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The economic problem—sometimes called the basic, central, or fundamental economic problem—is one of the fundamental economic theoretical principles in the operation of any economy. It asserts that there is scarcity; that is, that the finite resources available are insufficient to satisfy all human wants and needs. The question then becomes how to determine what is to be produced, and how the factors of production (such as capital and labor) are to be allocated. Economics revolves around methods and possibilities of solving this fundamental economic problem.
The economic problem arises mainly due to two facts: human wants are unlimited, but the means to satisfy human wants are scarce.
- 1 Overview
- 1.1 Opportunity cost and the production–possibility frontier
- 1.2 Needs
- 1.3 Wants
- 1.4 Choice
- 1.5 Four parts of the problem
- 2 See also
The economic problem is most simply explained by the question: "How do we satisfy unlimited wants with limited resources?" The premise of the economic problem model is that wants are constant and infinite due to constantly changing demands (often closely related to changing demographics of the population), but resources in the world to satisfy human wants are always limited to the amount of natural or human resources available. The economic problem—and methods to curb it—revolve around the idea of choice in prioritizing which wants can be fulfilled and what to produce for the economy.
Opportunity cost and the production–possibility frontier
The main method of working out how to prioritise these wants and needs is to look at the opportunity cost; that is, to look at what good must be prioritised first according to what needs that good will satisfy and how efficiently that good can satisfy infinite wants. A useful tool to assist in this is a production–possibility frontier (PPF). A PPF isolates two goods in an economy produced at any one given time to show the effect in the level production of each of those goods in relation to the level of production of the other. For example, food and clothing could be isolated on a PPF, and then one could look at what would happen if there was increased production of food, which is that the production of clothes would go down (due to the opportunity cost of producing food being producing clothes). New technology and new resources could affect the opportunity costs and the possible levels of production, but these potential factors (i.e., new technology and new resources) are ignored in using a PPF in order to get a model that is more easy to work with.
Needs are material items people need for survival, such as food, clothing, housing, and ware[clarification needed]. Until the Industrial Revolution, the vast majority of the worlds population struggled for access to basic human needs.
Wants are effective desires for a particular product, or for something which can only be obtained by working for it. While the fundamental needs of survival are key in the function of the economy, wants are the driving force which stimulates demand for goods and services. In order to curb the economic problem, economists must classify the nature and different wants of consumers, as well as prioritize wants and organize production to satisfy as many wants as possible.
One assumption often made in mainstream neoclassical economics (and the methods which attempt to solve the economic problem) is that humans inherently pursue their self-interest, and that the market mechanism best satisfies the various wants different individuals might have. These wants are often divided into individual wants (which depend on the individual's preferences and purchasing power parity) and collective wants (which are the wants of entire groups of people). Things such as food and clothing can be classified as either wants or needs, depending on what type and how often a good is requested.
The economic problem fundamentally revolves around the idea of choice, which ultimately must answer the problem. Due to the limited resources available, producers must determine what to produce first to satisfy demand. Consumers are considered the biggest influences of this choice, and the goods which they want must also fit within their budgets and purchasing power parity. Different economic models place choice in different hands.
Four parts of the problem
The economic problem can be divided into different parts, which are given below.
Problem of allocation of resources
The problem of allocation of resources arises due to the scarcity of resources, and refers to the question of which wants should be satisfied and which should be left unsatisfied; in other words, what to produce and how much to produce. More production of a good implies more resources required for the production of that good, and resources are scarce. These two facts together mean that, if a society decides to increase production of some good, it has to withdraw some resources from the production of other goods; in other words, more production of a desired commodity can be made possible only by reducing the quantity of resources used in the production of other goods.
The problem of allocation deals with the question of whether to produce capital goods or consumer goods. If the community decides to produce capital goods, resources will have to be withdrawn from the production of consumer goods. However, in the long run, the investment on capital goods will augment the production of consumer goods. Thus, both capital and consumer goods are important. The problem is determining what the optimal ratio of production between the two types of goods is.
The problem of all economic efficiency
Resources are scarce and it is important to use them as efficiently as possible. Thus, it is essential to know if the production and distribution of national product made by an economy is maximally efficient. The production becomes efficient only if the productive resources are utilised in such a way that any reallocation does not produce more of one good without reducing the output of any other good; in other words, "efficient distribution" means that any redistribution of goods cannot make anyone better off without making someone else worse off. (See Pareto efficiency.)
The inefficiencies of production and distribution exist in all types of economies. The welfare of the people can be increased if these inefficiencies are ruled out. Some cost will have to be incurred to remove these inefficiencies. If the cost of removing these inefficiencies of production and distribution is more than the gain, then it is not worthwhile to remove them.
The problem of full-employment of resource
In view of the scarce resources, the question of whether all available resources are fully utilized is an important one. A community should achieve maximum satisfaction by using the scarce resources in the best possible manner; resources should not be wasted or used inefficiently.
However, in capitalist economies, the available resources are not fully utilised. In times of depression, there are many people willing and wanting to work who go without employment. It supposes that the scarce resources are not fully utilised in a capitalist economy.
The problem of economic growth
If the productive capacity of the economy grows, it will be able to produce progressively more goods, which will result in a rise in the standard of living of the people in that economy. The increase in productive capacity of an economy is called economic growth. There are various factors affecting economic growth. The problems of economic growth have been discussed by numerous growth models, including the Harrod-Domar model, the neoclassical growth models of Solow and Swan, and the Cambridge growth models of Kaldor and Joan Robinson. This part of economic problem is studied in the economies of development.
Summary of the four parts
Thus, an economy has to solve a number of problems, but the basic cause behind all these problems is resource scarcity.