The Economic Problem

Key Terms:


Scarcity: An inadequate amount of something; a shortage. i.e., everything is limited (limited resources).

Economic Goods: Are goods/services that have a price when sold and provide a benefit to society. However, they are scarce.

Free Goods: Goods that are not scare and in excess abundance such as the Earth’s atmosphere.

Poverty: The quality or state of being poor; lack of money as well as any deficiency of elements or resources that are needed.

Firm (Business): A specific commercial enterprise or establishment, that produces an output (goods or services).

Positive Statement: A statement that can be verified by facts.

Normative Statement: A normative statement is one including a value judgement, expressing personal opinions about what ought to be, hence, cannot be tested or verified.

Value Judgement: A judgment of the rightness or wrongness of something, based on a particular set of values or on a particular value system.

Factors of Production: Resources used in the production process, to produce goods and services, the most important four categories are land, labour, capital, and entrepreneurship.

 

What is the Economic Problem?


The world faces a major problem, one known as scarcity. We have various resources which can be used by various people for various uses, and they everyone wants them! This is known as the economic problem simply phrased:


‘Unlimited Wants in the Face of Limited Resources’

If everything in the world was free everyone would simply want everything, hence the notion of economics is to ensure that resources are allocated as efficiently as possible to those who need/use them in the most effective way.


However, it is important to understand the difference between wants and needs. Wants are known as things people would ‘like’ to have and can survive without i.e. I would like a chocolate. Whilst needs are the things that are necessary for survival such as water, food, and air.


Goods that are finite are known as economic goods they usually tend to have a price, whilst some goods are regarded as not scarce and in excess abundance these are known as free goods, an example of this is the Earths atmosphere.


A reason that scarcity plays such as significant role in society is because it forces people to make choices. Every firm, household, and even the government make choices about what goods/services they wish to consume. This leads to them prioritising their needs first and then their wants. Due to this some of their wants will have to be ordered in terms of utility (satisfaction) and they will be forced to make a choice about what they truly want, resulting in them not fully satisfying their wants.


Positive Statements VS. Normative Statements


Every action in economics needs to be viewed in an objective way in order to ensure that biased is reduced and we fully understand the consequences of our actions and their impacts. This is especially important when we have to make so many decisions on a daily basis (due to scarcity). Hence, we need be able to understand and distinguish between normative and positive statements.


Normative statements express a personal opinion, known as a value judgement, about something that should be. This is often not based on facts but rather on beliefs and morals. An example may be whether income tax should be increased, the ´should´ adds room for personal opinion reducing objectivity.


Positive statements are statements based on facts and statistics there is no personal opinion given. Using the previous example, a response to that would be based on the statistics rather than an opinion.


Importance of Scarcity


Scarcity is a very important notion in economics as can be seen, simply due to the fact that it forces people to make decisions, some more difficult than others. However, the impacts these choices have on society are important as its important to understand that not everyone will benefit from them. An example of this may be the government choosing between two areas to invest into better housing or deciding between sectors where more funding needs to be allocated, both these decisions are made due to scarcity and they both have significant impacts on society.


Economics Agents and Their Behaviour


In economics we can identify 3 economics agents that play important roles in the decision-making process: households, firms, and the government.


Households refers to the normal individuals, and families. Households typically make decisions on expenditure, through their demand for good and services. Households also make decisions about how they supply their labour to firms.


Firms, aim to produce (supply) good and services to the consumers (i.e., households). Firms make 3 significant decisions:

  1. What good and services to produce.

  2. How will they be produced?

  3. For whom will it be produced and at what price.

The role of the government is to stimulate economic growth and its other government objectives (discussed in macroeconomics), as well as influence the economy through taxation and regulation of markets. Governments also provide services such as education and public transport.


Objectives of Economic Agents

Economic agents have different objectives that they aim to achieve through their decision making.


Households main objective is utility. Utility refers to the satisfaction someone received from the use of their good/service, for example if you like both hot chocolate and ice-cream and on a hot day you have to pick one you would most likely pick ice cream as it brings you the most satisfaction (utility) since its warm outside. Additionally, households provide their labour in return for wages which they can then use to purchase good and services, hence the end objective is utility however, it is achieved through working.


The main objectives of firms is simple, maximise profits. Firms don’t just produce a good or service simply for the reason of producing it, they produce it to create a profit for themselves.


The government has various objectives; ensuring that economic growth is achieved, keeping unemployment low, maintaining price stability, and keeping a healthy balance of payments are some of the main government objectives.


Evaluation of Economic Agents


So far, we have discussed the importance of scarcity, and how it causes economics agents to make choices. We have also talked about the objectives that these agents aim to achieve through their choices however, that is all correct only if we assume the economic agents will always operate in a rational manner, but do they?


Do households always buy goods and services for utility? In reality not all the time, some households may purchase goods or services that they don’t need/use a good example of this is gym memberships. Furthermore, households may provide their labour for free such as volunteer work and sometimes households donate money as well, all this going against the expected ‘rational’ behaviour.


Firms may also not always act rationally, instead there are non-profit organizations which goes against the typical profit maximisation. Firms may also chose to part-take in donations, volunteering and even sponsoring local events.


Whilst governments aim to make the best rational decisions, political influences may impact these choices leading to misallocation of resources and not always the best choice being taken. This could also happen due to information failure.


Factors of Production


In economics we have four main factors of production, these include both physical and human resources that are involved within the production process. The factors of productions can be regarded as inputs into to the production process to provide and output (goods/services). The four factors of production are:

  • Land – Land as a factor of production in economics is considered the actual land, as well as real-estate and any raw material input.

  • Labour – Labour is the factor of production concerned with human resources; this includes anyone from low skilled labourers to brain surgeons.

  • Capital – Unlike in business capital does not mean money in this scenario. Capital refers to any machinery or tools used in the production process

  • Enterprise – Enterprise is also a human resource and refers to the entrepreneur who manages the entire production process and takes all the risk.

The Rewards That Factor of Production Bring


The factors of production each bring in their own reward in return of there service as can be seen below:


 

References/ Further Reading:

The Economic Problem – Wikipedia - https://en.wikipedia.org/wiki/Economic_problem

Factors of Production – Wikipedia - https://en.wikipedia.org/wiki/Factors_of_production

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