Chapter 2: The Fundamental Economic Problems

Andrew Gillespie

Learning Objectives

By the end of this chapter you should understand

✓ the meaning of scarcity and choice;

✓ the key economic problems in society;

✓ the difference between a free market, a planned economy, and a mixed economy;

✓ the key advantages and disadvantages of each type of economy;

✓ the meaning of the production possibility frontier and productive efficiency

Short Answer Questions

1. What is meant by scarcity and choice in economics?2. What are the three fundamental economic questions?3. What is shown by a production possibility frontier (PPF)?4. What might cause an outward shift of the PPF?5. What is meant by opportunity cost?6. What is meant by productive efficiency?7. How are resources allocated in the free market?8. What is the output gap?9. What is meant by a mixed economy?10. What problems might occur in a planned economy?

Essay Questions

1. Is ‘what to produce’ the fundamental economic problem?

2. Discuss the importance of opportunity cost in economics.

3. Is the free market the best solution to the fundamental economic questions?

Production possibility frontier

Product A

Product B

Production possibility frontier

Product A

Product B

50

10

20 32

W

X

Y

ZProduct A

Product B

Product A

Product B

Economic growth

May be caused by an increase in the quantity

and/or quality of resources such as:• an increase in technology enabling capital

equipment to be more productive• a better educated or better trained workforce,

or a better approach to managing people• an increase in the land available; perhaps

because new technology allows more land to be reclaimed or to be used more productively.

Product A

Product B

Types of economy

Market forces Private and Public Sector State allocatesresources

FREE MIXED ECONOMY PLANNED/MARKET COMMAND

ECONOMY