The Economic Problem

The Economic Problem

What is the economic problem?
The economic problem arises because of deficient resources in the midst of endless wants. This is a basic problem faced by every economic agent (individual, business or government). People will always desire to have more goods and services but the resources they possess to meet those wants are insufficient.  In the same vein, businesses cannot pursue all profitable opportunities owing to the scarcity of resources at their disposal. Governments all over the world find it difficult to meet the demands of their citizens for services such as education, healthcare, employment, roads and so on. This is a fundamental problem -resources are scarce, limited or finite while wants are unlimited or infinite.

diagram showing uses of government revenue

Figure 1: Alternative uses of government revenue

What are resources?
Resources are the means of producing the goods and services we desire to have. They have to be combined for productive purposes. Resources, also known as factors of production, are inputs into the production process. There are four types of resources, namely land, capital, enterprise and labour.

Natural resources are referred to as land in economics. Land includes diamond, gold, crude oil, river and forest.  Raw materials are obtained from land and factories can be constructed on it. The human effort, mental and physical, used in production is called labour. The enterprise combines other resources for productive purposes and takes the risk of setting up the business. The machines, tools, factories and equipment made for the purpose of creating other goods and services are known as capital.   

The use of scarce resources requires payments which are rent, interest, profit, wages and salaries.  The cost of using land for production is rent while the reward of an entrepreneur is profit. However, the entrepreneur makes a loss if the venture is unsuccessful. The payment required for the use of man-made resources or capital is interest. And  labour is rewarded with wage or salary.

It is important to note that some resources are available in abundance and, therefore, are free for anyone to use. These resources are referred to as free goods such as air and sunshine.  Scarce resources are referred to as economic goods. Resources such as water, wind, oxygen or solar energy can be replenished and are never exhausted due to regular use. They are called renewable resources. Non-renewable resources cannot be replaced after use e.g. coal, crude oil and natural gas.

Scarcity leads to choice
Scarcity is a problem faced in all societies. The wants and needs of all economic actors will always exceed the available resources. So a choice has to be made since there are alternative ways of using the scarce resources. Choice occurs when some wants are selected for satisfaction based on the resources at the disposal of the decision-maker. The wants selected are usually the more pressing ones from a list known as the scale of preference. People arrange their wants in order of importance in the scale of preference.

Opportunity cost
Choice leads to opportunity cost. The alternative with the highest benefit is chosen by an economic agent. This means that other alternatives have to be given up or sacrificed. The benefit the consumer loses from not choosing the next best alternative is the opportunity cost. For example, a student may have two options in spending his money- buying a shirt or a book. The opportunity cost is the benefit lost from not buying a book if he decides to buy a shirt.