Economic problem

The economic problem, sometimes called the basic, central or fundamental economic problem, is one of the fundamental economic theories in the operation of any economy. It asserts that there is scarcity, or that the finite resources available are insufficient to satisfy all human wants and needs. The problem 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 the economic problem.

Economic problem arises mainly due to two reasons- (i) human wants are unlimited (ii) means to satisfy human wants are scarce.

Overview

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). However, 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 how do we know what to produce for the economy...........

Opportunity cost and Production Possibility Frontier

The main theory to decipher what and how to prioritise these wants and needs is to look at the opportunity cost (looks at what good must be prioritised first according to needs and how efficiently that the good can satisfy infinite wants). A good way to look at this is the production possibility frontier (PPF), this isolates two goods in an economy produced at any one given time to show the effect of what would happen if one changed according to the other and also the effects of new technology and new resources. For example, say that we have isolated two goods, food and clothing, and we look at what would happen if there was increased production of food (there is an opportunity cost of clothes so clothes would go down as food goes up), this varies according to what effects there are including new technology and new resources.

Needs

Needs are material items people need for survival, such as food, clothing, housing and ware. Until the Industrial Revolution, the vast majority of the worlds population struggled for access to basic human needs.

Wants

While the basic needs of survival are important 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 the market mechanism best satisfies the various wants different individuals might have. These wants are often classified into individual wants, which depend on the individual's preferences and purchasing power parity, and collective wants, those 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 asked for. Wants are effective desires for a particular product, or something which can only be obtained by working for it.

Choice

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.

• Socialism asserts that producers (workers) should have some control over the decisions that affect their welfare in the workplace and on the governmental level, which cooperatively formulates economic plans for economic decisions regarding the allocation and use of capital goods. Socialist systems that utilize the market for this role are termed market socialism.

• The idea of State socialism argues that most or all major economic choices (regarding production, allocation of inputs and distribution of output) should be made through central planning by the government. Only by constructing a cohesive plan that takes the good of everyone into account, so the idea states, can the best allocation of resources be achieved. (Also see Planned economy.)

• Communism refers to a stage of development where the productive forces are advanced to such a degree that it solves the economic problem, insofar as needs are concerned. A communist system is a highly developed form of socialism where productive property is held in common, individual autonomy from coercive social relations is abolished and the state no longer exists. (Also see Marxism.)

• Capitalism argues for a system where private businesses (and some state-owned enterprises, in the case of mixed economies) make economic decisions regarding investment decisions, production levels and distribution of output, where in the role of the government is to protect the property rights of individuals and companies, provide the institutional and infrastructural framework for the development of a market economy and the provision of some government social programs.

• In a free-market economy, which exists without the constraints of government wage and price controls, proponents of market capitalism argue that resources are automatically allocated toward the things that society collectively values the most. This form of capitalism argues for a laissez-faire approach, wherein the role of the government is to protect the property rights of individuals and companies so that they can have the confidence to undertake the economic activity (and risks) that will create the most value.
  • If a good or service is overvalued (i.e., the price is too high), the surplus will force providers of the good or service to lower their prices or to re-allocate their capacity to produce something more worthwhile.
  • If the supply of a good or service is inadequate, rising prices increase the value and so cause more production capacity to be directed toward the item. Adam Smith's The Wealth of Nations has been an extremely influential book for this school of thought.

The choice with regard to which goods and in what quantities are to be produced. Problem of scarcity leads to the origin of the problem of choice of best possible pattern of allocation of resources. The economic problem can be divided into different parts. They are given as below.

1. Problem of allocation of resources:

The problem of allocation of resources arises due to the scarcity of resources. That is why the question of scarcity goods for production implies which wants should be satisfied and which should be left unsatisfied. The problem of allocation of resources deals with the question of what to produce and how much to produce.

If the society decides to produce a definite commodity in volume, it has to withdraw some resources from the production of other goods. More production implies more resources. More production of a desired commodity can be made possible only by reducing the quantity of resources used in the production of other goods. Resources being scarce if the society decides to produce one good, the production of some other goods would have to be cut down.

The problem of allocation deals with, the question 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. In the long run the investment on capital goods will augment the production of consumer goods.

In an economy both capital as well as consumer goods is of equal importance. So the decision is to make social adjustment between the productions of the two.

2. The problem of all economic efficiency:

Resources should be, most efficiently used as it is scarce. Thus it is essential to know if the production and distribution of national product made by an economy is efficient. The production becomes efficient only if the productive resources are so utilised that any reallocation does not produce more of one good without reducing the output of any other good.

By efficient distribution means that any redistribution of goods cannot make some one better off without making anyone else worse off. 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.

3. The problem of full-employment of resource:

In view of the scarce resources a very pertinent questions may arise in the mind that whether all available resources are fully utilised. A community should achieve maximum satisfaction by using the scarce resources in the best possible manner. There should not be wrong use of resources or it should not be allowed to go waste.

But in capitalist economy the available resources are not fully utilised. In times of depression there are many willing workers to work but they go without employment. It supposes that the scarce resources are not fully utilised in a capitalist economy.

4. The problem of economic growth:

If the productive capacity of the economy grows, it will be able to produce progressively more goods as a result of which the living standard of the people will rise. 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 discasted by numerous growth models.

Some of these growth models are Harrod-Domar model, neo­classical growth models of Solo and Swan, Cambridge growth models of Kaldor and Joan Robinson etc. This part of economic problem is studied in the economies of development.

Thus an economy has to solve a number of problems. But the basic cause behind all these problems is resource scarcity.

See also

• Full employment
• Post-scarcity
• Job guarantee