Bruce Domazlicky  

III. 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.  

Table 1.2

                                    Method           Capital            Labor

                                        I                        4                     8

                                        II                       3                     9

                                        III                      3                   11  


            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. 

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