What is an economy? What are three basic economic questions?
What is an economy?
A system involved in the production, distribution and consumption of resources. Its goal is to handle the economic problem. It does this by making the best choice when using limited resources to satisfy unlimited human wants.
To solve this problem, the three basic economic questions must be asked:
- What is to be produced?
- How is production to be organized?
- For whom is production to take place?
The basic economic questions
Let’s apply the three basic questions to solve the economic problem.
Question 1: What is to be produced?
An economy needs to decide what to produce using the scarce resources it possesses. Decisions need to be made so an economy can provide the needs and wants of individuals. Needs are very important and wants are problematic because you cannot provide for all. In a command economy what is to be produced is decided by the government. In a free market economy different economic agents own and control resources. Therefore they will decide what to do with them based on what they perceive to have the greatest benefit.
- Government – Provide education, defense or UFO research.
- Business – Supply what goods or services, expand into new country or new product type?
- Personal – Buy new windows or go on holiday.
Of course an economy can divide its resources to produce several different goods at the same time.
Question 2: How is production to be organized?
How to organize production is concerned with the most efficient way to use resources. Decisions must be made about where, how and what inputs will be used in production. A company can choose to be labor-intensive or capital-intensive to manufacture its goods. For example, a manufacturer would find labor costs very cheap if its factories were in Asia, but maybe find better technology skilled workers in Europe. Other concerns could be what materials should be used?
For example, should wood or plastic be used to produce a firm’s furniture goods? Governments decide how production is organized by deciding how to organize the economy, i.e. command economy or free market economy.
Question 3: For whom is production to take place?
Production should produce benefits. The producer needs to decide how these benefits should be allocated. Another way of saying this is, once something has been produced – how should it be distributed?
For example, governments provide public services. Should they be free, provided at cost or priced according to market forces? For example, a business will provide the outputs of production to those who are willing and able to pay the market price.
