AQA Specification focus:
‘The central purpose of economic activity is the production of goods and services to satisfy needs and wants; the key economic decisions are: what to produce, how to produce and who is to benefit from the goods and services produced.’
Economic activity exists to meet society’s needs and wants through the production of goods and services. All economies face fundamental questions about resource allocation.
The Purpose of Economic Activity
The primary goal of economic activity is to produce goods and services that satisfy human needs (essential requirements such as food and shelter) and wants (non-essential desires such as luxury items). Because resources are scarce, societies must make decisions about their allocation. This process underpins how an economy functions and directly relates to the three fundamental economic questions.
Needs and Wants
Needs: Goods or services necessary for survival, such as food, water, and shelter.
Wants: Goods or services that improve quality of life but are not essential for survival.
Economic activity aims to provide a mix of goods and services that addresses both categories, though the exact balance depends on societal priorities.
The Three Economic Questions
Every economic system—whether a market economy, command economy, or mixed economy—must address the same three central questions due to the problem of scarcity.
1. What to Produce?
This decision determines the allocation of resources between different goods and services. Economies must choose:
Which goods to produce in greater quantities (e.g., healthcare vs. consumer electronics)
Which services to prioritise (e.g., education vs. defence)
How to respond to changes in consumer preferences and resource availability
The answer is influenced by:
Consumer demand in market systems
Government planning in command systems
Combination of both in mixed economies
2. How to Produce?
This involves deciding the methods of production and the resources to be used. The choice considers:
Technology available and its efficiency
Cost of factors of production (land, labour, capital, enterprise)
Environmental impact and sustainability
Labour-intensive vs. capital-intensive methods
Factors of Production: The inputs used to produce goods and services, classified as land, labour, capital, and enterprise.
In a market economy, firms seek to minimise costs while maximising output quality. In a command economy, central planners may prioritise employment or environmental goals.
3. Who is to Benefit?
Also known as the question of distribution, this asks how the output is shared among members of society. It considers:
Income distribution (equal vs. unequal)
Access to goods and services
The role of market forces vs. government intervention
Possible distribution methods include:
Allocation via price mechanism (those who can pay receive goods)
Government provision (e.g., free healthcare and education)
Subsidies to make essentials affordable
The Link Between Scarcity and the Three Questions
Scarcity forces societies to confront trade-offs:
The Production Possibility Frontier (PPF) illustrates the maximum possible output combinations of two goods given limited resources. Points on the curve represent efficient production levels, while points inside indicate inefficiency, and points outside are unattainable with current resources. Source
Producing more of one good means producing less of another (opportunity cost).
Choices about production methods may prioritise cost efficiency over environmental sustainability.
Distribution methods may reflect value judgements about fairness and efficiency.
Opportunity Cost: The next best alternative forgone when a choice is made.
Economic Systems and How They Answer the Questions
Different economic systems answer these questions in different ways:
Market Economy
What to produce: Determined by consumer demand and profitability
How to produce: Firms choose cost-effective methods
Who benefits: Those with the ability to pay
Command Economy
What to produce: Decided by government planning
How to produce: Set by central planners, often with social or political goals
Who benefits: Distribution according to government allocation policies
Mixed Economy
Combines elements of market and command systems to balance efficiency with equity.
The Role of Value Judgements
While positive economics focuses on objective analysis, these three questions often require normative judgements—opinions about what ought to happen. For example:
Should healthcare be free for all?
Should environmental concerns override short-term economic growth?
Should income equality be prioritised over incentives for innovation?
These judgements vary across cultures, political systems, and time periods.
Interdependence of the Three Questions
The answers to the three questions are interlinked:
A decision about what to produce influences how to produce (e.g., high-tech goods require capital-intensive methods).
Distribution choices affect demand, which feeds back into production decisions.
Changing technology may alter both production methods and the distribution of benefits.
Summary Points for Study
Economic activity aims to satisfy needs and wants through production.
All economies must answer what to produce, how to produce, and who benefits.
Scarcity makes these choices necessary, leading to trade-offs and opportunity costs.
Different economic systems prioritise these answers differently.
Normative value judgements shape policy decisions in answering the three questions.
FAQ
Societal priorities are shaped by cultural values, political systems, and economic conditions.
For example, a country facing food shortages will allocate more resources to agriculture, while a highly developed nation may focus on technology and services.
External influences such as global trade agreements, climate change, and international crises can also shift production priorities rapidly.
Technological advancements can make production more efficient, altering the balance between labour and capital use.
New machinery may replace labour in some industries.
Automation can reduce costs and increase output.
Environmental technologies may encourage more sustainable production methods.
These changes can also affect skill requirements, leading to shifts in employment patterns.
Distribution decisions involve value judgements about fairness, equality, and incentive structures.
Some argue for market-driven allocation to reward productivity, while others prioritise redistributing resources to reduce inequality.
Government policies on taxation, welfare, and subsidies often reflect these competing viewpoints, creating political debate.
A natural disaster can drastically alter priorities:
What to produce: Shift to essential goods and rebuilding materials.
How to produce: May require temporary, less efficient methods if infrastructure is damaged.
Who benefits: Aid distribution often prioritises the most affected populations.
Such events can also reshape long-term economic strategies and resource allocation.
Yes, changes in population, technology, political leadership, and global economic conditions can all alter a country’s approach.
For example, a nation may initially prioritise industrial growth but later shift towards sustainability and renewable energy.
Policy reforms, social movements, and economic crises often drive these changes, leading to a re-evaluation of what to produce, how to produce, and who should benefit.
Practice Questions
Define the term "opportunity cost" and explain why it is relevant to the three economic questions. (2 marks)
1 mark for a correct definition: Opportunity cost is the next best alternative forgone when a choice is made.
1 mark for explaining its relevance: It is relevant because when deciding what to produce, how to produce, and who benefits, there is always a trade-off between alternative uses of resources.
Explain how different economic systems (market economy, command economy, and mixed economy) answer the three economic questions: what to produce, how to produce, and who is to benefit. (6 marks)
Up to 2 marks for describing how a market economy answers each question:
What to produce: based on consumer demand and profitability (1 mark)
How to produce: firms choose most cost-effective methods (1 mark)
Up to 2 marks for describing how a command economy answers each question:
What to produce: government planning decides output (1 mark)
How to produce: central planners allocate resources (1 mark)
Up to 2 marks for describing how a mixed economy answers each question:
Combination of market forces and government intervention in determining output and methods (1 mark)
Government ensures basic needs are met, market allocates other goods (1 mark)
