THE ECONOMIC PROBLEM
In most textbooks, the economic problem is the question of how humans decide the questions of what or how much to produce and consume, who will produce and consume, and how income and wealth are to be distributed. The solution to the economic problem is effectively any one or combination of the ways of organizing an economy, and it is useful to know that there are three such ways: the “free” market, central planning or dictatorship (also known as socialism or communism), or government regulation (which has elements of the first two ways). When put in this way, we can also define economics as the study of how to solve the economic problem.
BUT WHAT IS AN ECONOMY?
If an “economy” is something to be organized, what exactly is it? Mankiw states that an economy is “just a group of people interacting with one another as they go about their lives.” Is this a good definition? It is certainly one in the spirit of Coase’s definition of economics as the study of human choice. Note, however, the dictionary meaning of “economy” as a “system of economic activity in a country or region.” If that is what an economy is, what exactly is “a system of economic activity”? In my view, that “system” is the “social institution” that we use to determine the production and distribution of economic goods and services. The system, as noted above, is any one of the following three: a market, a dictatorship, or a combination of both.