All economies regard scarcity as the most important economic problem. As such, there are not enough resources to cater for all the unlimited wants of people. Because of this scarcity, economists and governments try to answer three basic economic questions:
1. What to produce?
This decision is often a matter for the business sector. Businesses have to decide what goods and services to produce and how much of each good or service to produce. As we have seen, more of one thing generally means less of another (opportunity cost), so some difficult decisions arise here in the allocation of resources.
In a market capitalist economy, what to produce tends to be decided by the market. Businesses will look at demand and try to produce goods and service where there is the greatest level of demand. This question is then answered by the market forces of demand and supply.
2. How to produce?
Businesses will decide this on the basis of cost. Their aim is to make a profit – in fact the maximum profit possible. To help them do this, they need to produce as efficiently as possible. The more efficiently they produce, the lower the cost of production. So how much they use of each factor of production will depend on how much that factor costs and how productive it is. If labour is cheap, but nevertheless nearly as productive as more expensive machinery, then the business may choose labour intensive production. If, however, machines are more productive per dollar spent, then they may choose capital intensive production.
3. For whom to produce?
This question is to do with distribution of goods and services. Capital will shift to the areas where demand is highest. However, some consumers can not afford to pay the full market price for goods and services. So that some people do not miss out on basic goods and services, the government may subsidise the price of some things, for example education and health services.