Three Basic Economic Questions and Resource Allocation

The three basic economic questions are what to produce, how to produce it, and for whom to produce it. All three are to answer how we allocate resources to meet our needs and wants. But, then, the way we answer them also depends on the economic system we adopt.

The basic problem in economics is scarcity. We face limited resources to satisfy our needs and wants, which are unlimited. This situation gives rise to scarcity, which in turn forces us to make choices and raises the three questions above. Long story short, we have to make choices to allocate resources because we face scarcity. We must use resources at their highest use to satisfy what we need and want most.

To answer the three questions above, we need an economic system. It is the way in which we organize, process, and distribute available resources to the population.

The economic system determines how we answer all three questions. For example, under a free market economy, market mechanisms – demand and supply – decide what we produce, how to produce, and how to distribute it.

In contrast, the government is ultimately in charge under a command economy. The government regulates, starting from determining what is produced and how to produce and distribute it.

Why does scarcity force us to make choices?

Resources are limited. Meanwhile, we must satisfy our unlimited needs and wants. The situation gives rise to scarcity because limited resources are not enough to satisfy unlimited ones. Therefore, we cannot have everything we want. We must choose what we want most and how to use resources efficiently to fulfill what we want most.

For example, we have land for growing wheat and corn, the two products we most desire. Unfortunately, our land area is limited. Therefore, we must choose whether to use the land to plant more wheat or corn. The more grain we produce, the less corn we get. Conversely, the more corn we want, the less wheat we get.

Like land, labor is also limited. If we deploy farm laborers to grow corn, less is available to grow wheat. The opposite holds true if we raise more wheat.

The situation is the same when we are faced with agricultural machinery. It is limited, forcing us to choose whether to use it to grow wheat or corn.

Since scarce resources force us to make choices, we must be careful in making them. Two things we need to consider. First, the goods and services we produce are what we most desire. Second, we use resources most efficiently. Thus, our choices – ideally – should be to maximize resources in the best way possible to produce the goods and services we most desire. That way, we can avoid wasting resources while satisfying our needs and wants.

What are the three basic economic questions?

Scarcity forces the world’s economies to answer the following three questions, regardless of the economic system they adopt. These three are:

What to produce
How to produce
For whom to produce

These three basic economic questions will be answered through the adopted economic system.

What to produce

This question concerns what goods and services we should produce. We cannot produce all goods and services. Again, our resources are not enough to produce them all.

Answering this question requires us to answer what we need and want most. Of course, we may have different needs and wants. However, because we cannot fulfill all of these needs and wants using the available resources, we must choose which needs and wants are the most vital and must be fulfilled.

After mapping out our needs and wants, we sort them out and determine which goods and services we need to produce to satisfy them. This includes answering how much we need and what we should produce.

How to produce

How to produce is related to how we process resources to make goods and services. Answering this question requires us to think about and choose a method, technique, or technology in production. For example, we adopt labor-intensive techniques with more reliance on labor than capital. We use labor – workers’ skills and knowledge – to produce goods and services.

In other cases, we might use capital-intensive techniques. We depend more on capital, such as machinery and equipment, than labor.

Which technique we adopt depends on our needs. For example, we assume capital-intensive production to produce goods on a mass scale. By relying on machines, we can produce standardized output in significant quantities. Instead, we use labor-intensive production to make unique products, capitalizing on uniqueness in human skills and knowledge.

For whom to produce

This question requires us to make choices about how we distribute goods and services among populations. Several options appear, including:

Should all goods and services be distributed to everyone?
Are goods distributed in the same amount to each individual?
Are some people able to earn more than others?
Are certain goods and services only available to some people?

Under a command economy, the government responds to these choices. For example, the government determines how much each individual receives. Whether the government will distribute it to everyone and whether everyone gets an equal share depends on the government’s decision.

In contrast, under a free market economy, market mechanisms determine distribution. The market mechanism works through market supply and demand. On the demand side, for example, distribution is based on people’s ability to pay. Those with higher abilities have the opportunity to get more items. Conversely, a lower ability to pay makes us earn less. Long story short, how much stuff we can get depends on how much we can buy, which in turn depends on our income.

Three Basic Economic Questions and Resource Allocation

Why does scarcity force us to make choices?