Economics: The Three Basic Questions

Study Notes

Economies must address three fundamental questions because resources are limited and cannot meet all wants and needs.
What to Produce?:
- Deciding which goods and services to produce and in what quantities.
- Prioritizing the allocation of resources to meet the needs and desires of society.
- Examples: Allocating resources to healthcare or defense, or producing more medical supplies during a crisis.
How to Produce?:
- Determining the production methods and the combination of resources (land, labor, capital) to be used.
- Examples: Using labor-intensive or capital-intensive techniques, or sustainable production methods to minimize environmental impact.
For Whom to Produce?:
- Deciding how the goods and services are distributed among the population.
- Involves decisions on equity and fairness.
- Examples: Distributing goods based on purchasing power in a free market, or based on need in a command economy.

Government involvement is crucial for providing public goods, managing externalities, and regulating markets.
The extent of government involvement can be measured using the command economy equation.
Command Economy:
- Characteristics: Centralized control and planning, public ownership of resources and enterprises, and government-set prices and production targets.
- Examples: The former Soviet Union and North Korea.
Market Economy:
- Characteristics: Decisions driven by individual consumers and firms, private ownership of resources and enterprises, and prices determined by supply and demand.
- Examples: The United States (with some government intervention) and Hong Kong (with minimal government intervention).

Command Economy:
- Advantages: Rapid mobilization of resources, equal distribution of wealth and resources.
- Disadvantages: Lack of incentives, government inefficiency and corruption, and misallocation of resources.
Market Economy:
- Advantages: Promotes efficiency and innovation, provides a wide variety of goods and services, and consumers have freedom of choice.
- Disadvantages: Can lead to income inequality, market failures, and underprovision of public goods and services.
Traditional Economy:
- Characteristics: Decisions based on customs, traditions, and beliefs, typically agricultural or hunter-gatherer societies, and barter system.
- Examples: Indigenous tribes and rural areas in developing countries.

Graphs and charts are essential tools for visualizing economic data and making complex information easier to understand and analyze.
Bar Graph:
- Usage: Comparing different groups or categories.
- Example: Comparing the GDP of different countries.
Line Graph:
- Usage: Showing trends over time.
- Example: Tracking the unemployment rate over several years.
Pie Chart:
- Usage: Showing proportions of a whole.
- Example: Displaying the composition of government spending by sector.

Opportunity Cost:
- Definition: The value of the next best alternative that is foregone when making a decision.
- Examples: Personal (choosing between studying and socializing) and economic (investing in machinery or employee training).
Types of Economies:
- Command Economy:
  - Central planning, government control, and public ownership.
  - Advantages and disadvantages.
  - Examples like North Korea or the Soviet Union.
- Market Economy:
  - Supply and demand, private ownership, and minimal government intervention.
  - Advantages and disadvantages.
  - Examples like the United States or Hong Kong.
- Traditional Economy:
  - Customs and traditions guiding economic decisions.
  - Advantages and disadvantages.
  - Examples like indigenous tribes or rural communities in developing countries.
Factors of Production:
- Definition: The resources used to produce goods and services.
- Types:
  - Land: Natural resources used in production.
  - Labor: Human effort used in production.
  - Capital: Man-made resources used in production.
  - Entrepreneurship: The ability to combine land, labor, and capital to create and market new goods and services.
- Essay Points:
  - Contribution to Economic Growth: Explain how each factor contributes to increasing the output of goods and services.
  - Availability and Quality: Discuss how the abundance and quality of these factors affect production capabilities.
  - Examples: Use real-world examples to illustrate the significance of each factor.