How do economic systems solve the problem of scarcity?
HOW DO ECONOMIC SYSTEMS SOLVE THE PROBLEM OF SCARCITY?
Scarcity is not a new thing. Scarcity has always been with us and will be with us as long as we cannot get everything we want for free. Scarcity arises from the fact that resources (like land, labor and capital) are finite. Resources are the inputs used in the production of those things that we desire. Scarce resources are used to produce economic goods. Goods produced from scarce resources are also scarce. Thus, we constantly face decisions about how best to use them. Every economy has to decide 1) What will be produced? 2) How will it be produced? 3) For whom will it be produced?
Scarcity forces us to choose. In fact, the concept of choice forms the basis of economics. Moreover, the choices that we can make are constrained not only by scarcity but also by political, legal, traditional and moral forces. In other words, there are numerous non-economic forces also that determine and mold our decision making process. When a choice is made, some other thing that is also desired has to be forgone. In other words, another possible opportunity has to be missed or forgone, i.e. there is an opportunity cost. We have to make trade-offs.
The choices and trade-offs that we make determine the possible results that can be produced and give us the production possibilities curve. Societies that we live in also have to make such choices and trade-offs between the different types of goods (consumption goods and capital goods or alternatively current consumption vis-à-vis future consumption) it will produce.
Economic systems comprise of all institutional means through which national resources are used to satisfy human wants. Institutional means includes the laws of the nation and also habits, ethics and customs of its society.
There are three different types of economic systems:
> Capitalism or Laissez-faire economy
> Command economy
> Mixed economy
Each of these three economic systems has their own ways of addressing the problem of scarcity and face opportunity costs in making decisions.
a) A laissez faire economy, also known as capitalism, is an economic system in which individuals or group of individuals privately own productive resources and possess property rights to use these resources in the manner they choose, subject to certain legal restrictions. The USA and Hong Kong are new examples of market economies where firms decide the type and quantity of goods to be made in response to consumers needs. An increase in the price of one good encourages producers to switch resources into the production of that commodity. Consumers decide the type and quantity of goods to be bought. A decrease in the price of one good encourages consumers to switch to buying that commodity. People with high incomes are able to buy more goods and services than those who are less well off.
Capitalism solves the problem of scarcity by decision-making by private individuals. If a producer sees that the material of making a certain product is getting scarce, they will increase the price or reduce supply or both. When price increases, generally supply rises and demand falls till a balance between demand and supply is reached once again. When a producer has excess materials for a certain product, it will increase supply and reduce price. A market economy solves it problems of scarcity by increasing and decreasing price and supply. Competition is also the mechanism that obliges firms to seek ...
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Capitalism solves the problem of scarcity by decision-making by private individuals. If a producer sees that the material of making a certain product is getting scarce, they will increase the price or reduce supply or both. When price increases, generally supply rises and demand falls till a balance between demand and supply is reached once again. When a producer has excess materials for a certain product, it will increase supply and reduce price. A market economy solves it problems of scarcity by increasing and decreasing price and supply. Competition is also the mechanism that obliges firms to seek efficient ways of production. A market system also depends on technology to resolve the problem of scarcity. By research and development, firms find new ways of using scarce resources. Specialization is a very important term in a market economy. Specialized companies have a higher production rate and therefore make the whole economy more efficient. Another way the market economy solves the problem of scarcity is by importing. An additional method is to have alternatives for a certain good, which the consumer can choose.
An idealized capitalist system works within the institution of private property that is controlled and enforced through the legal framework of laws, courts and police. Further, such a system is one of free enterprise, where producers freely choose the resources they use in the products they produce. Consumers have freedom of choice also, as do workers and owners or resources in general. Individuals and producers express their desires through the market system, where prices are signals about the relative scarcities of different goods, services and resources. The roles of government is a limited one.
b) A command economy is an economic system in which the government controls the factors of production and makes all the key decisions about their use and about the distribution of income. Thus, in the command economy, decision-making is a centralized process. The USSR and North Korea are examples of command economies. The government sets output targets for each district and factory and allocates the necessary resources. Incomes are often more evenly spread out than in other types of economy. The government in a command economy tries to solve the problem of scarcity by only producing the goods that they assign priority to and thus depriving the individuals in the society from being able to satisfy some of their other wants.
In a command economy, the government, by deciding what the country needs and only using the resources, which are necessary, solve the problem of scarcity. If a resource becomes scarce they may not produce any more of that good and switch to an alternative good. The government decides what to produce and allocates the resources according to its decisions. Another method the governments use to solve the problem of scarcity is by raising prices, but they must make sure that even the poorest consumers can afford to buy it. It can also ask certain firms to increase their production of scarce resources or to expand (using more factors of production). During times of war, when resources are scarce, governments use the method of rationing for giving the minimum essential goods to its people.
c) A mixed economy is an economic system in which there is a mixture of ownership of resources and decision-making by both private individuals and the government. Thus, decisions about how resources should be used are made partly by individuals and partly by the government and other institutions in the public sector. Some sector of the economy, which are considered more critical, could be under government control where as most of the other sectors could be left for the private individuals to determine. The United Kingdom and France are examples of a mixed economy though both are more towards free market economy of the spectrum.
There are three main ways in which this type of system tries to solve the problem of scarcity. Under the first method, the government takes a little more control of the resources and supplies the firms with scarce resources or provides subsidies. Under the second method, the government can also set maximum and minimum price ranges. Scarcity is then prevented by making sure retailers do not sell below the price limit set. The final method they use is privatization. This entails selling state owned companies to the public. This helps the firms to become more competitive and efficient and also helps to improve the allocation of resources.
Thus, different economic systems have different ways of solving the problem of scarcity. Scarcity will always be there as an economic problem as we have discussed above, since resources are finite and decisions and trade-offs have to be made. In recent times, market economies have proved to be more successful and more and more countries are changing to adopting market economies or mixed economies, but towards the market economy end of the spectrum.
WHAT PROBLEMS DO GOVERNMENTS FACE FINDING THE BEST SOLUTION FOR THEIR COUNTRY?
When governments try to find ways and solutions to solve scarcity, they sometime create other problems. Governments that follow different systems encounter different problems while trying to find the best solution for their country.
In a free market system, trying to solve scarcity can lead to other problems. One of the problems is that free markets focus a lot on advancement and technology to improve efficiency and productivity. Advancement and technology lead to more mechanization of manufacturing processes resulting in less need for human labor. This leads to increased unemployment, which is a very big problem in many of the free market economies. When we talk about free market, we also talk about competition, which helps to allocate resources more efficiently. However, we should not allow firms to get too much power so that they turn into a monopoly. This could lead to higher prices for the consumers and higher profits for those companies. We can see that free markets carry many faults with their solutions and this is because of a lack of government intervention and control.
In a command economy the government has total control and therefore they decide how do deal with the problem of scarcity. However, their decisions also have many errors and plans do not always go as planned and many problems can occur. Governments can direct their resources into non-essential goods or for war, depriving their citizens from the more basic necessities. Sometimes governments can also forget some things in their plans, which can lead to big problems. For example, if the government controls and supplies all of the resources that the toy industry requires and it supplies all the materials except the plastic, it will cause a disruption in supply, and the goods will not be able to be produced. If the government raises prices then it will also have to raise wages, otherwise it will be hard for consumers to buy what they need. Another problem that can arise is when free markets try to control the price barrier. By doing this it can lead to the formation of illegal markets and sales. This could then become part of a black market, which could also overall increase crime. If a government decides to turn its economy into a mixed or free market economy (like Russia in the "Planning becomes a nightmare for Moscow" article), it will have to sell and privatize many of the companies. This could lead to inefficiency and a lot of misunderstanding. Planned economies have limited solutions but a large number of problems.
Since mixed economies are made up of both free market and command economies, they also face many problems because the solutions that they decide upon may work only for one side of the system and be damaging to the other side. They may over allocate resources to one sector or they may intervene too much in another sector. A mixed economy is never stable as it is always moving form being either more free or to being more controlled by the government. There can be prolonged debates on the desirability of public ownership or privatization of the key sectors of the economy on political and economic grounds.
In conclusion, when economic systems solve a problem like scarcity, they usually create other problems for themselves. They have to look for the best solutions, which will produce fewer problems. No economic system is perfect there will always be errors in their solutions but even though they cannot be perfect, they can always try to get better.
Bibliography:
. Richard Young. "Basic Economic Problems." Biz/ed. Available http://www.bized.ac.uk/stafsup/options/notes/econ201.htm#Heading8. 17 Sept 2004
2. "Economic Systems." World book 2003. CD-ROM.
3. Economics Explained
Anuraag Agarwal 12A / BMc Economics Standard 20/09/2004