The Basic Economic Problem: Practice Questions

These are original questions written for Marlbridge, in the style and at the standard of the examination. They are not reproduced past-paper questions — 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

---

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 three economic systems answers the questions “what to produce” and “how to produce”. [8]

5. A country moves from a planned to a market economy.

(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 economic growth and an increase in the productive capacity of an economy, using the production possibility curve. [4]

Section C

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]

---

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]. Planned economy: what is produced is decided by the government according to its assessment of social need and its plan targets [1] [1]; how is also decided by the state, which owns the means of production and allocates inputs to state enterprises, often with full employment as an objective rather than lowest cost [1] [1]. Mixed economy: both mechanisms operate — the private sector responds to prices, while the state provides goods the market underprovides and regulates the rest [2 marks may be awarded within the above].

5. (a) Any two, 2 marks each: greater efficiency and lower costs, since firms face competition and the profit motive rather than plan targets [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 inefficient state enterprises close, since the planned economy had concealed overstaffing [1] [1]. Growing inequality, as incomes come to depend on the market value of skills rather than being set by the state [1] [1]. Underprovision of public and merit goods such as healthcare and education if the state withdraws before regulation and taxation systems are in place [1] [1]. Price rises and instability when 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. An increase in productive capacity is shown by an outward shift of the whole production possibility curve, caused by more or better resources or improved technology [1] [1]. Economic growth in the short run can also occur by moving from a point inside the curve towards it, simply by using existing idle resources more fully [1]. Only the shift represents a permanent increase in what the economy is capable of producing [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].

---

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 selling bread as “primary” rather than secondary).