The Basic Economic Problem: Practice Questions

These are original questions written for Marlbridge, for revision and practice on this content. They are not reproduced past-paper questions, and they do not replicate the exam’s exact structure, question count or mark tariffs — examination boards hold copyright in their own papers. Use these alongside the official past papers available free from your board.

Related: The Basic Economic Problem revision notes

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Section A

1. Explain why economics is described as the study of choice. [2]

2. Distinguish between free goods and economic goods, giving an example of each. [3]

Section B

3. Explain the concept of opportunity cost as it applies to a government deciding whether to spend on defence or on healthcare. [4]

4. Explain how each of the market and mixed economic systems answers the questions “what to produce” and “how to produce”. [8]

5. A country’s government decides to reduce its intervention in the economy, giving markets a greater role in allocating resources.

(a) Explain two benefits it may experience. [4] (b) Explain two problems it may face. [4]

6. Explain three reasons why a purely free market economy is unlikely to exist in practice. [6]

7. Explain the difference between actual growth and economic growth (a permanent increase in productive capacity) on a production possibility curve. [4]

8. Distinguish between the primary, secondary and tertiary sectors of the economy, giving one example of each. [6]

9. Explain how the balance between these three sectors typically changes as a country develops. [3]

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Answers

1. Resources are scarce while wants are unlimited [1], so every individual, firm and government must decide how to allocate what is available — economics studies how those choices are made and their consequences [1].

2. A free good is unlimited in supply, has no opportunity cost and costs nothing to obtain, e.g. air [1] [1]. An economic good is scarce relative to demand, so it has an opportunity cost and commands a price, e.g. oil [1].

3. Resources spent on defence cannot also be spent on healthcare [1]. The opportunity cost of building a new fleet is therefore the hospitals, staff and treatments that could have been provided instead [1] — the next best alternative forgone [1]. Because the government’s budget is finite, every decision of this kind involves a real sacrifice, which is why such choices are politically contested [1].

4. Market economy: what is produced is determined by consumer demand signalled through prices — firms produce what is profitable [1] [1]; how it is produced is determined by the search for the lowest cost, since firms compete on price and must be efficient to survive [1] [1]. Mixed economy: what is produced is decided partly by consumer demand through prices in the private sector, and partly by the government according to its assessment of social need in the public sector [1] [1]; how it is produced is decided partly by firms competing on cost, and partly by the state providing certain goods and services directly [1] [1].

5. (a) Any two, 2 marks each: greater efficiency and lower costs, since firms face more competition and the profit motive rather than relying on state support [1] [1]. Greater consumer choice and better quality, since producers must attract buyers [1] [1]. Stronger incentives to innovate and invest, since entrepreneurs keep the rewards [1] [1]. (b) Any two, 2 marks each: rising unemployment as previously protected state-run enterprises close, since protection from competition had concealed overstaffing [1] [1]. Growing inequality, as incomes come to depend more on the market value of skills and less on state support [1] [1]. Underprovision of public and merit goods such as healthcare and education if the state withdraws support before regulation and taxation systems are in place [1] [1]. Price rises and instability when previously controlled prices are freed [1] [1].

6. Any three, 2 marks each: public goods would not be provided at all, because non-excludability makes them unprofitable, yet defence and street lighting are essential [1] [1]. Externalities are ignored, so pollution is overproduced and education underconsumed, which no government can accept [1] [1]. Monopoly power develops, allowing firms to exploit consumers, so competition law is needed [1] [1]. Inequality would be extreme, since those who own no productive resources and cannot work would receive nothing, which is politically and morally unacceptable [1] [1].

7. Economic growth, in this syllabus’s sense, is shown by an outward shift of the whole production possibility curve — a permanent increase in productive capacity, caused by more or better resources or improved technology [1] [1]. Actual growth can also occur in the short run by moving from a point inside the curve towards it, simply by using existing idle resources more fully [1]. Only the shift represents a genuine, permanent increase in what the economy is capable of producing; the movement towards the curve is temporary and reversible [1].

8. Primary sector — extracting raw materials directly from the earth, e.g. farming, mining or fishing [1] [1]. Secondary sector — manufacturing and construction, turning raw materials into finished or semi-finished goods, e.g. car manufacturing or construction [1] [1]. Tertiary sector — providing services rather than physical goods, e.g. retail, banking or tourism [1] [1].

9. As a country develops, the primary sector typically shrinks as a share of output and employment, while the tertiary sector grows [1] [1] — reflecting both rising incomes, which increase demand for services, and improved technology and productivity in agriculture and extraction, which need fewer workers to produce the same output [1].

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Where marks are usually lost

• Giving opportunity cost as the money spent rather than the alternative forgone.
• Saying a free good is one the government provides free.
• Describing economic systems without addressing both “what” and “how”.
• Confusing a movement towards the PPC with a shift of it.
• Naming a sector without giving a specific example, or giving an example that actually belongs to a different sector (e.g. describing a bakery baking bread as “primary” rather than secondary).