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THE BASIC ECONOMIC PROBLEM

Business activity involves satisfying consumers’ needs and wants. Businesses aim to satisfy these wants and needs by producing goods and services. When food is produced or a bus service is provided, resources (land, labour, capital and enterprise) are used up. These resources are scarce relative to needs and wants. In other words, these are not enough resources to satisfy all consumers’ needs and wants. This is known as the BASIC ECONOMIC PROBLEM. This means businesses, individuals and the government must make choices when allocating scarce resources between different uses. For example, a printer may have to choose whether to buy a new printing press to improve quality or some new computer software to improve administrative efficiency.

Economics is the study of how resources are allocated in situations where they have different uses. The choices faced by decision makers can be placed in order of preference. For example, a business may be considering three investment options but can only afford one. The decision makers might decide that the order is:

1. a new computer system;

2. a fleet of cars for the sales force;

3. a warehouse extension.

The business will allocate resources to the purchase of the new computer system. The other two options are foregone or given up. The benefit lost from the next best alternative is called the OPPORTUNITY COST of the choice. In this example it would be the benefit lost by not having a fleet of new cars.

What is an economy? An ECONOMY is a system which attempts to solve the basic economic problem. In the national economy the resources in a country are changed by business activity into goods and services which are bought by individuals. In a household economy the family budget is spent on a range of goods and services.

Local and international economies also act in the same way, but at different levels. The function of an economy is to allocate scarce resources amongst unlimited wants. The basic economic problem is often broken down into three questions.

§ What should be produced?In developed economies the number of goods and services produced from resources is immense. The economic system must decide which resources will be used to produce which products. For example, what proportion of resources should be used to produce food, housing, cars, cigarettes, cosmetics or computers? Should resources be used for military purposes? Should resources be used to generate wealth for the future? In less developed countries the decision about what to produce may be simpler. This is because the choices available are limited. For example, a very poor African village might be faced with the decision whether to produce wheat or maize. However, this is still a question about resource allocation and what to produce.

§ How should it be produced?The way in which goods and services are produced can vary. Decisions have to be made about such things as where production will take place, the method of production and the materials and labour that will be used.

§ For whom should it be produced? An economy has to determine how the final goods and services will be allocated amongst competing groups. For example, how much should go to students, should the unemployed receive a share of output, should Ethiopia receive a proportion of total UK output, should managers get more than workers?

How the above questions are answered will depend on the type of economic system. It is usual to explain how resources are allocated in three types of economy – the free market economy, the planned economy and the mixed economy. The way business activity is organized will be different in each of these systems.

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