The three basic economic questions which determine resource allocation: how to produce

The Basic Economic Problem: Resource Allocation Decisions

Why Resources Are Limited

Every economy faces scarcity – there are not enough resources (land, labour, capital and entrepreneurship) to satisfy all human wants. Because resources are limited, societies must decide how to allocate them efficiently.

The Three Fundamental Economic Questions

1. What goods and services should be produced?
2. How should these goods and services be produced?
3. For whom should the goods and services be produced?

Focus: How to Produce

The question “how to produce?” concerns the choice of production techniques and the combination of factors of production that will be used to create a given output. The aim is to achieve the desired output at the lowest possible cost while meeting quality, environmental and social standards.

Key Considerations in Production Decisions

• Factor Intensity – whether a method relies more on labour (labour‑intensive) or on capital/equipment (capital‑intensive).
• Technology – the level of technical knowledge and innovation that can increase productivity.
• Economies of Scale – cost advantages that arise when output increases.
• Resource Availability – the relative abundance or scarcity of land, labour, capital and entrepreneurship in the economy.
• Cost Minimisation – choosing the technique that yields the lowest total cost for a given level of output.

Cost Representation

The total cost of production can be expressed as:

\$C = wL + rK\$

where \$w\$ is the wage rate, \$L\$ is the amount of labour, \$r\$ is the rental rate of capital, and \$K\$ is the amount of capital employed.

Comparison of Production Methods

Decision‑Making Process

1. Identify the required output level.
2. Analyse the relative costs of labour, capital and technology.
3. Assess the availability of each factor in the economy.
4. Choose the technique that minimises total cost while meeting quality and regulatory standards.
5. Review periodically to incorporate technological advances and changes in factor prices.

Summary

“How to produce?” is a central economic decision that determines the combination of resources used in the production process. By evaluating factor intensity, technology, economies of scale and cost structures, producers can select the most efficient method, thereby addressing the basic economic problem of scarcity.