D. S.

ACADEMY
Subject: Economics Basic Problems of an Topic: Basic Problems Of an
Economy Economy

Worksheet

Study the passage, and answer the questions that follow.

"The central problem facing all societies is how the scarce resources available to that
society (land, labour, capital and entrepreneurial ability) are to be allocated between
competing and essentially unlimited wants. Any use of a resource to produce a good or
service implies an opportunity cost, because that resource can no longer be used to
produce alternative goods and services. Hence, the problem is how to allocate resources
efficiently.

In economic theory there are two basic models of resource allocation - the free market
economy and the command economy. In the free market economy, resources are
allocated through the price mechanism. An increase in demand creates a shortage, and
this shortage pushes up the price. An increase in price means more potential profit for
entrepreneurs, so therefore they produce more of this higher priced commodity, and less
of something else. The advantage of this system is that it happens automatically and
swiftly - what Adam Smith termed 'the invisible hand'. The problem with this system is
that only profitable commodities are valued, which means that socially desirable goods
that do not create much profit might not be produced.

In a command economy, resources are allocated via central planning (hence such
economies are sometimes known as 'planned' economies). A central committee looks at
what resources are available, and then decides how they are to be combined to produce
different goods and services. The stereotypical example of this system was the five year
plans produced by the Soviet economy under Joseph Stalin in the 1930s. The problem
with such an approach is that it can be difficult to judge the inter-dependence between
industries, meaning that firms might be deprived of vital raw materials. At the same
time, it is difficult to judge accurately what goods and services are wanted by final
consumers, which can result in shortages of certain commodities.

In the 21st century, all economies are in fact 'mixed' economies, with elements of both
markets and state control. In the UK, for example, most healthcare and education is
provided by the State whereas most other goods and services are dominated by the
private sector. This should in theory allow the best of both systems, although this is not
always the case…"

1) What are the four main factors of production? (2 marks)

2) Explain what is meant by 'the central economic problem' (4 marks)
3) What is meant by the term 'opportunity cost' (2 marks)
4) Why does the central economic problem create 'opportunity costs'
(2 marks)
5) How are resources allocated in a free market economy? (2 marks)
6) Why does supply respond to demand in a free market economy?(4 marks)
7) How are resources allocated in a command economy? (2 marks)
Page 1 of 3
Shop No. 9, Ruparel Gardens, Plot C-3, Sector 23, Nerul (E), Navi Mumbai. 27718413 / 9819009965
 D. S. ACADEMY
Subject: Economics Basic Problems of an Topic: Basic Problems Of an
Economy Economy

8) What is meant by a mixed economy? (2 marks)

9) Use the diagram below to answer questions (a) to (f)

With the available factors of production, an economy can produce the following
combinations of goods:
Consumer Goods
60 A

50 B

40 C I

30 D

20 H E

10 F

0 G
10 20 30 40 50
Capital Goods
(Machines)

a) Calculate the opportunity cost of increasing the production of consumer goods by 10

units at each interval (i.e. how many capital goods are given up when we increase
production of consumer goods from 0-12, then from 10-20 and so on)
(3 marks)
b) This increase in opportunity cost is why the production possibility frontier is a curve
rather than a straight line. Why does the opportunity cost increase (ie why is the
frontier a curve rather than a straight line)?
(5 marks)
c) Why is point I currently unobtainable? (2 marks)

d) Explain two ways in which the economy might be able to reach point I in the future
(4
marks)

e) What is the problem with producing at point H? (2 marks)

f) What might be the consequences over time for an economy of producing at point F
rather than point B? (Think about the proportions of each good being produced.
(3 marks)

Page 2 of 3
Shop No. 9, Ruparel Gardens, Plot C-3, Sector 23, Nerul (E), Navi Mumbai. 27718413 / 9819009965
 D. S. ACADEMY
Subject: Economics Basic Problems of an Topic: Basic Problems Of an
Economy Economy

g) Under what circumstances might a production possibility frontier:

(i) Shift inwards:
A
B

B A (3 marks)

(ii) Pivot
(5 marks)
Manufactured goods

Agricultural goods (3 marks)

Page 3 of 3
Shop No. 9, Ruparel Gardens, Plot C-3, Sector 23, Nerul (E), Navi Mumbai. 27718413 / 9819009965