What is the 'Basic Economic Problem'- (30%)

How does the market mechanism address the 'Basic Economic Problem'- (70%)

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Introduction

The basic economic problem is the scarcity of resources. People want more than can
be met with their available resources. The human needs are unlimited because they
grow and evolve while the means of fulfilling the needs (financial assets) are limited
(Stiglitz 1992: 48). The effort to overcome the relative lack of goods, in other words,
to solve the economic problem is the basis of the economic activity of people. If the
satisfaction of a need does not have a shortage of the appropriate resource, the action
for the acquisition of this instrument is not classified as economic (Drazen 2000:12).
The effort, for example, for inhalation of air lacks is not an economic action because
the air is in abundance.

The economic goods, of course, are not created on their own. It is the result of
people’s effort that uses whatever is available to them, to create resources that meet
their needs, i.e. the goods. The elements that are necessary for the creation of goods
are called productive assets. Consequently, when it is said that economic goods are in
relative scarcity or shortage, in fact, it is meant that there is a scarcity of productive
assets (nature/land, labor, capital). For example, land cannot be further expanded
since its size is limited.
The problem of scarcity of resources has as a result the allocation of resources. In
other words, it is the process of the selection of needs to be met and the amount of
resources used to meet them.
Thus economics is a social science, which deals with how society allocates scarce
resources among unlimited wants and needs (Drazen 2000:21).
The question that arises is how people allocate scarce resources to get the most value.

Scarcity of production assets

The scarcity of the asset “nature” is obvious because the land is limited in size and
productive forces. It cannot be expanded and the amount of food produced cannot
exceed the production capabilities of the land.
The scarcity of the asset “labor” is due to the limited number of people able to work
(not all people can work e.g. elder, handicapped, children)and to the fact that each

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person can only work a certain number of hours a day since people need to sleep and
eat.
The asset “capital” is the result of nature and labor, and since these are in scarcity,
capital will also be in scarcity. People can work certain hours therefore the amount of
capital produced is limited to these hours.

The Basic Economic Problem and the Market mechanism

The above mentioned definition is in many introduction to economic theory manuals.

It conceals through a non historical generalization, the fact that the main body of
economic science has dealt with the analysis of capitalist societies, which are
characterized, on the one hand, by the private ownership of the means of production
and unequal power relations between wage labor and capital and on the other from
freedom of entrepreneurial activity and the competition of capital assets in the market
(Persson and Tabellini 2000:66).
According to the orthodox economic analysis, the scarcity (= failure, lack of) of
resources in relation to social needs, forces each society to choose which products
should be produced and in what quantities (Gough 1979:120).
Moreover, the scarcity of resources (shortage of nature, labor and capital) means that
the production of a particular product has costs in the form of other goods and
services that could be produced in its place with the same resources spent for its
production. For example, the working time and the machines that are used for car
production cannot be used for the construction of schools.
The cost of producing a product, defined as the equivalent of the cost of
products that could be produced alternatively in its place, is called opportunity cost.
For example, if people decide to produce cars, the cost of the cars is equivalent to
what it could be produced instead of cars e.g. clothes. Each product has an
opportunity cost only when social resources are fully utilized (Barr 1998:77). When
there are idle production assets, that means productive resources are underemployed
(unemployment or incomplete use of existing machines), then the production of a
product has zero opportunity cost because it does not deprive already productive
resources form the production of other products (Le Grand et al. 1992:75)

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The scarcity of resources and the opportunity cost impose the non-wasting of
resources to maximize production, consumption and hence social welfare. This is
achieved on the one hand through the harmonization of the allocation of resources
among productive uses of the social needs and preferences, and on the other through
the savings of resources during the production of goods (Gough 1979:54). So, the
society avoids to produce useless products that nobody wants to consume or produce
useful products but with more resources than those that it could use if it combined
them better.

The avoidance of the waste of the productive resources of society through a

continuous effort of their saving and comprehensive utilization is related to the
concept of economic efficiency (Staniland 1985:122). An economy is effective when
it does not waste its limited resources by producing useless products when it
maximizes the produced goods by ensuring their full use and their excellent
combination. Because the capitalist system has as structural component
unemployment and periodic phases of overproduction or underemployment of
resources, it suffers from permanent economic inefficiency (Barr 1998:75).
A social system to be cost effective is an important achievement, because it
maximizes the production and consumption abilities of the society and hence social
welfare. But a cost-effective social system is not necessarily fair, because social
welfare can be unequally distributed among members of society. The wealth of some
people can coexist with the poverty of others.
The methods of analysis of the economists can be used to evaluate the different modes
of economic organization in achieving both efficiency and equity, as well as to
evaluate other objectives such as the promotion of consumer choices and social
solidarity (Persson and Tabellini 2000:234). Although, as mentioned above, the
determination of social goals is the result of the ideological and political
confrontation, economic argumentation can contribute significantly to the process of
clarifying objectives and options.

Generally in capitalist societies, it is possible to have a relation of a reverse

ratio between the objectives of economic efficiency and social justice. This is due to
the fact that when the employees and other social classes and strata achieve
redistribution of income to their benefit, then it is possible that the profit rate may fall,

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and as a consequence the amount of investment is reduced and the rate of product
slows down. So the efficiency of the economy may be reduced as a result of the
redistribution of income, although the latter contributes to achieving social justice
(Oatley and Silver 2003:210).

In summary, it can be said that social welfare that is based on the satisfaction of social
needs through consumption depends on :

➢ the harmonization of social preferences for product consumption with the

allocation of social resources in their production,
➢ the effective use of resources in goods production
➢ the fair distribution of income and the fair distribution of wealth, which ensure that
social welfare is distributed equitably among all members of society (Phelps
1985:42).
The harmonization of social preferences for product consumption with the distribution
of social resources for their production and the efficient use of resources in the
production of goods, refer directly to the goal of economic efficiency whereas the
equitable distribution of income and the equitable distribution of wealth refer to social
justice (Stiglitz 1992:95). The two objectives may conflict in capitalist societies.

Conclusion

The economic problem is a permanent problem for human societies. In the immediate
future there is neither a limitation of the needs nor a substantial increase in the
resources to satisfy needs. On the contrary, as the pessimistic scholars support the
economic problem will become more intense.
This forecast is based on three elements: 1) the continuous increase in world
population, 2) the depletion of energy sources and 3) the negative effects of the
production of many products in the natural environment e.g. contamination of rivers,
etc. (Staniland 1985:84).
But along with such bleak prospects there is the evolution of technology and the
possibility to find new energy sources that tend to dampen the intensity of the
economic problem. However, to the degree that developments can be predicted, the
basic economic problem seems to be permanent.

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Reference List

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Barr, N. 1998. The Economics of the Welfare State, Oxford University Press.
Drazen, A. 2000. Political Economy in Macroeconomics. Princeton.
Gough, I. 1979. The Political Economy of the Welfare State. Macmillan.
Le Grand, J., Propper, L. and Robinson, R. 1992. The Economics of Social Problems,
Macmillan.
Oatley, T. and Silver, M. 2003. International Political Economy:
Interests and
Institutions in the Global Economy, Harlow: Pearson.
Persson, T. and Tabellini, G. 2000. Political Economics: Explaining
Economic Policy. MIT Press.
Phelps, E.S.1985. Political Economy: An Introductory Text. New York:
WW Norto.
Staniland, M. 1985. What is Political Economy? A Study of Social
Theory and Underdevelopment. Yale.
Stiglitz, J. 1992. The Economics of the Public Sector. Oxford University Press.