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CHAPTER 2: THE ECONOMIC PROBLEM LECTURE NOTES
ECON 211: Microeconomic Principles
Arizona State University
Fall 2020
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The Economic Problem
Economics is the study of the management of finite goods and services in the face of endless
demands and requirements. Scarcity is an issue that affects all cultures, since there are never
enough resources to satisfy everyone's desires. This gives rise to the economic issue, which is the
dilemma of having to choose between competing demands for finite resources.
What is the Economic Problem?
The basic issue in economics is the economic problem. It happens when supplies are limited but
demands are infinite. In other words, it's the challenge of determining the best approach for
meeting human desires and needs within a given set of constraints. Regardless of a society's
degree of economic growth, it will always confront the economic challenge.
The Economic Conundrum of Scarcity and Free Will
Scarcity occurs when there are more desires than resources available to meet those wants.
Because of their scarcity, precious resources must be allocated among competing users,
necessitating choices to be made. When making a decision, you may have to give up some
aspects of your ideal situation in exchange for others that may be more important to you. A
student, for instance, may need to decide between studying for a test and going to a party. If they
go to the party instead of studying, they'll be less prepared for the test. When making a choice,
there is always an opportunity cost associated with it. The opportunity cost of going to the party
in the above case would be a lower final grade.
Competition and limited resources are to blame for the economy's woes. Because of their limited
quantity, decisions must be taken about their distribution. Each option comes with a set of trade-
offs that must be considered before making a final decision. The value of the best available
alternative that must be foregone due to a decision is known as its opportunity cost.
The economic crisis affects society as a whole, not just individuals. It's not just a personal issue;
it's a problem for everyone. The allocation of a society's resources is a decision that has far-
reaching effects on the quality of life in that society. A government, for instance, could have to
decide whether to invest on its people's schooling or it’s military. They may have to forego the
chance to invest in the education of their people if they want to increase spending on military
instead.
Economic Systems and the Economic Problem
Economic systems are the institutional frameworks and methods through which societies plan
and implement their economic activities and distribution of resources.
Methods of Economic Organization:
1. Economies of the Past:
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The earliest and most basic kind of economic organization
• rooted in time-honored practices that have been passed down through the ages.
Rather of focusing on making a profit, most producers instead prioritize meeting
basic needs.
Customs and traditions determine how resources are distributed.
Some native groups in Africa, Asia, and Latin America are good examples of this.
2. Controlled Economy:
This economic system is sometimes called a planned economy.
All means of production and distribution are state-owned.
All production, distribution, and allocation choices are made by one governing
body.
• There is a severe lack of individual financial investment in infrastructure.
• Cuba and North Korea are two examples.
3. Free Market:
• Also called a free-market economy or capitalist economy.
Markets are the mechanism through which individuals distribute resources.
Supply and demand are the driving forces behind market prices.
Factors of production are owned and controlled by individuals and businesses,
and these entities determine how resources are allocated and goods are
produced.
Property rights, contract enforcement, and limited economic regulation are the
only things the government is responsible for.
Countries like the USA and Japan are good examples.
4. A Market-Based and State-Guided Approach:
Most contemporary economies are what are known as "mixed economies,"
which have features of both command and market economies as well as
traditional ones.
The government's involvement in a mixed economy is higher than in a market
economy and less than in a system of command and control.
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Economic activities are regulated by the government to ensure preservation
of the environment and consumer safety, and the government also provides
public services and goods like national defense and education.
Typically, resource allocation and production choices are made by individuals
and businesses, but governments often step in to address market inefficiencies
and advance the public good.
The two examples given are the Canadian and Australian governments.
The Economic Conundrum:
The economy is in trouble because there aren't enough resources to meet everyone's
boundless demands and requirements.
It is necessary to make trade-offs when allocating scarce resources.
You will have to choose between competing uses of available resources.
Opportunity Cost and the Economic Problem
Opportunity cost is the worth of the best option not taken into account while making a decision.
The Problem with Opportunity Cost in the Economy
In economics, the term "opportunity cost" is used to describe the loss experienced as a
result of selecting one alternative over another. The opportunity cost of a choice is the
value of the best available alternative that must be given up in order to make that choice.
That which must be sacrificed in order to make a selection is the opportunity cost.
Resource scarcity and the associated need for effective resource allocation are at the heart
of the economic crisis. Since there are only so many resources to go around, people,
organizations, and governments all need to prioritize how they spend their money.
The economic dilemma may best be grasped by considering the idea of opportunity cost.
There are always options that didn't get picked whenever a decision is made. The value of
the best option that was not picked represents the decision's opportunity cost. It
represents the potential lost. That's why it's so important to calculate the opportunity cost
of your choices before you commit to anything.
Consider a farmer with a plot of land that would be suitable for either wheat or maize.
The value of the corn that might have been planted instead is the opportunity cost of the
farmer's choice to cultivate wheat. The value of the wheat that might have been produced
instead of corn is the opportunity cost if the farmer chose to cultivate corn.
Opportunity cost is also a factor when a high school graduate must choose between
further education and entering the workforce. Opportunity cost refers to how much
money a person might have earned if they began working after high school instead of
going to college. The opportunity cost is the income that might have been earned if the
individual had continued their education.
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The idea of opportunity cost is essential in commercial decision making. When running a
business, it is necessary to make choices about the use of scarce resources like time,
money, and manpower. Businesses may optimize profits and reduce losses by
considering the opportunity cost of each potential decision. Consider the case of a
corporation that must decide between funding R&D and increasing output. They can
make a better choice about which alternative to pursue if they calculate the opportunity
cost of each.
Allocating limited resources is a problem for governments as well. They are responsible
for allocating public funds and determining tax rates and regulatory frameworks. By
weighing the benefits and drawbacks of certain policies, governments may better meet
the requirements of their constituents. A government, for instance, could have to
prioritize spending on either healthcare or education. They can make a better choice
about which alternative to pursue if they calculate the opportunity cost of each.
The Economic Crisis and the Failed Market
The economic dilemma is the difficulty of meeting infinite human desires with finite means.
Market economies rely on pricing to help allocate resources and find economic solutions.
However, market failure occurs when resources are not allocated effectively. If resources are not
allocated in a manner that optimizes social welfare, then the market is failing.
Many different market failures exist, such as:
o When those whose lives are not directly affected by a transaction feel the effects of that
transaction, we say that there are externalities. People who live in close proximity to a
factory, for instance, may be exposed to harmful pollution. There may be both good and
negative externalities.
o Non-excludable and non-rival public goods are those that benefit everyone equally. After
a service or good has been made available to the public, it cannot be denied to any
potential users. When a product or service is non-rivalrous, it doesn't matter how many
people use it since there will always be enough for everyone. National security and clean
air are two examples of public goods.
o To put it simply, imperfect information arises when either the buyer or the seller lacks
access to all of the relevant data. One example is when a buyer is unaware of the item's
actual quality.
o When one company or a group of companies controls a significant portion of a market,
they are said to have market power over that product or service. A lack of competition in
the market may lead to monopolies, which in turn can lead to higher prices and less
production.
What the Government Can Do to Fix the Economy
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Governments may step in when markets are inefficient in allocating resources. Governments
may step in in a few different ways:
Markets may be regulated by governments to correct for externalities
and other market failures. To curb pollution, governments may
mandate stricter emission limits or mandate that businesses disclose all
relevant information about their goods.
Governments may be the providers of public goods like national
defense and parks.
Governments may stimulate or discourage the production or use of
specific products and services via the use of subsidies and taxes. The
government may provide financial incentives for the adoption of
renewable energy or place higher taxes on tobacco products to reduce
their popularity.
Governments may use antitrust laws to stop businesses from abusing
their market dominance and raising prices for consumers.
Governments may redistribute money and lessen economic inequality
via social welfare programs.
When markets do not distribute resources effectively, leading to a less-than-
ideal outcome for society, we say that the market has failed. Through
regulatory action, public provision, subsidies and taxes, antitrust enforcement,
and redistribution, governments can correct market failures and improve
social welfare.
The Economy and the Role of Microeconomics:
Microeconomics is the subfield of economics that analyzes how private entities, such as
households and businesses, allocate limited resources. Examines the market forces at work in the
creation, distribution, and consumption of products and services. In microeconomics, the issue
emerges when limited resources necessitate trade-offs and decisions among competing purposes.
Some essential facts about the economic crisis and microeconomics are as follows
In a market economy, microeconomics looks at how individual buyers, sellers, and businesses
act.
o In microeconomics, resource scarcity is the central economic issue, necessitating
trade-offs and prioritization of uses.
o Supply and demand are central to microeconomics, which explains how prices
work in a free market.
Government policies, such as taxes and subsidies, are also studied in
microeconomics because of their influence on market results.
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The Economic Crisis and Macroeconomics
When it comes to the economy as a whole, macroeconomics is the field of study. Concerns
including economic expansion, price stability, unemployment, and international commerce are
addressed. In macroeconomics, resource scarcity is the central issue, just as it is in
microeconomics.
Some essential facts about the economic crisis and macroeconomics are as follows:
The field of macroeconomics is concerned with the overall functioning and behavior of
economies.
In macroeconomics, resource scarcity is the central issue, necessitating decisions
on how best to allocate limited resources.
The Gross Domestic Product (GDP), inflation, and unemployment are all
indicators of economic health that are important to macroeconomics.
Macroeconomics looks at how government actions, including taxation and
spending, affect the economy as a whole.
The issue of scarcity is central to both microeconomics and macroeconomics,
but at distinct levels of inquiry.
Macroeconomics examines the overall performance and behavior of an
economy, whereas microeconomics examines the actions of individual
customers and businesses in a market setting.
The Economic Crisis and Globalization
The term "globalization" is used to describe the growing economic, cultural, and social linkages
between countries throughout the globe. As a result, countries have become more dependent on
one another as a result of increased commerce, investment, and the sharing of technologies and
ideas. While there are certainly positive aspects to globalization, it has also presented difficulties
for economies everywhere.
How to best distribute finite resources among endless desires and needs is at the heart of
the economic issue, which plagues every economy. The demand for products and services
is boundless, but resources like labor, land, and money are finite. Although globalization
didn't cause the current economic crisis, it certainly hasn't helped.
The increasing rivalry brought about by globalization has pushed businesses to improve
their productivity and creativity. Consumers have benefited from cheaper costs and wider
availability of products and services, but certain sectors have seen job losses and salary
stagnation as a result. Example: manufacturing employment in wealthy nations have
declined due to outsourcing to countries with cheaper labor costs.
Income disparity has grown as a result of globalization, both domestically and
internationally. Although many have been helped by globalization's poverty alleviation,
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the vast majority of its benefits have gone to a select few. Many middle- and working-
class families have seen their salaries remain stagnant since globalization, while the top
1% of earners have seized a disproportionate amount of the economic benefits.
The world's financial markets are also showing signs of the economic crisis. Financial
crises are more prone to spread from one country to another due to the increased
interconnectedness of countries. The global financial crisis of 2008, which had its origins
in the collapse of the US housing market, had far-reaching consequences for economies
throughout the world. Better regulation of the financial sector and increased international
cooperation are both necessary responses to the crisis.
Another facet of the economic crisis is the ecological damage caused by globalization.
The environmental and natural world are under more stress than ever before due to rising
resource demands and expanded global commerce. The negative effects of globalization
include warming temperatures, loss of forest cover, and depleted supplies.
In this age of globalization, there is no one solution that can be applied to the economic
crisis. One strategy may be to advocate for more international coordination and
collaboration. This entails working together on issues like commerce, finance, and
protecting the environment. This strategy is shown by international accords like the Paris
Climate Agreement and the Trans-Pacific Partnership (TPP).
Investing in employees' education and training is another strategy for meeting the
challenges of the global economy. Among these goals is the promotion of lifelong
learning and the provision of education and training in developing economic sectors.
Governments may help spur economic growth and job creation by investing in emerging
sectors and technology.
Progressive taxation, minimum wage regulations, and social safety net programs are just
some of the measures that policymakers might use to combat income disparity. These
measures may protect people most at risk from the economic effects of globalization and
aid in the redistribution of wealth.
The world economy has benefited much from globalization, but the difficulties it faces
have been exacerbated. Greater international cooperation, investments in education and
training, and policies to promote greater income equality are just some of the options that
policymakers should consider in light of these challenges. We can create a more stable
and fair global economy if we work to fix the economy in this age of globalization.
Tendencies Going Forward and the Economic Problem
Several economic trends are shaping our world today and will continue to do so in the future. In
this lecture, I'll go through a few of these tendencies and how they contribute to the economic
predicament.
I. Innovations in technology are one of the most influential forces that will affect the
economy of the future. The Internet of Things (IoT), artificial intelligence (AI), and
robots will alter our daily routines and the way we communicate with one another. These
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developments will lead to greater productivity, lower operating costs, and the birth of
brand-new markets and occupations.
o However, these developments in technology are not without their drawbacks.
They might also cause human employment to decline if computers begin
doing formerly human-performed duties. As a result, the economy will suffer
as people are forced to undergo costly retraining.
II. The economy will also feel the effects of another trend: the aging of the population.
Longer life expectancy means more individuals will be 65 and older, driving up
healthcare expenses and increasing demand for retirement and long-term care services.
The demands of an increasingly elderly population will place a burden on public finances
and provide an economic challenge.
III. Environmental sustainability is another trend that will influence the development of the
economy in the future. Businesses and governments will have to shift to a more
sustainable form of development as we learn more about the effects of climate change
and the depletion of natural resources. To achieve this goal, money must be put towards
renewable energy, clean technology, and eco-friendly activities.
The economic situation may worsen as a result of this shift to sustainability. It
could need a hefty investment up front, and the savings might not come
quickly enough. It might be tough to adopt changes in consumer behavior as
part of the transition to more sustainable practices.
IV. Another development that will have an impact on the future of the economy is
globalization. Increased international commerce and investment have fueled recent
economic expansion and created new employment possibilities as a result of
globalization's meteoric ascent. However, this has also increased competition, which may
threaten employment and lead to lower wages.
V. More and more people are migrating to urban areas, a phenomenon known as
urbanization, which is accelerating in many regions of the globe. As more people move
into urban areas, this could lead to increased economic activity and the creation of new
employment opportunities. On the other hand, economic difficulties may arise from
urban congestion and inadequate public services. Congestion, a lack of adequate housing,
and environmental degradation are all potential outcomes. To achieve sustainable
urbanization, governments must invest in infrastructure and planning.
VI. Consumers' priorities are shifting as a result of new information technologies and a
heightened awareness of social and environmental concerns. Customers are becoming
pickier about the products they buy and are pressuring companies to be more open and
eco-friendly. Businesses who are able to accommodate their customers' shifting tastes
will benefit. However, companies that don't change with the times may eventually fail.
VII. Short-term contracts and freelance labor, as opposed to permanent employment, have
been more common in recent years, giving rise to the so-called "gig economy." This shift
has been propelled by innovations in communication and computing that make it possible
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for people to freelance or work from home. People who would thrive with more freedom
and independence in the workplace may find openings in the gig economy. The absence
of job stability, benefits, and consistent income for those who work in the gig economy,
however, may be a serious economic burden.
VIII. AI: Artificial intelligence is an emerging technology with the potential to disrupt many
established industries. There will be more options for people to work and less money will
be spent thanks to AI. However, this trend also carries the risk of automating away
human jobs. Since workers may need to be retrained for new jobs that call for more
advanced skills, this may pose an economic challenge.
IX. Political instability is a major threat to economic growth because it raises levels of
uncertainty for firms and investors. There are a number of factors that may lead to
political instability, including civil unrest, corruption, and armed war. It may cause
businesses to hold back on spending, slow economic development, and raise the
unemployment rate. Governments should strive for politically stable settings that foster
economic expansion.
In conclusion, technology, an aging population, environmental sustainability, globalization,
urbanization, shifting consumer behavior, the gig economy, artificial intelligence, and political
instability are just some of the factors that will affect the economy in the years to come.
Individuals, companies, and governments may all benefit or suffer from these shifts. To secure a
long-lasting and successful future, it will be essential to address these tendencies.
