How to solve the economic problem?

In a previous blog post I looked at the economic problem. That is, how do economies solve the challenges of scarce resources and unlimited wants. 

This economic problem applies to individuals, companies and governments. But, at an economy-wide (country-wide) level, how does a government seek to solve the economic problem?

The key element is that a government must make choices. It must prioritise how it uses the scarce resources to achieve the best outcomes for society as a whole. 

There are four key economic questions that a society needs to answer.

Economic question one: What to produce?

An economy cannot produce every single good and/or service demanded by consumers and businesses. It does not have sufficient resources to do this. Instead it must choose which goods and services to produce...and maybe import the others from overseas.

Economic question two: How much to produce?

An economy cannot produce an infinite number of goods and services. Scarce resources put a limit on production levels. Here, a government wants to avoid waste. For example, if you produce more goods than consumers demand, you’ve got excess supply and a bunch of products sitting on shelves.

Economic question three: How to produce?

How will an economy make the goods and services? Labour? Capital? A mix? The key here is to make the goods and services efficiently — so with as little waste as possible. Maximum output for the inputs!

Economic question four: How to distribute production?

Who gets to access the goods and services? Does it depend on your income? Are they subsidised by the government? Are they given out free? This will depend on the goals of the government (whether it’s essential for everyone to have this good or service) and the role of the free market.

The challenge for governments is the difficulty in getting these questions ‘right’. It is hard to predict which goods and services to make — particularly how much of each to produce to precisely meet demand. Governments (and markets) don’t always get it right when answering the economic questions.

View from 3:15 onwards.