BASIC ECONOMIC PROBLEM The economic problem, sometimes called the 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. The problem then becomes how to determine what is to be produced and how the factors of production (such as capital and labour) are to be allocated. Economic 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. 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, revolves around the idea of choice in prioritizing which wants can be fulfilled. Needs: Human needs are material items people need for survival, such as food, clothing and some from of housing. Until the Industrial Revolution, the vast majority of the world’s 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. Choice: The economic problem fundamentally revolves around the idea of choice, which ultimately must answer the problem. Due to the limited resource available business 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 there budgets and purchasing power parity. The basic economic problem is that resources are scarce relative to the purposes to which they could be put. As a result choices have to be made about how to use resources. The basic economic problem is thus frequently referred to as ‘scarcity and choice’. A resource regarded as any feature of our environment that helps to support our well-being. There are two main types of resource: 1. Physical or natural resources – such as well, climates, water, minerals, forests and fisheries. 2. Human resources – People and there various skills. If we were to take stock of the world’s existing bundle of resources we would find that there are severy limitations to its ability to meet our infinite wants. Scarcity: Scarce resources can be broken down into four key ingredients: land, labour, capital and enterprise. Land includes all natural resources; labour includes all physical and mental effort; capital includes machinery and other items that go into further production; and enterprise is the art of combining the other three factors in the production process. Scarcity can be seen as resulting from the lack of availability in resources, from peoples insatiable wants, or from a combination of the two. The basic economic problems are: WHAT TO PRODUCE? This means an economy can chooses the mix of goods to produce. Should an economy devote resources to health and education indifference and policing? You have brains in your head. You have feet in your shoes. You can steer yourself any direction you choose. .... Dr. Seuss Every economy must answer three basic questions: what goods and services to produce, how to produce them, and for whom to produce them. Remember that resources (land, labor, capital, entrepreneurship) are scarce or limited. We cannot have everything; we must make choices. Which ones are best? For allocate efficiency we should choose the combination of goods and services that creates the most value or utility. Every choice bears a cost. We cannot choose one option without forfeiting another. Suppose the choice is to produce either a bag of potato chips or a tube of lipstick. If we choose the potato chips, we lose the lipstick. If we choose the lipstick, we lose the chips. To an economist, true costs are what we must sacrifice or give up to get something. In this case, the cost of the potato chips is the lost lipstick, and the cost of the lipstick is the lost bag of chips. The professional jargon calls these opportunity costs. Opportunity costs are the value that must be sacrificed or given up. They also are the value of our next best alternative or opportunity. Why? Every time we make a choice, what we sacrifice is our next best alternative. Rational decision makers will compare the relative values of potential goods and services. Or, in the jargon of economics, they compare the benefits and opportunity costs of that choice. HOW TO PRODUCE? This means who will do the production and which methods of production will be used. Should the economy use a system that is labour intensive and there by ensures everyone has a job who wants one or should we use more efficient methods of production that involve the use of machines even if this means fewer jobs? Waste not, want not. ...anonymous proverb To reach our production-possibilities curve (PPC) we must get the most we can from our limited resources. If we waste resources or use them inefficiently, we will produce less than we possibly could and drop inside or beneath our PPC. In other words, we need to produce with technical efficiency. That is, we need to use the least-cost methods of production. Using $5 of resources to produce what could have been made with $4 of resources is throwing away the potential output we could have gotten from the wasted resource. What method is best? There is no so single answer. It will depend upon the particular good and particular resources in question. However, the best methods almost always will involve significant specialization. We are very specialized producers. For example, I specialize in economic lectures. I produce lectures, earn income from doing so, and use my income to trade for goods and services produced by others. This specialization makes us all interdependent. We need others to produce the goods that we do not make ourselves. Why do we choose to specialize and trade with others rather than being self-sufficient? Simple. Specialization and trade raise our standard of living. We reap gains from specialization and trade for two major reasons. First, specialization allows us to practice and learn to become more proficient. If we spread our time and effort trying to play all sports, we never become expert in any one. If we specialize in baseball we can practice baseball skills repetitively. The practice helps us improve. The saying “practice makes perfect” certainly exaggerates, but practice does make us better. Second, specialization allows us to take advantage of our particular talents. People differ. Specialization allows us to concentrate on what we do best. Some of this is obvious. If Annie excels at cleaning and Laurie at cooking; it makes intuitive sense that Annie should specialize in cleaning and Laurie in cooking. If Annie can then trade some of her cleaning efforts to Laurie in return for Laurie’s cooking, both women should gain. This means who will consume the goods and services after they been produce- how will it be decided who receives them/ should an economy be geared to provide goods and services to every person as equally as possible or should those who work hard get more? What is the best method of distributing products to ensure the highest level of wants are met? In a free market economy, the producers of products determine social needs through the use of market signals. The most common of these signals is demand for products. It is often easily visible by what is known as demand-pull inflation, increases in the price of wanted goods due to a lack of supply and the purchaser's willingness to pay more for the product to guarantee himself access to it. This sends a signal to producers of the good that they can maximize their profits by allocating further resources to producing the good being demanded as opposed to other possible products. As production increases, the price level of the product in question ultimately settles at a new equilibrium point (the point at which supply equals demand) and both consumers and producers are content. When goods compete, these signals determine which product 'survives', as with VHS/BetaMAX and HD-DVD/Blu-Ray. The more heavily demanded good acquires more market share until it is unprofitable to manufacture the less heavily demanded good and ultimately it is phased out. As actors in an economy will undoubtedly pursue the better of products, this encourages innovation and development of new and better products to compete with those that currently dominate the market landscape. Production is pursued in a manner which ensures the least waste and maximizes efficiency, as to therefore maximize profit. The consumers, those for whom the goods are produced, are catered to by the producers, and are generally anyone who has goods/currency to exchange for the products they desire. WHAT PROVISION (IF ANY) IS MADE FOR ECONOMIC GROWTH? A society has to decide how much savings and investments (that is, how much sacrifice of current consumption) should be made for future economic progress. Generating shared and sustainable economic growth is the single most important objective for the Asia Pacific region over the next ten years. Despite the impressive export-led growth of the region there remain severe disparities between and within countries. These are likely to grow over the medium term if current trends continue. Growth needs to be employment-intensive and to encompass regions that are lagging, in order to secure stability and reduce poverty. To be sustainable, growth needs to confront a number of environmental challenges, such as scarcity of and competition for water resources, climate change, and widespread abuse of and non-compliance with environmental regulations. Australia supports policies and programs to generate increases in aggregate growth and, in special circumstances, target groups and regions that, for whatever reason, are not benefiting from broader growth. To accelerate economic growth the Australian aid program focuses on: Improving the policy environment for growth Promoting trade Infrastructure development, rural development and building skilled workforces Addressing the environmental challenges to growth including management of fresh water resources. How are Basic Problems Solved? We have explained above the four basic problem often economy which must be solved some-how or order by an economy. Now, the important thing to know is how an economy solves these central problems which are essential to its functioning. There are three main methods to solve these central problems. They are: 1. Capitalist economy 2. Planned economy 3. Mixed economy 1. Capitalist Economy: Problems Solution in Capitalist Economy 1. WHAT TO PRODUCE? Under capitalism, the first two are determined based on supply and demand. When there is more demand for something than there is available supply of it, the profit margin for producing that thing increases and capital investments will be made to increase production, producing profits for the investors. However, it will be to the investor's benefit to not produce an excess, as this would result in there being more supply than demand, which depresses the price and destroys the profits. 2. HOW TO PRODUCE? How to produce is simply, by the most efficient and economical means possible. The capitalist's (investor's) principal goal is to maximize profit, which is accomplished by producing the needed goods or services in the most efficient (least expensive per unit produced) means possible, and heavy investment in research and development to improve efficiency will generally pay off handsomely. Problems Solution in Capitalist Economy 3. FOR WHOM TO For whom to produce -- simply put, for those PRODUCE? who want something enough to pay for it. There is an underlying assumption of the ABILITY to pay, and of course the socialist/communist theorists of the world quickly jump on this and claim that this is the great "failure" of capitalism because it disenfranchises the poorer classes. But that is simply ignorance of the true beauty of the capitalist system -- in the capitalist system, there are HUGE profits to be made by finding ways to produce goods and services so efficiently that even the poorest can afford them. This is due to the simple fact that historically the poor outnumber the wealthy by factors of 10, 20, or 50 to one. When producing goods or services for the poor one must make considerably less profit on a per- unit basis, but this apparent "shortfall" is more than made up for in volume. 3. Mixed Economy: Problems Solution in Mixed Economy 1. WHAT TO PRODUCE? 2. HOW TO PRODUCE? 3. 3. FOR WHOM TO PRODUCE? 3. Planned Economy: Problems Solution in Mixed Economy 1. WHAT TO PRODUCE? In this method, the solution of the various basic problems is not achieved through the free working of demand for and supply of goods and factors. But to solve this problem, Government sets up a central planning authority which has been called by several names such as planning commission, planning ministry or planning board. 2. HOW TO PRODUCE? What goods should be produce and in what quantities, bow should they be produce, how should they be distributed among the population and how much should be invested to bring about economic growth are all decided by the basic planning authority. This method of solving the central problems through the use of economic planning had been adopted in the former communist countries such as Soviet Russia, Poland etc. 3. FOR WHOM TO There are thus to steps in the process of PRODUCE? distribution. The first is the distribution money incomes can be earned either by doing world for by landing the services of one’s properties such as land, capital and houses. Next step in the distribution process is the sharing of goods and services between different individuals or consumers. We have only indicated here that there are three main methods of solving the basic problems. How these basic problems are solved by a capitalist economy, mixed economy and centrally planned economy socialist economy.