Central problems arise in an economy due to scarcity of resources having alternative uses in relation to unlimited wants.
The Central Problem of all economies is scarcity.
Limited Resources + Unlimited Wants = Scarcity
Scarcity forces individuals, firms governments and societies to make choices.
Three basic questions must be answered in order to understand an economic system:
What is produced?
Every society has some system or mechanism that transforms that society’s scarce resources into useful goods and services. Every society decides Whether to produce more of food, clothing, housing or to have more of luxury goods, Whether to have more of consumption goods or to have investment goods.
How is it produced?
Society decides the technology to be used in the production of goods and services. Whether it should be labor intensive or capital intensive. e.g. in India, we have unemployment and labour is easily available. so, choosing a labor intensive technique will help in providing jobs to unemployed.
For Whom is it produced?
Who gets how much of the goods that are produced in the economy? How should the produce of the economy be distributed among the individuals in the economy? Who gets more and who gets less? Demand is an important factor which determines for whom the things are produced but the society determines how the product is evenly distributed so that it fulfills the need of everyone in the society.