What Are The Fundamental Economics Problem?
Production, Distribution, and Organization of goods and services are the primary economic activities that accomplish humans’ needs. However, the resources that satisfy human needs are unlimited. This scarcity of resources and vastness of human desires gives birth to the central problems of an economy.
Thus, in this blog, we learn what the fundamental economic problems and solutions for them are.
Let’s discuss some essential points you should know before discussing the fundamental economics problem.
Important Points To Remember
The issue of fundamental economic problems refers to the scarcity of resources and how to produce and distribute these scarce resources.
Scarcity refers to the finite supply of goods and raw materials.
The resources which are limited are known as finite resources.
Unlimited wants states that there is no end in the quantity of goods and services people like to consume.
Because of endless requirements, the consumption of resources is increasing more than the production of resources.
Now, let’s explore the fundamental economics problem.
What are the 3 fundamental economics problems?
The allocation of resources is a problem that an economy faces. The scarce resources create a troublesome situation in the production of goods and services. However, it is essential to allocate resources efficiently to satisfy the needs and resources of humans.
Economic difficulty is one that arises as a result of a lack of resources in making decisions. People have endless needs, but the resources to satisfy those desires are limited. As a result, meeting all human demands with limited resources is challenging.
The decisions taken depend on the three central problems of the economy.
Study the following discussion to learn the above fundamental economics problems.
What to produce?
The economic challenge is the decision to pick the various goods and the amounts that must be produced. There is a scarcity of labor, capital, machinery, land, equipment, and natural resources. As a result, it is difficult to meet every human need. However, it is critical to determine what commodities and services must be produced and in what amounts.
Consumer goods and capital goods are the two types of products created in an economy.
They are further subdivided into single-use products and durable goods.
How to produce?
This problem focuses on selecting techniques that are required to adopt and used in the production of goods and services.
The two majorly used techniques are;
Labour iLabor-intensive Technique (LIT)- This technique is used with the help of a large number of laborers and a small involvement of capital.
Capital Intensive Technique (CIT)- The technique includes more capital involvement and less labor.
For whom to produce?
It is one of the most prevalent and major economic barriers. It determines which goods are produced for different segments of society. For example, while all portions of society require necessary products and services, only a subset of society requires luxury resources. Simply put, resource allocation decisions in an economy are influenced by taste and desire.
the examples of various economics problems?
Consumers
It is one of the most basic examples of what are the fundamental economic problems. Families have scarce assets, and one needs to manage how to use these limited resources. For instance, with an annual salary of £10,000, a family might need to spend £5,000 per year on council tax, rent, and service bills. It remains £5,000 to determine which new clothes, food, transportation, and other assets they need to buy.
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Producers
Producers must create high-demand items while also responding to changing customer needs and purchasing behaviors. They must stay profitable (revenues higher than costs). Producers will need to analyze the best technique to manufacture the items on a regular basis.
Purchasing new machinery, for example, can increase resource productivity. It lets businesses produce things at a low cost. It is critical for international businesses where cutting-edge technology lowers manufacturing costs. Without changing the way they create, a company might become unprofitable. Firms may also need to make long-term expenditures to invest in cutting-edge goods and manufacturing methods.
Government
The government has limited resources, and the amount of taxes that they collect reduces the spending power. The government must decide the methods to get tax and whom this tax can spend on. For instance, the government may need to cut profits on low-income individuals to improve incentives to work. However, lowering goods will enhance differences and relative poverty. This can be a significant point to analyze the things about the fundamental economics problem.
Solutions to the Basic fundamental Economics Problems
Unequal distribution of natural resources stops the production of goods and services in an economy. Every economy has to face the problems of what to produce, how to produce, and from whom to produce. Overall, all economics uses two main methods to solve these basic problems. Those methods are:
(i) Free Price Mechanism
(ii) Controlled Price System or State Intervention
Price mechanism refers to the system of managing and organizing the decisions of every person in an economy. It took decisions through the prices decided with the help of free play of the market forces of demand and supply.
The cost of goods and services is decided when the quantity demanded becomes similar to the quantity supplied. Price mechanism facilitates determination of resources allocation and factor incomes, level of savings, consumption, and production.
On the contrary, a Controlled price system or state intervention refers to fixing goods and services prices. The government plays a vital role in deciding the cost of goods and services. The government may include a ‘Ceiling Price’ or ‘floor Price’ policy to control prices.
The importance of studying economics
So, what is the point of studying economics? Here are five reasons why economics is crucial to study.
It influences decisions.
Economists give data and projections to help businesses and governments make choices. This economic understanding—or economic intelligence—is based on data and modeling.
Everything is affected.
Economic difficulties have an impact on our daily lives. This surrounds taxation and inflation; interest rates and wealth; inequality and developing markets; and energy and the environment. Economics, as a broad discipline, gives solutions to a variety of health, social, and political challenges that affect households and larger groups.
Industries are affected.
Firms of all sizes and sectors must rely on economics, whether for product creation, pricing tactics, or determining how to promote. Because of its broad effect, studying economics may lead to a wide range of job opportunities in all areas of the economy, from agriculture to manufacturing to banking and consulting.
Encourages business success.
Understanding how customers act is important for a company’s success. Theories and models are used by economists to forecast behavior and inform business plans. For instance, how to analyze “big data.”
Conclusion
In this article, we have included details about what are the fundamental economics problem. This post has also explained the three different kinds of issues that are essential to determine the economic value of the market. Understanding these parameters, one can decide the major solutions to improve economic conditions. Capitalization can be utilized for the improvement of economic problems within the market.
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FAQs
1. Who is the father of economics?
Answer: Adam Smith is renowned as the father of the latest economists. He was an 18th-century Scottish economist, philosopher, and poet. He is the most famous for his 1776 book, “The Wealth Of Nations.”
2. What is the main cause of all economic problems?
Answer: Goods and services that satisfy human wants are produced with the help of resources such as land, labor, and enterprise. These resources are scarce. An economy cannot deliver all the goods and services as demanded by its citizens.
Methods of Economic Analysis
Economic analysis is the process of assessment or examination of any particular topic or issue to understand how they are affecting the organization or system. This process of analysis comprises administering and operationalizing a comprehensive and holistic study of various processes such as production, consumption, consumer behavior, national income, employment, and others. It studies and estimates the topic in detail with all the aspects associated with the industry concerned.
Moreover, the main objective of economic analysis is to observe the findings like productivity, efficiency, and effectiveness of ongoing functions within an economy.
There are two prominent types of methods of economic study or analysis:
A) Deductive Method B) Inductive Method.
Deductive method :
The Deductive Method is also known as the ‘ Analytical Method’ or ‘ Abstract Method ‘ or ‘ Priori Method ’ or ‘ Hypothetical Method ’.
is also known as the ‘ or ‘ ‘ or ‘ ’ or ‘ ’. In this method, the study starts by assuming factual information or rudimentary facts and then arriving at a concrete result or conclusion by following logical reasoning or analytical abilities. In this method, a theory is built on the basis of certain assumptions and experiments.
Hence in a nutshell we can say that in this method we start our study from a general assumption and conclude our analysis with specific objects, which means we go from general to specific.
Therefore, the common rule to remember in the case of deductive methods is to move from general inputs to a particular assumption and, eventually, constructive theories.
Stages involved in Deductive methodology :
Three stages or phases are recognized in the Deductive method :
1. Observation of the given topic
2. Making hypotheses using Logical reasoning
3. Experimentation of the hypothesis through more similar observations.
Ricardo, Senior, J S Mill, Malthus, Marshall, and Pigou used the Deductive method for their hypothesis.
Advantages of the Deductive method :
Simple and convenient : This method is observation based and is fairly easy to practice.
: This method is observation based and is fairly easy to practice. Avoids the necessity of experimentation: Experiments are essential and indispensable in subjects like physics, chemistry, etc unlike in the case of economics where the method works as an alternative to experiments.
Demerits of deductive reasoning :
Based on assumptions : There is a higher chance of going inaccurate conclusions leading to invalid predictions.
: There is a higher chance of going inaccurate conclusions leading to invalid predictions. Unrealistic approach: The method works on the basis general to specific using imagination of including all under the same umbrella, hence real-life problems cannot be solved by imaginative or utopic solutions.
Inductive method :
In this method, analysts or theorists advance from a practical outlook to a scientific problem in order to be more accurate in finding the most accurate solution using theoretical knowledge and practical applications.
The Induction method is processed in two forms,
a) Statistics
b) Experimentation.
a) Statistics b) Experimentation. This method is basically observed with statistical forms of investigations. It involves a lot of facts including numbers, quantities, and formal terms.
Advantages of the inductive method :
More pragmatic : It is a very practical and applicable method, and it is simply descriptive.
: It is a very practical and applicable method, and it is simply descriptive. More Accurate: It is subject to verification a number of times as it is based upon facts and statistics.
Laws and theories under the inductive method may not be universal but are condition specific.
Demerits of the inductive method :
If in case the analysts or theorists do not possess a balanced and stable judgment, then this method is unhelpful as they will be extracting insufficient data.
Unavailability of facts: since this method works upon the facts and their experimentation, it is often difficult to collect primary data and facts and their access for experiments.
The Inductive method is an incomplete method alone. It can be used if combined with deductive methods or deductive reasoning.
Deductive method vs Inductive method :
Basis Deductive Method Inductive Method Origin Used by those believing in classical theories Used by those who believe in Neo-classical Theories Technique Abstract Practical Other names Analytical, Prior, or Abstract Method Historical, Empirical, or Posterior Method Procedure Facts are followed by Logical Reasoning Practical Scenario to Scientific Techniques Scope Works under the Social Science Model Works under the Science Model Application Universal Situation Specific Results Confirmation of the Making of the Hypothesis Generalized Results Structure Highly Structured Method Less Structured
Therefore, it was not wrong, when in the past, there was a debate and some differences among economists over the best method between the deductive method and the inductive method of economic analysis. But in the present scenario, economists feel that both induction and deduction are necessary for the most appropriate observation, just as the right and the left, both eyes are essential for appropriate sight.
Economics: Methods, Types and Models
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Economics: Methods, Types and Models!
Methods:
The usual methods of scientific studies — deduction and induction, are available to the economist.
Both methods come from science, viz., Logic. The deductive method involves reasoning from a few fundamental propositions, the truth of which is assumed. The inductive method involves collection of facts, drawing conclusions from them and testing the conclusions by other facts.
Deduction and Induction:
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Deduction:
i. Starts from the general and moves to the particular.
ii. Begins with general assumptions and moves to particular conclusions.
iii. Develops a theory, and then examines the facts to see if they follow the theory.
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Example:
Let there be 360 degrees in circle – (A general assumption)
There are four right angles in circle – (A logical argument)
Therefore this right angle has 90 degrees – (A particular conclusion)
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Induction:
i. Starts from the particular and moves to the general.
ii. Begins with particular observations and moves to general explanations.
iii. Collects observations, then develops a theory to fit the facts.
Example:
This apple falls to the ground. (A particular observation)
All apples fall to the ground. (More observations)
All objects attract each other. (A general explanation)
Economics can be a very deductive subject, and economists are used to constructing complicated ‘models’ of human behaviour which begin with a number of assumptions. However, economics is also an empirical subject, using inductive methods to explain observed facts.
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Thus the downward sloping demand curve, for example, can be deduced from general assumptions about how people try to maximise their satisfaction from the purchase of goods and services. On the other hand, demand curves can be built up empirically, that is by observing actual customers reacting to market price changes, and when market researchers, census-takers and opinion pollsters collect necessary information, the data can be used inductively to make economic predictions.
In practice it can be very difficult to say where deduction ends and induction begins. Economists need to use both deduction and induction in their work.
Positive and Normative Economics:
Some economics textbooks begin by distinguishing between positive and normative economics. Positive economics deals with what is with objective explanations of the working of the economy. Normative economics is about what ought to be it puts forward views based on personal value judgments. Thus, positive economics deals with questions which, in principle at least, are testable.
Similarly, ‘A tax on a good will raise its price’ and ‘Business people will invest more when interest rates are low’, are positive statements about economics. Normative statements would include ‘the Governments ought to give more pensions to retired people in poor countries’, and ‘Unemployment is a more serious problem than inflation’.
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Positive statements and questions
Examples: ‘Amitabh Bachchan is a Hindi actor’;
‘Is this table made of wood?’
These statements/questions
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i. Deal with objective reality;
ii. Tell us something about the world around us;
iii. Can, in principle, be ‘true’ or ‘false’?
Even if we do not yet have the means to do so (e.g. to prove whether there is intelligent life in space), proof is ultimately possible using methods upon which everyone can agree.
Normative statements and questions:
Examples:
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‘Amitabh Bachchan is the best Hindi actor since ‘Dilip Kumar’. ‘Is this a beautiful table?’
These statements/questions.
i. Deal with subjective opinions;
ii. Tell us something about people’s view of the world, rather than the world itself; they are about values, attitudes or tastes;
iii. Cannot be proved true or false.
They can never be fully resolved because they often depend on moral attitudes (e.g., while most people would agree that Hitler was evil there are some persons who claim the opposite).
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Positive economics is the study of economic propositions which can be verified, at least in principle, by the observation of real-world events, and without using normative propositions or value judgments. Normative propositions tend to be prescriptive, and tell us what the person making the proposition believes ought to be done. In practice, the distinction between positive and normative economics is blurred. It is possible to put forward economic propositions which appear to be positive, but, in fact, rest upon value judgments.
Since Nobel Prize has been awarded to a number of economists doing work in the area of welfare economics, the subject has attracted considerable interest to students of economics in recent years. So, it is necessary to know what is meant by welfare economics.
Economics is often divided into two branches — positive and normative. Normative economics is often called welfare economics. The first book on the subject was written by A.C. Pigou. The name of his book is The Economics of Welfare (1920).
Theme:
Welfare economics is concerned with comparing one state of the economy with another on the basis of value judgments (or ethical considerations) and suggesting some criteria for improving social welfare. Thus, welfare economics deals mainly with normative and ethical issues relating to social choice and individual values.
Purpose:
The purpose of welfare economics is to explain how a society efficient allocation of resources can be identified and achieved. Pigou assumed measurable and inter-personal comparison of utility. According to him, any transfer of income from a relatively rich man to a poor person of the same nature (and temperament) implies an increase in social welfare (or the aggregate sum of satisfaction). This is because income transfer enables more intense wants to be satisfied at the expense of less intense wants.
Modern Version:
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Modern welfare economics is based on Vilfredo Pareto’s principles of excluding interpersonal comparison of utility. No doubt, Pareto’s writing appeared earlier than Pigou’s book (which first appeared in 1912 as Wealth and Welfare). But they were popularised in England in 1913.
According to Pareto (an Italian economist), total economic welfare is the sum of individual welfare. But one individual’s welfare cannot be compared with that of another individual. So inter-personal comparisons are ruled out. Thus, only those policies that make at least one person better-off without making anyone else worse-off are considered to increase total welfare. Thus, if a million people are made substantially better-off and one individual make slightly worse-off by a policy, the policy does not increase welfare by Pareto’s definition.
However, the Pareto criterion has been severely criticised over the years. Bergeson, Samuelson, Kaldor, Scitovsky, Arrow and above all, Amartya Sen have suggested alternative criteria of welfare maximisation.
In a broad sense, welfare economics studies both positive and normative questions. The notion of ‘best in economics’ involves considerations of efficiency and equity.
Economic Models:
An economic model is a simplification of reality which abstracts from the complexities of the real world in order to explain economic phenomena and to make predictions.
Models can be expressed in various ways. The most obvious is to use words; most of the economic models are verbal models. They can also be expressed diagrammatically. Any model is a considerable simplification of reality.
Testing Models:
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In order to use models we usually have to be able to quantify the variables involved. In principle this may seem an easy task, is practice it is quite difficult.
Evaluating Theories:
Theories can never be proved correct because it is not possible to check a theory against every possible observation.
From this viewpoint, a good theory is one that makes wide ranging claims which can be tested, while leaving itself open to falsification.