The economic problem – sometimes called basic or central economic problem – asserts that an economy's finite resources are insufficient to satisfy all human wants and needs. It assumes that human wants are unlimited, but the means to satisfy human wants are limited. The economic problem is the problem of rational management of resources or the problem of optimum utilization of resources. It arises because resources are scarce and resources have alternative uses
Three questions arise from this:
• What to produce?
• How to produce? &
• For whom to produce?
- What to produce?
'What and how much will you produce?' This question lies with selecting the type of supply and the quantity of the supply, focusing on efficiency.
e.g. "What should I produce more; laptops or tablets?"
- How to produce? Capital goods or consumer goods
'How do you produce this?' This question deals with the assets and procedures used while making the product, also focusing on efficiency.
e.g. "Should I hire more workers, or do I invest in more machinery?"
- For whom to produce?
'To whom and how will you distribute the goods?' and 'For whom will you produce this for?' arises from this question. This question deals with distributing goods that have been produced, focusing on efficiency and equity.
Economics revolve around these fundamental economic problems.
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 is the loss in terms of potential benefit had another action been taken. We make choices every day. We have to, as we have limited resources but so many wants. We therefore must decide which wants to satisfy and which not to. All choices involve giving something up. This leads to opportunity cost. This issue of 'what to give up' exists not only for consumers like us but for governments and businesses too.
Needs and wants
Needs are things or material items of peoples need for survival, such as food, clothing, housing, and water. Everyone has a different needs and wants. Until the Industrial Revolution, the vast majority of the world's population struggled for access to basic human needs.
Wants are effective desires for a particular product, or for something that 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 that stimulates demand for goods and services. 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.
An assumption often made in mainstream neoclassical economics (and methods that try 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.
Three 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 must be withdrawn from the production of consumer goods. In the long run, however, investment in capital goods augments the production of consumer goods. Thus, both capital and consumer goods are important. The problem is determining the optimal production ratio between the two.
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 utilized 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 redistributing 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 must 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 resources
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—not wasting resources or using them inefficiently. There are two types of employment of resources:
In capitalist economies, however, available resources are not fully used. In times of depression, many people want to work but can't find employment. It supposes that the scarce resources are not fully utilized in a capitalistic economy.
The problem of economic growth
If productive capacity grows, an economy can produce progressively more goods, which raises the standard of living. 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 the economic problem is studied in the economies of development.