What is an economic problem and why does it arises?
An economic problem is basically the problem of choice which arises because of scarcity of resources. Human wants are unlimited but means to satisfy them are limited. Therefore, all human wants cannot be satisfied with limited means. Wants differ in intensity and limited resources have alternative uses. In such a background, every consumer tries to satisfy his maximum wants. Therefore, one has to choose as to what goods one should consume and in what quantity. Economic problem arises the moment problem of choice arises. Actually speaking, economic problem is basically the problem of choice.
Due to scarcity of resources, the problem which arises before an individual consumer also arises collectively before an economy. On account of scarcity of resources, an economy has to choose between the following:
(i) Which goods should be produced and in what quantity?
(ii) What technique should be adopted for production?
(iii) For whom goods should be produced?
These three problems are known as the central problems or the basic problems of an economy. This is so because all other economic problems cluster around these problems. These problems arise in all economies, whether it is socialist economy like that of China or a capitalist economy like that of America.
From the above analysis, it is clear that an economic problem arises because of the following causes:
(i} Human wants are unlimited:
Human wants are unlimited. After the satisfaction of one want, another want arises. There is a difference in the intensity of wants also. Thus, there is an unending circle of wants, when they arise, are satisfied and arise again.
(ii) Limited resources:
Means are limited for the satisfaction of wants. Scarcity of resources is a relative term, for satisfying a particular human want, resources can be in abundance, but for the satisfaction of all the wants, resources are scarce. This is called relative scarcity of resources where resources are scarce in relation to the wants they are expected to satisfy.
(iii) Alternative uses of resources:
Limited resources can be put to many alternative uses. For example, electricity can be used for domestic light as well as for industrial power.
(iv) Problem of choice:
Human wants are unlimited but resources to satisfy them are limited and this gives rise to the problem of choice, such as what should be produced and how and for whom production should be done. The problem of choice is the economic problem. Had resources also been unlimited like human wants, there would have been no problem of choice and hence no economic problem. In other words, scarcity of resources is the mother of all economic problems. In short, "Multiplicity of wants and scarcity of means are the two foundation stones on which the whole edifice of economic problems stands."
Economic Problems and Crisis
The past few years have, at least been good news for those studying economic crisis. We seem to have had a bewildering array of different crisis – credit crunch, financial crisis, fiscal crisis, banking crisis, economic crisis, depression economics, oil price shock, currency crisis, housing crashes and more. We’ve even had a few potential crisis that never materialised – Flu epidemic crisis, volcano crisis.
Arguably, we should be calling continued mass unemployment a crisis. In many ways it is more serious than a currency or credit crisis.
All crisis are to some extent interelated. Here’s a summary of what they involve.
Types of Economic Crisis
Credit Crisis.
This is a crisis primarily involved in the financial sector. It refers to the lack of money and credit for banks and other financial institutions. For example, in 2008, many banks found it difficult to gain sufficient access to credit. They had come to rely on borrowing money on money markets, but due to loan default and a collapse in confidence, banks were reluctant to lend. Some banks ran out of money completely and went bust (in case of Lehman Brothers) or had to be rescued – Northern Rock. See: Credit crisis
Financial Crisis.
This is really another name for a credit crisis. However, it implies a wider implication. As well as difficulty in getting funds it relates to the implications of banks and consumers not being able to borrow leading to banks suffering from insufficient funds. Financial crisis explained
Financial Crisis Asia 1997
Japanese Financial Crisis
Economic Crisis.
When people talk of an economic crisis, it could involve a variety of serious economic problems such as currency collapse, hyper inflation. Perhaps the most common crisis, is a steep fall in GDP and deep recession. This is the most serious economic crisis as it leads to the most serious impact on human welfare – in terms of economic inactivity and mass unemployment. The credit crisis played a direct role in leading to wider economic problems a year later. See: Economic Crisis
Fiscal Crisis
A fiscal crisis refers to governments struggling to repay its debt and struggling to borrow enough money to meet its budget deficit. If markets fear governments have borrowed too much, and there is little chance of repayments, there will be a selling of the government bonds, pushing up interest rates and giving government bonds a very low credit rating. It then becomes a difficult cycle to break. Markets won’t lend. Governments have to cut deficit by slashing spending. But, slashing spending can cause a fall in GDP and hence even lower tax revenues. A fiscal crisis, usually involves governments seeking outside help such as IMF intervention. e.g. European Fiscal Crisis.
An economic crisis will worsen a governments budget deficit as tax revenues fall in a recession. Also in a financial crisis, markets are more sensitive to risk and may worry if governments look vulnerable. See also sovereign debt crisis
Currency Crisis.
A currency crisis occurs when there is a rapid fall in the value of the currency as investors become nervous of holding a countries assets. A gradual depreciation (like 20% fall in value of Sterling over past couple of years) would not be seen as a currency crisis. However, in the case of Iceland, the value of the Icelandic currency fell very rapidly as people lost confidence in the Icelandic financial sector. A currency crisis can be caused by a fiscal crisis. If governments look to default on bonds, foreign investors will want to sell any bonds they have causing a fall in exchange rate. A currency crisis can also occur in a semi fixed exchange rate if markets feel a currency is overvalued. e.g. Sterling in 1992 when it was in ERM. What causes currency collapse?
Hyperinflation
When there is very high inflation and the value of money collapses making ordinary transactions difficult. Hyperinflation
Supply Side Shock
A rapid rise in oil prices can depress an economy, leading to higher inflation and lower output. (Shift in SRAS to the left). e.g. UK economy in 1970s
Related
Fundamental Economic Problem