Because an economys production is limited by its resources and technological knowledge, every society, no matter how rich or poor, makes choices. That means every society must have a way of determining what commodities are produced, how these goods are made, and for whom they are produced? Indeed, these three fundamental questions of economic organization what, how, and for whom are as crucial today as they were at the dawn of human civilization. Lets look closer at them:
· What commodities are produced and in what quantities? A society must determine how much of each of the many possible goods and services it will make, and when they will be produced. Will we produce bread or shirts today? A few high-quality shirts or many cheap shirts? Will we use scarce resources to produce many consumption goods (like bread) or will we produce fewer consumption goods and more investment goods (like bread-making machines), which will boost production and consumption tomorrow?
· How are goods produced? A society must determine who will do the production, with what resources, and what production techniques they will use. Who farms and who teaches: Is electricity generated from oil, from coal, or from nuclear power: With much air pollution or with little?
· For whom are goods produced? One key task for any society is to decide who gets to eat the fruit of the economys efforts. Or, to put it formally, how is the national product divided among different households?
HOW MARKETS SOLVE THE THREE ECONOMIC PROBLEMS
· What goods and services will be produced is determined by the daily dollar votes of consumers through their daily purchase decisions. The money that they pay into businesses cash registers ultimately provides the payrolls, rents, and dividends that consumers, as employees, receive as income. Firms in turn are driven by the desire to maximize profits profits being net revenues or the difference between total sales and total cost. Firms abandon areas where they are losing money; by the same token, firms are lured by high profits into production of goods in high demand.
· How things are produced is determined by the competition among different producers. The best way for producers to meet price competition and maximize profits is to keep costs at a minimum by adopting the most efficient methods of production. Sometimes change is incremental and consists of little more than tinkering with the machinery or adjusting the input mix to gain a cost advantage that can be very important in competitive market. At other times there are drastic shifts in technology.
· For whom things are produced who is consuming, and how much depends, in large part, on the supply and demand in the markets for factors of production. Factor markets determine wage rates, land rents, interest rates, and profits such prices are called factor prices. The same person may receive wages from a job, dividends from stocks, interest from a certificate of deposit, and even rent from a piece of property. By adding up all the revenues from factors we can calculate peoples market incomes. The distribution of income among the population is thus determined by the amount of factors (person-hours, acres, etc.) owned and prices of the factors (wage rates, land rents, etc.)