God created people with free will, and some of these people will freely choose salvation, while some others will freely choose to reject salvation.
God could have chosen to create only the subset of people who will freely choose salvation.
It seems to me that 2 is preferrable to 1, and it is compatible with free will. However, 1 is the world we live in. Why did God choose to create the world with this feature?
Several ways of answering this are possible, some of them less pleasing to the ears, others less pleasing to the mind, and all of them depending on your view of foreknowledge, free-will, and the 'ideal' character of God.
(1) Many 5-point Calvinists are effectively determinists for whom, saved or damned, all people ultimately are caused/led by God in their predestined path. Calvinists judge the situation to be good as long as God is being glorified. If he, by his grace, predestines some sinners to repent and be saved, he is glorified because of the display of grace. And if he, by his justice, condemns to eternal torment those who sin and reject his rule over their lives, he is glorified because of the display of justice. Both situations glorify God, and so he intentionally created a world where people would both be saved and damned. In this way a Calvinist can argue that your "2." is not the ideal world because he only displays his grace and not his justice, meaning he is not maximally glorified. A Calvinist believes God could create your "2." world, but that such a world is not as good as world "1." You may disagree, but Calvinists base the goodness of a world not only on how many are saved (although they think this is good), but on whether God's qualities are revealed and he is most glorified.
(2) Molinism stands somewhere between Calvinism and Classical Arminianism, and essentially says that, after consider all possible worlds (via his omniscience) he created a world where anyone capable of being saved by their free-choice is able to, and ultimately chooses to, be saved. This world sounds almost like your "2." but includes externalities. This world also includes people who freely choose to reject God and are consequently unable to enter God's presence in heaven by their own choice. In this world, God's judgement on them glorifies himself in its justice, but it also honors the reality of their free will. A Molinist might say that the only world where genuine free-will is possible includes some people who consciously reject God. This is only a claim, but one can imagine a straightforward explanation: If I had 10 rats and let them choose cheese or apples, but I shot all the rats who moved towards the apples I can report my findings that 100% of rats prefer cheese over apples. This seems to be misrepresentative of the data however, meaning I haven't really given the rats a real choice. Obviously not-creating someone is different than shooting a rat that is currently alive, but the effect is the same - to do so invalidate free-will as free-will.
(3) A classical Arminian can effectively say something similar to the Molinist but instead of speaking of possible worlds, they would talk more about knowledge of the future. This view is also called, "simple foreknowledge". God knows who, in this world, will choose faith in him and be saved (as opposed to determining them to have faith in him as in Calvinism, or choosing from several possible worlds so as to determine who will choose to put their faith in him) and so to these persons he extends the grace necessary for them to overcome the effects of sin and death and to choose to follow him. The response to your "2." would be the same as a Molinist, "If God creates a world where humans have genuine free will, some people will choose to reject him." You can start to see how Molinism and Arminianism move away from the determinism of Calvinism and so would answer you question by saying God cannot create world "2." God is still all-powerful, but they understand all-powerful to mean, able to do anything that is (logically) possible. A square-circle is illogical, as is a world with free will where no one chooses to reject God. Some Calvinists on the other hand think that God's omnipotence is absolute, extending even beyond logic.
(4) Finally, open theism moves a step back even from Arminianism to say that God does not omniscient. God is extremely intelligent, he knows everything that has happened (past), and is happening (present), but he does not know, with certainty, what will happen (future). They would argue that even Classical Arminianism takes away real free-will by God knowing the future before it happens. Go back to our rats. Imagine I know which rats will choose cheese and which will choose apples even before they do so. But if I know this for certain, it is not possible for rats that I know will choose cheese to choose apples, and it is not possible for rats I know will choose apples to choose cheese. In this way, even if I don't cause them to choose what they do, my knowing what they will do for certain, still takes away the reality of the choice, robbing them of free will. Therefore, although could know the future, he willingly limits his knowledge of the future to good guesses so that he can create a world with real free will. Therefore, they can reply to your question by saying that in world "2." God does not know who will/would reject him, so he can't actually 'not-create' them.
In my perspective, Calvinism has a world where God sounds a bit evil and free-will is definitely not free-will. Molinism kind of does the same thing but in a weird sort of way, it essentially robs possible people of existence to avoid them making certain kinds of choices. Meanwhile Classical Arminianism seems to honor the reality of free-will, as well as a classic understanding of God's attributes, since Open Theism rejects the classical view of omniscience.
Let’s begin with some definitions before we address the issue...
Foreknowledge: God is the Creator of all that comes into being. As such He knows what He created and what He would create later. God’s knowledge is not learnt or the result of external inputs, but internally produced. He knows all that He created, but He doesn’t know what He did not create or planned to create later.
Sovereignty: God is sovereign and free! Creation is the result of God’s free action. He can choose to create or not to create anything, anybody. But, of course, God cannot create anything that is illogical or nonsensical e.g. Another true God, triangular circles, a stone he cannot lift etc. They are intrinsically impossible to know or create. In His freedom God can leave out ‘gaps’ in His creation, which have nothing preordained, therefore there is nothing to know about them. He can choose to create beings without free will [inanimate things and lower life forms] and beings with free will [angels and humans].
Free beings: God in His sovereignty can create free beings that can exercise their freedom within God given limits. Free beings will be given true ‘freedom’ or ‘free will’ from God’s preordination/predetermination. This is possible only because God can withhold His sovereignty, which is part of God’s sovereignty. Therefore, God doesn’t predetermine what the free beings should/would do. God leaves them in the ‘gaps’ He created where He provides multiple possibilities, which God knows only as possibilities, among which the free beings can choose from by exercising their freedom. Only when the free beings choose from the possibilities at that very instant God knows that as actuality. Prior to that time those decisions neither existed in free beings nor in God’s plan. Which is why, until that time they are intrinsically impossible to know about.
By limiting His freedom God made freedom possible for free beings He creates. In other words, where freedom for the free beings begins, there the freedom for God stops. ‘Limiting own freedom’ is part of God’s freedom.
For many the option 2 seems to be preferable, but it is not compatible with true free will. God doesn’t create anyone designating to hell. If He does, only then He can truly know that person is going to hell. But that would render God unjust and evil. Apart from examining ones life in the midst of current possibilities and predicting safely, God doesn’t know ones destiny as an actuality in the end.
I recommend you watch:
https://www.youtube.com/watch?v=YF06B_uiQio
https://www.youtube.com/watch?v=v1Yhab36Y0I
