Economic problem
Encyclopedia
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.
In short, the economic problem is the choice one must make, arising out of limited means and unlimited wants.
and how do we know what to produce for economy
Concepts in the economic problem Needs
Human 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.
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.
s and purchasing power parity
. Different economic models place choice in different hands.
Economy
An economy consists of the economic system of a country or other area; the labor, capital and land resources; and the manufacturing, trade, distribution, and consumption of goods and services of that area...
. It asserts that there is scarcity
Scarcity
Scarcity is the fundamental economic problem of having humans who have unlimited wants and needs in a world of limited resources. It states that society has insufficient productive resources to fulfill all human wants and needs. Alternatively, scarcity implies that not all of society's goals can be...
, 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
Factors of production
In economics, factors of production means inputs and finished goods means output. Input determines the quantity of output i.e. output depends upon input. Input is the starting point and output is the end point of production process and such input-output relationship is called a production function...
(such as capital
Capital (economics)
In economics, capital, capital goods, or real capital refers to already-produced durable goods used in production of goods or services. The capital goods are not significantly consumed, though they may depreciate in the production process...
and labor) are to be allocated. Economics
Economics
Economics is the social science that analyzes the production, distribution, and consumption of goods and services. The term economics comes from the Ancient Greek from + , hence "rules of the house"...
revolves around methods and possibilities of solving the economic problem.
In short, the economic problem is the choice one must make, arising out of limited means and unlimited wants.
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 human 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 economy
Concepts in the economic problem Needs
Human needs are material items people need for survival, such as food, clothing, housing and ware. Until the Industrial Revolution
Industrial Revolution
The Industrial Revolution was a period from the 18th to the 19th century where major changes in agriculture, manufacturing, mining, transportation, and technology had a profound effect on the social, economic and cultural conditions of the times...
, the vast majority of the worlds population struggled for access to basic human needs.
Wants
While the basic needs of human survival are important in the function of the economy, human 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
Neoclassical economics
Neoclassical economics is a term variously used for approaches to economics focusing on the determination of prices, outputs, and income distributions in markets through supply and demand, often mediated through a hypothesized maximization of utility by income-constrained individuals and of profits...
(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
Purchasing power parity
In economics, purchasing power parity is a condition between countries where an amount of money has the same purchasing power in different countries. The prices of the goods between the countries would only reflect the exchange rates...
, 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, businesses 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 budgetBudget
A budget is a financial plan and a list of all planned expenses and revenues. It is a plan for saving, borrowing and spending. A budget is an important concept in microeconomics, which uses a budget line to illustrate the trade-offs between two or more goods...
s and purchasing power parity
Purchasing power parity
In economics, purchasing power parity is a condition between countries where an amount of money has the same purchasing power in different countries. The prices of the goods between the countries would only reflect the exchange rates...
. Different economic models place choice in different hands.
- SocialismSocialismSocialism is an economic system characterized by social ownership of the means of production and cooperative management of the economy; or a political philosophy advocating such a system. "Social ownership" may refer to any one of, or a combination of, the following: cooperative enterprises,...
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 socialismMarket socialismMarket socialism refers to various economic systems where the means of production are either publicly owned or cooperatively owned and operated for a profit in a market economy. The profit generated by the firms system would be used to directly remunerate employees or would be the source of public...
.
- The idea of State socialismState socialismState socialism is an economic system with limited socialist characteristics, such as public ownership of major industries, remedial measures to benefit the working class, and a gradual process of developing socialism through government policy...
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 economyPlanned economyA planned economy is an economic system in which decisions regarding production and investment are embodied in a plan formulated by a central authority, usually by a government agency...
.)
- CommunismCommunismCommunism is a social, political and economic ideology that aims at the establishment of a classless, moneyless, revolutionary and stateless socialist society structured upon common ownership of the means of production...
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 MarxismMarxismMarxism is an economic and sociopolitical worldview and method of socioeconomic inquiry that centers upon a materialist interpretation of history, a dialectical view of social change, and an analysis and critique of the development of capitalism. Marxism was pioneered in the early to mid 19th...
.)
- CapitalismCapitalismCapitalism is an economic system that became dominant in the Western world following the demise of feudalism. There is no consensus on the precise definition nor on how the term should be used as a historical category...
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, wherein 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 capitalismCapitalismCapitalism is an economic system that became dominant in the Western world following the demise of feudalism. There is no consensus on the precise definition nor on how the term should be used as a historical category...
argues for a laissez-faireLaissez-faireIn economics, laissez-faire describes an environment in which transactions between private parties are free from state intervention, including restrictive regulations, taxes, tariffs and enforced monopolies....
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 surplusEconomic surplusIn mainstream economics, economic surplus refers to two related quantities. Consumer surplus or consumers' surplus is the monetary gain obtained by consumers because they are able to purchase a product for a price that is less than the highest price that they would be willing to pay...
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 SmithAdam SmithAdam Smith was a Scottish social philosopher and a pioneer of political economy. One of the key figures of the Scottish Enlightenment, Smith is the author of The Theory of Moral Sentiments and An Inquiry into the Nature and Causes of the Wealth of Nations...
's The Wealth of NationsThe Wealth of NationsAn Inquiry into the Nature and Causes of the Wealth of Nations, generally referred to by its shortened title The Wealth of Nations, is the magnum opus of the Scottish economist and moral philosopher Adam Smith...
has been an extremely influential book for this school of thought.
- If a good or service is overvalued (i.e., the price is too high), the surplus