Generally, individuals and firms are assumed to be motivated by self-interest. Explain the central economic problem of limited resources and unlimited wants. [10]

This essay question is adapted from an actual A level economics essay examination

This economics essay is about the central problem of economics, and explains that the pursuit of self-interest by individuals and firms results in an efficient allocation of earth’s resources through the price mechanism, which solves the problem of scarcity and the central economic questions of what to produce, how to produce, and for whom to produce. Any society, whether capitalistic, socialist, or a command economy, needs to answer these three important economic questions. 

Human wants are unlimited, while the factors of production used to produce goods and services to meet human wants, which are land, labour, capital, and entrepreneurship are limited. Land refers to gifts of nature and natural resources, like physical land, oil, and natural gas. Labour refers to manpower and man’s efforts and “human capital”. Capital in economics often refers to goods that produce other goods, for example, machinery. And entrepreneurship refers to human risk taking and decision making to coordinate the limited resources available, and as Schumpeter once said, entrepreneurs use “creative destruction” to keep the economy humming with new goods and services that displace older goods and services. These four resources are limited, but are most importantly required to produce goods and services. 

However, human wants are unlimited; for example, people need food, clothing, housing, transportation, leisure and entertainment, education, and many other goods and services to meet their material standard of living. This situation of limited factors of production of land, labour, capital, and entrepreneurship, but unlimited human wants, results in scarcity. 

Scarcity necessitates choice, which means that rational economic choices have to be made to allocate the resources to competing uses. One related important economic concept here is the idea of opportunity cost, which is the cost of the next best alternative – rationally, as resources are scarce, allocating resources to one purpose means forgoing the next best alternative. In other words, there are trade-offs that arise from the allocation of the factors of production to competing uses. 

However, there is a solution that addresses the central problem of economics. 

This solution is the free market, with the price mechanism, which as Adam Smith once said, acts like "an invisible hand" that coordinates the matching of limited resources to competing uses. According to economic theory, this is the intersection of demand and supply that determines the optimal price and the quantity eventually produced, ceteris paribus. Ceteris paribus is the condition that all other factors remain constant; one example here is that, for the price mechanism to allocate resources efficiently, there should be no market failures resulting in allocative inefficiency. Demand is defined as the willingness and ability to purchase a good or service, ceteris paribus, while supply is defined as the willingness and ability to produce a good or service, also ceteris paribus. In economic theory, the optimal price and economic output of goods and services are the outcome of rational choices of millions, if not billions, of suppliers, producers, and firms meeting the requirements of millions of consumers, individuals, and households. 

In conclusion, the pursuit of self-interest by individuals and firms utilises the price mechanism to address the economic problem of scarcity, and it is the intersection of demand and supply that leads to an efficient allocation of scarce economic resources.

Economics Tutor's Comment - This is an excellent effort for the A levels and covers a few important economic concepts and arguments. However, it takes a slightly different approach compared to other economics essays on the central problem of economics that, for example, talk about signalling, rationing, incentivising effects of prices. What is the limitation of using that kind of approach? Also, it could be improved with the use of an economics diagram, and explaining the diagram could also add higher order reasoning to this paper. Nonetheless, it is still quite clear that this student’s economic theory is quite strong. Always think about what you could do to make your economics essays even better. Thank you for reading. Cheers!  

JC Economics Essays - This economics essays blog helps economics students with the A-Levels (Cambridge, A1/S, A2, A H1/H2/H3 levels), and even the international AS level economics examinations. IB students can also benefit from the economics content in JC Economics Essays. This top-quality economics essays website provides a range of relevant and useful economics content, materials, tips and techniques, and model economics essays that students in the United Kingdom and Singapore, and all around the world, can use to excel in their studies and economics examinations.

This model essay with economics tutor’s comments was contributed by WT, our Economics expert who helps students understand the beauty of Economics and its applications. WT has a strong interest in Econometrics, Economic History, International Trade, and Game Theory. This economics post was edited by SS, the editor of JC Economics Essays.

Consumers and producers are generally assumed to be motivated by self-interest. Explain how the pursuit of self-interest can help to address the central economic problem of limited resources and unlimited wants. [10]

Adapted from an actual economics essay examination

This economics paper explains that the pursuit of self-interest results in an efficient allocation of resources through the price mechanism, which addresses the problem of scarcity. 

Human wants are unlimited, while earth's resources of land, labour, capital, and entrepreneurship are limited. This results in scarcity. What is scarcity? It refers to the situation where resources that are limited are not able to meet the requirement of unlimited wants. However, there is a solution to meeting these two different imperatives - and that is the free market, with its price mechanism, which as Adam Smith said, acts like "an invisible hand". 

The price mechanism means that it is the intersection of demand and supply that determines the price and the quantity eventually produced. It is the rational choice of millions of suppliers, producers, and firms meeting the requirements of millions of consumers, individuals, and households. Demand is defined as the willingness and ability to purchase a good or service, ceteris paribus, while supply is defined as the willingness and ability to produce a good or service, also ceteris paribus. 

The price mechanism addresses the central problem of economics, coordinating resources to their best uses, and solving the problem of what to produce, how to produce, and for whom to produce, because it serves the important four functions of signaling, rationing, allocating, and incentivising. The signaling function is one where the price of a good allows for a re-calibration of the quantity demanded and quantity supplied. As the price of a good increases, indicating a more pronounced situation of scarcity, the quantity demanded of a good falls, while the quantity supplied rises, ceteris paribus. The converse is also true, where the fall in the price of a good, which indicates an amelioration of scarcity, results in an increase in the quantity demanded and a fall in the quantity supplied.

Given the prevailing market prices, buyers who seek to maximise their utility will demand the good. Under this demand function, those are willing and able to pay for the good are able to obtain it, while those who are not willing or able to pay will go without the good. Meanwhile, producers who are willing and able to produce the good at a cost below or equivalent to the prevailing market price will produce it, as they are incentivised to maximise profits, while those who produce at a cost above the market price will not. This also determines the allocation of resources that go into producing this good.

In conclusion, the pursuit of self-interest utilises the price mechanism to address the problem of scarcity, achieving an efficient allocation of resources.

Economics Tutor's Comment - This is a very strong effort for the A levels and covers quite a few important points and arguments. The candidate's use of economic theory is quite strong in this economics essay. However, one should not and cannot rest on one's laurels. What would make this economics essay even better? Thank you for reading. Cheers!  

JC Economics Essays - This economics essays site helps students with the A-Levels (Cambridge, A1/S, A2, H1/H2 levels), and the international AS level economics examinations. This blog provides a range of useful economics content, materials, tips and techniques, and model economics essays that students in the United Kingdom, and all around the world, can use to excel in their studies and examinations.

This model essay with sample comments was contributed by WT, our resident Economics expert who helps students understand the beauty of Economics and its applications in real life. WT has a strong interest in Econometrics, Economic History, International Trade, and Game Theory, especially applications to real life. This economics post was edited by S. S., the editor of JC Economics Essays.

(b) “The government should produce all public goods and all merit goods”. Is this statement accurate from an economist’s point of view? (15)

(b) “The government should produce all public goods and all merit goods”. Is this statement accurate from an economist’s point of view? [15]

Note: please read the economics tutor's comments at the back after reading this economics essay. 

The efficient allocation of resources is the use of a country’s limited resources in such a manner that maximises the total welfare of the people. A pure market economy will not be able to do this for three main reasons: the emergence of imperfect market structures, externalities and the lack of public goods. Therefore, government intervention is needed to deal with these market failures. In this paper, we shall look at the main features of the market economy, and then look at its limitations.

Firstly, in a market economy, there is private ownership of resources and finished goods. Individuals and firms can thus transfer ownership to any other party that they wish. Secondly, the allocation of resources is determined by a unique system known as the price mechanism of the market. The forces of demand representing consumers and the forces of supply that represent producers interact to determine the price of goods – thus leading to “the invisible hand” allocating resources to the best possible uses. The price mechanism is the channel by which consumers signal to producers of the goods they want and the respective quantity that they want.

The market mechanism is also very efficient because decision making is completely decentralised. Producers respond at the local market level immediately to consumer preferences. As freedom of choice and profit motive is allowed, producers will use scarce resources as efficiently to produce. Intense competition also forces producers to produce at the lowest cost and thus forces producers to produce at the lowest cost and thus forces them to innovate and invent new products in order to satisfy the wants of consumers. In the long run, it is the consumer who benefits in the form of new, better and cheaper products.

However, the market economy is not without its drawbacks and the most serious one is its inability to deal with externalities. Externalities are benefits (positive externality) and costs (negative externality) that fall on society due to economic activities which the price mechanism is unable to account for.

In the case of public goods, no producers would want to produce goods like street lighting or radio broadcasts because these are non-exclusive between payers and non-payers. And they are also inexhaustible. Thus, in a market economy, they would not be produced although the consumers would generally benefit from these goods. Thus, to maximise welfare, government should supply the good at zero market price. The government may either produce these goods itself or contract the production of these goods to the private sector. The government would hence, finance the production of these goods from tax revenue.

Even in the case of market goods, the market will not produce a quantity at the socially optimum level- private companies would only produce education for those who can pay although it is to society’s benefit in the long run to provide all children with education Thus, the government would intervene in the case of merit goods by providing subsidies.

Subsidies are transfers from the government to individuals and firms. In the case of merit goods, a subsidy can be provided directly to producers or consumers. Legislation, which is enacting laws and regulations to ensure optimum consumption of a good, can also, be implemented by the government. Thus, the fear of being penalised increases the demand for the goods, leading to greater consumption. The government may also provide the shortfall of merit goods or may contract private firms to supply the shortfall. The government can also educate the public through mass media and carry out campaigns to teach the citizens the importance of consuming the merit good. Thus, in the case of merit goods, the government would have to intervene as it has large revenue from taxes that is able to finance the provision of merit goods unlike private enterprises which do not have such a large capital base.

In the case of a negative externality, private consumers and businesses would generate the social costs of pollution, congestion and environment degradation in the process of seeking their own interest. As the market fails to place a market value on these costs, they get away with paying for them. Thus, the government also has to intervene in this case due to the negative externality generated that affects the third party. Thus, the government would have to impose taxes such that producers would be motivated to produce using greener technologies in order to reduce their probability of them having to pay taxes that add on t their production costs. The government may also introduce legislation in order to reduce emissions and negative externalities in production.

Figure 1: Marginal Social Costs, Benefits and Marginal Private Benefits, costs

Indeed for the efficient allocation of resources, form all points of view, production of any good should be where the MSC=MSB. As show in Figure 1, output 0Q0, is the ideal level of production from society’s point of view. However, the market will only consider MPC which is only part of MSC. Marginal Private Benefit is only part of MSB. Therefore, goods are either under produced or overproduced. Hence, government intervention is required to correct these market imperfections in order to achieve the socially optimum level of output.

The market mechanism may also undermine consumer’s welfare. As producers are profit motivated-they only produce for the rich-people who can afford to pay. Thus, food, housing, medical services and even ordinary goods will not be adequately produced and provided for the poor.

Another disadvantage is the market economy does not guarantee against the concentration of economic power in the hands of a few. This is called a monopoly or an oligopoly. One company would then be able to exploit consumers.

Finally, the market economy, as seen in history, causes a wide gap or disparity between groups of people in the country. Massive wealth is held by a few and this small group gets richer because one needs wealth to generate more wealth. Thus, the market economy may fail to maximise society’s welfare.

For the above reasons, it is best that some form of government supervision of economic activities may be present. A good example of this is Singapore. This country has prospered due to the spirit of free enterprise-private ownership and profit. However, the government has set up a number of authorities to ensure that resources are efficiently allocated while market forces prevail. The Urban Redevelopment Authority (URA) looks into the use of limited land space. The Land Transport Authority (LTA) supervises private and public transportation. The Port of Singapore Authority (PSA) looks into ports and shipping. In this way, Singapore benefits from the market system: without its bad effects.

JC ECONOMICS ESSAYS - Economics Tutor's Note: This is a very interesting approach. I think this Economics essay is interesting, well thought-out and reflective. In fact, it is rather good. However, it is not the standard way to deal with "A" level exam questions. In terms of an A level answer, this would not be the proper way to answer the economics question. The standard view should be something like:

Essay Introduction - Define public goods and merit goods, perhaps arguing that merit goods are underconsumed and underproduced because of either imperfect information or the presence of positive externalities. Introduce the main arguments. 

Essay Thesis - Yes, on the one hand, the government should produce public goods and merit goods (Diagram +egs + why)

Essay Anti-thesis - No, on the other hand, the government shouldn’t produce public goods and merit goods (Diagram + egs + why)

It can legislate, it can use free market, it can use the Coase theorem (perhaps tradeable permits or other methods), it can subsidise private producers. (Include limitations of the government also; government failure - thus it shouldn't, since it could be even worse.)

Essay Synthesis, for an evaluative conclusion that weighs the arguments and their merits - Govt produces public goods, govt taxes/subsidises. Demerit/merit goods should not be directly provided. Clever, pithy, evaluative opinion-based statement justified with Economics reasoning, concepts, and theories at the end.

Having said that, think of how you could approach this essay question and think about the answers that you would give. This student answered the question in a divergent way, but there are lots that we can learn from it. Perhaps, this economics essay could be even better if the student had focused on answering the question directly or in a more clear or obvious manner. Thanks for reading and cheers.