BASIC ECONOMIC

PROBLEMS AND HOW

APPLIED ECONOMICS
SOLVES ECONOMIC
PROBLEMS
LESSON 3
 OBJECTIVES:

Specifically, this module will help you to:

1. identify the basic economic problems
2. illustrate how applied economics can be used to
solve economic problems
3. construct framework to solve the economic problem
4. solve problems on economic activities
 INTRODUCTION

In the article of Forbes Custom (2017), The Philippines:

Asia’s New Economic Powerhouse, the Philippine economy has
transformed into one of Asia’s most dynamic economies on the
back of fast-paced Gross Domestic Product (GDP) growth.
(www.forbes.com).
 INTRODUCTION

For the longest time, it has all the opportunities to sustain its
growth and stability. However, due to the problem on pandemic,
at present, it is suffering from economic depression. The issue of
scarcity on supply due to limited resources, but unlimited wants,
is the ultimate economic problem. Scarcity implies a limited
quantity of resources needed in production.
 INTRODUCTION

Guru, S. (2020) mentioned, the main issues on production

include the products to produce; how to produce these products
and for whom to produce the products and how to make the
economy grow. Economics, therefore, is concerned with the
allocation of resources to make the most efficient use of these
resources.
 THE FOUR BASIC ECONOMIC PROBLEMS

In the article of Guru, S. (2020) Basic Central Problems

Faced by an Economy, there are basic problems common to all
economies. In terms of production, common to all countries is the
problem on scarcity. This arises because the resources are limited
and have alternative uses. This problem gives rise to four basic
problems of an economy.
 THE FOUR BASIC ECONOMIC PROBLEMS

In this topic, we will look into these basic problems of what

to produce, whom to produce, how to produce and what
provisions on production for economic growth. As we said earlier,
economics can be a tool to solve these economic problems.
Economists formulate strategic solutions to economize the
problems such as economic growth or the ability to produce
goods and services, reduce expectation or the ability to reduce our
wants such as lessening consumption, and improve the use of
resources or the capacity to use our existing resources wisely.
THE FOUR BASIC ECONOMIC PROBLEMS
 THE FOUR BASIC ECONOMIC PROBLEMS

The four basic economic problems or central problems faced by

an economy are as follows:
1. What to produce?
2. How to produce?
3. For whom to produce?
4. What Provision (if any) is made for economic growth?
 1. WHAT TO PRODUCE?

This implies that society has to decide which goods and in

what quantities are to be.
Further, an important choice about the production of goods
and resource allocation is to decide about what amounts of
consumer goods and capital goods are to be produced. As shall be
made clear later, this decision about the allocation of resources
between consumer goods and capital goods is of crucial
importance from the point of view of economic growth.
 1. WHAT TO PRODUCE?

Society has to decide not only the relative amounts of

consumer and capital goods to be produced but it has also to
determine the specific quantity of each type of capital good and
each type of consumer goods. More generally, in answering the
question what goods shall be produced, society would have to
choose somehow or other among scores of goods such as cars,
hospitals, schools, houses, radios, televisions, nuclear bombs,
wheat , rice, cloth, machinery, steel, soap, lipsticks, terylene,
nylon, etc. But this decision is only half the battle.
 1. WHAT TO PRODUCE?

Once society has decided which goods shall be produced, it

must then give proper weights to each of the good it selects to
produce. Suppose society has decided to produce wheat,
hospitals, schools and cloth from the above list. The fact that
resources are scarce means that society cannot produce unlimited
amounts of even these selected goods.
 1. WHAT TO PRODUCE?

Therefore, society must decide how much wheat, how many

hospitals, how many schools and how many meters of cloth are to
be produced. In fact, most of the goods in the above list will be
decided to be produced. Only the question of what quantity of
each of the goods is to be produced would have to be decided.
 2. HOW TO PRODUCE?

This means with what combination of resources a society

decides to produce goods. A combination of resources (or factors)
implies a technique of production. Usually, there are various
alternative techniques of producing a commodity and the society
has to choose among them, each technique using a different
combination of resources like labor and capital.
 2. HOW TO PRODUCE?

For instance, cotton cloth can be produced with either

handlooms, or power looms or automatic looms (as used in
modern textile mills). Production with technique of handlooms
involves the use of more labor relatively to capital and therefore
represent a labor-intensive technique.
 2. HOW TO PRODUCE?

On the other hand, the production of cloth with automatic

looms of the modern textile mills involves use of more capital
relative to labour and hence represents a capital-intensive
technique of production. Likewise, alternative techniques
involving different degrees of capital and labour intensity are
available in case of other commodities. Obviously, the choice
between different techniques would depend on the available
supplies of different factors of production and their relative
prices.
 2. HOW TO PRODUCE?

Scarcity of resources demands that goods should be

produced with the most efficient method. If the economy uses its
resources inefficiently, the output would be smaller and there
would be unnecessarily sacrifice of goods that otherwise would
have been available. Therefore, relatively abundant factors and
economies as much as possible those factors which are relatively
scarce.
 3. FOR WHOM TO PRODUCE?

For whom to produce implies how the national product is to

be distributed among the members of the society. Productive
resources and the resulting output being scarce, we cannot satisfy
all wants of all the people. Therefore, a society has to decide who
should get how much from the total output of goods and services.
 3. FOR WHOM TO PRODUCE?
This is, as it were, sharing of national cake among the
people constituting a society. Obviously, in a free-market
economy who would get how much of national output depends on
his money income. The greater the money income a person
enjoys, the greater the amount of goods he would be able to buy
from the market. Therefore, the greater the inequalities in the
distribution of money incomes, the greater the inequalities in the
distribution of national output. Therefore, this raises the question
as to how a free-market economy decides about the distribution of
money incomes.
 3. FOR WHOM TO PRODUCE?
Money income can be obtained in two ways. First, it can be
obtained through work that is, selling one’s labor service. Wages
(and salaries) represent the incomes from work. Differences in
wages earned by various people arise due to differences in
production activities, skill, education as well as due to the
bargaining powers of various social classes and a host of social
and institutional factors.
 3. FOR WHOM TO PRODUCE?

Second, income can be made from property such as land,

factories and other forms of capital. Rent, interest and profits are
the examples of income from property. Differences in the
ownership of property in a free-market economy cause
differences in incomes from property.
 3. FOR WHOM TO PRODUCE?

Thus, money incomes of the people made in these ways go

to determine the distribution of national output. Therefore, in
order to explain the determination of output, we have to explain
how distribution of income, that is, wages of labor, rent of land,
interest on capital and profits of enterprise arc determined.
 3. FOR WHOM TO PRODUCE?

How the national income is to be distributed has been a

burning topic not only in the field of economics but also in
politics. There is perhaps no topic in the whole of economics on
which discussion has been so hot and furious as the distribution
of national product and income.
 3. FOR WHOM TO PRODUCE?

Some have argued with a good deal of justification that all

people should get equal incomes and hence equal shares from the
national product. According to Karl Marx, the distribution of
national income should be on the basis of “from each according
to his ability, to each according to his needs”. Another important
view has been that each individual should get income equal to the
contribution he makes to the national production.
 4. WHAT PROVISION SHOULD BE MADE
FOR ECONOMIC GROWTH?
Both an individual and a society would not like to use all its
scarce resources for current consumption only. This is because if
all resources are used for producing consumer goods only and no
provision in terms of allocating some resources for investment,
that is, for production of capital goods, is made, the future
resources or productive capacity would not increase.
 4. WHAT PROVISION SHOULD BE MADE
FOR ECONOMIC GROWTH?
This implies that incomes or standards of living of the
people would remain stagnant. Indeed, if no such provision is
made for future, the future productive capacity and hence the
levels of living may decline. For, in the absence of this provision,
the stock of capital would fall due to depreciation as a result of its
use for producing consumer goods in a period.
 4. WHAT PROVISION SHOULD BE MADE
FOR ECONOMIC GROWTH?
This is better expressed by quoting an old Chinese saying
which states. “He who cannot see beyond the dawn will have
much good wine to drink at noon, much green wine to cure his
headache at dusk and only rain water to drink for the rest of
days.” Therefore, a wise individual or a society likes to provide
for its growth of productive capacity.
 4. WHAT PROVISION SHOULD BE MADE
FOR ECONOMIC GROWTH?
This requires that a part of its resources should be devoted
to the production of capital goods and for promotion of research
and development activity. The capital accumulation and
technological progress achieved in this way would enable the
society to produce more of consumer goods in the future and
ensure higher living standards for its people.
 4. WHAT PROVISION SHOULD BE MADE
FOR ECONOMIC GROWTH?
It follows that provision for capital accumulation and
technological progress implies sacrifice of some current
consumption. Therefore, a society has to decide how much saving
and investment (that is, how much sacrifice of current
consumption) should be made for future economic progress.
 4. WHAT PROVISION SHOULD BE MADE
FOR ECONOMIC GROWTH?
The pangs of the sacrifice of some current consumption for
promoting economic growth are greatly felt in less developed
countries like India where not only the present consumption
levels are very low (and therefore any sacrifice of current
consumption is handwriting) but also the need for economic
growth is very pressing.
 WHAT, HOW AND FOR WHOM: SUBJECT
MATTER OF MICRO-ECONOMICS?

We have explained above the four basic problems which

have been the concern of economists. The function and purpose
of all economic systems is to solve these problems. It is
noteworthy that the analysis of first three problems, namely, what,
how and for whom to produce are discussed in what is now called
microeconomics.
 WHAT, HOW AND FOR WHOM: SUBJECT
MATTER OF MICRO-ECONOMICS?
Microeconomics studies behaviour of individual consumers
as to what they will consume and demand, of producers or firms
as to what and how they will produce, of individual industries as
to how demand for their products and the supply by them will
determine their prices. It is their demand for and prices of various
products that determine the allocation of resources between them.
 WHAT, HOW AND FOR WHOM: SUBJECT
MATTER OF MICRO-ECONOMICS?
Besides, microeconomics studies how prices of factors such
as wages of labour, rent of land, interest on capital and profits of
enterprise are determined. It is these factor prices that, on the one
hand, determine the incomes of various individuals and hence the
demand for various products and, on the other hand, determine
the cost of the products It is the money incomes of the various
people that determine who would get how much from national
output.
 WHAT, HOW AND FOR WHOM: SUBJECT
MATTER OF MICRO-ECONOMICS?
It may be noted that not only does microeconomics explain
the different mechanisms through which the above four problems
are solved but also analyses the implications of alternative
choices made in this regard for welfare of the society.
 MACROECONOMICS: WHETHER
RESOURCES ARE FULLY UTILIZED?
Now, the pertinent question is which of the above problems
are studied by what is now called macroeconomics. This requires
some elaboration. Despite the fact that not enough resources are
available to satisfy all human wants, in a free market economic
system it so happens that they are not fully utilized. This goes
contrary to the view held by the Classical and Neo-Classical
economists who believed in the existence of full employment of
resources.
 MACROECONOMICS: WHETHER
RESOURCES ARE FULLY UTILIZED?
A noted English economist challenged this viewpoint during
nineteen thirties during which a severe depression overtook the
capitalist economies. At this time, strange phenomenon of a large
number of workers (human resources) was rendered unemployed
and a good deal of the factories and capital equipment installed in
then remained idle or under-utilized.
 MACROECONOMICS: WHETHER
RESOURCES ARE FULLY UTILIZED?
Keynes in his well-known work “General Theory of
Interest, Money and Employment” explained that despite the
scarcity of resources, the unemployment may be caused due to
the lack of effective demand. Thus, the level at which
employment of labor and (non-human resources will be used and
hence the level of national income will be determined depends on
effective demand.
 MACROECONOMICS: WHETHER
RESOURCES ARE FULLY UTILIZED?
Keynesian analysis greatly improved our understanding of
the working of the capitalist system which cause involuntary
unemployment of human and capital resources due to lack of
effective demand. Macroeconomics is concerned with explaining
how the employment of resources and hence the level of national
income is determined and what causes fluctuations and growth in
them.
 APPLIED ECONOMICS ON BASIC ISSUES
AND PROBLEMS
Applied Economics seeks to solve the problems on scarcity.
This happens when human wants for goods and services exceed
the available supply. In a modern economy, it is evident that a
division of labor happens when people earn income by
specializing in what they produce. They will use that income to
purchase the products they need or want every day (BC Campus
2020).
 APPLIED ECONOMICS ON BASIC ISSUES
AND PROBLEMS
Also, in the division of labor, it allows workers and firms to
produce more. This is because:
a) agents focus on areas of advantage due to natural factors and
skill levels; b) the agents learn and invent; c) the agents take
advantage of economies of scale. Division and specialization of labor
only work when individuals can purchase what they do not produce in
markets. Applied economics then helps you understand the basic
problems facing the world today. It helps you become a well-rounded
thinker. And most importantly, it prepares you to be a good citizen.
THE END