internet date.

19. Sunk CostsSunk Costs
 Expenditure made that cannot beExpenditure made that cannot be
recovered no matter what choice is made.recovered no matter what choice is made.
– E.g.: Bataan Nuclear Power Plant; much ofE.g.: Bataan Nuclear Power Plant; much of
Philippine foreign debt (NAPOCOR);Philippine foreign debt (NAPOCOR);
depreciation of the peso to encouragedepreciation of the peso to encourage
exports, & cost the economy OFWs bane;exports, & cost the economy OFWs bane;
– Globalization at the expense of domesticGlobalization at the expense of domestic
industriesindustries

20. Marginal CostsMarginal Costs
 Weighed against Marginal BenefitsWeighed against Marginal Benefits
 E.g. Effect of imposition of 12% VAT:E.g. Effect of imposition of 12% VAT:
MC = lower consumption, investment & employmentMC = lower consumption, investment & employment
MB = higher Government Revenue, reduced BudgetMB = higher Government Revenue, reduced Budget
deficitdeficit
 E.g. Effect of trade liberalization (lower Tariffs onE.g. Effect of trade liberalization (lower Tariffs on
imports):imports):
MC = lower Government Revenue, higher BudgetMC = lower Government Revenue, higher Budget
Deficit, shut down of domestic industries, higherDeficit, shut down of domestic industries, higher
unemploymentunemployment
MB = lower prices of and more goods available toMB = lower prices of and more goods available to
consumers, low inflation rateconsumers, low inflation rate

21. More on Marginal Costs vs.More on Marginal Costs vs.
Marginal BenefitsMarginal Benefits
 E.g. considering the inconvenient truth of GlobalE.g. considering the inconvenient truth of Global
warming, what if we decide to abolish thewarming, what if we decide to abolish the
“Carbon Economy.” Effects are:“Carbon Economy.” Effects are:
MC = shut down of carbon-based businesses, no moreMC = shut down of carbon-based businesses, no more
PUBs & PUJs so we walk, decline in investments,PUBs & PUJs so we walk, decline in investments,
higher unemployment, decline in GNPhigher unemployment, decline in GNP
MB = clean air, clean water, reversal of global warmingMB = clean air, clean water, reversal of global warming
(assuming all countries do the same), rise of carbon-(assuming all countries do the same), rise of carbon-
less production activities, increased investments andless production activities, increased investments and
employment in alternative activities.employment in alternative activities.

22. Reading GraphsReading Graphs
 The slope of a curveThe slope of a curve
like the budgetlike the budget
constraint gives theconstraint gives the
change in the no. ofchange in the no. of
CDs that can beCDs that can be
purchased if one buyspurchased if one buys
another DVD. Slopeanother DVD. Slope
is negative.is negative.
0
2
4
6
8
10
12
14
0 1 2 3 4 5 6
Slope=-2
A
E
8
6
2 3
A
E
Rise/Run
=(6-8)/(3-2)
=-2
CD
s
DVDs

23. Reading Graphs (Cont’d.)Reading Graphs (Cont’d.)
Positive
slope
Income
Years of
Schooling
The
slope of
a
vertical
line is
infinite
y
x
The slope of a flat,
horizontal line is zero
y y
x