The Central problems of what and how much to produce; how to produce and for whom to produce are determined by the free price mechanism.
(i) What to Produce:
Let us consider the first question: ‘which commodities are to be produced and in what quantities? The commodities which do not command positive prices in the market would not be produced.
Therefore only those commodities with positive prices are to be produced and in such a way that would clear the markets.
The quantity in which a commodity is to be produced is set at that level where demand equals supply. If quality produced is more or less, then there will be dis equilibrium in the market and price will fluctuate.
Hence, to maintain stable equilibrium price it becomes necessary to make demand and supply equal. This rule is applicable for each commodity. In this way, first central problem is solved.
(ii) How to Produce:
In context of this it is: ‘which techniques are to be adopted’? Technology means the correct proportion in which the different factors of production are to be employed. There are two types of techniques.
A labour-intensive technique would employ relatively more labour and less capital. On the other hand, capital- intensive technique means more capital and less labour.
The choice of technique depends on the prices of the factors of production. That is, if labour is cheap and capital is expensive, a labour-intensive technique would be considered and vice-versa.
The prices of labour and capital are determined by the demand for and supply of labour and capital respectively .In this way, the second problem will be solved.
(iii) For Whom to Produce:
The solution of this problem is very simple commodity can be consumed only by people who have more purchasing power. Price mechanism determines the income of the workers, i.e.; purchasing power.
The purchasing power of the owner of capital is determined in the same way. Thus, when the price of every commodity and every factor of production are determined, the third problem will be solved.