Chapter 1

1
Defnition of
Economics
It is the study of wealth (Adam smith)
Or
It is the study of welfare (Pegout)
Or it is
A study of exchange and production
2
The standard defnition
!conomics is the social science which examines
how people choose to use its limited or scarce
resources in attempting to satisfy their
unlimited wants
3
Branches of
Economics
!conomics is usually di"ided
into two main #ranches
1$ %icroeconomics
&$ %acroeconomics
4
Microeconomics
which examines the economic #eha"iour of
indi"idual actors such as #usinesses' households'
and indi"iduals' with a "iew to understand
decision ma(ing in the face of scarcity and the
allocation conse)uences of these decisions$
5
%acroeconomics
which examines an economy as a whole with a
"iew to understanding the interaction
#etween economic aggregates such as
national income' employment and in*ation$
6
Other topics includes
international economics' la#our economics'
welfare economics' information economics'
resource economics' en"ironmental economics'
managerial economics' fnancial economics'
ur#an economics' de"elopment economics'
and economic geography$
7
+hy we study economics

,ope to ma(e money$

+orry to #e considered illiterate if they cannot

understand the laws of demand and supply$

To understand the e-ect of the information

re"olution on shaping our society$

To understand the e-ect of internet$

8
Continue

To #e fully informed a#out the international trade$

To study the tradeo- #etween in*ation and

unemployment$

To help you in"est your sa"ing$

To (now how to ma(e economic decision$

9
Scarcity and Choice

Scarcity means that people want more than

is a"aila#le$ .carcity limits us #oth as
indi"iduals and as a society$

As individuals' limited income (and time and

a#ility) pre"ent us from doing and ha"ing all
that we might li(e$
10
.carcity for society

As a society' limited resources (such as

manpower' machinery' and natural
resources) fx a maximum on the amount of
goods and ser"ices that can #e produced
11
.carcity re)uires choice

People must choose which of their desires they

will satisfy and which they will lea"e unsatisfed$

+hen we' either as indi"iduals or as a society'

choose more of something' scarcity forces us to
ta(e less of something else$
12
/ew defnition

!conomics is sometimes called the study of

scarcity #ecause economic acti"ity would not
exist if scarcity did not force people to ma(e
choices$
13
The logic of economics

,ow do economic go a#out the complex

understanding of the economic acti"ities$

The following are the some of the common

fallacies encountered in
economic reasoning 0logic12
The post hoc fallacy

This in"ol"es the inference of causality$ The

post hoc fallacy occurs when we assume the
pre"ious e"ent cause the later one' which is
not necessary correct assumption$

The failure of holding other things
constant

3emem#er to hold other things constant when you are

analy4ing the impact of one "aria#le on the economic
system$

e$g$ the e-ect of tax rate on tax re"enue$

The fallacy of
composition

.ome times we assume that what holds true

for part of a system also holds true for a whole$

In economics howe"er' we fnd that the whole

is di-erent than the sum of parts$

+hen you assume that what is true for the part

is also true for a whole' you are committing the
fallacy of composition$
!xamples

If one farmer produce cucum#er' he will ha"e

a higher income' #ut if all farmers produce
cucum#er they will ha"e lower income$
Basic problems of
economic organiation

!r basic three "uestions

The three problems of
economics

+hat commodities are produced

and what )uantities5

,ow are goods produced5

6or whom are goods produced5

#hat commodities are
produced and $hat "uantities ?

The society ha"e to decide and determine

how much of each goods will ma(e and when
they will #e produced$

+ill we produce pi44as or shirts today$

Or will we produce fewer consumer goods and

more in"estment goods
%o$ are goods
produced ?

The society ha"e to determine who will produce

with what resources and what techni)ues they
will use$

+ho farms and who teaches5

Is electricity generated from oil' or from the sun5

+ill factories #e run #y people or ro#ots5

+ill we use the la#or intensi"e or capital intensi"e

techni)ue5
&or $hom are goods
produced'

+ho gets to eat the fruits of economic acti"ates5

Is the distri#ution of income and wealth is fair

and e)uita#le5

,ow is the national product di"ided among

di-erent household5

Are many people poor and few rich5

7o high wages go to teachers or farmers5

The distri#ution system

+e ha"e di-erent distri#ution systems

depending on and though alternati"e economic
systems$

+e ha"e mar(et' command' mixed and Islamic

economy$
25 25
(ositive and )ormative
Economics
This is to study
what is for positi"e economics
or
$hat ought to be for normative
Positive economics

Positive economics studies economic

#eha"ior without ma(ing 8udgments 0
$ It descri#es what exists and how it
wor(s$
Positive economics
includes :

Descriptive economics' which
in"ol"es the collection of data that
descri#e phenomena and facts$

Economic theory, which in"ol"es

#uilding models of #eha"ior$

An economic theory is a general

statement of cause and e-ect' action and
reaction$
Normative economics

Normative economics* also called policy

economics' analy4es outcomes of economic
#eha"ior' e"aluates them as good or #ad'
and may prescri#e courses of action$

!ach economy has a stoc( of limited resources

(la#or' technological (nowledge' factories and tools'
capital' materials' land' energy)

!ach economy has to decide how to allocate his

resources among the di-erent possi#le
commodities$

9and for producing wheat or housing the population$

.ociety:s technological
possi#ilities
+nputs and outputs

Inputs are the resources a"aila#le for the society$

Another terms for inputs are factors of productions$

6actors of Production are land' la#or' capital and

management$
land

Or more generally natural resources that

represents the gift of nature to our
producti"e process$

It includes the land it self' the energy

resources that fuel our cars ; heat our
homes' non<energy resources li(e copper'
iron and sand' the en"ironmental resources'
such as clean air and drin(a#le water$
la#or

Includes the human time spend in production at all

s(ill le"els$

Includes also human time spend in management$

capital

Capital resources from the dura#le goods of

an economy$

Capital goods include machines' roads'

truc(s$
%anagement

+e might consider it as a part of the la#or

or as a fourth factor of production$
The (roduction
(ossibility &rontier ,((&-

The production possibility frontier (ppf)

is a graph that shows all of the com#inations
of goods and ser"ices that can #e produced if
all of society:s resources are used e=ciently$
Alternati"e Production
possi#ilities
Possi#ilities
Computers
) Thousands (
Tomatoe
s
) Tons (
Opportunity
Cost
A 0 15 -
> 1 14 1
C 2 12 2
7 3 9 3
! 4 5 4
6 5 0 5
The Production Possi#ility
6rontier

The production
possi#ility frontier
cur"e has a negati"e
slope' which indicates
a trade<o- #etween
producing one good
or another$
The Production Possi#ility
6rontier

Points inside of the

cur"e are ine=cient$

At point H, resources
are either unemployed,
or are used
inefficiently.
The Production Possi#ility
6rontier

Point F is desira#le
#ecause it yields
more of #oth goods'
#ut it is not attaina#le
gi"en the amount
of resources a"aila#le
in the economy$
The Production Possi#ility
6rontier

Point C is one of the

possi#le com#inations
of goods produced
when resources are
fully and e=ciently
employed$
The Production Possi#ility
6rontier

A mo"e along the cur"e

illustrates the concept of
opportunity cost$

6rom point 7' an increase

the production of capital
goods re)uires a
decrease in the amount
of consumer goods$
The 9aw of Increasing Opportunity
Cost

The slope of the ppf

curve is also called
the marginal rate of
transformation
(MRT).
the law of increasing
opportunity cost

The negati"e slope of the ppf cur"e re*ects

the law of increasing opportunity cost.
As we
As we
increase the production of one good' we
increase the production of one good' we
sacrifce progressi"ely more of the other$
sacrifce progressi"ely more of the other$
.carcity' Choice' and
Opportunity Cost

Human wants are unlimited, but

resources are not.

Three #asic )uestions must #e

answered in order to understand
an economic system2

#hat gets produced'

%o$ is it produced'

#ho gets $hat is produced'

.carcity' Choice' and Opport$
Cost

!"ery society has some system or mechanism

that transforms that society:s scarce
resources into useful goods and ser"ices$
.carcity' Choice' and
Opportunity Cost

Capital refers to the things that are

themsel"es produced and then used to
produce other goods and ser"ices$

The #asic resources that are a"aila#le to a

society are factors of production2

Land

Labor

Capital
.carcity' Choice' and
Opportunity Cost

Production is the process that transforms

scarce resources into useful goods and
ser"ices$

3esources or factors of production are the

inputs into the process of production? goods
and ser"ices of "alue to households are the
outputs of the process of production$
.carcity and Choice in a One<
Person !conomy

/early all the #asic decisions that

characteri4e complex economies must also
#e made in a single<person economy$

Constrained choice and scarcity are the

#asic concepts that apply to e"ery society$

Opportunity cost is that which we gi"e up or

forgo' when we ma(e a decision or a choice$
.carcity and Choice in a One<
Person !conomy
!=ciency

!=ciency means that the economy:s

resources are #eing used as e=ciently as
possi#le to satisfy people:s needs and desires$
Producti"e e=ciency

Producti"e e=ciency occurs when an

economy cannot produce more of one good
without producing less of another good$

This implies that the economy is on its

production possi#ility frontier$
Collection of economic
data

!conomic data includes )uantitati"e and

)ualitati"e data$

@uantitati"e data includes the numeric or

measura#le data$

i$e$ prices' )uantities' proft' product' cost'

and so on$

@ualitati"e data' includes descripti"e data

such as' )uality$
53
Primary and secondary
data

+e collect primary economic data through

)uestionnaires' meetings' focus group' and so
on$

And we collect the secondary data through

#oo(s' maga4ines' the net' and the Palestinian
#ureau of statistics$
%odels

6ormulation of models of economic

relationships' for example' the relationship
#etween the general le"el of prices and the
general le"el of employment
55
.tatistics

Ta(ing economic statistics of production and

applying the data collected' and applying the
model #eing used to produce a representation
of economic acti"ity
56
57 of 33
,ow to 3ead and
Anderstand Braphs

A grap is a two<dimensional
representation of a set of
num#ers or data$
58 of 33

A time series
grap shows
how a single
"aria#le
changes o"er
time$
Total isposa!le "ersonal #ncome in
the $nited %tates& 1975'2002 (in
!illions of dollars)
1000
1500
2000
2500
3000
3500
4000
4500
5000
5500
6000
6500
7000
7500
8000
1975 1980 1985 1990 1995 2000
*ear
T
o
t
a
l

d
i
s
p
o
s
a
!
l
e

p
e
r
s
o
n
a
l

i
n
c
o
m
e
,ow to 3ead and Anderstand
Braphs
59 of 33
,ow to 3ead and Anderstand
Braphs

The Cartesian coordinate system is

the most common method of showing
the relationship #etween two "aria#les$

The hori4ontal line is

the !"a#is and the
"ertical line the $"
a#is$ The point at
which the hori4ontal
and "ertical axes
intersect is called
the origin$
60 of 33

The point at +hich the line The point at +hich the line
intersects the *'a,is (point intersects the *'a,is (point a a) )
is called the is called the Y-intercept Y-intercept . .

The The Y-intercept Y-intercept, is the -alue of , is the -alue of Y Y

+hen +hen X X . 0/ . 0/
61 of 33

The The slope slope of the line of the line

indicates +hether the indicates +hether the
relationship !et+een the relationship !et+een the
-aria!les is positi-e or -aria!les is positi-e or
ne0ati-e/ ne0ati-e/

The slope of the line is The slope of the line is

computed as follo+s& computed as follo+s&
b =

Y
X
Y Y
X X
=

1 0
1 0
62 of 33

This line slopes upward'

indicating that there
seems to #e a positi"e
relationship #etween
income and spending$

Points A and B' a#o"e

the CDE line' show that
consumption can #e
greater than income$
,ow to 3ead and Anderstand
Braphs
63 of 33
A A downward-sloping downward-sloping line line
descri!es a descri!es a negative negative
relationship relationship !et+een 1 and */ !et+een 1 and */
An An upward-sloping upward-sloping line line
descri!es a descri!es a positive positive
relationship relationship !et+een 1 and !et+een 1 and */ */
64 of 33
b = =
5
1 0
0 5 . b = =
7
1 0
0 7 .
b = =
0
1 0
0
b = =
1 0
0
65 of 33