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.

Explain the possible conflicts in the achievement of macroeconomic aims when using demand-management policies. [10]

This paper explains possible conflicts in the achievement of macroeconomic aims. When governments utilise demand management policies, there may be conflicts or trade offs amongst those goals. The most common conflict is the conflict between achieving full employment and price stability. There are also other conflicts such as those between achieving internal and external stability. This paper explains various possible conflicts in the achievement of macroeconomic aims when governments use demand management policies, such as fiscal and monetary policies.

First, demand management policies such as expansionary fiscal and monetary policies are often used to achieve full employment. For example, when there is an increase in government spending as governments spend on building infrastructure to boost economic activity, there is an increase in AD and hence an increase in real national income. As more resources are employed, the economy operates closer to full employment. However, there is a trade off as the economy will also face demand pull inflation as demand rises and bids up costs of factors of production. Demand pull inflation is defined as a persistent, sustained, and inordinate increase in the general price level due to increases in AD near or at the full employment level. Many fast developing countries like China with fast-rising AD and increasingly less spare capacity will likely face this conflict. On the other hand, contractionary fiscal and monetary policies can be used to reduce demand pull inflation, but this in turn conflicts with economic growth and employment, thus posing yet another trade off.

Second, as expansionary demand management policies are used to achieve economic growth, the balance of payments may worsen. For example, if interest rates are lowered to reduce costs of borrowing, households will borrow more to spend on consumer durables and firms may also invest more as expected net profitability increases. This leads to an increase in AD and real national income. However, the demand for imports and hence import expenditure increases too. This is because many consumer durables may be imported and firms may also import raw materials and machineries for their investments. Assuming that export revenue does not rise as quickly, the balance of trade worsens. Ceteris paribus, the current account and hence balance of payments worsens. Thus countries like Singapore with high MPM will be more likely to suffer from this conflict. This is because the increase in import expenditure is larger when national income increases. Vice versa, contractionary demand management policies to correct or address a balance of trade deficit can conflict with economic growth and employment.

If a country wants to achieve economic growth, it may choose to use expansionary monetary policy to increase AD. When interest rates are lowered, the cost of borrowing is lowered. This causes households to borrow more to purchase consumer durables such as televisions and refrigerators. This causes C to increase. Firms will also find that expected profitability of investment increases as costs of borrowing falls, given that economic conditions remain the same and returns on investments do not change. Thus I increases. Since C and I are components of AD, AD will increase, resulting in an increase in real national output and hence actual economic growth. However, in an open economy, the lower interest rates would likely result in capital outflow. If there is massive capital outflow as funds move to countries which offer higher interest rates, the capital and financial account will worsen. This leads to a worsening balance of payments. Hence, the desire to achieve actual growth via expansionary monetary policy can conflict with the desire to achieve a healthy balance of payments.

Furthermore, there is also a conflict between achieving a healthy balance of payments and price stability. If a country is facing a deficit in its current account and balance of payments, it may make use of demand management policies to improve the current account. For example, an expenditure switching policy of currency depreciation would help decrease the price of exports in terms of foreign currency and increase the price of imports in terms of domestic currency. As export competitiveness increases, the demand for exports and hence export revenue increases. At the same time as imports become more expensive, consumers switch to purchasing domestic goods instead. Assuming that Marshall Lerner condition holds, when IPEDx + PEDmI >1, balance of trade improves. Since X-M increases, AD increases and general price levels increase too.  However, if the economy is import-reliant, the depreciation of the currency could lead to imported inflation as the prices of imported raw materials increase. This causes the SRAS to fall and the general price level to increase. Thus a healthy balance of payments is achieved at the expense of price stability. An example of this would be Singapore, where imported inflation is likely to happen if the currency depreciates. This explains why Singapore is reluctant to depreciate its currency even when BOT is worsening.

In conclusion, there is a need to consider the use of supply side policies in some cases to minimise these trade-offs, conflicts in macroeconomic goals. Alternatively, a suitable mix of government policies may be considered to mitigate possible unintended consequences which may arise.

JC Economics Essays: Special thanks to W for her contribution of this well-written economics essay. However, this economics essay was not done under timed examination conditions. 

This paper explains the possible conflicts amongst macroeconomic goals of governments, and is basically about explaining the various trade offs and conflicts: inflation versus economic growth, internal versus external stability, and other such conflicts. 

There are many good points to learn from this paper. First, it directly addresses the question. It also has many definitions and examples, which suggests that the candidate has learnt her economics material well. The essay is also very well written, and is clear cut, accurate, and to the point; however, perhaps some diagrams could have been drawn. What economics diagrams would you have drawn in this case, and why? Economics essays often benefit from a relevant, well labelled, and accurate diagram that illustrates and analyses a point. Thanks for reading and cheers!