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Research Question: Explain what is meant by the economic problem and its three constituent parts, and critique competing perspectives as to the best type of economic system to encourage businesses to be efficient.
In operating world economies, the general economic problem is that of the scarcity of resources. This typically springs from the belief that the resources like land, labor, capital and other assets are limited and therefore raises the underlying question of how to best utilize these resources to achieve maximum business efficiency in the economic environment. This is in fact one of the fundamental concepts that encompass the operations of existing economic systems (David, 2002). The perception as reflected through the research, study and beliefs of various economists and researchers is that the scarcity of resources is a phenomenon that gives rise to three important aspects primarily the allocation, distribution and production of resources.
The questions hence asked by economists are what to manufacture or produce, how to best allocate resources such as labor, materials and capital to best achieve production efficiency and for what consumers should these goods and services be used. The researchers and economists are therefore striving to find methods and strategies to help solve these core aspects that stem from the basic economic problem of scarcity. The underlying cause of scarcity of resources is related to the unlimited needs and wants of the people. With the evolving concepts and technological trends in modern times, the needs and desires of the people have also increased thereby posing a problem with regards to the use of products and services that require many resources. The allocation, production and distribution efficiency is hence a consideration to ensure that the diverse needs and wants of the people are met and that the resources are utilized in the most appropriate manner to meet allocation and production needs. (Clifford, 1987)
Economists tend to provide solution to the fundamental query:
How to meet unlimited needs and wants with limited resources?
The study reflects that the needs and wants of the people are consistent and unlimited primarily because of the changing trends and patterns of demand related to goods and services. Hence the existing efforts tend to provide solution by prioritizing needs and wants that can be fulfilled focusing on what to manufacture or produce for the consumers. This also entails the concept of Opportunity Cost which is a feasible option apart from the strategy of prioritizing. The concept is related to the fact that we as users of goods and services tend to make choices and therefore will select the most appropriate need to fulfil thus giving something up which in turn results in an opportunity cost. The same is true for enterprises and business organizations that need to make choices and analyze opportunity cost when deciding on the allocation, production and distribution of resources to best meet the market needs and requirements (Hanley et al., 2007)
The needs for basic facilities like food, clothing and shelter are a consistent aspect and therefore fundamental aspect of the economic system too but it is the varying desire and need for non-survival aspects beyond the basic human needs that drive the market economies. Economists hence need to analyze which of these needs are critical to market efficiency, categorize or prioritize these needs and then optimize the production and allocation aspects in order to satisfy these needs focusing on meeting as much needs as possible. The neoclassical belief or school of thought that is usually adopted by many western economies projects the idea that human beings strive for the fulfilment of particular needs and the market tends to provide opportunities to best meet these wants and desires.
According to researchers, wants and needs are classified into two broad categories, individual needs and collective needs where individual needs would be those that are directly related to a person's need or preferences and purchasing power relevance while collective needs are those that map onto an entire group's needs as a whole. The economic problem of scarcity of resources to fulfil these individual and collective wants can therefore be classified into three core aspects, allocation of resources, production of resources and distribution of resources or Pareto efficiency. The allocation of resources and its efficiency in the business environment arises due to lack of resources leading to the complexity of which particular needs to satisfy and what goods and services to produce and in what quantity. The problem can be reflected through the illustration that if a business decides to enhance production of a certain good in order to meet a specific need and demand, it would have to slash resources from the manufacture or production of other services and products since resources are limited (Hanley, 2007).
Markets then have to decide whether to produce capital goods or consumer goods which is the fundamental problem of the allocation of resources. Increasing the production of consumer goods will require withdrawal of resources from the production of capital goods. Economists believe that in the long-run the production of capital or consumer goods will result in the increased production of the other commodity thereby reflecting the importance of both types of goods in the market. The idea is to look for the optimal balance in the production quantities of both the consumer and capital goods.
The second aspect of the economic problem is the production of goods since there are limited resources available and the most optimal use is required to meet specific needs and to derive market efficiency. The production of any good is believed to be efficient when effective resources are utilized in a manner such that the output of any other good is not reduced and more quantity of the same product is not produced in the process by reallocation of resources. Economists consider this to be the distribution efficiency that ensures maximum efficiency in the utilization of resources and production of goods (Illge and Schwarze, 2006).
Resources can be labor-intensive or capital intensive and therefore markets should ensure that the resources are not used inefficiently or wasted focusing on achieving the best use of scarce resources. Economies should consider whether all available resources have been fully utilized in the most efficient manner (Illge and Schwarze, 2006). For example, in capitalism based economic systems, full utilization of available resources is not achieved. The neoclassical framework of Swan and Solow also highlight the concept of economic growth and its relevance to utilization of scarce resources stating the fact that an increase in the production capacity of goods would lead to economic growth and therefore a better standard of living for the people. The third problem relates to the distribution of goods where the market has to decide who to provide the goods and services to.
The economic decision would entail three concepts that reflect allocation efficiency, production efficiency and distribution efficiency to achieve economic environment efficiency. The allocation efficiency relates to the concept that goods produced at prices that are equal to their market price would enable the consumers to enjoy value for money. Production efficiency would also lead to efficiency in the market where the cost of production is low and resources are utilized more efficiently. Efficiency of the distribution would entail the fair and regulated distribution of goods (Robert, 2008).
The question then arises that how do organizations make economic decisions that allow them to operate effectively in the business environment and what economic system best facilitates the resolution of the economic problem? There are primarily four types of market economies operating at the moment in the modern times and each economic system has its own advantages or disadvantages.
The traditional economic system is the conventional method of selling and buying goods or services that conform to the core traditions, beliefs, customs and preferences. There is no surplus profit in such an economic system or market and the resource utilization is often regulated by dominant economies where any surplus is given to an authoritative party or distributed. Such a market is prevalent in third world countries in some areas and contains minimal waste. Such an economy as compared to market based or mixed economy is not appropriate for economic stability (Hanley, 2007)
The centralized control based system is the command economy where government controls the economic decisions and all aspects regarding the allocation, production and distribution of resources and large reserves of the state are managed by this central authority. Such an economy can utilize resources effectively by producing efficient resources and providing goods to consumers at affordable prices. Through effective government regulations resource allocation can be optimized and there is no job shortage reflecting economic stability. It is closer to the Interventionist theory of economics that believes in external intervening to achieve efficiency.
A market economic system is like a free economy that also harbors the concept of Marxism and Socialist economic aspects where core resources are not regulated by the government system including special areas of the economy. Organizations and business firms tend to decide what goods to produce and how to regulate supply and demand. Hence people tend to enjoy luxury goods in controlled resources and the government does not get too powerful only intervening where required to ensure market stability. The Green Concept of market economy tends to focus on ensuring a better environment by regulating aspects of production, allocation and distribution that tend to influence the environment in a negative manner (Illge and Schwarze, 2006)
A mixed economic system is a blend of the market and command economies that tends to include features of both the systems. Some mixed economies are free markets reflecting the neoclassical economic philosophy that opposes government intervention while some economic markets operate as command economies with the government intervening and regulating economic factors through policies and laws. In such an economy, the market is free with specific areas such as education, agriculture and transportation regulated by the state government. The disadvantage of such an economic system is that laws and regulations can make access to markets difficult while providing too much control and authority to the regulating bodies such as the state government (Gemma, 2014).
Markets provide solution of resource allocation efficiency through the rational buying pattern of the consumer and the production patterns of goods and services in response to the fall and rise in products. The consumers use their rational thinking to provide optimum price for the products that conforms to their satisfaction level while the producers tend to increase the production of goods with an increase in price and decrease the production with the fall in prices. Producers sell products to gain profits while taking risks in the process. In this way the resources are allocated that conform to consumer preferences and requirements (Hanley, 2007).
The market trends to contribute to production efficiency in the manner that signifies the concepts of division of labor to match demand for goods and specialization. The prices of goods and services will either fall or rise predicting the demand trends for the commodities hence the supply and demand factors are regulated and serviced through changes in the production capacity. In competing markets the consumers tend to get a diverse range of goods and products as the producers are provided with opportunities to manufacture goods at low costs thus contributing to business and economic growth. In case of a loss the producers tend to leave the market whole a surplus of profit or high profitability margin would result in the introduction of a new producer in the market.
Distribution efficiency is achieved in the market through opportunities that are highly rewarding and based on the purchase power of the individual, hence goods are produced and business operations are conducted without any external intervention. The trend reflects using the lowest possible prices for the goods in the market to maximize profits and increase consumer buying. This capitalism is reflected by the neoclassic economic theory that believes in free markets and no external interventions in making economic decisions.
When there is a market failure or an externality, the government has to intervene in order to facilitate fair trade and economic efficiency. Hanley (2007) explained market failure as a situation where the market does not allocate limited resources efficiently to achieve the best economic flexibility. An externality is also a decision made by a person that can affect others in the market in a positive or negative way leading to a loss of Pareto efficiency in case of a negative externality as explained by Heller (1976). To ensure the best interest of the community and fair trade, the government intervenes by setting rules and regulations such as environmental regulations, taxes, tariffs and ownership rights to control issues like monopoly, under-provision of merit goods, short-term horizon and inequalities of wealth and income.
For example, the emission of pollutants and waste production as a result of manufacturing activity in industries can harm the environment and the community causing air and land pollution. Similarly the selling of cigarettes results in a cost to the healthcare sector affecting smokers and the community. These are negative externalities and must be regulated. Some of the examples of government intervention include:
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