The Three Basic Economic Questions
Every society is confronted with the problem of scarce resources, which
requires it to make choices as to how to use its resources.
There are three fundamental economic questions that all societies must
answer in some way. These
questions are unavoidable in that they MUST be answered.
The first question is What to
produce? Since resources are scarce, a society must determine
which goods it will produce and in what quantities.
The production possibilities curve best illustrates this question.
The curve shows all of the possible production combinations in a
society. It must decide which of
those combinations is the right one for it.
The second question is How to
produce? This concerns
the methods of production that are used to produce goods and services.
Since resources are scare, efficient methods of production must be
employed. What exactly does
efficient mean in this context?
In a pure technical sense, efficiency means to produce some level of
output using the fewest resources possible.
Consider Table 1.2 which gives the amounts of capital and labor needed
to produce one personal computer. Technical
efficiency would require that Method III not be used to produce the
personal computer. (Why not?)
That would leave Methods I and II as candidates.
Notice that we cannot choose between on grounds of pure technical
efficiency. But suppose we know
that a unit of labor costs $50 while a unit of capital costs $100.
Which method of production would be used?
If you said Method II, then you are starting to think like an
economist. Method I would cost
$800 ( 4 times $100 plus 8 times $50) while Method II only costs $750 (3 times
$100 plus 9 times $50). Using the
concept of economic efficiency,
we know that Method II is best in this case.
Economic efficiency goes beyond technical efficiency by also
considering the value of the resources that are needed to produce some output
level. Therefore, economic
efficiency maximizes the value of the output (or the amount of consumer
satisfaction) given the value of the inputs or
minimizing the value of the inputs to produce some value of output.
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The third economic question is For
whom to produce? Once society
has chosen a point on the production possibilities curve, it will have some
combination of goods and services that is available.
It must also decide how to distribute those goods and services among
the population. This is a complex
question and the answer is not an easy one.
We will address it in Chapter 9.