Gillespie: Business Economics 2e

Chapter 03

1. Discuss the importance of opportunity cost in economics.

Answers may include:

Opportunity cost measures the benefit foregone in the next best alternative. When making
any decision it is important to consider not only the immediate costs involved in it but also
what would be sacrificed to pursue this course of action. In international trade, for
example, a country is competitive in the production of any given product if it has a lower
opportunity cost than others (see chapter 16) because it sacrifices less. A return of 5%
may look attractive in itself but if the alternative could earn 7% then it is not so attractive.
Opportunity cost is therefore a key concept in decision making.

2. Is the free market the best solution to the fundamental economic questions?

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The fundamental economic problems are: what to produce, how to produce, and who to
produce it for. These problems arise because of scarcity and choice. There are limited
resources and unlimited wants therefore decisions have to be made about how best to
allocate resources.

The different ways in which resources may be allocated are: the free market, the planned
economy, and the mixed economy. The mixed economy is inevitable because there are
always going to be elements of private and public sector but there are considerable
differences in the degree of intervention.

The free market has the advantage of having decisions made by individuals pursuing their
own objectives and not requiring central coordination and administration. The danger of
this is that some products may be produced that society as a whole finds undesirable.
Another problem is that as businesses pursue profit some individuals or organisations
may be exploited. Also the people who get the products are the ones with money: without
money you will not have healthcare or education, for example. The command economy
can control what is ‘best’ for society and therefore prevent the production of some
products and encourage the production of others. However, managing the whole economy
is difficult administratively and what the government wants may not match what their
citizens want.

Overall, there are advantages and disadvantages of each system. To decide which is best
is a political one made by voters or the party in power. These views can change over time
as political views change; for example, China has allowed more free enterprise in recent
years.

© Oxford University Press, 2013. All rights reserved.

 Gillespie: Business Economics 2e
Chapter 03

3. Does the government need to regulate business behaviour more?

Answers may include:

The free market has many potential failures and imperfections such as monopoly,
externalities and asymmetric information. This may require government intervention to
remedy the failures. The government may tax, subsidise, provide directly or legislate.
Whether more intervention is needed depends on the views of the voters and MPs,
whether forms behaviour gets worse and whether existing approaches have been relaxed.
In recent years there have been many instances of undesirable behaviour such as
criticisms of the rewards to bankers even after the financial crisis, the phone hacking
scandal by News International and the misrepresentation of the LIBOR interest rate by
banks. This has led to greater pressure to control some sectors of the economy in the
UK.

© Oxford University Press, 2013. All rights reserved.