Check the attachments  Academic Year: 2021/2022 Semester: Spring 2022

ECON251

First Principles

Chapter 1

• A set of principles for understanding how individuals make choices

• A set of principles for understanding how individual choices interact

• A set of principles for understanding economy-wide interactions

WHAT YOU WILL LEARN
IN THIS CHAPTER

I- Individual Choice
Individual choice is the decision by an individual of what to do, which
necessarily involves a decision of what not to do.

Basic principles behind the individual choices:
1. Resources are scarce.
2. The real cost of something is what you must give up to get it.
3. “How much?” is a decision at the margin.
4. People usually take advantage of opportunities to make themselves better off.

Principle# 1

Choices Are Necessary Because Resources Are Scarce

• A resource is anything that can be used to produce something else.
• Examples: land, labor, capital

• Resources are scarce – the quantity available isn’t large enough to
satisfy all productive uses.
• Examples: petroleum, intelligence

Principle# 2

The True Cost of an Item Is Its Opportunity Cost

• The real cost of an item is its opportunity cost: what you must give up in
order to get it.

• Opportunity cost is crucial to understanding individual choice
• Example: The cost of attending an economics class is what you must give up to be in

the classroom during the lecture. Sleep? Watching TV? Rock climbing? Work?

• All costs are ultimately opportunity costs.

Opportunity Cost

• In fact, everybody thinks about opportunity cost.

• It is all about what you have to forgo to obtain your choice.

I WOULD RATHER BE SURFING THE INTERNET

Principle# 3

“How Much?” Is a Decision at the Margin

• You make a trade-off when you compare the costs with the benefits
of doing something.

• Decisions about whether to do a bit more or a bit less of an activity
are marginal decisions.

Marginal Analysis
Making trade-offs at the margin: comparing the costs and
benefits of doing a little bit more of an activity versus doing a
little bit less.

The study of such decisions is known as marginal analysis.
• Examples: Hiring one more worker, studying one more hour, eating one

more cookie, buying one more CD, etc.

Principle# 4

People Usually Respond to Incentives, Exploiting Opportunities to Make
Themselves Better Off

• An incentive is anything that offers rewards to people who change
their behavior.
• Examples:

1. Price of gasoline go down à people buy more fuel-efficient cars;
2. There are more well-paid jobs available for college graduates with
economics degrees à more students major in economics

• People respond to these incentives.

SUMMARY

1. Everyone has to make choices about what to do and what not to do.
Individual choice is the basis of economics.

2. The reason choices must be made is that resources—anything that
can be used to produce something else—are scarce.

3. Because you must choose among limited alternatives, the
true cost of anything is what you must give up to get it— all
costs are opportunity costs.

SUMMARY

4. Many economic decisions involve questions not of “whether” but of
“how much?” Such decisions must be taken by performing a trade-off
at the margin—by comparing the costs and benefits of doing a bit
more or a bit less. Decisions of this type are called marginal decisions,
and the study of them, marginal analysis, plays a central role in
economics.

5. The study of how people should make decisions is also a
good way to understand actual behavior. Individuals usually
respond to incentives — exploiting opportunities to make
themselves better off.

II-Interaction: How Economies Work
Interaction of choices—my choices affect your choices, and vice
versa—is a feature of most economic situations.

Principles that underlie the interaction of individual choices:
1. There are gains from trade.
2. Markets move toward equilibrium.
3. Resources should be used as efficiently as possible to achieve

society’s goals.
4. Markets usually lead to efficiency.
5. When markets don’t achieve efficiency, government

intervention can improve society’s welfare.

Principle# 5

There Are Gains From Trade

• In a market economy, individuals engage in trade: They provide goods
and services to others and receive goods and services in return.

• There are gains from trade: people can get more of what they want
through trade than they could if they tried to be self-sufficient.

This increase in output is due to specialization: each person
specializes in the task that he or she is good at performing.

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The economy, as a whole, can produce more when each
person specializes in a task and trades with others.

There Are Gains From Trade

“I hunt and she gathers – otherwise we couldn’t make ends meet.”

Principle# 6

Markets Move Toward Equilibrium

• An economic situation is in equilibrium when no individual would be
better off doing something different.

• Any time there is a change, the economy will move to a new
equilibrium.
• Example: What happens when a new checkout line opens at a busy

supermarket?

Principle #7

Resources Should Be Used As Efficiently As Possible to Achieve Society’s
Goals

• An economy is efficient if it takes all opportunities to make some people
better off without making other people worse off.

• Should economic policy makers always strive to achieve economic
efficiency?

• Equity means that everyone gets his or her fair share. Since people can
disagree about what’s “fair,” equity isn’t as well-defined a concept as
efficiency.

Efficiency vs. Equity

• Example: Handicapped-designated parking spaces in a busy parking
lot

• A conflict between:
• equity, making life “fairer” for handicapped people, and
• efficiency, making sure that all opportunities to make people better off have

been fully exploited by never letting parking spaces go unused.

• How far should policy makers go in promoting equity over efficiency?

Principle #8

Markets Usually Lead to Efficiency

• The incentives built into a market economy already ensure that
resources are usually put to good use.

• Opportunities to make people better off are not wasted.

• Exceptions: Market failure (the individual pursuit of self-interest
found in markets makes society worse off )à the market outcome is
inefficient

Principle #9

When Markets Don’t Achieve Efficiency, Government Intervention Can
Improve Society’s Welfare

Why do markets fail?:
• Individual actions have side effects not taken into account by the market

(externalities).

• One party prevents mutually beneficial trades from occurring in the
attempt to capture a greater share of resources for itself.

• Some goods cannot be efficiently managed by markets.
• Example: freeways and traffic

SUMMARY

6. The next level of economic analysis is the study of interaction—
how my choices depend on your choices, and vice versa. When
individuals interact, the end result may be different from what
anyone intends.

7. Individuals interact because there are gains from trade: by
engaging in the trade of goods and services with one another,
the members of an economy can all be made better off.
Specialization – each person specializing in the task he or she is
good at – is the source of gains from trade.

SUMMARY

8. Because individuals usually respond to incentives, markets
normally move toward equilibrium—a situation in which no
individual can make himself or herself better off by taking a
different action.

9. An economy is efficient if all opportunities to make some
people better off without making other people worse off are
taken. Resources should be used as efficiently as possible to
achieve society’s goals. But efficiency is not the sole way to
evaluate an economy: equity, or fairness, is also desirable, and
there is often a trade-off between equity and efficiency.

SUMMARY

10. Markets usually lead to efficiency, with some well-defined exceptions.

11.When markets fail and do not achieve efficiency government
intervention can improve society’s welfare.

III-Economy-Wide Interactions

Principles that underlie economy-wide interactions

Principle# 10: One person’s spending is another person’s
income.

Principle# 11: Overall spending sometimes gets out of line
with the economy’s productive capacity.

Principle# 12: Government policies can change spending.

SUMMARY
12.Because people in a market economy earn income by selling

things, including their own labor, one person’s spending is
another person’s income. As a result, changes in spending
behavior can spread throughout the economy.

14.Overall spending in the economy can get out of line with the
economy’s productive capacity. Spending below the
economy’s productive capacity, leads to a recession; spending
in excess of the economy’s productive capacity leads to
inflation.

15.Governments have the ability to strongly affect overall
spending, an ability they use in an effort to steer the economy
between recession and inflation.

ECON251

Economic Models: Trade-offs and Trades

Chapter 2

Why models? Simplified representations of reality—play a crucial role in
economics

Three simple but important models:
production possibility frontier

Comparative advantage

WHAT YOU WILL LEARN
IN THIS CHAPTER

I- The Production Possibility Frontier

I- The Production Possibility Frontier

• The production possibility frontier (PPF) illustrates the trade-offs
facing an economy that produces only two goods.
It shows the maximum quantity of one good that can be produced for
any given production of the other good.

• The PPF improves our understanding of trade-offs by considering a
simplified economy that produces only two goods by showing this
trade-off graphically.

• It shows well the opportunity cost, efficiency and growth principles.

I- The Production Possibility Frontier

2820 400

30

9

15

Quantity of computers

A

B

C

Quantity of phones

I-The Production Possibility Frontier

2820 400

30

9

15

Quantity of computers

A

B

D

C

Feasible and
efficient

in production
Not feasible

Quantity of phones

Feasible but
not efficient

Question 1
If society is producing a combination of goods on its production
possibilities frontier

a. it must be employing all available resources.
b. it must be growing.
c. it is using all the available natural resources but may not be using all
available labor resources.
d. Both a and b.

Production Possibilities for Two Countries

16 400

30

18

U.S. Production Possibilities

Quantity of
computers

Quantity of phones

Production Possibilities for Two Countries

3060

10

8

Quantity of
computers

Quantity of phones

Brazilian Production Possibilities

Comparative Advantage and Gains from Trade

16 40
0

30

18

60

8
10

(a) U.S. Production and Consumption

Quantity of computers Quantity of computers

Quantity of phonesQuantity of phones

(b) Brazilian Production and Consumption

30

Comparative Advantage and Gains from Trade

16 40
0

30

18

60

8
10

(a) U.S. Production and Consumption

Quantity of computers Quantity of computers

Quantity of phonesQuantity of phones

(b) Brazilian Production and Consumption

30

Comparative Advantage and Gains from Trade

United States and Brazilian Opportunity Costs

U.S. Opportunity
Cost

Brazilian
Opportunity Cost

One phone 3/4 computers > 1/3 computer

One
computer 4/3 phone < 3 phones

Question 2
The slope of the production possibility frontier shows

a. how inputs must be changed to keep them fully employed.
b. the technically efficient combinations of the two goods.
c. how demanders are willing to trade one good for another.
d. the opportunity cost of one good in terms of the other.

Specialize and Trade
• Both countries are better off when they each specialize in what they

are good at and then trade.

• It’s a good idea for Brazil to make the phones for both of them,
because its opportunity cost of a phone in terms of computer not
made is only 1/3 of a computer, versus 3/4 computer for the United
States.

• Correspondingly, it’s a good idea for the United States to make
computers for both of them.

16 40
0

30

18

60

8
10

(a) U.S. Production and Consumption

Quantity of computers Quantity of computers

Quantity of phonesQuantity of phones

(b) Brazilian Production and Consumption

30

How the Two Countries Gain from Trade

Both the United States and Brazil experience gains from trade:
§ U.S. consumption of computers increases by two, and its consumption of

phones increases by four.
§ Brazilian consumption of computers increases by two, and his consumption of

phones increases by four.

Phones

Computers

Phones

Computers

Comparative vs. Absolute Advantage

• An individual has a comparative advantage in producing a good or
service if the opportunity cost of producing the good is lower for that
individual than for other people.

• An individual has an absolute advantage in an activity if he or she can
do it better than other people. Having an absolute advantage is not
the same thing as having a comparative advantage.

U.S. vs. Brazil – Absolute vs. Comparative

• The United States has an absolute advantage in both activities: it can
produce more output with a given amount of input (in this case, its
time) than Brazil.

• But we’ve just seen that the United States can indeed benefit from a
deal with Brazil because comparative, not absolute, advantage is the
basis for mutual gain.

U.S. vs. Brazil – Absolute vs. Comparative

• So Brazil, despite its absolute disadvantage, even in phones, has a
comparative advantage in phones making.

• Meanwhile the United States, which can use its time better by making
computers, has a comparative disadvantage in phones making.

SUMMARY

1. Almost all economics is based on models.

An important assumption in economic models is the other things
equal assumption, which allows analysis of the effect of a change in
one factor by holding all other relevant factors unchanged.

SUMMARY

2. One important economic model is the production possibility
frontier. It illustrates: opportunity cost, efficiency, and economic
growth.

There are two basic sources of growth: an increase in factors of
production — resources such as land, labor, capital, and human
capital, inputs that are not used up in production — and improved
technology.

SUMMARY

3.Another important model is comparative advantage, which explains
the source of gains from trade between individuals and countries.
Everyone has a comparative advantage in something.

This is often confused with absolute advantage, an ability to produce
a particular good or service better than anyone else.

Question 3

Trade is based on
a. absolute advantage.
b. comparative advantage.
c. production costs.
d. relative dollar prices.

Question 4

Absolute advantage is found by
a. comparing opportunity costs.
b. calculating the dollar cost of production.
c. comparing the productivity of one nation to that of another.
d. first determining which country has a comparative advantage.

Question 5

If labor in Mexico is less productive than labor in the U.S. in all areas of
production,

a. neither nation can benefit from trade.
b. Mexico can benefit from trade but the U.S. cannot.
c. Mexico will not have a comparative advantage in any good.
d. both nations can benefit from trade.

Example:
Suppose Alaska each month can produce either 300 pounds of coffee
and no salmon, or 500 salmon and no coffee, or any combination in
between. Brazil each month can produce either 400 pounds of coffee
and no salmon, or 300 salmon and no coffee, or any combination in
between.
a. Assume that all production possibility frontiers are straight lines. Draw one diagram showing

the monthly PPF for Alaska and another showing the monthly PPF for Brazil. Put quantity of
fish on the horizontal axis.

b. Which country has the comparative advantage in coffee production? In fish production?
c. Suppose Brazil adopts a new technology for catching fish that doubles the quantity of fish they

can produce each month. Using the diagram in (a), draw the new monthly PPF for Brazil.
d. After the innovation, which country has the comparative advantage in coffee production? In

fish production?

Example:
• In Italy, an automobile can be produced by 8 workers in one day and a

washing machine by 3 workers in one day.
• I the United States, an automobile can be produced by 6 workers in one

day and a washing machine by 2 workers in one day.

a) Which country has an absolute advantage in the production of automobiles? In
washing machines?

b) Which country has an comparative advantage in the production of
automobiles? In washing machines?

c) What pattern of specialization results in the greatest gains from trade between
two countries?

Example:

These figures illustrate the production possibilities frontiers for Robinson Crusoe and Friday with 12
hours of labor.

a. What is the opportunity cost of 1 kg fish for Robinson Crusoe? For Friday?

b. Robinson Crusoe has a comparative advantage in __________ and Friday has a comparative
advantage in ___________

Example:

a. The opportunity cost of 1 bottle of perfume for Nancy is …..
b. The opportunity cost of 1 bottle of perfume for Roger is ….
c. Nancy has a comparative advantage in __________ and Roger has an

absolute advantage in __________

ECON251
Spring 2022

Finance Department

Chapter 3

Demand and Supply

Discuss the variables that influence demand.

• Discuss the variables that influence supply

• Use a graph to illustrate market equilibrium.

The Interaction of Demand and Supply

•Demand schedule A table showing the relationship between the price of a
product and the quantity of the product demanded.

•Quantity demanded The amount of a good or service that a consumer is
willing and able to purchase at a given price.

•Demand curve A curve that shows the relationship between the price of a
product and the quantity of the product demanded.

•Market demand The demand by all the consumers of a given good or
service.

The Demand Side of the Market
Demand Schedules and Demand Curves

FIGURE 3-1

A Demand Schedule and Demand

Curve

The Demand Side of the Market
Demand Schedules and Demand Curves

As the price changes, consumers change the

quantity of energy drinks they are willing to buy.

We can show this as a demand schedule in a

table or as a demand curve on a graph.

The table and graph both show that as the price

of energy drinks falls, the quantity demanded

rises.

When the price of energy drinks is $3.00,

consumers buy 60 million cans per day. When

the price drops to $2.50, consumers buy 70

million cans.

Therefore, the demand curve for energy drinks

is downward sloping.

The Demand Side of the Market

•Law of demand The rule that, holding
everything else constant, when the price of a
product falls, the quantity demanded of the
product will increase, and when the price of a
product rises, the quantity demanded of the
product will decrease.

The Law of Demand

The Most Important Factor on the Demand Side
PRICE

We are discussing Price of the book (price of one particular good) here.

First, at P=10 kd, Quantity Demanded is 55 books.

1)When P decreases to 7kd Q Demanded increases to 75 books and D curve moves down from point A to point C

2) Now, if P increases from 10kd to 12kd, Q Demanded decreases to 40 books and D curve moves up from point A
to point B

Important Note: When the price of one particular good is changed, as a result Q Demanded is changed and D curve
moves along itself (up, if P increases and down, if P decreases)

A

C

B

Cases of 5 Demand Factors
Factor 1. Income (change in income results in changes on demand of Normal goods and Inferior goods)

Case: If income increases:

Normal Goods (high quality, expensive) Inferior Goods (low quality, cheap)

Demand for Mais AlGhanim Demand for McDonalds

Factor 2. Price of Related Goods (Substitutes: Tea and Coffee, sugar and honey); Complements: Ink and Printer). (Change in Price of one related good
results in the change of Demand on another good)

Case on Substitutes: Price of Tea increased Case on Complementary goods: Price of Ink increased

Demand on Tea Demand on Coffee Demand on Ink Demand on Printers

Cases of 5 Demand Factors
Factor 3. Population and Demographics (change in the number of population or demographics (% composition of population) result in changes in demand
of Normal goods and Inferior goods)

Case: If population increases: Case: If % of children under 5 years increases:

Demand for all goods Demand for Toys

Factor 4. Future Price Expectations (If buyers expect high price in the future, they buy more now; If they expect low prices in the future, they buy less now)

Case: Price of Gold will increase in two months Case: Price of Rice will decrease next month

Demand on Gold Demand on Rice

Cases of 5 Demand Factors
Factor 5. Taste (people follow trends and style)

Case: If Business education is considered prestigious and beneficial for the future:

Demand for Business Education

Important Notes: Under all those 5 Demand factors

1. Entire Demand is changed.

2. Demand Curve shifts to the Right (if Demand increases), or to the Left (if Demand decreases)

The Demand Side of the Market

•Substitution effect The change in the quantity
demanded of a good that results from a change
in price, making the good more or less expensive
relative to other goods that are substitutes.

•Income effect The change in the quantity
demanded of a good that results from the effect
of a change in the good’s price on consumers’
purchasing power.

What Explains the Law of Demand?

The Demand Side of the Market

•Ceteris paribus (“all else equal”) condition The
requirement that when analyzing the relationship
between two variables—such as price and quantity
demanded—other variables must be held constant.

•A shift of a demand curve is an increase or a
decrease in demand. A movement along a demand
curve is an increase or a decrease in the quantity
demanded.

Holding Everything Else Constant:

The Ceteris Paribus Condition

FIGURE 3-2

Shifting the

Demand Curve

Holding Everything Else Constant:

The Ceteris Paribus Condition

The Demand Side of the Market

When consumers increase the quantity of

a product they want to buy at a given

price, the market demand curve shifts to

the right, from D1 to D2.

When consumers decrease the quantity of

a product they want to buy at any given

price, the demand curve shifts to the left,

from D1 to D3.

The Demand Side of the Market

•Normal good A good for which the demand
increases as income rises and decreases as income
falls.

•Inferior good A good for which the demand
increases as income falls and decreases as income
rises.

Variables That Shift Market Demand

• Income

Many variables other than price can influence market demand.

The Demand Side of the Market

•Substitutes Goods and services that can be used
for the same purpose.

•
Complements Goods and services that are used
together.

Variables That Shift Market Demand

• Prices of related goods

Consumers can be influenced by an advertising campaign for a
product.

• Tastes

The Demand Side of the Market

•Demographics The characteristics of a population with
respect to age, race, and gender.

• Population and demographics

• Expected future prices

Consumers choose not only which products to buy but also when
to buy them.

Variables That Shift Market Demand

The Demand Side of the Market
Variables That Shift Market Demand

TABLE 3-1

V