Three Basic/core Economic Problems Facing All Economies

Describe the three basic/core economic problems facing all economies.

Economic problems emerge because our desire for goods and services to consume is greater than our ability to produce those goods and services. As humans, we have unlimited wants and limited resources. This is referred to as scarcity, which exists because there are insufficient resources to produce the goods and services to fully satisfy all wants. Another part of the problem is the fact that resources are not distributed evenly between countries and societies. As a result we are forced to choose among alternative options. For example, you might go into a shop and see two great-looking pairs of jeans but you only have enough money (resources) to buy one of them. Another example is that, a business might have received a major order for its products and wants to increase production but does not have the staff or the equipment and raw materials to meet the order in full.

The above mentioned examples highlight the problem of scarce resources in relation to wants and needs. Because no economy can produce enough goods and services to satisfy all its citizens' wants, choices must be made. The decision to have one thing over another involves a cost. Not a monetary cost, but what is known in economics as an opportunity cost, that is the next best alternative foregone. In other words, the cost of any choice that you make is the value of the best opportunity that you give up in order to make that choice.

In an economy, the supply of goods and services results from the production process where various inputs are brought together and combined to create goods and services. These inputs are classified into the three "factors of production" namely, land, labor and capital.

Land refers not only to land in the conventional sense of tracts of ground, but all other natural resources, that is, gifts of nature, including bodies of water, oil reserves, all the minerals found in the earth and even animals. Labor is the broad category of human effort, both physical and mental effort that goes into production. Capital is the stock of material assets which ranges from plant and machinery, airports and highways to human knowledge and skills that are used to, or facilitates further production of goods and services, complementing labor.

To use these resources, wages are paid to labor, interest to capital, and rent to land. The factors of production are versatile and may be combined in different proportions to produce the same thing. The United States is capital abundant and uses machinery intensively for farming. China is labor abundant and uses people intensively for farming .Since economic resources are scarce, they must be allocated efficiently. In essence economies are therefore faced with three key questions that must be answered, and these three questions are the basic or core economic problems of all economies.

The first question is what goods and services should be produced? This question is very important. Do we produce capital goods or consumer goods? Do we produce goods for home consumption or for trade? All these reflect the question of allocative efficiency . This means producing goods and services in the best relative amounts to maximize the economic wellbeing of the society.

The second question is how should goods and services be produced? This refers to the type of production techniques to be used. Should the economy use a system that is labor intensive, thereby ensuring everyone who wants a job has one, or should we use more efficient methods of production that involve the use of machines, even if this means more pollution and fewer jobs? The fundamental question then is how should goods and services be produced to ensure the efficient use of scarce resources?

The third question is who should get the goods and services that the economy has produced. Should an economy be geared to providing goods and services to every person as equally as possible or should those who work hard get more? How do we distribute our resources? The determination for the distribution of the goods and services will be reflected in what is produced. This raises the common questions of equity and fairness .

To answer these economic questions, different economic systems have developed. These systems revolve around how people in societies allocate the scarce resources to satisfy competing wants and needs. In other words, an economic system is the formal means through which a society seeks to address the three fundamental questions identified earlier. There are three main types of economic systems that can be identified. These are a market economy, a planned economy, and a mixed economy.

The market economy is also known as the free market economy or capitalist economy. The market system relies on the demand for and supply of goods and services to determine what is produced. Whatever people are demanding and willing to pay the highest price for, those are the things which gets produced. There is minimal government intervention to ensure law and order and the capital and land are usually privately owned. The decision about how to produce the goods and services demanded is made by producers who search for the best available technology to produce at the lowest unit cost. This enables them to maximize their profits, as cost will be as low as possible compared to a given revenue resulting from the going market price for the goods. The decision about who to produce for is based purely on the ability to pay rather than need. Incomes will vary under the market system. As capital and land is owned by individuals, incomes will also depend on interest and rents accrued to land owners and capitalists. Since income largely determines one's share of output, what people get out of the economic system is what they put into it. Examples of economies under this system are the US, Great Britain and Japan.

There is also the command or planned economy. In this economy it is the government, a highly centralized decision-making body that has the responsibility to answer the economic questions. It is the government which owns all factors of production and makes all decisions about production and consumption. Practically this involves allocating resources among different industries. Then telling those in charge of companies in those industries exactly what to produce and how much to produce. Finally, specifying to whom the products are to be distributed. In this type of system markets have very little say in how it operates since it is state controlled. There is also no role for household preferences that means, there is no way for consumers to express their concerns or dissatisfaction. Examples of economies under this system are Cuba and North Korea.

In reality most, if not all, countries operate under mixed economic system.