Economics | The three basic problems

Chapter 1: The Three Basic Problems

👋 Welcome to the World of Economics!

Hello! Welcome to one of the most fundamental topics in Economics. Ever wondered why you can't have everything you want? Or why societies have to make tough decisions, like building a new MTR line instead of a new park? It all comes down to a core concept called scarcity.

In this chapter, we're going to explore the three huge questions that every single society—from a small village to a big city like Hong Kong—must answer because of scarcity. Understanding these problems is the first step to thinking like an economist. Don't worry, we'll break it all down with simple examples you see every day!

The Three Big Questions Every Society Must Answer

Remember, the basic economic problem is scarcity: we have unlimited wants but only limited resources to satisfy them. Because of this, we are forced to make choices. These choices can be boiled down to three basic economic questions.

1. What to produce?

This question is about deciding which goods and services a society should create with its limited resources. Since we can't produce everything, we have to choose.

Example: Should Hong Kong's government use a piece of land in Central for a new public park or for a commercial office building? A company like Apple has to decide whether to use its engineers and factories to produce more iPhones or more MacBooks.
This is a choice about the types and quantities of goods to produce.

2. How to produce?

This question is about choosing the best method of production. It involves deciding which combination of resources (like labour and machinery) to use.

Example: Should a clothing factory hire more workers to sew shirts by hand (labour-intensive) or buy more automated sewing machines (capital-intensive)? Should a restaurant use a high-tech ordering system or hire more waiters to take orders?
This is a choice about the production method.

3. For whom to produce?

This question is about how the goods and services that are produced are distributed among the people in society. Who gets to consume what is made?

Example: Who gets to live in the newly built public housing estates? Who can afford the tickets for a popular concert? Should goods be distributed to those who can pay the highest price, or to those who have the greatest need?
This is a choice about the distribution of goods and services.

Quick Review: The 3 Questions

A simple way to remember the three basic economic problems is the "What, How, For Whom" trio.
- What to produce? (Types and quantities)
- How to produce? (Production methods)
- For whom to produce? (Distribution)

Solving the Problems: Different Approaches

So, how do societies actually answer these three big questions? There are different ways to make these decisions. The HKDSE syllabus wants you to know about three main methods, using examples.

Method 1: By Society's Customs and Traditions

In some societies, economic decisions are based on long-held customs, beliefs, and traditions that are passed down from one generation to the next.

Example: In some traditional farming communities, a farmer's son becomes a farmer, and a blacksmith's daughter might learn the family trade. They use the same farming techniques their ancestors did ("How"). They produce the same crops every year ("What"), and the harvest is shared based on the community's historical rules ("For Whom").

This method provides stability but is often resistant to change and is not common for making most decisions in a modern economy like Hong Kong.

Method 2: By Government Decisions

Here, a central authority (the government) makes the key economic decisions. The government decides what to produce, commands how it should be done, and determines who receives the final products.

Example: The Hong Kong government decides to build a new public hospital ("What"). It awards the construction contract to a company and sets the building standards ("How"). Once built, the hospital services are available to all citizens at a heavily subsidised rate ("For Whom"). Another great example is the provision of public housing and compulsory education.

Method 3: By the Market Mechanism

This is where decisions are made by the interactions of individual buyers and sellers in the market. Instead of a central planner, the "invisible hand" of the market, through prices, guides the decisions. Don't worry if this sounds tricky, it's actually quite logical!

Here’s how it works for each question:

- What to produce? It's decided by consumers' demand. If lots of people want to buy electric cars, the price of electric cars might rise, signaling to companies that it's profitable to produce more of them. Goods that are not in demand won't be profitable, so firms stop making them. You vote with your money!

- How to produce? It's decided by producers seeking to maximize profit. A firm will choose the production method that is most efficient and has the lowest cost. If wages are very high, a firm might invest in more machinery to save on labour costs.

- For whom to produce? It's decided by people's purchasing power. Those who are willing and able to pay the market price for a good or service will get it. For example, anyone who can afford the ticket price can go see a movie at the cinema.

Key Takeaway: Three Ways to Solve the Problems

1. Customs & Traditions: Decisions based on the past.
2. Government Decisions: Decisions made by a central authority.
3. Market Mechanism: Decisions made by the interaction of buyers and sellers, guided by prices.

Did you know? Most countries today, including Hong Kong, are mixed economies. This means they use a combination of the market mechanism and government decisions to solve the three basic problems. For example, you can buy a smartphone in a free market, but your education is heavily provided and funded by the government.

The Rules of the Game: Private Property Rights

For the "market mechanism" to work, we need a clear set of rules. The most important rule is about ownership. If you don't really own anything, you can't buy or sell it! This is where private property rights come in.

What are Private Property Rights?

Private property rights are the legally protected rights of an individual to control a resource. Think about your smartphone. Because you have private property rights over it, you can control it. These rights can be broken down into three parts:

1. The Exclusive Right to Use: You, the owner, have the right to decide how to use your property.
Example: You can use your apartment to live in, or you can choose to leave it empty. It's your call.

2. The Exclusive Right to Receive Income: You have the right to all the income and benefits generated by your property.
Example: If you rent out your apartment to a tenant, you have the exclusive right to collect the rental income.

3. The Right to Transfer: You have the right to transfer your property to others, either by selling it, giving it away, or leaving it in a will.
Example: You can sell your apartment to another person.

Why are Private Property Rights SO Important for a Market Economy?

This is a super important connection to make! Private property rights are the foundation on which the whole market mechanism is built.

The syllabus states that "clear delineation of private property rights is a prerequisite for the use of price mechanism." This means that before prices can work their magic in the market, we must first have a clear system of ownership. Here's why:

• They enable trade: If ownership is not clear, you can't have buying and selling. Imagine trying to sell a bike that doesn't clearly belong to you! When people can legally own and transfer goods, markets can form.


• They create incentives: When you own something, you have an incentive to take care of it, improve it, and use it in a way that creates value. Why? Because you get to keep the income and benefits! This encourages resources to be used efficiently.


• They allow resources to move to their highest-valued uses: Because people can trade their private property, resources can be bought by those who value them the most (measured by their willingness to pay). Example: If Person A is willing to pay $5 million for an apartment and Person B is only willing to pay $4 million, the market, through the price mechanism, allows the apartment to be sold to Person A, who values it more. This is an efficient allocation of resources.

Common Mistake Alert!

Don't think "property" just means land or a flat! Private property rights apply to almost everything:
- Your money in the bank.
- The shares you own in a company.
- Your clothes, books, and phone.
- Even your own ideas (which are protected by patents and copyrights, a form of property rights).

Final Key Takeaway

The three basic economic problems—What, How, and For Whom to produce—arise from scarcity. Societies can answer them through tradition, government command, or the market mechanism. For the market mechanism to function, well-defined private property rights are essential as they create the foundation for trade and provide incentives for efficient resource use.