The Foundations of Free Enterprise
by Allen, Armstrong, and Wolken
The Economic Problem
Economics is the study of how a society turns resources into goods and services to satisfy the wide variety of wants and desires of its members. But this is a simple statement of an extremely complex problem. The difficulty arises because our resources are limited relative to our wants and desires. We all like good food, fancy clothes, cars, boats, microwave ovens, refrigerators, dishwashers, television sets, and so forth. But there just aren’t enough of these things to go around. So, some of our wants must go unsatisfied.
This problem is complicated because natural resources have many different uses. For example, a tree in the forest could be left there to beautify the countryside. Or it could be cut down and used for firewood. Or cut into lumber for constructing a house. Once we have made our choice, we give up all other uses for that tree. Since all resources have alternative uses, part of our problem is to choose which way they are to be used. When we make this choice, we also decide which wants will not be satisfied. For this reason, economics is often referred to as the “science of choice,” the study of choosing among alternatives. Thus, the basic economic problem requires us to decide which wants are to be satisfied and to use our limited resources in the production of appropriate goods and services.
Suppose we add together all resources available to us and represent this total by a small circle (above). These resources can be divided into three groups: land, labor, and capital. Land includes not only the ground itself but such things as trees, plants, rivers, lakes, the minerals beneath the ground, and the air around us. We commonly refer to these as our natural resources. Labor includes both our physical and mental skills. The tools, machines, and factories used to make other products are capital
These resources, by themselves, cannot satisfy human wants. A tree standing in the forest does not provide shelter. It must be cut down, sawed into boards, and assembled according to a plan before it becomes a house. Thus, our resources land, labor, and capital must be combined to produce the goods and services that will satisfy our wants.
Let’s add to our diagram a second circle whose area represents the total amount of goods and services produced. This circle represents the “pie” available to members of our society. In similar fashion, we add together all the wants and desires of the individual members of society and represent these by a third circle. Note that the area of circle 3 exceeds that of circle 2. There are never enough goods and services to satisfy all wants and desires. When we satisfy some wants, others are left unsatisfied. This is the problem of scarcity.
We must be careful when we talk about what the third circle represents. Our first impulse might be to call it society’s wants and desires. But society is nothing more than a group of individuals. After all, is there anything that everyone in society can agree on? Probably not. In this sense, society, as a group, does not have any wants or desires of its own. There is no such thing as our “collective wants.” The third circle, then, represents an adding together of the wants and desires of the individual members of society. We should keep this distinction in mind throughout this discussion.
We may be tempted to suggest that over time our wants might be fully satisfied. That is, goods produced in the future might be used to satisfy those wants left unsatisfied in the present. Unfortunately, most of our wants cannot be satisfied once and for all, but must be continually satisfied. The Big Mac we eat today will not satisfy tomorrow’s appetite. Even those few wants that can be satisfied by a one-time-only diversion of resources are quickly replaced by new wants. For better or worse, history shows us we have unlimited appetites but limited abilities to produce goods and services. We live in a world in which we must make choices. We must decide how to use scarce resources considering the millions of available options. In a world of scarcity, the need to choose is our inescapable destiny.
By scarcity we mean there is not enough of an item to satisfy the demand for it. We do not mean necessarily that only a small quantity of an item exists. For example, rotten eggs are relatively few in number, but they are not scarce because there is no demand for them. On the other hand, the earth has billions of barrels of oil. But oil is scarce because of high demand.
Scarcity is not unique to any one society. Every group of people in the world faces scarcity. Its universal presence forces all societies to respond to three fundamental economic questions: (1 ) What should be produced? (2) How should it be produced? (3) How should it be divided among the members of society?
The “what to produce” question refers to the problem of choosing which goods and services (and how much of each) are to be produced from available resources in order to satisfy our wants most fully. As mentioned earlier, a tree can be used for many different things, as part of a park (to provide beauty), as firewood (to provide heat), or as part of a house (to provide shelter). We must decide how much we value beauty, heat, and shelter. The use considered most valuable will determine whether the tree is left standing, chopped up into firewood, or cut into lumber.
Once we have decided “what to produce” we must decide “how to produce” it. For example, suppose we decide to build a house. It could be made of wood or bricks. Suppose we choose wood. Our tree can be cut into lumber by several men with hand saws, one man with a chain saw, or by a sawmill. This is just one of the choices to be made in determining how to produce that house. Similarly, most items can be produced by using different methods or combinations of resources. Because resources are scarce, we want to use them in the most efficient way possible so the total output of society (the size of the pie) will be as large as possible and the wants left unsatisfied will be as few as possible.
The third question we must answer is “how to divide” the fruits of production among the members of society. Who will live in the house? The owners of the tree, the men who cut the lumber, or the carpenters who built it? Or, should it go to someone who had nothing to do with its production? The answer to the “how to divide” question determines the size of the slice of pie each member of society receives.