Three Basic Economic Questions

In our earlier section where we discussed scope of economics, we had talked about three basic economic questions remember?

  1. What to produce?
  2. How to produce?
  3. Whom to produce for?

Economic theory is concerned with how society answers the basic economic questions of what goods and services should be produced, and in what amounts, how these goods and services should be produced (i.e., the choice of the appropriate production technology), and for whom these goods and services should be produced.

Let us now look at these three questions in details

What to Produce?

In today’s economy what goods are produced is decided by the consumer rather than the producer himself. Look at any profitable firms; they would be only producing goods and services that are demanded by the consumers.

Those firms which produce only commodities will lose out their relevance sooner for instance typewriters, audio cassettes, etc…

Consumers express their preferences through their purchases of goods and services in the market. The authority of consumers to determine what goods and services are produced is often referred to as consumer sovereignty.

Consumer sovereignty is the authority of consumers to determine what goods and services are produced through their purchases in the market.

How to Produce?

This refers to the technology used to produce a particular good, this is normally determined by the firm’s management. It refers to the input used in production, production process, organization of those factors of production and the proportion in which these inputs are combined to produce goods and services that are most in demand by the consumer.

The main aim of any organization is profit maximization, this aim leads to deciding what factors of production will be used. In competitive markets, firms that do not combine productive inputs in the most efficient (least costly) manner possible will quickly be driven out of business.

Whom to Produce for?

Consumers

These are those people who are willing to shell out money for the goods and services that are produced and are the direct beneficiaries of the production process.

While the what and the how questions lend themselves to objective economic analysis, answers to the for whom question are fraught with numerous philosophical and analytical pitfalls.

Income determines an individual’s ability to pay, and income is derived from the sale of the services of factors of production. When you sell your labor services, you receive payment. The rental price of labor is referred to as a wage or a salary. When you rent the services of capital, you receive payment. Economists refer to the rental price of capital as interest.

In market economies, the returns to the owners of these factors of production are largely determined through the interaction of supply and demand. Thus, an individual’s income is a function of the quality and quantity of the factors of production owned. Questions about the distribution of income are ultimately questions about the distribution of the ownership of factors of production and the supply and demand of those factors.

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