Spring 2009

The response an economy makes to the first ques-tion—What to produce?—depends on the goodsand services a society wants. In a communiststate, the government will decide what a societywants, but in a capitalist economy consumers areallowed to signal what products they want by wayof their demands for specific commodities. In thenext chapter, we will investigate how the con-sumer demand for individual products is deter-mined and how markets meet these demands. Fornow, we will assume that consumers, individuallyand as a society, are able to decide on the mix ofgoods and services they most want, and that pro-ducers supply these items at acceptable prices.

Once we know what goods a society wants,the next question its economic system mustanswer is how these goods and services are to beproduced. In the end, this problem comes downto the simple question of how labor, capital, andland should be combined to produce the desiredproducts. If a society demands a huge amount ofcorn, say, we can expect its utilization of land,labor, and capital will be different from a societythat demands digital equipment. But even aneconomy devoted to corn production could beorganized in different ways, perhaps relying onextensive use of human labor, or perhaps relyingon automated capital equipment.

Once an economy has determined whatgoods and services to produce and how to pro-duce them, it is faced with the distribution ques-tion: Who will get the resulting products? catesthe goods and services it produces to consumers.In a capitalist economy, most products are distrib-uted through private markets. In a socialist econ-omy, many goods are produced in state-ownedfacilities. Theoretically, governments in socialisteconomies use tax monies to subsidize producers,to consumers. In a capitalist economy, most prod-ucts are distributed through private maron theirefficiency and the quality of their products.

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As we have seen, every country has to decide what to pro-

duce, how to produce it, and decide who receives the output. With

the first two questions countries desire to do each as efficiently as

possible, but this leads to two different aspects of efficiency.

Production efficiency occurs when the mix of goods society

decides to produce is produced at the lowest possible resource or

opportunity cost. decides to produce is produced at the lowest pos-

sible resource or opportunity cost. Alternatively, production effi

resources. Firms use the best technology available and combine

the otherAlternatively, production effi resources. Firms use the

best technology available and combine the other resources to pro-

duce products at the lowest cost to society.

Allocative efficiency occurs when the mix of goods and services

produced are the most desired by society. In capitalist countries

this is determined by consumers and businesses ciency requires

that the right mix of goods be produced at the lowest cost.

Every economy faces constraints or limitations. Land, labor, capi-

tal, and entrepreneurship are all limited. No country has an infinite

decides to produce is produced at the lowest possible resource or

opportunity cost. Alternatively, production effi resources. Firms

available workers, or the space and machinery that would be

needed to put them all to work; no country can break free of these

natural restraints. Such limits are known as production possibili-

ties frontiers (PPFs) and they are the focus of the next section.

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