Define the economic problem. Explain how individual consumers, business firms and the government are all faced with the economic problem. Identify the different economic factors that influence how each group seeks to address this problem.
The economic problem occurs because of the fact that the supply of resources used to produce goods and services are limited or finite but there is an infinite amount of demands and wants of individuals. In other words, the economic problem is consequence of limited resources, but unlimited wants.
Individuals must decide what is the best item to buy with their limited resources. This is called opportunity cost, which involves the consumer determining which goods and services will provide the most satisfaction and value for money. In market economies, consumers have sovereignty over the market and thus they influence which products are produced and the amount produced. However, many businesses persuasively advertise unwanted or unnecessary goods and services to certain consumers, which can result in a misallocation of resources.
In accordance to the economic problem, businesses have a number of issues to address: What to produce? How to produce? How much to produce? To whom to distribute?
What to produce – Firms must decide which production combination of goods and services will involves the least cost but result in the largest amount of produce
How to produce – refers to what method of production of the selected goods and services Is the most cost effective and efficient
How much to produce – involves predicting the amount of goods and services that will be needed and demanded. Using these statistics, the business will attempt to produce a quantity of goods equal to or as close as possible to that amount. This prediction is usually based on the amount of consumption, demand and profit of the previous year.
To whom to distribute – the ratio of distribution of goods and services across the country, state or region, according to consumer demands and availability of transport.
The government has a regulatory role in the economy through the control of taxes and redistribution of income. For example, when an economy has a low level of economic activity, the government can increase it’s expenditure on things such as infrastructure, and could lower taxes to encourage consumer and business spending. Similarly, the government could decrease spending and increase taxes to influence saving and less shopping ‘splurges’, to reduce the economic activity.
The Reserve Bank can also act as a regulator and can dramatically alter the direction of an economy. The Reserve Bank can raise and lower interest rates which influences domestic saving and investment, and also affects foreign investment. For example raising interest rates would encourage foreign countries to buy Australian dollars to capitalise on the interest of their investment. The government has some bearing on the actions of the Reserve Bank, however its influence is quite minor.
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