What? How? For whom?
We have already identified the fundamental economic problem as scarcity. There are not enough resources to cater for all the unlimited wants of people. Because of this scarcity, economists and governments try to answer three fundamental questions:
- WHAT TO PRODUCE?
- FOR WHOM TO PRODUCE?
- HOW TO PRODUCE?
What to produce?
This decision is a matter for both government and the private sector. The government has to decide what goods and services to provide and how much of each to provide. As we have seen, more of one thing generally means less of another (opportunity cost), so some difficult decisions arise here.
The private sector also has to decide what to produce, but this will tend to be decided by the market. Firms will examine demand and try to produce goods where there is the greatest level of demand. This question is then answered by the market forces of demand and supply.
For whom to produce?
This question is looking at the distribution of the goods and services we produce. Factors of production earn incomes. These incomes can be used to purchase goods and services. So the higher the level of income, the more goods and services can be demanded. In the market sector of the economy, this question is therefore decided by relative rewards to factors of production. Different criteria will be applied in the case of government provided services such as free state education.
How to produce?
Firms will decide this on the basis of cost. Their aim, as we have seen, is to make a profit - in fact the maximum profit possible. To help them do this, they need to produce as efficiently as possible. The more efficiently they produce, the lower the cost of production. So how much they use of each factor of production will depend on how much that factor costs and how productive it is. If labour is cheap, but nevertheless nearly as productive as more expensive machinery, then the firm may choose labour intensive production. If, however, machines are more productive per dollar spent, then they may choose capital intensive production.
Economies approach these questions in different ways. Some may choose to have a large government sector (perhaps even total state control) whereas other may choose to leave things almost totally to the private sector and markets. This means that economists consider three different types of economy: mixed economies, free market economies and centrally planned economies.
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