The Basic Economic Problem
Countries have a limited amount of resources. They are not enough in supply to produce all the goods and services required to satisfy the unlimited wants of people. Therefore economic agents have to make choice which results in an opportunity cost.
It refers to the apportionment of resources among the competing uses. Resources can best be allocated by finding an appropriate solution for each of the three questions of allocation.
Questions of Allocation
The following questions are common for all countries alike.
1. What to produce?
Countries can not produce all the goods and services demanded by their people. They need to decide what goods and services (and in what quantities) should be produced by using the available resources.
2. How to produce?
There are two methods of production a firm can employ in its production process.
a. Labour Intensive Method: Using more labours in the production process.
b. Capital Intensive Method: Using more capital in the production process.
3. For whom to produce?
The distribution of goods and services is based on the personal real income. The higher the income, the larger the share of the national output consumed. Therefore, we need to decide how the total real income should be shared out.
Conflicts of Interest
Resources are scarce. Most of them are non-replaceable. It indicates that utilization of more resources at present will reduce the supply of these resources for future consumption.
At the same time, we need to take into account the trade-off between Consumer goods and Capital goods. An increase in the production of capital goods at present will reduce the current production of consumer goods but will increase the future output of the latter.
A country can produce Cp1 capital goods and Cn1 consumer goods with its available resources. But, an increase in the output of capital goods from Cp1 to Cp2 would lead to a fall in consumer goods from Cn1 to Cn2.