5 MOL! – Fundamental Questions of Economics3 min read

Now let’s back up a little and consider the problem of scarcity in greater detail.

Unlimited wants don’t go well with limited resources. We can’t have everything that we want. Society has to make choices, and sometimes, really tough ones.

Imagine if you had the power to control the entire economy for a day. Do you think you could do it? Maybe. Just produce the same as yesterday. But what about a week? Or a month? Or a year? Would it make sense for us to produce and consume the exact same goods and services year after year? What if preferences change? How would you know?

Tough questions I know. Well here’s the big idea: the problem of scarcity motivates the three fundamental questions in economics.

1. What and How Much to Produce?

Do we want more iPhones or more Samsung Galaxys? Chicken or fish? More schools or more hospitals? How much of each to produce?

These are problems of choice. Yesterday I wrote about having a ranked ordering of choices and now what we need is to find a way as a society to rank all our options and then pick the best ones. Sounds impossible?

Because it is impossible. Countless governments have tried (i.e. communist states) and failed. You just can’t get enough information to make all the decisions centrally.

But it turns out that there is a trick. The economy does this automatically, like magic. The magician is the price mechanism. –cliffhanger

2. How to Produce?

Remember the shovel and excavator example? The reality is that the excavator is not always better. First, it’s going to be a lot more expensive than the shovel. Second, you should probably pick the right tool for the job — if you are going to make a sandcastle, or dig a hole in your playground, then using an excavator is clearly an overkill.

overkill

In general, we want to pick the production method and factors of production that are the cheapest. To state this more precisely: society wants to minimise cost for any specified quantity of output.

3. For Whom to Produce?

The final question is about distribution. This is more complicated because it involves thinking about ethics. (wow!) In a nutshell, it involves thinking about whose wants we should satisfy. If you are really interested, Google these two things: utilitarian and egalitarian.

In summary, scarcity creates the need for tough choices and motivates the three fundamental questions of economics — what and how much to produce, how to produce, and for whom to produce.

Question of the Day

Answers will be given tomorrow.

Which of the following is one of the three fundamental economic questions?

a. What will the inflation rate be next year
b. What will the price of Google stocks be tomorrow
c. How to minimise the cost of production
d. How to make people work harder at their jobs

The answer to yesterday’s question is B — $10.

Further Questions

  1. Do you think the government should decide what gets produced?  Why might it be a good idea? What are some problems with that?

  2. Find out how the price mechanism works.

  3. If there were no laws and no government, would people still want to produce things? Why or why not?

We look forward to seeing your responses in the comments section below!

And if you have yet to subscribe to the daily 5 Minutes Only Lah!, you can read more about it here or simply subscribe below.

Till next time, dream economics.

He who has a why to live for can bear almost any how.

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3 Comments

  1. […] resources in the most efficient manner. This is a key concept and it’s closely related to one of the fundamental questions of economics — How to Produce. It’s so important that there is a special name for it — productive […]

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  2. […] the diagram, points B and C are productive efficient as all the resources are fully utilised. This doesn’t help answer the economic problem of what and how much to produce. Should the economy produce at point B, C or on some other point? Hence, another yardstick is […]

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