Production, distribution and disposition of goods and services are the basic economic activities of life. In the course of these activities, every society has to face scarcity of resources. Because of this scarcity, every society has to decide how to allocate the scarce resources.
These decisions lead to the central problems that are faced by every economy: what to produce, how to produce, and for whom to produce. These problems are called central problems because they are the most basic problems of an economy and all other problems revolve around them.
Allocation of resources refers to the problem of assigning the scarce resources in such a manner so that maximum wants of the society are fulfilled. As resources are limited in relation to the unlimited wants, it is important to economize their use and utilize them in the most efficient manner.
The problem of allocation of resources is studied under three heads: what to produce, how to produce, and for whom to produce.
What to Produce?
This problem involves the selection of goods and services to be produced and the quantity to be produced of each selected commodity. An economy has to decide which goods should be produced and in what quantities based on the importance of various goods. The problem of ‘what to produce’ has two aspects: what possible commodities to produce and how much to produce.
The guiding principle of ‘what to produce’ is to allocate resources in a manner that gives maximum aggregate satisfaction.
How to Produce?
This problem refers to the selection of techniques to be used for the production of goods and services. A good can be produced using different techniques of production. Generally, techniques are classified as labour-intensive techniques (LIT) and capital-intensive techniques (CIT). The selection of technique is made with a view to achieving the objective of raising the standard of living of people and providing employment to everyone.
The guiding principle of ‘how to produce’ is to combine factors of production in such a manner so that maximum output is produced at minimum cost, using the least possible scarce resources.
For Whom to Produce?
This problem refers to the selection of the category of people who will ultimately consume the goods. Goods are produced for those people who have the paying capacity, which depends on their level of income. This problem is concerned with the distribution of income among the factors of production that contribute to the production process.
The guiding principle of ‘for whom to produce’ is to ensure that urgent wants of each productive factor are fulfilled to the maximum possible extent.
In addition to ‘allocation of resources,’ there are two more central problems: the problem of fuller and efficient utilization of resources, and the problem of growth of resources.