Central Problems of an Economy

Because every economy faces scarcity — limited resources set against unlimited wants — every economy, whatever its size or level of development, must answer three central questions about how to use its scarce resources. These are often called the central problems of an economy, and they arise directly out of the scarcity-and-choice framework introduced earlier in this chapter.

1. What to produce, and in what quantities? Since resources are limited, an economy cannot produce everything its people might want in unlimited amounts. It must decide which goods and services to produce — consumer goods or capital goods, agricultural goods or industrial goods — and how much of each, given that producing more of one good means the resources are no longer available to produce something else (the very idea of opportunity cost from Section 2).

2. How to produce? Having decided WHAT to produce, an economy must also decide the technique of production — for instance, whether to use a labour-intensive technique (more workers, less machinery) or a capital-intensive technique (more machinery, fewer workers) to produce a given good. The choice of technique affects how efficiently the economy's scarce resources are used, and how much output results from a given quantity of resources.

3. For whom to produce? Once goods are produced, they must be distributed among the members of society. This is fundamentally a question about the distribution of national income and wealth — should output go mainly to those who own the most productive resources, or should it be shared more evenly, and by what mechanism (market prices, government redistribution, or some combination) should this distribution be decided? …