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SOCIAL STUDIES 3 GRADING

REVIEWER
Learning Guide 3.1 Circular Flow of Economy

A. Circular Flow of Goods and Services

The economy is described as a simple process involving the two sectors:

households and business firms. The two sectors play an important role in the
production and distribution of goods and services. As shown in Diagram 3.1, the two
sectors interact with one another through the market, which are classified into two: the
market for factors of production and the market for finished products.

In the market for factors of production, firms purchase factors of production owned
by households like land, labor and capital. Households supply to the market. In the
market for goods and services, households use their earnings from selling the factors
of production to buy products from firms. From there the factors will flow to business
firms, which will be utilized in producing goods and services. All the produced goods
and services flow to the market for finished products.

The circular flow of the economy shows the relationship between income and
expenditures. It describes all the transactions among the different sectors of the
economy, including the households, firms, government, financial market and foreign
sector. The four sectors are connected by three types of markets, namely, market for
goods and services, market for factors of production, and the financial market.

In order to satisfy their needs, households will consume the finished products. Both
sectors attain satisfaction by mutually providing each other’s needs. They utilize their
resources to attain the things they need. By doing these, equilibrium in the economy is
established. It keeps the economy going.
Diagram 3.1
 Circular Flow Between Households and Business Firms

B. Flow of Money as Payments for Two Sectors

In the Diagram 3.2, shows the flow of money. It initiates the money flow by giving
payments to the factors of production, rent for land, wages for labor, interest for capital,
and profit for entrepreneur, used in producing the products and services. These are the
firm revenues from selling goods and services to the households that are distributed as
payments to the factors of production owned by households. Example, the business
firms paid ₱50M for using the factors of production. The amount will be received by the
households as their income. The ₱50M received by the households as payment for
factors of production will be spent for consumption of finished products, which the
business firms produced. So, ₱50M will be received by business firms as payment for
the finished products, which will serve as the income of business firms. Income is the
amount of money received as payment for produced goods and services.
 The total flow of money represented by adding up all the consumption spending
by households is total spending on goods and services produced in the economy which
is equal to the market value of all the final goods and services produced in the economy
and that is the gross domestic product (GDP) of the economy.

C. Flow of Savings, Investment and Financial Market

There are instances where the households save a part of their income. To do this,
they reduce the amount of money intended for consumption. Savings is settings aside a
portion of a person’s income for future use. When a household set aside part of their
income as savings, which goes into financial markets where household savings are
channeled into investment spending by firms. It is considered a leak in the circular flow.
What causes the leak? When a household decides to save in the financial market, not all
of its income will be spent on consumption. Its saving exits from the flow and this is
why it is considered a leak. It can re-enter the flow in the form of investment. At this
point, investment comes in. Investment is the accumulation of stocks to be used in the
expansion of production in the future. Investment spending by firms are spending on
capital goods, such as machinery and factories. It is the financial market that shows the
relationship between those who want to save and lend, and those who want to borrow
and invest. Financial market is the market in which the people trade financial securities
and derivatives at low transaction costs.

If the savings is ₱10M, and ₱10M should be injected in the flow to attain
equilibrium in the economy. Investment is considered as inflow to the circular flow. That
condition should always prevail in the economy so that the aggregate demand or the
total quantity of goods and services demanded equals the aggregate supply or the total
output of the producers. Equilibrium is attained when savings equals investment. In
other words, inflow and outflow in the circular flow should be equaled to have balance
economy.

D. The Government and Foreign Sector in the Circular Flow

An economy is not complete if the role of the government is not included in the
activities of households and business firms.

Collecting taxes of the government in two sectors, (households and business

firms) is the responsibility of the government which is used for social services. The
taxes raised by the government will be spent on necessary products and services
(government expenditure). Some of the social services of the government are the
construction of the roads, bridges, and other infrastructure; provision of basic
education, and medical services. Every time a household pays a tax, its total income is
reduced by an amount that in turn will be spent by the government. It remains in the
circular flow of the economy, but in different form. For the households, the government
gives transfer payment in the form of pensions, scholarships, social services, and other
benefits.
 The government provides subsidy to business firms and assumes the role of a
consumer and a supplier of the finished products in the market. The government plays
the role of a consumer and supplier of the factors of production to continue the circular
flow of products and services in the economy.

The foreign sector has a significant contribution to the development of our

economy. All sectors in the economy deal and transact business with other countries.
The foreign sector is part of our economic activities.

All in all, for the Philippine economy as a whole, market value of all the final
goods and services produced in the economy equals the total expenditures on the
economy’s output of goods and services, which in turn equals the total income of
everyone in the economy.

Learning Guide 3.2- Measures of National Income

Values Integration:

· Responsibility

· Concern for others

· Cooperation

Content:

A. Importance of Measuring National Income

According to Campbell R. McCornek and Stanley Brue in their book Economics

Principle, Problems and Policies (2022), it is important to measure national income
because:
1. It can give an idea about the level of production of the economy in a particular year
and can explain why the country's production is so high or low.

2. We can monitor the direction of our economy and know if there is any growth or
decline in the country's total production.

3. The information gathered from the national income will guide economic planners to
develop policies that can improve the lives of the people and increase the economic
performance of the country.

4. If there is no systematic way of measuring national income, only speculation will be

the basis without a solid basis. If so, the data is unreliable.

5. Through National Income Accounting, the stability of the economy can be

measured.

B. Measurement of an Economic Growth- GDP and GNP:

Gross Domestic Product:

Usually, GDP and GNP are mistakenly taken as one and the same measurement of
economic conditions. However, the two have significant differences. They differ
in terms of the items included in their calculation. One measurement commonly used is
the gross domestic product (GDP).

GDP measures total production within the country. It is the market value of all goods
and services produced within the country during a specific period of time. Market value
refers to the value of the product and service that exists in the market. This product is
ready to use which is included in the calculation of GNP/GNI. These are called
final goods or finished products and do not need to be processed to become finished
products and used for consumption.

Market value is the actual amount that consumers are willing to pay for a good or
service available in the market. Only finished products and services are included in GDP.
All the production within the country is included in our GDP, even when a foreigner
produces it for as long as it is done inside our country. On the other hand, the GDP of
the Philippines excludes the income earned by Filipinos working abroad but it includes
income earned by foreigners who work in the Philippines.
Intermediate products or goods that are used as materials or inputs for
finished products or services are not included in GDP. Why? This is to avoid double
counting. To avoid double counting, the Value Added Approach or product approach is
used to include only finished goods in computing GDP. Double counting occurs when
the value of final goods includes the value of intermediate goods.

1. Intermediate goods - are goods or services used to produced final good or finished
product.These goods are also known as producer goods.

2. Final goods - are goods or services that are purchased by the households used for
final consumption. It is also known as consumer goods.

Gross National Product

Another measure of economic growth is the GNP. GNP refers to gross national
product. Gross National Product (GNP) known as Gross National Income (GNI) refers to
the total market value of goods and services produced by the citizens of a country. It is
considered as the most important indicator in measuring the development of the
economy.

GNP is the accumulation of all products and services produced in the country. The GNP
of the Philippines is the sum of income earned by permanent residents of the country. It
measures total production of the country’s citizens wherever they may be in the world. It
also includes the income of a family per day and of businesses from the sale of their
products and services produced by Filipino citizens abroad. GNP subtracts all finished
products made by foreigners in the country and adds all the production made by the
country’s citizens in different parts of the world.
C. Two ways to measure for GDP

The two methods to measure GDP are the Expenditure Approach and the Income
Approach because GDP may refer to spending (expenditure of the buyer) or
income (income of the seller) which we have already learned in the circular flow of the
economy.

1.Expenditure Approach - takes into account total spending by the household,

firm, government and external factor on finished goods and services. In
calculating GDP is to add up consumer spending on goods and services, investment
spending by firms, government spending on goods and services and exports. To add all
of this together then subtract the value of imports.

The equation shown below:

GDP= C+ I+G+X-M

C-stands for consumption, I for investment, G for Government spending,

X for Export, and M is Import.

2.Income Approach - refers to income earned from selling factors of production such
as wages of laborers, rent for land, interest on capital, and profit of the entrepreneur.
Another way of calculating GDP is to add up all the income paid by domestic firms to
factors of production employed in the economy-the wages paid to labor; the interest
paid to those who lend their savings to firms and the government; the rent paid to those
who lease their land or buildings to firms; and the profit paid to the owners of the firm’s
capital

It is shown in this equation breaks GDP by the four sources of income.

GDP=wages + rent + interest + profit

D. Approaches to GNP Measurement:

There are three ways to measure the GNP. Whatever approach is used, the
total GNP/GNI is the same. All sectors have contributions to the economic performance
of the country.

1.Final Expenditure Approach

All the economic sectors like households, government, firms and foreign market have
their own expenses which are important in measuring the GNP.

a. Government Expenditure are the expenses for infrastructure projects like construction
of roads, hospitals, and school buildings. The government spends for the salaries of the
employees in the government like doctors, nurses, teachers, military personnel,
policeman, clerks, senators, congressman, judges, and even the president of the
country. The travelling expenses of the president of the country, the delivery of social
services are also considered as government expenditures.

b. Personal Expenditure (P) are the expenses of households for food, clothing, housing,
jewelry, appliances and other products and services for personal consumption.

c. Business Expenditure are the invest in fixed capitals like machineries, buildings, office
equipment, changes in stocks and inventories of the businessman.

d. Net Export are the exports and imports. In order to determine the country’s spending
on foreign goods and services, the expenses in imports(M) are deducted from the
expenses in exports(X). It will be positive if the exports are higher than the imports.

e. Statistical Discrepancy are the errors in measuring the GNP/GNI. Any discrepancy
that cannot be determined and the components traced is considered as a discrepancy
in the computation.

When all the expenditures mentioned above are put together, GNP/GNI will be
computed. The formula for measuring the GNP/GNI using this approach is:

GNP/GNI = G + P + B (X-M) + NFIA + SD

Using the hypothetical data, for example:

G=160M pesos
P=180M pesos
B=135M pesos
M= 18M pesos
X= 20M pesos
NFIA = 210M pesos
SD= 3M pesos
GNP/GNI= 724M pesos

2.Industrial Origin Approach

The Value Added Approach is another term for Industrial Origin Approach. All the
contribution of each sector like agriculture, industry and services are computed.
In processing and production of goods and services results the value of the goods
which depends on the contribution of every sector.
3.Factor Income Approach

In each factor of production receives payment for its services and this serves
as income. Some of the various payments such as rent for land, wages for workers,
interest for capital, and profit for entrepreneurs. It shows the GNP /GNI using the
different income received in the economy.

Summary of Ideas:

Economic performance is measured to give us an idea on the economic conditions

of the country. It is measured by the following;

GDP- (Gross Domestic Product) -refers to national income which is used to

measures total production within the country. It is the market value of all finished
products and services in a country during a specific period of time.

GNP- (Gross National Product)-measures total production of the citizens of a

country wherever they may be in the world. It subtracts all finished products made by
foreigners in a country and adds all the products made by its citizens in different parts
of the world.

Learning Guide 3.3- Inflation and The Price Level

Values Integration:

· Concern for others

· Perseverance

· Thriftiness
A. Inflation:

The continuing increase in the general price level of goods and services is
called inflation. Price increase is a part of everyday life. Due to rising prices, the current
value of the peso is not the same as in the past. The peso can buy fewer goods today
compared to the past because the prices of goods have increased. Inflation decreases
the purchasing power of the peso. The continuous increase in the prices of goods and
commodities is one of the biggest problems in the economy. The rich and poor are both
experience this problem.

As of now, some of the basic commodities like meat, fish, chicken, beef, rice, sugar,
milk, and cooking oil are affected by inflation. It cannot be controlled. This is an
uninterrupted increase of goods and services for a period of time. The annual percent
change in the overall price level is known as inflation rate.

B. Causes of Inflation:

· There are causes of inflation that led to three types;

· Cost push inflation

· Demand pull inflation

· Structural inflation

Cost push inflation comes from a continuous increase in the cost of production. Due to
an increase in production costs caused by an increase in the prices of the factors of
production, the seller has to raise the prices of his merchandise. Example is the
escalating price of oil in the world market.

Mandatory increase in wages, increased cost of raw materials, breakdown or damage to

machineries and equipment, and the producer increasing the price of his products to
compensate for the increase cost of production to maintain level while still supporting
the demand, cause the prices of goods and services to increase. Example, if workers
demand for a wage increase, the employers or producers act on it by increasing the
price of the products.

Demand pull inflation comes from an excess demand of goods and services. It is the
result of a faster increase in total demand in the economy compared to total supply. An
example of this is the tendency of the Asian countries to order more fuel whenever
there is an increase in its cost, further increasing the prices of oil.

The households, business firms and government, all these sectors of the economy have
their own demand. The demand of these sectors comprises the aggregate demand of
the economy. The demand pull-inflation happens if the sectors desire to buy products
and services more than available supply in the market. Therefore, it is the condition
where aggregate demand is more than aggregate supply.

Structural inflation comes from when the government implements new economic policy
like tax reform, the result is price increase. The increase in the normal price of
commodities is a result of an imbalance and abrupt increase of demand and supply of
the different sectors of the economy. Every action and movement of each economic
sector causes an increase in the price of commodities. This is called structural inflation.

C. Effects of Inflation:

To study inflation is very important because it affects the flow of money in the
economy. If the prices increase quickly, households and firms are forced to changed
their spending behavior. Therefore, inflation also affects decisions concerning savings
and investments.

Individuals may suffer or benefit from higher rates of inflation. Those with fixed
income lose because their income could buy less goods and services. Inflation affects
the circular flow of economy. When overall prices increase, households spend less,
which in turn affects the income of firms, saving, investment, tax collection, and
government spending. Lenders and bank savers lose when inflation rate is greater than
interest rate. Real interest rate is measured as nominal interest rate less inflation rate. If
we lend at an interest rate of 5% we will lose because the interest rate is not corrected
for the effects of inflation. They are paid in the future with money that is worth less.

However, borrowers could benefit from inflation. If their loans specify a fixed rate of
interest, they can pay their loans in the future with money, that is worth less.

D. People Who Benefit from Inflation

1.People without fix income

The income of individuals sometimes moves in accordance with price change.

Their income may increase rapidly at a higher rate than that of inflation. Groups who
earn more compared to the rate of price increase are entrepreneurs, investors and
resource owners.

2.Debtors

Debtors benefit during a price increase particularly if interest rates of loans are
lower than inflation rate.
3.Speculators

Businessmen who are inclined to buy products with unstable prices speculate that
their price can increase rapidly and easily. Example of this are land, jewelry, gold and
other precious stones. Whatever the condition of the economy, the price of such
products is increasing.

E. People Who Are Hurt from Inflation

1.Creditors

If there is an inflation, an individual who give loans experience losses because the
interest on loans may not enough to cover the price increase.

2.Individuals who save

One of the best practices of man is saving money which is good and meaningful
activity. But during inflation, the money in the bank depreciates in value due to the low
interest rate of the bank.

3.People with fixed income

People who received a fix income every month even during a price increase are
negatively affected by inflation. They are the workers and employees such as clerks,
nurses, teachers, janitors, drivers and laborers.

F. Measuring The Price Increase

The government assigns and selects products to be included in the basket of

goods or market basket of goods in order to study the price change which is usually
purchased by an average family for a specific period of time. A price index is formed
from the market basket of goods. It depends on what commodities would be examined.

G. Instruments in Measuring Price Indexes

Price index is a number that compares the prices of present year to the prices of
base year.

1.Wholesale Price Index and Retail Price Index

This instruments shows and calculates the differences in the value of finished
products, intermediate products and crude materials in wholesale and trading. The price
for the volume of goods is called wholesale while retail is the price for every piece of
goods.
2.GNP Deflator or GNP Implicit Price Index

The implicit price index is the price index derived as the ratio of a value over a
volume index. A deflator is a figure expressing the change in prices over a period of
time for a product or a basket of products, which is used to deflate (price adjust) a
measure of value changes for the same period. The GNP/GNI deflator is being used to
know the value of GNP based on the previous year.

3.Consumer Price Index

How do we measure price changes in the economy? We have to use a price index
which serves as a basis to measure price changes of goods. The consumer price index
(CPI) is one of the most popular price indexes. It measures price changes of a
representative basket of goods and services consumed by a typical household during a
given base year. It is a vital instrument used in describing the economy. Through it, the
cost of living can be approximated.

Formula for CPI:

CPI= (current prices of basket of goods and services) x 100

(base year prices of a basket of goods and services)

H. Importance of CPI

The cost of living is the amount of money needed to purchase the basic
necessities. It can be identified as the weight assigned in each item included in the
basket of goods by the household. The CPI is used to determine The Purchasing Power
of Peso (PPP) or the equivalent value at base year, prices of goods and services that a
peso could buy at current prices. It computes the actual amount of the peso in an
assigned time compared to a preferred year. As the CPI increase, the purchasing power
of peso decreases.

I. Purchasing Power of Peso (PPP)

In computing the PPP, the formula 100/CPI is used to determine the real value of
the peso compared to a base year. Another formula that can be used to determine the
PPP:

PPP = 1 x 100

CPI

Purchasing power of peso shows the ability of peso to buy goods and services.
J. Core Inflation and Headline Inflation

Have you read about reports on “Headline Inflation” and Core Inflation”. What is
the difference between the two?

Headline inflation, is the type of inflation in some occasions that includes volatile
products whose prices fluctuate because they are affected by different conditions
related to the environment and politics. Example of this are food items whose prices are
affected by changing weather conditions, and petroleum whose prices are affected by
political conditions in other countries.

Core inflation excludes volatile products like food and petroleum whose prices may
change often every month. It is used as the basis of long-term inflation trend, including
future inflation. Core inflation is more reliable when crafting economic policies because
it shows actual price movements of products.

Summary of Ideas:

People have different reactions and comments when the price increases
because it has different impact to the lives of the people. Inflation is part of our daily
lives and economic development and affects the circular flow of the economy. When
overall prices increase, households spend less, which in turn affects the income of
firms, saving, investment, tax collection, and government spending.