The basic economic problem

The basic economic problem is there are scarce resources to produce wants and needs of the people. So firms confront the three basic economic questions of what to produce, how to produce and for whom to produce. As we cannot produce everything, we need to decide what to produce and in what quantities. It determines the allocation of scarce resources amongst alternative uses. So we have to choose for example, whether to produce lots of goods and services, such as food, clothing and vehicles to improve our standard of living or whether we to produce lots of military hardware to improve our defenses.

Since resources are scarce to produce unlimited wants we need to consider how resources can be used to produce best outcome. We need to consider how we can get the maximum use out of the resources available to us. But other issues beside purely economic concerns should be considered when deciding how to produce. For example, through slavery or forced labor we could produce more goods and services in an economy but there is a moral objection to such arrangement crop yielding could be increased through genetically modified plants but this may lead to damage to the ecosystem.

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Economist uses the term labor intensive and capital intensive to describe the alternative methods. We cannot satisfied all the wants of all the population, decisions have to be taken concerning how many of each person’s wants are to be satisfied which leads to income distribution. We need to decide whether everyone is going to have a more or less equal share of what others. Statistics reveal great disparity since 15% of the population of rich countries for example, USA, Western Europe, Canada and Japan receives approximately 80% of world income while 57% of the world’s population in poor countries for example; India, China, Indonesia, etc. eceives only 5%. Hence the world economy is essentially producing for consumption by rich nations only.

The basic economic questions are inextricably linked to the working of the price system. When the price of good increases, consumers will want less but producer will want to sell more. These responses in turn determine what, how and for whom to produce. For example, during the OPEC oil crises of the 70s (price of oil increased from $12 per barrel to $30 per barrel between 1978-80. Higher price of oil meant that there was an increase in demand for substitutes for example; gas-fired central heating whose production increased.

It also meant that firms looked for cheaper methods to produce goods ( for example; airlines looked for some more fuel efficient air craft). In terms of income distribution benefits went to the OPEC countries whose sales revenues increased whereas oil-importing countries such as Germany and japan lost out. Lastly the three economic questions due to basic economic problem can be determined by which type of economic system exists. Under market economies the price system is predominant whereas in command economies are primarily based on government intervention.