Each and every economy has to answer 3 fundamental questions: what to produce, how to produce, and for whom to produce the goods and services. All societies need to make a decision regarding the the perfect combination of factors to produce the desired output of services or products. For instance, exactly how much land, labour, and capital needs to be used to manufacture consumer goods like desktops and automobiles.
This basic economic question arises because modern society faces the problem of scarcity wants and requirements are limitless, but resources are scarce. Due to the fact that society does not have enough resources to make every item which every human being wants, society must make a decision regarding which resources to make use of in the production of a good or service. Does society produce running sneakers from genuine leather or faux leather? Should it manufacture vehicles with the help of robots or manual labor?
Which techniques should be used to produce? Technology implies the right proportion in which the various factors of production should be applied. There are 2 kinds of techniques. A labour-intensive technique would utilize relatively more labour and less capital. In contrast, capital- intensive approach means more capital and less labour.
The choice of technique is dependent upon the prices of the factors of production. That is, if labour is inexpensive and capital is costly, a labour-intensive approach would be taken into consideration and vice-versa. The costs of labour and capital are based on the demand for and supply of labour and capital respectively.
For example, The KidsToy company is organizing the production of a new line of stuffed toys. Company decision makers are thinking about two options a computerized, high-tech manufacturing center handled by a few professional software engineers or a low-tech manufacturing facility employing countless semi-skilled workers and very little equipment.
The KidsToy can accomplish equal production from either option. Having said that, because the wage paid to labour is comparatively high in comparison to the expense on equipment, The KidsToy chooses the high-tech manufacturing over low-tech.
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How does this demonstrate resource allocation and the how to produce? question. The higher cost of labor induces The KidsToy company to create stuffed toys with relatively more machines and relatively less labour. But why is the cost greater? Most probably it is higher because labour foregoes more valuable alternatives. The final thought is that more affordable resource (equipment) are employed, making manufacturing more efficient and resulting in more affordable prices.