The Economic Problem

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The Economic Problem

Some textbooks make this topic one of their first chapters. After all, what is economics all about if we cannot attempt to solve the economic problem? In the first section below we look at what this problem is all about.

The title of this topic is 'Free market v. command economies'. These are two examples of economic systems that can be used to attempt to solve the economic problem. We will look at the different economic systems in the next Learn-It.

The economic problem is all about scarcity. If every inhabitant of every country in the world had everything they wanted, would there be an economic problem? Would we need economists?

Unfortunately, we tend to have infinite wants, but the resources required to produce these wants are scarce. Hence, decisions have to be made as to how these resources are used, what is produced and how the final products are distributed in the economy.

In the topic called 'Market failure',we introduced the production possibility frontier (PPF). It illustrates the problem of scarcity very well. The frontieris convex to the origin. If an economy is on the PPF it means that all of the economy's resources are being used and they are being used as efficiently as possible. In this situation the economy cannot produce more of one set of goods without sacrificing another set of goods. This is the sacrifice, or opportunity cost.

The Economic Problem

The diagram above shows this opportunity cost on a PPF. Note that any good produced in the economy has to be either military or non-military. The two groups are mutually exclusive. If an economy is at point A, it is producing M1 military goods and NM1 non-military goods. If it were decided that more non-military goods should be produced (a move to point B, for example) there would have to be a sacrifice in terms of military goods. At point B, the economy enjoys NM2 − NM1 extra non-military goods, but at the expense of M1 − M2 military goods. The sacrifice of M1 − M2 military goods is the opportunity cost of making NM2 − NM1 extra non-military goods.

The Economic Problem

The key point here is that a choice has to be made. Whether the economy is at point A or point B, it cannot produce more of both sets of goods (not in the short run, anyway).

The choice of a government at each general election is all about voting for the Political Party that you think will do the best job at making these choices. Almost every day there is something in the news about cuts in spending here and increases in spending there. It's never all good news. If a government spends in one area it has less to spend in another.

At the top of the last section, I touched on three questions that governments(who run economies) have to ask themselves. What will be produced? How will it be produced? For whom will it be produced (or, how should the resulting production be distributed)? You will find these questions in every textbook. The answers to these questions depend on what economic system a government decides to operate. In 'The different economic systems' Learn-It, we look at the choice of economic systems for governments and find out how these three questions are answered when each of the systems is adopted.

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