1.4 BASIC ECONOMIC QUESTIONS AND ECONOMIC SYSTEMS

The problem of resource scarcity forces the society to make choices. There are three basic questions to be answered in the process of making choices. These basic questions are shown in Figure 1.9.

Figure 1.9: Basic questions in economy

1.4.1 Basic Economic Questions

1. What Should be Produced? Society needs to determine the types of goods and services to be produced using limited resources to maximise their satisfaction. The selected combination must be in PPC as it is the efficient production combination.
   
   When the type of output required has been identified, society has to determine the production amount for every output chosen. The indifference curve of society indicates the relative importance for every product in  society’s point of view. If society chooses to produce more consumer goods, then consumer goods for current use will give more satisfaction compared to capital goods that can increase production in the future.
2. How Should it be Produced? After deciding on the type and quantity of output to be produced, comes the question of how it should be produced. Here arises the need for a mechanism that can transfer resources from a low-demand industry to a higher demand industry. In a free-market economy, this task is carried out by the market mechanism.
   
   Resources are distributed through the process of demand and supply. In this process, resources will shift into the industry that offers the highest pay. Meanwhile firms in the industry have to utilise resources efficiently to avoid wastage.
3. For Whom Should it be Produced? Once produced, goods and services have to be distributed. Consumer goods will be disseminated to consumers while capital goods to firms. A mechanism should be available for this purpose. In the free-market economy, this task is carried out by the price mechanism. All consumers and producers who can afford to buy the economic product at the stated market price will be able to obtain what they require.

1.4.2 Economic Systems

We have stated before that society needs to answer three basic economic questions of what should be produced, how andfor whom it should be produced. These questions are answered based on the economic system chosen by the particular society. Here we will look at the four basic economic systems. Even though most societies may not be clearly included into any of the systems, we can categorise them depending on the main characteristics that they possess. Figure 1.10 shows society’s choice of four economic systems.

Figure 1.10: Society’s choice of economic systems

1. Traditional System This is the oldest and most influential system. The world’s early civilisations are mostly characterised by this system. In today’s modern economic system, it is almost unnoticed that the three basic economic questions are resolved based on the traditional system.
   
   In the state of Kedah for example, why is it that paddy planting activity remains the main source of income for most of the local people whereas other sectors have developed rapidly? Why is it that there are still many people replanting rubber trees even when they know that the price of rubber is unstable most of the time? These situations are connected to tradition. Possibly, many paddy and rubber planters prolong their activities due to tradition, not the market needs.
   
   It is the same with usage, why do many of us consume rice at least once daily even though other food sources may provide us the same or even better nutrients? Thus, without realising, the traditional system still plays an important role in resolving society’s economic questions.
2. Free Market or Price System The free market system or price system is a system where decisions are made based on market needs. Matters such as labour, land, goods and services, including time, have its own value or market price. It is also through the market that decision to the three basic problems of economy is made: what, how and for whom. Even though there is no organisation or central coordinator making these decisions, this system does not create chaos but becomes organised instead.
   Society uses price as an indication to producers on what should be produced. Price competition ensures production to answer the question of “how?” by using an efficient production method to face competition. The question of “to whom” also can be resolved by price because those with money and willingness to spend are the ones who will acquire what they want.
   Most economic research that you will encounter from this point on, such as the producer and consumer theory, is the study of the price system. However, in most macroeconomics studies, governmental roles have been included due to its importance in the real situation.
   The main characteristics of a free market system are:
   1. Private ownership;
   2. Self-interests;
   3. Without government intervention; and
   4. Price system.
   The advantage of free-market system is in terms of resource allocation. Free-market gives rise to efficiency of resource allocation because resources will be distributed to the sector that gives the highest evaluation towards resource.
   
   However, the downside of this causes an unequal distribution of wealth, since those who are unable to compete will be left behind. This system also hardly promotes the production of public goods because public goods do not maximise personal profit.
3. Centrally-planned System In the centrally-planned economic system, the answers to the three basic economic questions are done by the central planning coordinator. All economic and social activities of the people are controlled and regulated by that particular body.
   
   The main characteristics of this system are:
   1. Property Ownership by the Government All economic resources such as land, natural resources and public facilities like transportation, industrial communication and bank system are owned by the government.
   2. Centrally-planned Economy
      All economic plans are determined by the government to ensure mutual well-being. Planning will determine what will be produced by the economy, how production will be carried out and ensure equality of distribution.
   3. Limited Freedom
      Producers do not have the freedom in choosing goods and services to be produced because the use of resources controlled by the government has been determined. However, consumers are free to choose products and services that have been produced.
4. Mixed Economy System A mixed economy system is commonly practiced by most countries today. However, the level of mixture varies depending on the level of government intervention in the economic system. Even though the United States of America is considered as a free-market country or capitalism, its government also has its own roles due to the existence of tax and social welfare systems.
   
   For example, the terrorist attack on 11 September 2001 gave rise to a lot of government intervention and this proved that in reality, they do not practice true capitalism.
   
   The purpose of government intervention in the economic system is to patch up weaknesses of the free-market system. The government applies directive power and rules such as collecting tax and providing subsidies. The same applies with the production of public goods that are less appealing to private bodies such as electricity supply, water supply and transportation. Besides that, the government also plays a role in stabilisation and economic growth.