All economic systems that have ever existed or will ever exist have to answer some basic questions. Let's explore the questions and some answers.
1 - What goods and services will be produced?
2 - How will the goods and services be produced?
3 – Who will get the goods and services?
4 – How will the system accommodate change?
5 – How will the system promote progress?
Throughout history different countries have used different organizing methods to answer the basic economic questions. The command system (socialism or communism) is not as prevalent today as in the past. We will focus on the market system.
Some of the main characteristics of a market system are
Private property Freedom of enterprise and choice
Self-interest markets and prices
Technology and capital
Specialization of resources Use of money
Active, but limited, government
The answer to the first question is that we let the supply and demand of the market determine what and how much to produce. Goods that consumers are both willing and able to buy, and producers are willing and able to make, get made in the amount that both working together see fit. You may be willing and able to go to the moon, but no supplier is willing and able to make that available at this time (although it seems we are getting closer). But just think about all the items that are available in the markets we have today.
Note consumers “vote” for goods to be made with their dollars and the goods are likely to be made if firms can make profit.
The answer to the second question is producers will use the least cost combination of inputs to produce a given level of output. The reason for this is twofold. First, by using the least cost methods more profit will be earned by the producer.
Producers certainly like to make profit. But, the second reason is that if a producer does not use least cost methods of production, when other producers do, the high cost producer may not be able to compete with the other low cost producers and will eventually go out of business.
Say there are three ways of making a good from a technical point of view. Here we list the number of units of each resource needed to make a good:
Entrepreneurial ability technique 1
1 technique 2
1 technique 3
Next I show what each resource costs per unit and we can then see how much it costs to make the units under each technique. For now, let’s just say we look to the market to find what it costs to get each unit of each resource. Here technique 2 would be used!
Land $2 technique 1
4 ($8) technique 2
2 ($4) technique 3
Entrepreneurial $3 ability
The answer to the third question is those who are willing and able to pay for the items made. We become able to pay by giving up something that is valuable to us - labor or other assets.
Some person who is probably now dead was the first to notice and say, “change is the only permanent thing in this world.” In our economy we see consumers change their buying habits and technologies in production change.
How does the market system accommodate this change? Well, the process goes something like this: Goods we no longer want become less profitable and eventually we have less made (pay phones, for example), while what we want becomes more profitable and we have more made (cell phones). Resource owners move their resources to place where they get the most.
The authors relate that the market system is like a huge communication system through which prices of goods and resources and profits from production communicate to people where to direct resources.
What do you think should happen to the number of resources we devote to health care given the current state of prices and resources used in health care in the US?
This is my idea – we should put more resources into health care – like flood the market with doctors!
What is progress?
Let’s say, quite crudely, that you can refer to the amount of output in our economy as the size of a big pie. You could also consider the size of the piece of the pie you get as your standard of living. In this sense progress usually means making a bigger pie and having folks get a larger piece.
Does a market system allow for progress? Sure does! When you let folks earn cash from advances they make then folks build a better mouse trap! This happens along the lines of technological progress and the accumulation of capital goods.
Are there problems with using a capitalist, market based system to answer the 5 basic questions? Sure there are monopoly, public goods, and the like. Another problem might be what to do about those who do not have the ability to generate what it takes to consume the items needed to survive.
We should always be aware and on the look-out for potential problems.