2018 H2 Economics Paper 2 Essay 3: Suggested Answers

When undertaking large public projects, a government must allocate limited resources to maximise social welfare. A rational decision weighs benefits against costs and considers opportunity cost, distribution, externalities, practical constraints and the quality of information.

Costs and opportunity costs. A government must assess explicit costs such as construction, labour and materials, and implicit costs such as environmental or social disruption. The central concept is opportunity cost, the value of the next best alternative forgone. Since public funds are limited, money spent on one project cannot fund healthcare, education or housing, so the project must yield greater net social benefit than other uses to be allocatively efficient.

Benefits and their distribution. The government weighs the size of the expected benefits and also who receives them. Total benefits exceeding total costs is not enough; broad-based, inclusive benefits that improve access to services, raise employment or reduce regional disparities are more justifiable than benefits captured by a small group, reflecting both efficiency and equity.

Unintended consequences and externalities. Projects create externalities, costs or benefits falling on third parties, such as job creation and improved connectivity, or noise, congestion and environmental damage. A rational approach uses social cost-benefit analysis to compare all private and external costs and benefits, proceeding only where net social benefit is positive.

Constraints and information. The government must respect fiscal capacity, since excessive borrowing risks long-term instability, as well as technical, administrative and time constraints. Decisions also depend on reliable data on demand, costs and benefits, which is often incomplete, so feasibility studies, cost-benefit analysis and sensitivity analysis support an evidence-based rather than intuitive decision.