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What is the fundamental economic problem?

Last updated 13 Jul 2023

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The basic economic problem, also known as the fundamental economic problem, refers to the scarcity of resources in relation to the unlimited wants and needs of individuals and societies. It is the central issue in economics and arises due to the imbalance between what people desire and the resources available to fulfill those desires.

In essence, the basic economic problem can be summarized by three key questions:

• What to produce: Since resources are limited, societies must decide what goods and services to produce and in what quantities. This involves making choices about which products or services are most needed or desired by the population.
• How to produce: Once the decision on what to produce is made, societies must determine the most efficient and effective methods of production. This involves deciding on the combination of resources to use, such as labor, capital, and technology, to produce the desired goods and services.
• For whom to produce: After determining what and how to produce, societies need to allocate the produced goods and services to different individuals and groups. This raises questions about the distribution of resources and the equitable allocation of goods and services among the population.

The basic economic problem arises from the reality of scarcity. Resources such as land, labor, capital, and natural resources are limited, while human wants and needs are virtually unlimited. As a result, individuals, businesses, and societies must make choices and trade-offs to allocate resources efficiently, optimize production, and satisfy the most pressing needs and desires.

Economics as a social science discipline seeks to study and analyse the basic economic problem and develop theories and models to understand how societies make decisions regarding resource allocation, production, and distribution in the face of scarcity.

Here are some of the ways that economic systems try to address the fundamental economic problem:

• Market economies: Market economies are based on the principle of supply and demand. Prices are determined by the interaction of buyers and sellers in the market. This system allows for the efficient allocation of resources, but it can also lead to inequality and environmental problems.
• Planned (command) economies: Planned economies are based on the principle of central planning. The government decides what goods and services will be produced and how resources will be allocated. This system can ensure that everyone's basic needs are met, but it can also be inefficient and inflexible.
• Mixed economies: Mixed economies combine elements of market economies and planned economies. The government plays a role in the economy, but it also allows for some degree of free market activity. This system is often seen as a way to balance the efficiency of market economies with the equity of planned economies.

The fundamental economic problem is a complex issue that has no easy solutions. However, different economic systems offer different approaches to addressing the problem.

• Water Scarcity
• Scarcity bias
• Resource Scarcity
• Opportunity cost

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The Economic Problem

All societies face the economic problem , which is the problem of how to make the best use of limited, or scarce, resources. The economic problem exists because, although the needs and wants of people are endless, the resources available to satisfy needs and wants are limited.

Limited resources

Resources are limited in two essential ways:

• Limited in physical quantity , as in the case of land, which has a finite quantity.
• Limited in use , as in the case of labour and machinery, which can only be used for one purpose at any one time.

Choice and opportunity cost

Choice and opportunity cost are two fundamental concepts in economics. Given that resources are limited, producers and consumers have to make choices between competing alternatives. Individuals must choose how best to use their skill and effort, firms must choose how best to use their workers and machinery, and governments must choose how best to use taxpayer’s money.

Making an economic choice creates a sacrifice because alternatives must be given up. Making a choice results in the loss of benefit that an alternative would have provided. For example, if an individual has £10 to spend, and if books are £10 each and downloaded music tracks are £1 each, buying a book means the loss of the benefit that would have been gained from the 10 downloaded tracks.  Similarly, land and other resources, which have been used to build a school could have been used to build a factory. The loss of the next best option represents the real sacrifice and is referred to as opportunity cost .  The opportunity cost of choosing the school is the loss of the factory, and what could have been produced.

It is necessary to appreciate that opportunity cost relates to the loss of the next best alternative, and not just any alternative. The true cost of any decision is always the closest option not chosen.

Samuelson’s three questions

America’s first Nobel Prize winner for economics, the late Paul Samuelson , is often credited with providing the first clear and simple explanation of the economic problem – namely, that in order to solve the economic problem societies must endeavour to answer three basic questions – What to produce? How to produce? And, For whom to produce?

What to produce?

Societies have to decide the best combination of goods and services to meet their varied wants and needs. Societies must decide what quantities of different resources should be allocated to these goods and services.

How to produce?

Societies also have to decide the best combination of factors to create the desired output of goods and services. For example, precisely how much land, labour, and capital should be used to produce consumer goods such as computers and motor cars?

For whom to produce?

Finally, all societies need to decide who will benefit from the output from its economic activity, and how much they will get. This is often called the problem of distribution. Different societies may develop different ways to answer these questions.

A free good is one that is so abundant that its consumption does not deny anyone else the benefit of consuming the good. In this case, there is no opportunity cost associated with consumption or production, and the good does not command a price. Air is often cited as a free good, as breathing it does not reduce the amount available to someone else.

Production Possibility Frontiers

1.1 What Is Economics, and Why Is It Important?

Learning objectives.

By the end of this section, you will be able to:

• Discuss the importance of studying economics
• Explain the relationship between production and division of labor
• Evaluate the significance of scarcity

Economics is the study of how humans make decisions in the face of scarcity. These can be individual decisions, family decisions, business decisions or societal decisions. If you look around carefully, you will see that scarcity is a fact of life. Scarcity means that human wants for goods, services and resources exceed what is available. Resources, such as labor, tools, land, and raw materials are necessary to produce the goods and services we want but they exist in limited supply. Of course, the ultimate scarce resource is time- everyone, rich or poor, has just 24 expendable hours in the day to earn income to acquire goods and services, for leisure time, or for sleep. At any point in time, there is only a finite amount of resources available.

Think about it this way: In 2015 the labor force in the United States contained over 158 million workers, according to the U.S. Bureau of Labor Statistics. The total land area was 3,794,101 square miles. While these are certainly large numbers, they are not infinite. Because these resources are limited, so are the numbers of goods and services we produce with them. Combine this with the fact that human wants seem to be virtually infinite, and you can see why scarcity is a problem.

Introduction to FRED

Data is very important in economics because it describes and measures the issues and problems that economics seek to understand. A variety of government agencies publish economic and social data. For this course, we will generally use data from the St. Louis Federal Reserve Bank's FRED database. FRED is very user friendly. It allows you to display data in tables or charts, and you can easily download it into spreadsheet form if you want to use the data for other purposes. The FRED website includes data on nearly 400,000 domestic and international variables over time, in the following broad categories:

• Money, Banking & Finance
• Population, Employment, & Labor Markets (including Income Distribution)
• National Accounts (Gross Domestic Product & its components), Flow of Funds, and International Accounts
• Production & Business Activity (including Business Cycles)
• Prices & Inflation (including the Consumer Price Index, the Producer Price Index, and the Employment Cost Index)
• International Data from other nations
• U.S. Regional Data
• Academic Data (including Penn World Tables & NBER Macrohistory database)

For more information about how to use FRED, see the variety of videos on YouTube starting with this introduction.

If you still do not believe that scarcity is a problem, consider the following: Does everyone require food to eat? Does everyone need a decent place to live? Does everyone have access to healthcare? In every country in the world, there are people who are hungry, homeless (for example, those who call park benches their beds, as Figure 1.2 shows), and in need of healthcare, just to focus on a few critical goods and services. Why is this the case? It is because of scarcity. Let’s delve into the concept of scarcity a little deeper, because it is crucial to understanding economics.

The Problem of Scarcity

Think about all the things you consume: food, shelter, clothing, transportation, healthcare, and entertainment. How do you acquire those items? You do not produce them yourself. You buy them. How do you afford the things you buy? You work for pay. If you do not, someone else does on your behalf. Yet most of us never have enough income to buy all the things we want. This is because of scarcity. So how do we solve it?

Visit this website to read about how the United States is dealing with scarcity in resources.

Every society, at every level, must make choices about how to use its resources. Families must decide whether to spend their money on a new car or a fancy vacation. Towns must choose whether to put more of the budget into police and fire protection or into the school system. Nations must decide whether to devote more funds to national defense or to protecting the environment. In most cases, there just isn’t enough money in the budget to do everything. How do we use our limited resources the best way possible, that is, to obtain the most goods and services we can? There are a couple of options. First, we could each produce everything we each consume. Alternatively, we could each produce some of what we want to consume, and “trade” for the rest of what we want. Let’s explore these options. Why do we not each just produce all of the things we consume? Think back to pioneer days, when individuals knew how to do so much more than we do today, from building their homes, to growing their crops, to hunting for food, to repairing their equipment. Most of us do not know how to do all—or any—of those things, but it is not because we could not learn. Rather, we do not have to. The reason why is something called the division and specialization of labor , a production innovation first put forth by Adam Smith ( Figure 1.3 ) in his book, The Wealth of Nations .

The Division of and Specialization of Labor

The formal study of economics began when Adam Smith (1723–1790) published his famous book The Wealth of Nations in 1776. Many authors had written on economics in the centuries before Smith, but he was the first to address the subject in a comprehensive way. In the first chapter, Smith introduces the concept of division of labor , which means that the way one produces a good or service is divided into a number of tasks that different workers perform, instead of all the tasks being done by the same person.

To illustrate division of labor, Smith counted how many tasks went into making a pin: drawing out a piece of wire, cutting it to the right length, straightening it, putting a head on one end and a point on the other, and packaging pins for sale, to name just a few. Smith counted 18 distinct tasks that different people performed—all for a pin, believe it or not!

Modern businesses divide tasks as well. Even a relatively simple business like a restaurant divides the task of serving meals into a range of jobs like top chef, sous chefs, less-skilled kitchen help, servers to wait on the tables, a greeter at the door, janitors to clean up, and a business manager to handle paychecks and bills—not to mention the economic connections a restaurant has with suppliers of food, furniture, kitchen equipment, and the building where it is located. A complex business like a large manufacturing factory, such as the shoe factory ( Figure 1.4 ), or a hospital can have hundreds of job classifications.

Why the Division of Labor Increases Production

When we divide and subdivide the tasks involved with producing a good or service, workers and businesses can produce a greater quantity of output. In his observations of pin factories, Smith noticed that one worker alone might make 20 pins in a day, but that a small business of 10 workers (some of whom would need to complete two or three of the 18 tasks involved with pin-making), could make 48,000 pins in a day. How can a group of workers, each specializing in certain tasks, produce so much more than the same number of workers who try to produce the entire good or service by themselves? Smith offered three reasons.

First, specialization in a particular small job allows workers to focus on the parts of the production process where they have an advantage. (In later chapters, we will develop this idea by discussing comparative advantage .) People have different skills, talents, and interests, so they will be better at some jobs than at others. The particular advantages may be based on educational choices, which are in turn shaped by interests and talents. Only those with medical degrees qualify to become doctors, for instance. For some goods, geography affects specialization. For example, it is easier to be a wheat farmer in North Dakota than in Florida, but easier to run a tourist hotel in Florida than in North Dakota. If you live in or near a big city, it is easier to attract enough customers to operate a successful dry cleaning business or movie theater than if you live in a sparsely populated rural area. Whatever the reason, if people specialize in the production of what they do best, they will be more effective than if they produce a combination of things, some of which they are good at and some of which they are not.

Second, workers who specialize in certain tasks often learn to produce more quickly and with higher quality. This pattern holds true for many workers, including assembly line laborers who build cars, stylists who cut hair, and doctors who perform heart surgery. In fact, specialized workers often know their jobs well enough to suggest innovative ways to do their work faster and better.

A similar pattern often operates within businesses. In many cases, a business that focuses on one or a few products (sometimes called its “ core competency ”) is more successful than firms that try to make a wide range of products.

Third, specialization allows businesses to take advantage of economies of scale , which means that for many goods, as the level of production increases, the average cost of producing each individual unit declines. For example, if a factory produces only 100 cars per year, each car will be quite expensive to make on average. However, if a factory produces 50,000 cars each year, then it can set up an assembly line with huge machines and workers performing specialized tasks, and the average cost of production per car will be lower. The ultimate result of workers who can focus on their preferences and talents, learn to do their specialized jobs better, and work in larger organizations is that society as a whole can produce and consume far more than if each person tried to produce all of their own goods and services. The division and specialization of labor has been a force against the problem of scarcity.

Trade and Markets

Specialization only makes sense, though, if workers can use the pay they receive for doing their jobs to purchase the other goods and services that they need. In short, specialization requires trade.

You do not have to know anything about electronics or sound systems to play music—you just buy an iPod or MP3 player, download the music, and listen. You do not have to know anything about artificial fibers or the construction of sewing machines if you need a jacket—you just buy the jacket and wear it. You do not need to know anything about internal combustion engines to operate a car—you just get in and drive. Instead of trying to acquire all the knowledge and skills involved in producing all of the goods and services that you wish to consume, the market allows you to learn a specialized set of skills and then use the pay you receive to buy the goods and services you need or want. This is how our modern society has evolved into a strong economy.

Why Study Economics?

Now that you have an overview on what economics studies, let’s quickly discuss why you are right to study it. Economics is not primarily a collection of facts to memorize, although there are plenty of important concepts to learn. Instead, think of economics as a collection of questions to answer or puzzles to work. Most importantly, economics provides the tools to solve those puzzles.

Consider the complex and critical issue of education barriers on national and regional levels, which affect millions of people and result in widespread poverty and inequality. Governments, aid organizations, and wealthy individuals spend billions of dollars each year trying to address these issues. Nations announce the revitalization of their education programs; tech companies donate devices and infrastructure, and celebrities and charities build schools and sponsor students. Yet the problems remain, sometimes almost as pronounced as they were before the intervention. Why is that the case? In 2019, three economists—Esther Duflo, Abhijit Banerjee, and Michael Kremer—were awarded the Nobel Prize for their work to answer those questions. They worked diligently to break the widespread problems into smaller pieces, and experimented with small interventions to test success. The award citation credited their work with giving the world better tools and information to address poverty and improve education. Esther Duflo, who is the youngest person and second woman to win the Nobel Prize in Economics, said, "We believed that like the war on cancer, the war on poverty was not going to be won in one major battle, but in a series of small triumphs. . . . This work and the culture of learning that it fostered in governments has led to real improvement in the lives of hundreds of millions of poor people.”

As you can see, economics affects far more than business. For example:

• Virtually every major problem facing the world today, from global warming, to world poverty, to the conflicts in Syria, Afghanistan, and Somalia, has an economic dimension. If you are going to be part of solving those problems, you need to be able to understand them. Economics is crucial.
• It is hard to overstate the importance of economics to good citizenship. You need to be able to vote intelligently on budgets, regulations, and laws in general. When the U.S. government came close to a standstill at the end of 2012 due to the “fiscal cliff,” what were the issues? Did you know?
• A basic understanding of economics makes you a well-rounded thinker. When you read articles about economic issues, you will understand and be able to evaluate the writer’s argument. When you hear classmates, co-workers, or political candidates talking about economics, you will be able to distinguish between common sense and nonsense. You will find new ways of thinking about current events and about personal and business decisions, as well as current events and politics.

The study of economics does not dictate the answers, but it can illuminate the different choices.

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• The Economic Problem

Our modern lives have become so comfortable that we often don't stop to think whether another thing we recently bought was actually a necessity or simply a want. It may well be that an increase in comfort or convenience provided you with some happiness, albeit short-lived. Now, imagine the extent of everyone's wants and wishes. Someone has smaller ones, but someone has larger ones. The more you have, the more you want; this is the fundamental economic problem. While your wants are unlimited, the world's resources are not. Is there hope for the future of humanity to sustain itself without depleting the vast resources of the precious planet we call home? This article will help you find this out!

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What is meant by the economic problem?

What is the economic problem example?

What are the solutions to the economic problems?

What is the economic problem of scarcity?

What is the main cause of the economic problem?

Define scarcity

What is a need?

What is a want?

What are the three basic economic questions?

What are factors of production?

What is an opportunity cost?

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• Economic Efficiency
• Economic Modelling
• Economic Resources
• Economic Systems
• Economic Way of Thinking
• Economic and Social Goals
• Economic policy
• Economics as Social Science
• Factors of Production
• Graphs in Economics
• Imperfect Information
• Introduction To Economics
• Marginal Analysis
• Market Economy
• Mixed Economy
• Normative and Positive Statements
• Production Possibility Curves
• Resource Allocation
• Scope of Economics
• Trade Offs in Economics
• Traditional Economies
• Utility Theory
• Factor Markets
• Imperfect Competition
• Labour Market
• Market Efficiency
• Microeconomics Examples
• Perfect Competition
• Political Economy
• Poverty and Inequality
• Production Cost
• Supply and Demand

The Economic Problem Definition

The economic problem is the fundamental challenge facing all societies, which is how to satisfy unlimited wants and needs with limited resources. Because resources such as land, labor, and capital are scarce, people and societies must make choices about how to allocate them.

Economists call this lack of resources scarcity. But here's the real kicker: the global population is rising, and everyone has wants and needs. Are there enough resources to satisfy all those desires?

Scarcity occurs when society cannot fulfill all its wants because resources are limited.

Well, you are certainly in the right place to find the answer to this question at the right time. Because if you are reading this article, this means that you are interested in Economics. Economics is a social science that studies how people attempt to satisfy their unlimited wants by carefully allocating scarce resources.

Dive deeper into what economists study in our article - Introduction to Economics.

Needs vs. Wants

To find out the answer to our question, let's first try to classify human desires into needs vs. wants. A need is defined as something necessary for survival. It may sound vague, but essential clothing, shelter, and food are usually classified as needs. Everyone needs these basic things to survive. It's that simple! What are wants then? A want is something that we would like to have, but our survival does not depend on it. You may want to have expensive filet mignon for dinner at least once, but it is definitely beyond what would be considered a necessity.

A need is something necessary for survival.

A want is something that we would like to have, but is not necessary for survival.

Three Basic Economic Questions

• The three basic economic questions:
• What to produce?
• How to produce?
• For whom to produce?

What do they have to do with the fundamental economic problem? Well, these questions provide a basic framework for allocating scarce resources. You may think, wait a minute, I scrolled all the way here to find some answers, not more questions!

Bear with us and look at Figure 1 below to see how our wants are connected to the three basic economic questions.

Now let's discuss each of these questions in turn.

The Economic Problem: What to produce?

This is the first question that needs to be answered if society is to allocate its resources efficiently. Of course, no society can sustain itself if all the resources are spent on defense, and none are spent on food production. This first and foremost question helps to identify a set of things that society needs to sustain itself in balance.

The Economic Problem: How to produce?

How should the factors of production be allocated to produce the required things? What would be the efficient way to make food, and what would be the efficient way to make cars? How much labor force is there in a community? How would these choices impact the affordability of the final product? All these questions are densely combined in one question - how to produce?

The Economic Problem: For whom to produce?

Last but not least, the question of who will be the final user of the things made is important. The choices made when answering the first of the three questions mean that the scarce resources were used to create a set of particular products. This implies that there may not be enough of one specific thing for everyone. Imagine a lot of resources were allocated for food production. This means that not everyone in that society can have a car.

The Economic Problem and the Factors of Production

Now, you may be wondering, what exactly constitutes these scarce resources we are trying to use to produce the things we need? Well, economists refer to them as factors of production . In simple terms, factors of production are the inputs used in the production process.

There are four factors of production, which are:

• Entrepreneurship

Figure 2 below shows an overview of the four factors of production.

Factors of production are the inputs used in the production process.

Let's briefly go over each of them in turn!

Land is arguably the densest factor of production. It contains the land for agricultural or building purposes, or mining, for example. Land, however, also includes all natural resources such as oil and gas, air, water, and even wind. Labor is a factor of production that refers to people and their work. When someone is employed producing a good or a service, their labor is an input into the production process. All the jobs and professions you can think about are classified as labor, from miners to cooks, to lawyers, to writers. Capital as a factor of production includes items like machinery, equipment, and tools utilized to produce the final good or service. Do not confuse it with financial capital - money used to finance a particular project or a venture. The caveat with this factor of production is that it has to be manufactured before it can be used as an input into the production process.

Entrepreneurship is a factor of production as well! It is distinguished from the other factors of production because of three things:

• It involves the risk of losing money that the entrepreneur invests into the project.
• Entrepreneurship itself can create opportunities for more labor to be employed.
• An entrepreneur organizes the other factors of production in a way that would yield the most optimal production process.

The four factors of production are land, labor, capital, and entrepreneurship.

We know that by this point, you have probably lost all hope of finding the answer to the questions of resource allocation posed above. The truth is, the answer is not that simple. To put it short, you have to study economics as a whole to be able to answer these questions, at least partially. Economic models like the most straightforward supply and demand model to the complex models of aggregate investment and saving all contribute to solving the problems of scarce resource allocation.

To learn more on these topics, check out our articles:

- Factors of Production

- Supply and Demand

- Aggregate Supply

- Aggregate Demand

The Economic Problem Examples

Let's go over three examples of the fundamental economic problem:

• time allocation;
• budget allocation;
• human resource allocation.

The Economic Problem of Scarcity: Time

An example of an economic problem you may experience daily is how to allocate your time. You need to allocate your time to many things, from spending time with family to studying, to exercising, to doing chores. Choosing how to allocate your time between all these is an example of the fundamental economic problem of scarcity.

The Economic Problem of Scarcity: Opportunity Cost

Opportunity cost is the cost of the next best alternative foregone. Every decision involves a trade-off. Imagine you are deciding whether to eat pizza or quinoa salad for lunch. If you buy pizza, you won't be able to purchase quinoa salad and vice versa. A similar thing is happening with a multitude of other decisions you make daily, and they involve opportunity cost. Opportunity cost is a direct result of the fundamental economic problem and the need for rationing scarce resources.

Opportunity cost is the cost of the next best alternative foregone.

The Economic Problem of Scarcity: Spots at a Top College

Top colleges receive more applications than the places they have available each year. This means that a lot of applicants will, unfortunately, be rejected. Top colleges use advanced screening requirements to admit the students who will do well and reject the rest. They do this by looking not only at how high their SAT and GPA scores are but also at their extracurricular activities and achievements.

The Economic Problem - Key takeaways

• The fundamental economic problem results from the mismatch between limited resources and unlimited wants. It is referred to as 'scarcity' by economists. Scarcity occurs when society cannot fulfill all its wants because resources are limited.
• A need is something necessary for survival. A want is something that we would like to have, but is not necessary for survival.
• Opportunity cost is the cost of the next best alternative foregone and is an example of the fundamental economic problem.

Flashcards in The Economic Problem 15

The fundamental economic problem results from the mismatch between limited resources and unlimited wants. It is referred to as 'scarcity' by economists.

The solutions to the economic problem come from answering the three basic economic questions, which are:

The economic problem of scarcity is the fundamental economic problem. It occurs due to resource scarcity and our unlimited desires.

The main cause of the fundamental economic problem is the scarcity of resources in light of the unlimited wants of humanity.

Scarcity occurs when the society cannot fulfill all its wants because resources are limited.

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Frequently Asked Questions about The Economic Problem

The fundamental economic problem results from the mismatch between limited resources and unlimited wants. It is referred to as 'scarcity' by economists.

The solutions to the economic problem come from answering the three basic economic questions, which are: What to produce? How to produce? For whom to produce?

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1.1 What Is Economics, and Why Is It Important?

Learning objectives.

By the end of this section, you will be able to:

• Discuss the importance of studying economics
• Explain the relationship between production and division of labor
• Evaluate the significance of scarcity

Economics is the study of how humans make decisions in the face of scarcity. These can be individual decisions, family decisions, business decisions or societal decisions. If you look around carefully, you will see that scarcity is a fact of life. Scarcity means that human wants for goods, services and resources exceed what is available. Resources, such as labor, tools, land, and raw materials are necessary to produce the goods and services we want but they exist in limited supply. Of course, the ultimate scarce resource is time- everyone, rich or poor, has just 24 hours in the day to try to acquire the goods they want. At any point in time, there is only a finite amount of resources available.

Think about it this way: the total land area of the main Hawaiian islands is only 10,931 square miles. Because land and other natural resources are limited, so are the numbers of goods and services we can produce with them. Combine this with the fact that human wants seem to be virtually infinite, and you can see why scarcity is a problem.

If you still do not believe that scarcity is a problem, consider the following: Does everyone need food to eat? Does everyone need a decent place to live? Does everyone have access to healthcare? In Hawaiʻi there are people who are hungry, homeless, and in need of healthcare, just to focus on a few critical goods and services. Why is this the case? It is because of scarcity. Let’s delve into the concept of scarcity a little deeper, because it is crucial to understanding economics.

What is a good and what is a service?

Goods have a physical tangible presence, for example, a pizza or a scissors. Services have no physical tangible presence but have economic value (people are willing to pay to get this service). Examples of services include the delivery of a pizza or getting your hair cut.

Only around 20% of workers in the US work at jobs where they produce goods. The percentage is even smaller in Hawaiʻi: only 4% of workers in Hawaiʻi produce goods! What are the main services produced in Hawaiʻi and what are the main goods?

The Problem of Scarcity

Think about all the things you consume: food, shelter, clothing, transportation, healthcare, and entertainment. How do you acquire those items? You do not produce them yourself. You buy them. How do you afford the things you buy? You work for pay. Or if you do not, someone else does on your behalf. Yet most of us never have enough to buy all the things we want. This is because of scarcity. So how do we solve it?

Visit this website to read about how the United States is dealing with scarcity in resources.

Every society, at every level, must make choices about how to use its resources. Families must decide whether to spend their money on a new car or a fancy vacation. Towns must choose whether to put more of the budget into police and fire protection or into the school system. Nations must decide whether to devote more funds to national defense or to protecting the environment. In most cases, there just isn’t enough money in the budget to do everything. So why do we not each just produce all of the things we consume? The simple answer is most of us do not know how, but that is not the main reason. (When you study economics, you will discover that the obvious choice is not always the right answer—or at least the complete answer. Studying economics teaches you to think in a different of way.) Think back to pioneer days, when individuals knew how to do so much more than we do today, from building their homes, to growing their crops, to hunting for food, to repairing their equipment. Most of us do not know how to do all—or any—of those things. It is not because we could not learn. Rather, we do not have to. The reason why is something called the division and specialization of labor , a production innovation first put forth by Adam Smith in his book, The Wealth of Nations .

The Division of and Specialization of Labor

The formal study of economics began when Adam Smith (1723–1790) published his famous book The Wealth of Nations in 1776. Many authors had written on economics in the centuries before Smith, but he was the first to address the subject in a comprehensive way. In the first chapter, Smith introduces the division of labor , which means that the way a good or service is produced is divided into a number of tasks that are performed by different workers, instead of all the tasks being done by the same person.

To illustrate the division of labor, Smith counted how many tasks went into making a pin: drawing out a piece of wire, cutting it to the right length, straightening it, putting a head on one end and a point on the other, and packaging pins for sale, to name just a few. Smith counted 18 distinct tasks that were often done by different people—all for a pin, believe it or not!

Modern businesses divide tasks as well. Even a relatively simple business like a restaurant divides up the task of serving meals into a range of jobs like top chef, sous chefs, less-skilled kitchen help, servers to wait on the tables, a greeter at the door, janitors to clean up, and a business manager to handle paychecks and bills—not to mention the economic connections a restaurant has with suppliers of food, furniture, kitchen equipment, and the building where it is located (check out the video below). A complex business like a large manufacturing factory or a hospital can have hundreds of job classifications.

The Division of Labor at work at Marukame Udon in Waikiki:

Why the Division of Labor Increases Production

When the tasks involved with producing a good or service are divided and subdivided, workers and businesses can produce a greater quantity of output. In his observations of pin factories, Smith observed that one worker alone might make 20 pins in a day, but that a small business of 10 workers (some of whom would need to do two or three of the 18 tasks involved with pin-making), could make 48,000 pins in a day. How can a group of workers, each specializing in certain tasks, produce so much more than the same number of workers who try to produce the entire good or service by themselves? Smith offered three reasons.

First, specialization in a particular small job allows workers to focus on the parts of the production process where they have an advantage. (In later chapters, we will develop this idea by discussing comparative advantage .) People have different skills, talents, and interests, so they will be better at some jobs than at others. The particular advantages may be based on educational choices, which are in turn shaped by interests and talents. Only those with medical degrees qualify to become doctors, for instance. For some goods, specialization will be affected by geography—it is easier to be a wheat farmer in North Dakota than in Florida, but easier to run a tourist hotel in Florida than in North Dakota. If you live in or near a big city, it is easier to attract enough customers to operate a successful dry cleaning business or movie theater than if you live in a sparsely populated rural area. Whatever the reason, if people specialize in the production of what they do best, they will be more productive than if they produce a combination of things, some of which they are good at and some of which they are not.

Second, workers who specialize in certain tasks often learn to produce more quickly and with higher quality. This pattern holds true for many workers, including assembly line laborers who build cars, stylists who cut hair, and doctors who perform heart surgery. In fact, specialized workers often know their jobs well enough to suggest innovative ways to do their work faster and better.

A similar pattern often operates within businesses. In many cases, a business that focuses on one or a few products (sometimes called its “ core competency ”) is more successful than firms that try to make a wide range of products.

Third, specialization allows businesses to take advantage of economies of scale , which means that for many goods, as the level of production increases, the average cost of producing each individual unit declines. For example, if a factory produces only 100 cars per year, each car will be quite expensive to make on average. However, if a factory produces 50,000 cars each year, then it can set up an assembly line with huge machines and workers performing specialized tasks, and the average cost of production per car will be lower. The ultimate result of workers who can focus on their preferences and talents, learn to do their specialized jobs better, and work in larger organizations is that society as a whole can produce and consume far more than if each person tried to produce all of their own goods and services. The division and specialization of labor has been a force against the problem of scarcity.

Trade and Markets

Specialization only makes sense, though, if workers can use the pay they receive for doing their jobs to purchase the other goods and services that they need. In short, specialization requires trade.

You do not have to know anything about electronics or sound systems to play music—you just buy an iPod or MP3 player, download the music and listen. You do not have to know anything about artificial fibers or the construction of sewing machines if you need a jacket—you just buy the jacket and wear it. You do not need to know anything about internal combustion engines to operate a car—you just get in and drive. Instead of trying to acquire all the knowledge and skills involved in producing all of the goods and services that you wish to consume, the market allows you to learn a specialized set of skills and then use the pay you receive to buy the goods and services you need or want. This is how our modern society has evolved into a strong economy.

Why Study Economics?

Now that we have gotten an overview on what economics studies, let’s quickly discuss why you are right to study it. Economics is not primarily a collection of facts to be memorized, though there are plenty of important concepts to be learned. Instead, economics is better thought of as a collection of questions to be answered or puzzles to be worked out. Most important, economics provides the tools to work out those puzzles. If you have yet to be been bitten by the economics “bug,” there are other reasons why you should study economics.

• Virtually every major problem facing the world today, from global warming, to world poverty, to the conflicts in Syria, Afghanistan, and Somalia, has an economic dimension. If you are going to be part of solving those problems, you need to be able to understand them. Economics is crucial.
• It is hard to overstate the importance of economics to good citizenship. You need to be able to vote intelligently on budgets, regulations, and laws in general. When the U.S. government came close to a standstill at the end of 2012 due to the “fiscal cliff,” what were the issues involved? Did you know?
• A basic understanding of economics makes you a well-rounded thinker. When you read articles about economic issues, you will understand and be able to evaluate the writer’s argument. When you hear classmates, co-workers, or political candidates talking about economics, you will be able to distinguish between common sense and nonsense. You will find new ways of thinking about current events and about personal and business decisions, as well as current events and politics.

The study of economics does not dictate the answers, but it can illuminate the different choices.

Key Concepts and Summary

Economics seeks to solve the problem of scarcity, which is when human wants for goods and services exceed the available supply. A modern economy displays a division of labor, in which people earn income by specializing in what they produce and then use that income to purchase the products they need or want. The division of labor allows individuals and firms to specialize and to produce more for several reasons: a) It allows the agents to focus on areas of advantage due to natural factors and skill levels; b) It encourages the agents to learn and invent; c) It allows agents to take advantage of economies of scale. Division and specialization of labor only work when individuals can purchase what they do not produce in markets. Learning about economics helps you understand the major problems facing the world today, prepares you to be a good citizen, and helps you become a well-rounded thinker.

Self-Check Questions

• What is scarcity? Can you think of two causes of scarcity?
• Residents of the town of Smithfield like to consume hams, but each ham requires 10 people to produce it and takes a month. If the town has a total of 100 people, what is the maximum amount of ham the residents can consume in a month?
• A consultant works for $200 per hour. She likes to eat vegetables, but is not very good at growing them. Why does it make more economic sense for her to spend her time at the consulting job and shop for her vegetables?
• A computer systems engineer could paint his house, but it makes more sense for him to hire a painter to do it. Explain why.

Review Questions

• Give the three reasons that explain why the division of labor increases an economy’s level of production.
• What are three reasons to study economics?

Critical Thinking Questions

• Suppose you have a team of two workers: one is a baker and one is a chef. Explain why the kitchen can produce more meals in a given period of time if each worker specializes in what they do best than if each worker tries to do everything from appetizer to dessert.
• Why would division of labor without trade not work?
• Can you think of any examples of free goods, that is, goods or services that are not scarce?

Bureau of Labor Statistics, U.S. Department of Labor. 2015. “The Employment Situation—February 2015.” Accessed March 27, 2015. http://www.bls.gov/news.release/pdf/empsit.pdf.

Williamson, Lisa. “US Labor Market in 2012.” Bureau of Labor Statistics . Accessed December 1, 2013. http://www.bls.gov/opub/mlr/2013/03/art1full.pdf.

Answers for Self-Check Questions

• Scarcity means human wants for goods and services exceed the available supply. Supply is limited because resources are limited. Demand, however, is virtually unlimited. Whatever the supply, it seems human nature to want more.
• 100 people / 10 people per ham = a maximum of 10 hams per month if all residents produce ham. Since consumption is limited by production, the maximum number of hams residents could consume per month is 10.
• She is very productive at her consulting job, but not very productive growing vegetables. Time spent consulting would produce far more income than it what she could save growing her vegetables using the same amount of time. So on purely economic grounds, it makes more sense for her to maximize her income by applying her labor to what she does best (i.e. specialization of labor).
• The engineer is better at computer science than at painting. Thus, his time is better spent working for pay at his job and paying a painter to paint his house. Of course, this assumes he does not paint his house for fun!

Principles of Microeconomics - Hawaii Edition Copyright © 2018 by John Lynham is licensed under a Creative Commons Attribution 4.0 International License , except where otherwise noted.

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• Preparatory

Lesson Explainer: Fundamental Economic Problem Economics • Third Year of Secondary School

In this explainer, we will learn how to recognize the fundamental economic problem.

The basic building blocks of economic activities are human needs and resources. Let us recall the definition and characteristics of human needs.

A need of an individual is a feeling of distress leading them to act to diminish or satisfy the need. While a need may be satisfied by consuming suitable resources, the quantity of an individual’s needs continues to increase over time. In the context of a society, we also know that human needs are widely varied between different individuals. In other words, there is a limitless and diverse demand for resources in a society.

We also recall that resources are categorized as free or scarce, in terms of their availability. The availability of free resources, such as air and water, far exceeds the demand for their consumption. If all resources were free, there would not be any economic problem in the society since they would be able to satisfy everyone’s needs.

However, we know that most resources are scarce, which means that needs for the resources far exceed their availability. Any economic problem can be traced back to the fundamental conflict between scarcity of resources and the limitless and diverse nature of human needs, which is known as the fundamental economic problem.

Definition: Fundamental Economic Problem

The fundamental economic problem states that human needs are diverse and continuously increasing, while resources to satisfy them are relatively limited.

We can represent the fundamental economic problem using the following diagram.

For instance, we can consider a need for transportation, which can be satisfied by purchasing a car. We know that a car is a scarce resource, which means that there is a greater number of people with this need compared to the number of available cars. Hence, some individuals will be able to obtain cars to satisfy their needs, while other individuals’ needs will not be satisfied. Furthermore, individuals with cars will likely develop new needs, for example, to obtain better cars, leading to an unending cycle of the fundamental economic problem that cannot be fully resolved.

Recall that a need for transportation is a secondary need, which is for achieving the happiness of the individual or improving the condition of the society. When we consider the fundamental economic problem involving this secondary need, its consequences do not seem grave. Let us consider this problem involving a primary need, which is essential for an individual’s survival.

The need to eat is a primary need, and every individual in a society has this need. The need to eat is also frequently renewed, and the satisfaction of the primary need to eat often motivates a new secondary need to eat better or more scarce food. Since these needs are limitless and diverse, there will not be enough food to satisfy every individual’s need. Because this need is tied to the individual’s survival, the scarcity of food creates a much more serious problem compared to the scarcity of cars. The survival of individuals is at stake when the fundamental economic problem is tied to primary needs.

In our first example, we will consider the root causes of the fundamental economic problem.

Example 1: The Fundamental Economic Problem

Which of the following are the two root causes of the fundamental economic problem?

• Scarcity of resources
• Maximizing profit
• Social welfare
• Unlimited human needs

In this example, we need to identify the root causes of the fundamental economic problem. Recall that the fundamental economic problem states the following: human needs are diverse and continuously increasing, while resources to satisfy them are limited.

The first part of the statement addresses the unlimited and diverse human needs, option IV, while the second part of the statement refers to the scarcity of resources, option I. Hence, the root causes of the fundamental economic problem are the scarcity of resources and unlimited human needs, which are I and IV.

In the previous problem, we identified the scarcity of resources and unlimited human needs as the root causes of the fundamental economic problem. Let us now consider how we, as individuals or as a society, can address the fundamental economic problem.

Definition: Economic Choices

Individuals or economic entities can address the fundamental economic problem by making economic choices. The objective of any economic choice is to allocate the limited resources to maximize their utility.

In the definition above, the term utility refers to the total satisfaction derived from the consumption of resources. Hence, when an economic entity , that is, an individual, a firm, or a government, makes economic choices, it considers how to maximize the benefits of the existing resources.

Making economic choices requires the entity to set priorities of different needs so that some will be satisfied before others. For instance, an individual can choose to satisfy the need to tour Italy, or a government can choose to fund the construction of a new school. These are examples of economic choices where an individual or a government decides to satisfy a specific need over others. Since making a choice inevitably means that we are not choosing the other options, we leave other needs unsatisfied when an economic choice is made.

Definition: Opportunity Cost

Opportunity costs are the effects or consequences of alternative options in an economic choice. If the effects are financial, which include profits and losses, the opportunity cost, or the cost of foregone options, can be written as a difference between the alternate and chosen options.

The relationship between the fundamental economic problem, economic choices, and opportunity costs are represented in the following diagram.

Opportunity costs are also known as missed opportunities. Let us consider possible opportunity costs of the economic choice to tour Italy. An example of nonfinancial opportunity costs may be the missed opportunity to visit relatives during that time. On the other hand, the cost of travel is a financial opportunity cost, which is measured in terms of the difference between the travel costs incurred by the tour and the savings that could be made by not undertaking the tour. Before making economic choices, the opportunity costs of all available options should be considered in order to maximize the benefit.

In the next example, we will examine the relationship between economic choices and opportunity costs.

Example 2: Economic Choices and Opportunity Costs

Which of the following correctly describes the relationship between opportunity costs and choices?

• Opportunity cost refers to the financial implications of making choices.
• If two individuals make the same economic choice, the opportunity cost for the two individuals is the same.
• Every economic choice is accompanied by an opportunity cost.
• Opportunity cost is always positive.
• Opportunity cost is always negative.

In this example, we need to identify the correct statement regarding the relationship between opportunity costs and choices. Recall that choices are necessary because of the scarcity of resources and that the purpose of an economic choice is to allocate the limited resources to maximize benefits. We also recall that opportunity costs are the effects or consequences of alternative options in an economic choice.

Let us consider each option.

Option A: This option could be appealing since the word cost has a financial connotation. However, the opportunity cost does not have to be related to financial implications. Instead, it may represent the qualitative effects of foregone options. Hence, this statement is inaccurate.

Option B: Let us consider an example of opportunity cost in order to determine whether this statement is accurate. Say that two different individuals make the choice to tour Italy over summer. For one, the opportunity cost could be the missed opportunity to visit relatives, while for the other, the opportunity cost could be the missed opportunity to take courses over the summer to further their education. As this example demonstrates, opportunity costs of the same economic choices could vary between different individuals due to the different availability of alternative options. Hence, this statement is inaccurate.

Option C: Opportunity costs are inevitable in economic choices since there are always alternatives to consider. This is a true statement.

Options D and E: If the effects are financial, the opportunity cost is written as the difference between the alternate and chosen options. Since it is a difference, the opportunity cost may be positive or negative depending on which quantity is larger. Hence, this statement is inaccurate.

Option C is the only accurate description of opportunity costs and choices since every choice is accompanied by opportunity costs.

In the previous example, we considered the relationship between economic choices and opportunity costs. We learned that opportunity costs are widely varied depending on available alternative options. Opportunity costs for financial costs and benefits are often considered more objectively since they can be expressed explicitly as a difference. Qualitative opportunity costs should also be considered, although it is more difficult to remain objective regarding these items.

In the next example, we will identify different opportunity costs associated with a specific economic choice made by a national government.

Example 3: Understanding Opportunity Costs

After careful review, a national government decided to fund the construction of a bridge. Alternatives considered were the construction of a new high school and an increase in the wages of government employees. Which of the following is not an opportunity cost for the national government’s choice to fund the construction of the bridge?

• Improved morale among government employees due to the raise in pay
• Improvement in the quality of high school education
• Improved efficiency in traffic due to the new bridge
• Difference in financial cost between the construction of the bridge and the alternatives considered

The national government in this example decided to fund the construction of a bridge, where the alternative options considered were the construction of a new high school and an increase in the wages of government employees. We need to identify which of the given statements does not relate to opportunity costs. Recall that opportunity costs, also known as missed opportunities, are the effects or consequences of alternative options in an economic choice.

Option A: Improved morale among government employees is an effect we can expect from the alternative option of an increase in the wages of government employees. This can be considered as a possible missed opportunity; hence, it is an example of an opportunity cost associated with the current choice.

Option B: Improvement in the quality of high school education is an effect we can expect from the alternative option of the construction of a new high school. This can be considered as a possible missed opportunity; hence, it is an opportunity cost associated with the current choice.

Option C: Improved efficiency in traffic is an effect we can expect from the chosen option, which is the construction of a bridge. This is not an example of missed opportunities; hence, it is not an opportunity cost.

Option D: Recall that when opportunity costs are financial, they are expressed as the difference between the effects of the alternative and chosen options. Hence, the difference as mentioned here represents a financial opportunity cost associated with the current choice.

Option C, which describes the effect of the chosen option, is not an example of opportunity costs.

In the previous examples, we learned about opportunity costs resulting from economic choices. Let us now consider the efficiency of an economic system.

The efficiency of an economic system is measured by the amount of resources wasted during their allocation. An economic system is efficient if few to no resources are wasted. Since the goal of any economic choice is to allocate the limited resources to maximize benefits, good economic choices will lead to an efficient economic system. Other than considering the opportunity costs, what other factors affect the ability for governing entities to make good economic choices?

For a government to make good economic choices, it needs accurate and detailed information about the population it serves. Information can greatly aid economic decision making by reducing wasted resources during their allocation. In other words, the efficiency of an economic system is, for a large part, determined by the ability to obtain accurate and appropriate information when making economic choices. For instance, accurate data on the number of children in different regions of a nation will enable the government to choose the optimal location to build a new school and to satisfy the need for education. Accurate information about the state of poverty will enable the government to deliver available resources where the need is the greatest.

We can also consider the importance of information for individuals and companies. An individual with a need for shelter should have accurate information about available public shelters to efficiently satisfy the need. A company producing goods should have accurate information about how many consumers have the need for the goods it is producing. As we can see, the availability of accurate and appropriate information enables the reduction of wasted resources in economic choices made by individuals or companies.

Conversely, the problem of missing or inaccurate information is known as information failure.

Definition: Information Failure

Information failure is the deficiency in available information necessary for making economic choices.

Information failure often leads to bad economic choices, which lead to inefficient economic systems. For instance, inaccurate information about the number of children in different regions of a nation will likely cause the government to choose a site for a new school that is not optimal. This will produce wasted resources both from unnecessary transportation for children to get to school and some families deciding not to use the new school. This is an example of information failure in a government.

Information failure can occur for individuals as well. Incomplete information about harmful effects of certain ingredients may lead individuals to consume unhealthy food, which can worsen their health. This leads to wasted healthcare resources.

In the next example, we will identify an example of information failure.

Example 4: Understanding Information Failure

Which of the following is a description of information failure?

• The government releases inaccurate unemployment numbers, causing the stock market to tumble.
• A company produces an oversupply of toys due to data from an inaccurate survey.
• An individual is undecided on which product to use due to too much available information from the Internet.
• Reporting of unemployment numbers by the government is delayed, causing uncertainties in the stock market.

We recall that information failure is the deficiency in available information necessary for making efficient economic choices. Hence, we need to identify which of the given examples are poor economic choices resulting from deficiency in available information.

Let us consider each scenario.

Option A: In this scenario, the government produced an inaccurate report, which resulted in falling stock prices. While inaccurate information is involved in this scenario, falling stock prices is not an example of bad economic choices. Hence, this is not an example of information failure.

Option B: In this scenario, data from an inaccurate survey led a company to overproduce toys. Overproduction of toys is an example of an economic choice that resulted from the survey’s inaccurate information. This is an example of information failure.

Option C: In this scenario, too much information has left an individual undecided on a type of product to use. No economic choices have been made by the individual, and the problem is the oversupply of information rather than the deficiency of information. Hence, this is not an example of information failure.

Option D: In this scenario, the report of unemployment numbers is delayed, causing uncertainties in the stock market. The deficiency of information at this time has caused the problem, but there are no economic choices involved in this scenario. Hence, this is not an example of information failure.

Option B, which describes a company making a bad economic choice based on inaccurate information, is an example of information failure.

We have learned about the fundamental economic problem and its components as well as the effects of economic choices. When only a small number of needs and resources are involved in the fundamental economic problem, the optimal economic choices appear to be within reach. However, economic issues in today’s society are complex and multifaceted. The diversity of human needs and interconnected networks of different economic systems make economic issues very difficult and profound, but they also make this subject interesting and exciting.

Definition: Economics

Economics is a social science studying how individuals and societies use scarce resources to satisfy increasing and diverse needs.

In other words, economics seeks to solve the fundamental economic problem. Depending on the types of economic problems considered, economics can be divided into several branches.

In terms of the scale of economic problems considered, the subject is split into micro- and macroeconomics.

Macroeconomics studies economic behaviors of an overall economy or society. Economic choices examined here include the ones made by the national government as well as international organizations. Microeconomics considers economic problems in context of smaller entities, such as individuals or firms. Economic choices studied here concern behaviors of, and interactions between, consumers and producers of resources. The distinction between these two branches of economics is represented in the following diagram.

There are many other subdivisions in economics, which are specialized in the scope of economic problems considered. For instance, welfare economics studies various social welfare models, aiming to design an efficient economic system to deliver available resources to individuals in need. Development economics concerns developing countries and various priorities and strategies for these countries to achieve economic growth over time.

In our final example, we will consider what is studied in microeconomics.

Example 5: Distinguishing Different Fields of Economics

Which of the following best describes what is studied in microeconomics?

• Behaviors of consumers and producers
• General levels of economic activity
• Evaluating the efficiency of economic decisions
• Improving economic and social conditions

In this example, we need to identify which phrase best describes the study of microeconomics. Recall that we have encountered several branches of economics: macroeconomics, microeconomics, welfare economics, and development economics. Let us match each subject with the topics in the options.

Option A: Behaviors of consumers and producers lead to small-scale economic problems, which are studied in microeconomics. Hence, this option describes what is studied in microeconomics.

Option B: General levels of economic activity describe the types and quantities of economic activities in a large population, which lead to large-scale economic problems. We recall that macroeconomics mainly deals with large-scale economic problems at regional, national, or international levels. Hence, this is a topic studied in macroeconomics.

Option C: Efficiency of economic decisions involves reducing waste when allocating limited resources. This topic often arises when considering different social welfare models, where resources should be delivered to individuals in need with as little waste as possible. Such problems are studied in welfare economics.

Option D: Recall that development economics addresses various priorities and strategies for developing countries to achieve economic growth. This involves improving economic and social conditions of developing countries; hence, this is a topic of development economics.

Option A, behaviors of consumers and producers, best describes what is studied in microeconomics.

Let us finish by recapping a few important concepts from this explainer.

• The fundamental economic problem states that human needs are diverse and continuously increasing, while resources to satisfy them are limited.
• Individuals or economic entities can address the fundamental economic problem by making economic choices. The objective of any economic choice is to allocate the limited resources to maximize benefits.
• Opportunity costs are the effects or consequences of alternative options in an economic choice. If the effects are financial, the opportunity cost can be written as a difference between the alternate and chosen options. Some opportunity costs are qualitative and many do not involve financial implications.
• The efficiency of an economic system is largely determined by the ability to obtain accurate and appropriate information when making economic choices. Information failure is the deficiency in available information necessary for making economic choices.
• Macroeconomics studies economic behaviors of an overall economy or society.
• Microeconomics considers economic problems in the context of smaller entities, such as individuals or firms.
• Welfare economics studies various social welfare models, aiming to design an efficient economic system to deliver available resources to individuals in need.
• Development economics concerns developing countries and various priorities and strategies for these countries to achieve economic growth over time.

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• Central Problems Of Economy Study Material

Central Problems of an Economy : Study Material

Central problems of an economy.

An economic problem generally means the problem of making choices that occurs because of the scarcity of resources. It arises because people have unlimited desires but the means to satisfy that desire is limited. Therefore, satisfying all human needs is difficult with limited means.

Causes of Economic Problem

• Scarcity of resources: Resources like labour, land, and capital are insufficient as compared to the demand. Therefore, the economy cannot provide everything that people want.
• Unlimited Human Wants: Human beings’ demands and wants are unlimited which means they will never be satisfied. If a person’s one want is satisfied, they will start having new desires. People’s wants are unlimited and keep multiplying, therefore, cannot be satisfied because of limited resources.
• Alternative Uses: Resources being scarce, the same resources are used for different purposes. and it is therefore essential to make a choice among resources. For instance, petrol is used in vehicles and is also used for generators, running machines, etc. Therefore, the economy should now make a choice within the alternative uses.

List of Economic Problems:

(a) what to produce.

• A country cannot produce all goods because it has limited resources.
• It has to make a choice between different goods and services.
• Every economy has to decide what goods and services should be produced.
• Example: If a farmer has a single piece of agricultural land, then he has to make a choice between two goods, i.e., whether to grow rice or wheat.
• Similarly, our government has to decide where to allocate funds, for the production of defence goods or consumer goods, and if both, then in what proportion.

(B) How to produce?

• This problem refers to the choice of technique of production. It arises when there is an availability of more than one way to produce goods and services.
• Labour intensive technique(greater use of labour)
• Capital intensive technique(greater use of machines)
• Labour intensive technique promotes employment whereas capital intensive technique promotes efficiency and growth.

(C) For whom to produce?

• The society cannot satisfy all the wants of all the people. Therefore, it has to decide who should get how much of the total output of goods and services.
• Society has to make choice of whether luxury goods or normal goods have to be produced. This distribution or proportion directly relates to the purchasing power of the economy.

Examples of Economic Problems

CHIT-CHAT TIME (In this conversation, Raju is asking his mother to cook pizza and French fries for him. But Mother is in the dilemma that if she prepares pizza for Raju, then how she could make salad for Raju’s father.) Raju: I want my reward for this achievement. Mother:  Okay tell me. What do you want? Raju: I want to eat Pizza and French fries. Please prepare it for me. Mother: But Raju Vegetables are limited and today market is also closed and I have to prepare salad for your dad. Either I can prepare 2 Pizzas or Full plate of salad. Raju: No, I want to eat Pizza and French Fries anyhow. ( Mother is thinking about what to prepare as vegetables are available in limited quantities.) Mother: Ok I will prepare 1 Pizza and French Fries for you and half plate salad and French Fries for your dad. (Mother is chopping potatoes for French fries and vegetables for pizza) Raju: Mom, How much time you will take to prepare my meal. Mother: Dear, wait for 20 minutes. ( Mother called Rahul, Your pizza and French fries is ready now ) Raju: Thanks Mom. Mother: Did u like it? Is it Yummy? Raju: Yes mom. Pizza is out of the world. But… Mother: But.. what? Raju: Fries served in McDonalds are different from ours, I mean shape, size and crispiness of our fries is not up to the mark. Mother: Yeah I agree, But McDonald prepare fries with the help of automatic hi-tech machines. Dear, quality differs when goods made by automatic machines (capital intensive technique) and when goods are handmade (labour intensive techniques) (In the above conversation Mom is trying to explain Rahul that there are two types of production techniques i.e. Capital intensive technique and labour intensive technique) (Dad sitting on the dinner table and asking Rahul’s mother why she has prepared only half plate salad) Father: Sneha, why have you prepared only a half plate salad for dinner today? Mother: Today, Raju got full marks in Business studies Test. Father: Oh wow! Great. Mother: So he demanded to pizza. But Vegetables required to prepare pizza fell short and market was also closed. Father: Oh! Then what did you do? Mother: Then I thought to make fries with pizza and spared some vegetables for salad. Father: Great job! You are smart wife and also a smart mother.  Who knows how to make optimum utilization and effective allocation of limited resources. I think you are the true economist in our home.

LETS PRACTICE

• The choice of technique
• Distribution of income
• Market value of goods
• The choice of goods

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• What to produce?
• Where to produce?
• For whom to produce?
• None of these
• Factoral distribution of Income
• The choice of product

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Applied Economics: Definition, How It Works, and How It's Used

Katrina Ávila Munichiello is an experienced editor, writer, fact-checker, and proofreader with more than fourteen years of experience working with print and online publications.

Investopedia / Michela Buttignol

What Is Applied Economics?

The aim of applied economics is to inform economic decisions and predict possible outcomes. Applied economics relates the conclusions drawn from economic theories and empirical studies to real-world situations.

The purpose of applied economics is to improve the quality of practice in business, public policy, and daily life by thinking rigorously about costs versus benefits, incentives, and human behavior. It can involve the use of case studies and econometrics , which is the application of real-world data to statistical models and comparing the results against the theories being tested.

Key Takeaways

• Applied economics is the use of the insights gained from economic theory and research to make better decisions and solve real-world problems. 
• Applied economics is a popular tool in business planning and for public policy analysis and evaluation.
• Individuals can also benefit from applying economic thinking and insights to personal and financial decisions.

Understanding Applied Economics

Applied economics is the application of economic theory to determine the likely outcomes associated with various possible courses of action in the real world. By better understanding the likely consequences of choices made by individuals, businesses, and policymakers, we can help them make better choices. If economics is the science of studying how people use various, limited means available to them to achieve given ends, then applied economics is the tool to help choose the best means to reach those ends. As a result, applied economics can inform a "to-do" list identifying steps that can be taken to increase the probability of positive outcomes in real-world events.

The use of applied economics may first involve exploring economic theories to develop questions about a circumstance or situation and then drawing upon data resources and other frames of reference to form a plausible answer to that question. The idea is to establish a hypothetical outcome based on the specific ongoing circumstances drawn from the known implications of general economic laws and models.

Applied Economics Relevance in Financial Choices

Applied economics can illustrate the potential outcomes of financial choices made by individuals. For example, if a consumer desires to own a luxury good but has limited financial resources, an assessment of the cost and long-term impact such a purchase would have on assets can compare them to the expected benefit of the good. This can help determine if such an expense is worthwhile . Beyond finances, understanding the meaning of the economic theories of rational choice , game theory , or the findings of behavioral economics and evolutionary economics can help a person make better decisions and plan for success in their personal life and relationships.

For example, a person who wants to quit smoking might recognize that they are prone to hyperbolic discounting and might choose to employ precommitment strategies to support their long-term preference to quit over more powerful short-term preferences to smoke. Or a group of friends sharing a large bowl of popcorn might explicitly or implicitly agree to limits, or shares, for how much popcorn each will take in order to avoid a tragedy of the commons situation.

Making Better Business Decisions

Applied economics can also help businesses make better decisions. Understanding the implications of economic laws of supply and demand combined with past sales data and marketing research regarding their target market can help a business with pricing and production decisions. Awareness of economic leading indicators and their relationship to a firm's industry and markets can help with operational planning and business strategy. Understanding economic ideas such as principal-agent problems , transaction costs , and the theory of the firm can help businesses design better compensation schemes, contracts, and corporate strategies. 

Bottom Line

Applied economics is an invaluable tool for public policymakers. Many economists are employed to predict both the macro- and microeconomic consequences of various policy proposals or to evaluate the effects of ongoing policy. Applied macroeconomic modeling is routinely used to project changes in unemployment, economic growth, and inflation at the national, regional, and state levels.

Understanding the way the economic incentives and compensating behaviors created by public policy impact real-world trends in things like job growth, migration, and crime rates is critical to implementing effective policy and avoiding unintended consequences . For example, understanding what the application of the laws of supply and demand implies about the effects of price floors, along with case studies and empirical research, can inform better policy regarding minimum wage laws.

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Examples of economic problems

The fundamental economic problem is the issue of scarcity but unlimited wants. Scarcity implies there is only a limited quantity of resources, e.g. finite fossil fuels. Because of scarcity, there is a constant opportunity cost – if you use resources to consume one good, you cannot consume another. Therefore, an underlying feature of economics is concerned with dealing how to allocate resources in society to make the most efficient and fair use of resources. The main issues are:

• What to produce?
• How to produce?
• For whom to produce?

Examples of economic problems include

• How to deal with external costs/pollution , e.g. pollution from production.
• How to redistribute income to reduce poverty , without causing loss of economic incentives.
• How to provide public goods (e.g. street-lighting) which are usually not provided in a free market.
• How should we measure economic welfare? Is it wrong to focus on ouptut and income? (as economics has in the past) – New measures of economic welfare try to include broader range of factors, such as environment, education, health care.

Video summary

Micro economic problems

1. The problem of externalities

The economic problem of pollution

One of the most frequent problems is that economic decisions can have external effects on other people not involved in the transaction. For example, if you produce power from coal, the pollution affects people all over the world (acid rain, global warming). This is a particular problem because we cannot rely on the free market to provide the most efficient outcome. If we create negative externalities , we don’t take them into account when deciding how much to consume. This is why we can get overconsumption of driving a car into a city centre at peak hour. If everyone maximises their utility, it doesn’t lead to the most efficient outcome – but gridlock and wasted resources.

Externalities, usually need some kind of government intervention. For example, taxes on negative externalities (e.g. sugar tax) or subsidies on positive externalities (e.g. free public education) even banning cars in city centres.

But, even the solution to market failure (e.g. taxes), creates its own potential problems, such as how much to tax? will there be tax evasion? The administration costs of collecting tax.

Environmental issues

Economics is traditionally concerned with utility maximisation – allowing individuals to aim at increasing their economic welfare. However, this can ignore long-term considerations of environmental sustainability. If we have over-consumption in this century, it could cause serious problems for future generations – e.g. global warming, loss of non-renewable resources. The difficulty is that the price mechanism doesn’t take into account these future costs, and policies to reduce consumption may prove politically unpopular.

– How to deal with potential future environmental costs?

Monopoly was an economic problem that Adam Smith was concerned about in his influential book of economics “A Wealth of Nations.” For various reasons firms can gain monopoly power – and therefore the ability to set high prices to consumers. Given a lack of alternatives, monopolies can make high profits at the expense of consumers, causing inequality within society. Monopoly power can also be seen through monopsony employers who pay lower wages to their workers.

How to deal with the problem of monopoly? – A government may seek to encourage competition, e.g. rail franchising, or price regulation to prevent excessive prices.

Inequality/poverty

This shows that 10% of the world population still live on below $1.90 a day – though the figure has reduced in past three decades.

Inequality is considered a problem because of normative opinions such as – it is an unfair distribution of resources. Also, you could argue there is a diminishing marginal utility of wealth . If all wealth is owned by a small percentage of the population, this reduces net welfare. Redistributing the money to the very poor would enable a greater net utility to society.

Five of the world’s largest companies  Apple, Microsoft, Alphabet, Cisco and Oracle, have a total of $504bn cash savings (2015) This is money unused, whilst people around the world have insufficient food.

Inequality is a problem. However, it is also a problem to know how much we should seek to reduce poverty. Many will agree on the necessity of reducing absolute poverty – but how far should we take it? Should we aim for perfect equality (Communism) or should we aim for equality of opportunity?

Another issue with reducing poverty is that measures to reduce poverty may cause unintended consequences – e.g. higher income tax on high earners may create disincentives to work. Giving benefits to the low paid may reduce incentives to work.

Volatile prices

Some agricultural markets can have volatile prices. A glut in supply can be bad news because the fall in price can lead to lower revenue for farmers. It could even cause some to go out of business because of a bad year. These volatile markets can cause swings in economic fortunes.

Irrational behaviour

In some asset markets, we have seen volatile prices exacerbated by irrational exuberance . Consumers have often been caught up in a market frenzy – hoping that rising prices will make them richer – and expecting prices to keep rising. We can see this in issues such as tulip mania , the South Sea Bubble, railway mania, and the recent property bubbles.

Macroeconomic problems

Mass unemployment 1933

Unemployment has been a major economic problem in advanced economies. One of the principal causes of unemployment is swings in the business cycle. A fall in demand for goods during a recession, causes people to be laid off. Because of the depressed state of the economy, there is an imbalance between demand and supply of workers.

Unemployment can also be caused by rapid changes in labour markets, for examples, unskilled workers unable to gain employment in a high tech economy. Unemployment is a problem because it is a waste of resources, but more importantly, it leads to very high personal costs, such as stress, alienation, low income and feelings of failure.

A recession is a period of negative economic growth – a decline in the size of the economy. It exacerbates problems of inequality and unemployment. A problem of recession is that it can create a negative spiral. When demand falls, firms lay off workers. The unemployed have less money to spend causing further falls in demand.

In the great depression, unemployment rose to over 20% – the unemployed also had little support and relied on soup kitchens.

High inflation can be a serious problem if prices rise faster than wages and nominal interest rates. In periods of rapidly rising prices, people with savings will see a decline in their real wealth. If prices rise faster than wages, then people’s spending power will decline. Also, rapidly rising prices creates confusion and uncertainty and can cause firms to cut back on investment and spending.

Countries which have experienced hyperinflation , have seen it as a very traumatic period because all the economic certainty is washed away, leaving people without any certainty. Hyper inflation can cause not just economic turmoil but political turmoil as people lose confidence in the economic situation of the economy.

Balance of payments/current account deficit

A current account deficit on the balance of payments means an economy is importing more goods and services than it is exporting. To finance this current account deficit, they need a surplus on the financial/capital account. For many modern economies, a small current account deficit is not a problem. However, some developing economies have experienced a balance of payments crisis – where the large deficit has to be financed by borrowing, and this situation usually leads to a rapid devaluation of the currency. But, this devaluation increases the price of imports, reduces living standards and causes inflation.

Exchange rate volatility

In some cases, the exchange rate can cause economic problems. For example, countries in the Euro were not able to change the value of their currency against other Eurozone members. Because countries like Greece and Portugal had higher inflation rates, they became uncompetitive. Exports fell, and they developed a large current account deficit. The overvalued exchange rate caused a fall in economic growth.

On the other hand, a rapid devaluation can cause different problems. For example, when the price of oil fell, oil exporting countries saw a decline in export revenues, leading to a fall in the value of the currency. A rapid devaluation causes the price of imports to rise and causes both higher inflation and lower growth. A difficult problem for policymakers to deal with.

Development economics

Developing economies face similar economic problems, but any issue is magnified by low GDP and high levels of poverty. For example, unemployment in a developing economy is more serious because there is unlikely to be any government insurance to give a minimum standard of living.

Poverty cycle . Some developing economies may be stuck in a poverty trap. Low growth and low saving ratios lead to low levels of investment and therefore low economic growth. This low growth and poverty cause the low savings and investment to be continued.

More examples

• Problems facing UK economy in 2015
• Economic problems of EU

Last updated: 17th November 2019, Tejvan Pettinger , www.economicshelp.org, Oxford, UK

28 thoughts on “Examples of economic problems”

Scarcity in resource is all over. It could be jobs, skills, capital, land, medicines, equipment, hospitals, universities, schools, houses, food, water etc

Sorry…it is not yet….

Enjoyed the lesson

what does economic mean

That is economic factors are addressed

Can I buy printed materials of this article Economic problems

Hi, Pettinger!

Really nice article, thank you. However, I am not sure I’ve got something you stated: isn’t inequality a macroeconomics issue? Because, you see, the scope of microeconomics is restricted to the individual actions of the economic agents (i.e., the “invisible hand science”) and inequality can only be properly handled by a macroeconomics perspective – or, at least, that’s the way I see it. Can you clarify that, please?

P.S.: if you are interested, I’ve answered this same question at stackexchange ( https://economics.stackexchange.com/questions/41448/is-inequality-a-micro-or-macro-economics-issue )

Govt.is also responsible for inequality , unemployment and low GDP growth by not taking efficient decisions in order to boost the economy.

Comments are closed.

• > Economics
• > Financial Analytics

What is Managerial Economics? Definition, Types, Nature, Principles, and Scope

• Ritesh Pathak
• Nov 26, 2020
• Updated on: Nov 21, 2023

Businesses run on various theories that are explained in Economics. Managerial Economics is the stream of management studies that emphasizes solving problems in businesses using the theories in micro and macroeconomics . This branch of economics is used by firms to not only find a solution to problems in daily running but also for long-term planning. We can also say that Managerial economics is a practical application of theories in economics. 

“Managerial economics is concerned with the application of economic concepts and economic analysis to the problems of formulating rational managerial decisions.” - Edwin Mansfield, Economics Professor, University of Pennsylvania  

We should also look here at What is economics? Economics is an inevitable part of any business. All the business assumptions, forecasting, and investments are based on this one single concept. Investopedia explains “Economics is a social science concerned with the production, distribution, and consumption of goods and services. It studies how individuals, businesses, governments, and nations make choices about how to allocate resources.” So, theories in economics are not just some statements written but rather they act as fuel for a firm. In the broader picture, economics also helps nations in policy formation. 

So, in this blog, we will discuss the branch of economics that helps businesses to find a solution to almost every problem they may face. We will discuss the definition of managerial economics, its nature, its scope in businesses, and the principles of managerial economics. 

Also Read |   5 Key elements of Financial Analysis

Definition of Managerial Economics

Managerial economics is defined as the branch of economics which deals with the application of various concepts, theories, methodologies of economics to solve practical problems in business management . It is also reckoned as the amalgamation of economic theories and business practices to ease the process of decision making. Managerial economics is also said to cover the gap between the problems of logic and problems of policy. 

Managerial economics is used to find a rational solution to problems faced by firms. These problems include issues around demand, cost, production, marketing, and it is used also for future planning. The best thing about managerial economics is that it has a logical solution to almost every problem that may arise during business management and that too by sticking to the microeconomic policies of the firm.  

When we talk of managerial economics as a subject, it is a branch of management studies that emphasizes solving business problems using theories of micro and macroeconomics . Spencer and Siegelman have defined the subject as “the integration of economic theory with business practice to facilitate decision making and planning by management.” The study of managerial economics helps the students to enhance their analytical skills, developing a mindset that enables them to find rational solutions.

Nature of Managerial Economics 

We know about managerial economics like what it is and how different people define it. Managerial Economics is an essential scholastic field. It can be termed as a science in the sense that it fulfills the criteria of being a science. 

We all know science as a systematic body of knowledge and it is based on methodological observations. Similarly, Managerial Economics is also a science of making decisions and finding alternatives, keeping the scarce of resources in mind. 

In science, we arrive at any conclusion after continuous experimentation. Similarly, in managerial economics policies are formed after constant testing and trailing. 

In science, principles are universally acceptable and in managerial economics, policies are universally applicable at least partially if not fully. 

Nature of Managerial Economics

We will now look at the characteristics of managerial economics in brief. 

Art and Science

Managerial Economics requires a lot of creativity and logical thinking to come up with a solution. A managerial economist should possess the art of utilizing his capabilities, knowledge, and skills to achieve the organizational objective. Managerial Economics is also considered as a stream of science as it involves the application of different economic principles, techniques, and methods, to solve business problems.

Microeconomics

In managerial economics, problems of a particular organization are looked upon rather than focusing on the whole economy. Therefore it is termed as a part of microeconomics. 

Uses Macroeconomics

Any organization operates in a market that is a part of the whole economy, so external environments affect the decisions within the organization. Managerial Economics uses the concepts of macroeconomics to solve problems. Managers analyze the macroeconomic factors like market conditions, economic reforms, government policies to understand their impact on the organization. 

Multi-disciplinary

Managerial Economics uses different tools and principles from different disciplines like accounting, finance, statistics, mathematics, production, operation research, human resource, marketing, etc. This helps in coming up with a perfect solution. 

Management oriented and pragmatic

Managerial economics is a tool in the hands of managers that aids them in finding appropriate solutions to business-related problems and uncertainties. As mentioned above, managerial economics also helps in goal establishment, policy formation, and effective decision making. It is a practical approach to find solutions. 

Types of Managerial Economics

Everyone has their perceiving ability, so the same goes with managerial economics. All managers perceive the concept of managerial economics differently. For some, customers’ satisfaction can be the priority while some may focus on efficient production. This leads us to different types of managerial economics. So, let us explore the different approaches to managerial economics. 

Liberal Managerialism

Market is a free and democratic place in terms of decision making. Customers get a lot many options to choose from. So, companies have to modify their policies according to consumers’ demands and market trends. If not done so, it may result in business failures. This is what we call liberal managerialism. 

Normative Managerialism

The normative view of managerial economics means that the decisions taken by the administration would be normal, based on real-life experiences and practices. The decisions reflect a practical approach regarding product design, forecasting, marketing, supply and demand analysis, recruitments, and everything else that is concerned with the growth of a business. 

Radical Managerialism

Radical managerialism means to come up with revolutionary solutions. Sometimes, when the conventional approach to a problem doesn’t work, radical managerialism may have the solution. However, it requires the manager to possess some extraordinary skills and thinking to look beyond. In radical managerialism, consumer needs and satisfaction are prioritized over profit maximization. 

So, these were the three different types of managerial economics. These are decided based on the different approaches by managers.

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Principles of Managerial Economics

The great macroeconomist N. Gregory Mankiw has given ten principles to explain the significance of managerial economics in business operations which can be further classified into three categories. 

Principles of How People Make Decisions

Based on the real-life decision-making processes, four principles are recalled in Managerial Economics. 

1. People Face Tradeoffs

There are enormous options in the market. So, people have to make choices among the various options available. 

2. Opportunity Cost

Every decision involves an opportunity cost that is the cost of those options which we let go of while selecting the most appropriate one.

3. Rational People Think at the Margin

When we make choices from the various options available and before investing the capital or resources we look at the profit margin we would make in the investment.

4. People Respond to Incentives

It is human nature to look for something extra while purchasing something. Decision-making is affected by the incentives attached to a particular product or service. Positive incentive motivates people to opt for the particular product while negative incentive discourages. 

Principles of How People Interact

Communication with the audience plays a vital role in good performance. Over the years, organizations have realized the need to communicate well with their audience. Based on this, three principles are given in Managerial Economics. 

1. Trade can Make Everyone Better Off

This principle states that trade is a medium to exchange services and products. Everyone gets a fair chance to offer products and services which they are good at making and also to purchase those products and services.  Also Read: The success story of Delhivery

2. Markets Are Usually A Good Way to Organize Economic Activity

Market is a place where buyers and sellers interact with each other. Consumers put in their demands and requirements and the producers decide on the production and supply of those products and services.

3. Government can better the market outcomes

Government intervenes in business operations whenever there are unfavorable market conditions like the current pandemic situation or also for the welfare of society. One example of the latter is deciding the minimum wage for laborers. 

Referred Blog |   How is India recovering from the economic slowdown . 

Principle of How Economy Works as a Whole

Three principles are given to explain the role of the economy in the functioning of an organization. 

1. A Country’s Standard of Living Depends on the Goods and Services produced

The role of organizations in the economic growth of a country is one of the major, so, the organizations must be capable enough to produce goods and services for the population. This ultimately raises the standard of living and also contributes to GDP growth. 

2. Price Rises When Government Prints Too Much Money

If there is surplus money available with people, their spending capacity increases, ultimately leading to a rise in demand. When the producers are unable to meet the consumer’s demand, inflation takes place.  Referred blog : What does the 24% shrink in India’s GDP mean?

3. Society Faces a Short-Run Tradeoff between Inflation and Unemployment

Government bring-in policies to tackle the problem of unemployment and boost the economy in the short run as well. This further leads to inflation. 

Scope of Managerial Economics

Managerial Economics has a more narrow scope. It solves a firm’s problem using microeconomics. In the situation of scarce resources, managerial economics ensures that managers make effective and efficient decisions that are equally beneficial to customers, suppliers, and the organization. The fact of scarcity of resources gives rise to three fundamental questions-

What to produce?

How to produce?

For whom to produce?

To answer these questions, a firm makes use of managerial economics principles.

Managerial Economics is not only applicable to profit-making business organizations, but also to non- profit organizations such as hospitals, schools, government agencies, etc.

Read this article to know about the scope of Managerial Economics in detail.

We tried to explain Managerial Economics through this blog. The definition of Managerial Economics says that it is a branch of economics that deals with the application of various theories, concepts, and methodologies to solve business problems. It is said to cover the gap between problem of logic and problem of policy. 

For any firm to be successful, it needs to solve its problems logically and rationally. Managerial Economics helps the managers to make effective and efficient decisions using the concepts of microeconomics. One of the top characteristics of Managerial Economics is that it uses the different factors of macroeconomics helping firms to act according to the market trends. 

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Engineering Economics: Meaning and Characteristics

In this article we will discuss about the meaning and characteristics of engineering economics.

Meaning of Engineering Economics :

Engineering is the profession in which knowledge of the mathematical and natural sciences gained by study experience and practice is applied with judgment to develop ways to utilise economically the material and forces of nature for the benefit of mankind.

Engineering Economics is a subject of vital importance to Engineers. This subject helps one understand the need for the knowledge of Economics for being an effective manager and decision maker.

The Economics theories are used to take decisions related to uncertain and changing business environment. Economics theories deal with the principles of demand, pricing, cost, production, competition, trade cycles, and national income and so on.

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As the design and manufacturing process become more complex, the engineer is making decisions that involve money more than ever before. The competent and successful engineer at present must have an improved understanding of the principles of economics. The engineering economics is concerned the systematic evaluation of the benefits and costs of projects involving engineering design and analysis.

Engineering economics quantifies the benefits and costs associating with engineering projects to determine if they save enough money to warrant their capital investments. Engineering economics requires the application of engineering design and analysis principles to provide goods and services that satisfy the consumer at an affordable cost. Engineering economics is also relevant to the design engineer who considers material selection.

Engineers are planners and builders. They are also problem solvers, managers and decision makers. In the beginning of the 20 th century, engineers were mainly concerned with the design, construction, operation of machines structures and processes.

They have accorded least attention to the human and physical resources that have provided the final products. Many factors have contributed to an expansion of engineering responsibilities and concerns. Apart from the conventional work, now engineers are expected not only to create novel technological solutions but also to make skilful financial analysis of the effects of implementation.

Engineering economics involves the systematic evaluation of the economic benefits of proposed solutions to engineering problems. The engineering economics involves technical analysing with emphasis on the economic aspects and has the objective of assisting decisions.

Engineering economics is closely aligned with Conventional Micro-Economics. It is devoted to problem solving and decision making at the operational level. Thus “Engineering Economics refers to those aspects of economics and its tools of analysis most relevant to the Engineer’s decision making process”.

The Procedure Used to Assist Decision-Making :

The seven-step procedures used to assist the decision making are:

1. The recognition, definition and evaluation of the problem.

2. Search for potential as well as feasible alternatives.

3. Incorporating the basic cash flow approach.

4. Decision should serve the long term interest of the organisation.

5. Analysing the economic aspects of the engineering problem.

6. The preferred alternative is based on the total effort.

7. Attention to ensure feedback for improvement of operation.

Special Characteristics :

For the clear understanding of the subject matter one must have the knowledge of the special characteristics of Engineering Economics:

1. Engineering Economics is closely aligned with Conventional Micro-Economics.

2. Engineering Economics is devoted to the problem solving and decision making at the operations level.

3. Engineering Economics can lead to sub-optimisation of conditions in which a solution satisfies tactical objectives at the expense of strategic effectiveness.

4. Engineering Economics is useful to identify alternative uses of limited resources and to select the preferred course of action.

5. Engineering Economics is pragmatic in nature. It removes complicated abstract issues of economic theory.

6. Engineering Economics mainly uses the body of economic concepts and principles.

7. Engineering Economics integrates economic theory with engineering practice.

Related Articles:

• 5 Main Characteristics of Business Economics
• Is Managerial Economics a Science or an Art or Both?
• Utility: Meaning, Types and Characteristics | Economics
• Business Economics: Definition, Characteristics and Scope

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Microeconomics

Course: microeconomics   >   unit 1.

• Introduction to economics
• Scarcity and rivalry
• Four factors of production

Economic models

• Normative and positive statements

Lesson summary: Scarcity, choice, and opportunity costs

Key Takeaways

Scarcity and choice, positive vs. normative analysis, common errors.

• Not all costs are monetary costs. Opportunity costs are usually expressed in terms of how much of another good, service, or activity must be given up in order to pursue or produce another activity or good.
• You might hear the fourth economic resource referred to as either entrepreneurship or technology. The terms are used interchangeably but mean the same thing: the ability to make things happen. Take the example of computers—a computer itself would be considered a good, but our ability to make computers would be considered technology.
• The word capital is used in everyday language to mean what economists would call financial capital . If you see the word capital on its own in an economics context, it refers to physical capital —equipment, machinery, or tools used to produce goods and services. Physical capital is tangible, but financial capital isn't always so.

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