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Basic Economic Ideas and Resource Allocation Chapter 1: Introducing economies (PPC graphs in separate notes) AS Level Economics (9708)£0.14
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Basic Economic Ideas and Resource Allocation
Chapter 1: Introducing economies
(PPC graphs in separate notes)
AS Level Economics (9708)
The basic economic problem
We have unlimited wants and limited resources. This creates scarcity and therefore not
all wants and needs can be satisfied. We are then forced to make a choice. This gives
rise to opportunity cost.
Opportunity cost: the cost of a choice is the value of the next best alternative forgone.
Examples of opportunity cost: the government needs to choose between investing in
education and healthcare. If the government chooses to invest in healthcare there is an
opportunity cost of education.
Scarcity: A situation that arises because people are faced with unlimited wants but have
limited resources.
The coordination problem
The problem associated with bringing different economic activities to produce economic
value. In other words, these are the complications that arise when deciding which type
of economy (free market, mixed, planned) to implement.
To help with the coordination problem we ask the three economic questions:
1. What to produce
2. How to produce it
3. For whom to produce
Free market economy: Market forces are allowed to guide the allocation of resources
within a society.
Economic questions in a free market:
1. What to produce: Determined by consumer preferences
2. How to produce it: As producers aim to make a profit, producers will attempt to
produce the good at a low cost
3. For whom to produce: Whoever has the greatest purchasing power
Advantages and disadvantages of a free market
, Advantages
● Firms are likely to be efficient because they produce goods demanded by
consumers
● There is no government intervention
Disadvantages
● Only benefits the wealthy
● Allows for the creation of monopolies, which exploit the market by overpricing
goods
● Overconsumption of demerit goods
● Public service goods such as police services are not provided in a free market
Planned economy: The government allocates all scarce resources in an economy
where there is greater need.
Economic questions to in a planned economy:
1. What to produce: Determined by government preference
2. How to Produce: Produced by government and government employees
3. For whom to produce: Government decides whom its produced for
Advantages and disadvantages of a planned economy
Advantages
● Easier to control resources in a time of crisis such as war
● Government can compensate for market failures by reallocating resources
● Ensures that everyone has basic needs met
● Reduces inequality
● Abuse of monopoly power can be prevented
Disadvantages
● Limits democracy and personal freedom
● Does not cater to consumer preferences
● Government failure
Mixed economy: resources allocated partly through price signals and partly on the basis
of direction by government.
Economic questions in a mixed economy
1. What to produce: Determined by both consumer and government preference
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