A Level Economics

A Level Economics:

Fundamental Economic Questions

Notes from the video ‘Diffusion| A Level Economics |Fundamental Economic Questions‘ :

The central economic problem is scarcity (learn more about scarcity here).

Because of scarcity, a society cannot have all it wants and there are three fundamental economic questions faced by every economy.

1. What should be produced? 

When you use the economy’s scarce resources to produce one thing, you give up on producing on another. For example, producing better education may require cutting back on other services, such as health care.

In a free market, production is determined by market forces. Firms will produce and supply goods and services demanded by the consumers.

In a mixed economy, or an economy with government intervention, the government may decide to produce more public goods or goods that improve economic welfare. Examples of public goods include public water supplies and street lighting.

Public goods may not be produced if it was left entirely to market forces because people are not willing to pay for it, in other words, there is no effective demand. One of the main reason is that it is difficult to exclude someone who does not pay for the good from benefiting from the provision of the good. For example, once street lighting is provided, it is difficult to exclude people who did not pay for the street lighting from enjoying the benefits of the street lighting. So, no one would be willing to be pay for the street lighting if he or she is able to enjoy the benefits for free. This is known as the free rider problem in economics.

2. How should goods and services be produced?

There are all sorts of choices to be made in determining how goods and services should be produced.

For example, a firm have to decide to produce a good with a new materials or recycled materials or to produce it in its own factory or outsource it.

In general, firms will try and produce goods for the most profitable and cost-effective method. Sometimes, these methods may affect third parties negatively. For example, a factory owner may choose to dump toxic chemical waste from his factory into nearby reservoir and poison the water because this method is cheaper compared to sending it to the toxic waste collector.

So, in a mixed economy, government may regulate production methods to limit harm to third parties or damage to the environment.

3. For whom should goods and services be produced?

When a good or service is being produced, a decision needs to be made about who will get it. 

In a free market, goods are provided for those with the ability to pay, or purchasing power. 

In more altruistic societies, goods and services may be produced for people who cannot afford them. For example, many western economies provide free healthcare.

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