There are basic economic problems every economy faces. Definitely, there will be the availability of limited resources. Human wants are insatiable that’s one of the reasons scarcity arises. Let’s assume that there are more than enough resources, the economic problem would not probably arise.
But the study of economics makes us understand that there will always be basic economic problems every country wants to solve.
With the effective application of economic solutions to problems, the living standard of people can be improved.
What are the basic economic problems?
The fundamental economic problems every economy and society encounter are:
- What to produce
- How to produce
- For whom produce
- Efficiency of resource use
- Instability and unemployment
What To Produce
This has to do with confronting the problem of resource allocation. It’s important to set priorities since we can not have everything despite our insatiable wants.
This way, we must make a decision on what to produce. As earlier pointed out, economic resources are limited, hence the available ones have to be allocated in such a way that they would meet society’s needs.
As such, what should be produced depends on the needs and wants of the people. How to provide a solution to the problem of “what to produce” is approached differently in:
Socialist system
Capitalist system
Socialist system
In a socialist system whereby private property belong to the state and the state’s central authority controls and directs resource allocation.
The state decides on the nature and quantity of goods and services to be produced. This is achieved through the estimation of the wants and needs of the people.
Capitalist system
In a capitalist system, the market forces of demand and supply and the free choice of consumers and producers determine how resources should be allocated and what should be produced.
How To Produce
What techniques should be applied in production? Having identified what to produce and for whom to produce, it’s imperative to know how to implement production.
Questions like:
What are the available methods?
How should the methods be employed?
Which method is most cost-effective to achieve the desired result?
For instance, a country like Nigeria which has abundant crude oil and gas faces the problem of how to refine it into a usable product.
It was Alhaji Dangote owner of the Dangote refinery who was able to solve the problem which is going to cut reliance on foreign refineries.
It is very important to point out that the decision of on which method to use for production should depend on the prevailing circumstances in each country.
This is definitely a problem of distribution. How will the produced goods be distributed? Should everyone have an equal share of social income?
For instance, to site a beer brewery in a country that is guided by Shariah Law may be a wasted resource e.g Northern Nigeria where beer products worth billions of Naira had been destroyed because of Shariah.
For Whom To Produce
Above all, for whom to produce is a fundamental problem of every society. For whom to produce, what to produce, are largely determined by the price system.
Efficiency Of Resource Use
In relation to economics, efficiency involves making the choices that will give the greatest possible degree of satisfaction.
Efficiency is the goal of getting the most out of productive efforts. This can be divided into two: 1) allocative efficiency, 2) technical efficiency.
The efficiency of resource use is one of the economic problems every society faces because there must be efficiency in the organisation and management of resources in order to achieve the set target in production.
This is measured in terms of the value of the commodities produced and the value of the inputs or resources used in producing them.
Instability and Unemployment
Economic instability and high unemployment rate are prevailing problems confronting many economies around the world, especially in poorly managed economies.
Inflation, especially hyperinflation, if not controlled, may lead to an economic crisis while poor monetary policies could wreck an economy.
Unemployment could fuel social vices and social disorder as can be seen in Nigeria. At the time of publication (Monday, March 28, 2022), youth unemployment in Nigeria stood at 42.5 per cent
In the United States, youth unemployment stood at 8.3 per cent as of February 2022, according to tradingeconomics.com, that a huge difference between the U.S. and Nigeria.
In Nigeria, many graduates can not find jobs. Most of them remained unemployed for several years.
Recap:
Every economy faces five basic economic problems, though new problems are emerging, they still revolve around the ones listed above. It is expected of a responsible government to provide solutions to any economic problem.
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The fundamental economic problem is the issue of scarcity but unlimited wants. Scarcity implies there is only a limited quantity of resources, e.g. finite fossil fuels. Because of scarcity, there is a constant opportunity cost – if you use resources to consume one good, you cannot consume another. Therefore, an underlying feature of economics is concerned with dealing how to allocate resources in society to make the most efficient and fair use of resources. The main issues are:
- What to produce?
- How to produce?
- For whom to produce?
Examples of economic problems include
Video summary
Micro economic problems
1. The problem of externalities
The economic problem of pollution
One of the most frequent problems is that economic decisions can have external effects on other people not involved in the transaction. For example, if you produce power from coal, the pollution affects people all over the world (acid rain, global warming). This is a particular problem because we cannot rely on the free market to provide the most efficient outcome. If we create negative externalities, we don’t take them into account when deciding how much to consume. This is why we can get overconsumption of driving a car into a city centre at peak hour. If everyone maximises their utility, it doesn’t lead to the most efficient outcome – but gridlock and wasted resources.
Externalities, usually need some kind of government intervention. For example, taxes on negative externalities (e.g. sugar tax) or subsidies on positive externalities (e.g. free public education) even banning cars in city centres.
But, even the solution to market failure (e.g. taxes), creates its own potential problems, such as how much to tax? will there be tax evasion? The administration costs of collecting tax.
Environmental issues
Economics is traditionally concerned with utility maximisation – allowing individuals to aim at increasing their economic welfare. However, this can ignore long-term considerations of environmental sustainability. If we have over-consumption in this century, it could cause serious problems for future generations – e.g. global warming, loss of non-renewable resources. The difficulty is that the price mechanism doesn’t take into account these future costs, and policies to reduce consumption may prove politically unpopular.
– How to deal with potential future environmental costs?
Monopoly
Monopoly was an economic problem that Adam Smith was concerned about in his influential book of economics “A Wealth of Nations.” For various reasons firms can gain monopoly power – and therefore the ability to set high prices to consumers. Given a lack of alternatives, monopolies can make high profits at the expense of consumers, causing inequality within society. Monopoly power can also be seen through monopsony employers who pay lower wages to their workers.
How to deal with the problem of monopoly? – A government may seek to encourage competition, e.g. rail franchising, or price regulation to prevent excessive prices.
Inequality/poverty
This shows that 10% of the world population still live on below $1.90 a day – though the figure has reduced in past three decades.
Inequality is considered a problem because of normative opinions such as – it is an unfair distribution of resources. Also, you could argue there is a diminishing marginal utility of wealth. If all wealth is owned by a small percentage of the population, this reduces net welfare. Redistributing the money to the very poor would enable a greater net utility to society.
Five of the world’s largest companies Apple, Microsoft, Alphabet, Cisco and Oracle, have a total of $504bn cash savings (2015) This is money unused, whilst people around the world have insufficient food.
Inequality is a problem. However, it is also a problem to know how much we should seek to reduce poverty. Many will agree on the necessity of reducing absolute poverty – but how far should we take it? Should we aim for perfect equality (Communism) or should we aim for equality of opportunity?
Another issue with reducing poverty is that measures to reduce poverty may cause unintended consequences – e.g. higher income tax on high earners may create disincentives to work. Giving benefits to the low paid may reduce incentives to work.
Volatile prices
Some agricultural markets can have volatile prices. A glut in supply can be bad news because the fall in price can lead to lower revenue for farmers. It could even cause some to go out of business because of a bad year. These volatile markets can cause swings in economic fortunes.
Irrational behaviour
In some asset markets, we have seen volatile prices exacerbated by irrational exuberance. Consumers have often been caught up in a market frenzy – hoping that rising prices will make them richer – and expecting prices to keep rising. We can see this in issues such as tulip mania, the South Sea Bubble, railway mania, and the recent property bubbles.
Macroeconomic problems
Mass unemployment 1933
Unemployment has been a major economic problem in advanced economies. One of the principal causes of unemployment is swings in the business cycle. A fall in demand for goods during a recession, causes people to be laid off. Because of the depressed state of the economy, there is an imbalance between demand and supply of workers.
Unemployment can also be caused by rapid changes in labour markets, for examples, unskilled workers unable to gain employment in a high tech economy. Unemployment is a problem because it is a waste of resources, but more importantly, it leads to very high personal costs, such as stress, alienation, low income and feelings of failure.
Recession
A recession is a period of negative economic growth – a decline in the size of the economy. It exacerbates problems of inequality and unemployment. A problem of recession is that it can create a negative spiral. When demand falls, firms lay off workers. The unemployed have less money to spend causing further falls in demand.
In the great depression, unemployment rose to over 20% – the unemployed also had little support and relied on soup kitchens.
Inflation
High inflation can be a serious problem if prices rise faster than wages and nominal interest rates. In periods of rapidly rising prices, people with savings will see a decline in their real wealth. If prices rise faster than wages, then people’s spending power will decline. Also, rapidly rising prices creates confusion and uncertainty and can cause firms to cut back on investment and spending.
Countries which have experienced hyperinflation, have seen it as a very traumatic period because all the economic certainty is washed away, leaving people without any certainty. Hyper inflation can cause not just economic turmoil but political turmoil as people lose confidence in the economic situation of the economy.
Balance of payments/current account deficit
A current account deficit on the balance of payments means an economy is importing more goods and services than it is exporting. To finance this current account deficit, they need a surplus on the financial/capital account. For many modern economies, a small current account deficit is not a problem. However, some developing economies have experienced a balance of payments crisis – where the large deficit has to be financed by borrowing, and this situation usually leads to a rapid devaluation of the currency. But, this devaluation increases the price of imports, reduces living standards and causes inflation.
Exchange rate volatility
In some cases, the exchange rate can cause economic problems. For example, countries in the Euro were not able to change the value of their currency against other Eurozone members. Because countries like Greece and Portugal had higher inflation rates, they became uncompetitive. Exports fell, and they developed a large current account deficit. The overvalued exchange rate caused a fall in economic growth.
On the other hand, a rapid devaluation can cause different problems. For example, when the price of oil fell, oil exporting countries saw a decline in export revenues, leading to a fall in the value of the currency. A rapid devaluation causes the price of imports to rise and causes both higher inflation and lower growth. A difficult problem for policymakers to deal with.
Development economics
Developing economies face similar economic problems, but any issue is magnified by low GDP and high levels of poverty. For example, unemployment in a developing economy is more serious because there is unlikely to be any government insurance to give a minimum standard of living.
Poverty cycle. Some developing economies may be stuck in a poverty trap. Low growth and low saving ratios lead to low levels of investment and therefore low economic growth. This low growth and poverty cause the low savings and investment to be continued.
More examples
- Problems facing UK economy in 2015
- Economic problems of EU
Last updated: 17th November 2019, Tejvan Pettinger, www.economicshelp.org, Oxford, UK