Economic Theory and the Problem of Resource Allocation

The rational of economic theory

Making CHOICES is an every day occurrence. Individuals, households, firms

producing goods and services, governments and even the international community make

choices. Choices have to be made for the simple reason that there is SCARCITY. The best-

known scarcity is that of money to buy all the things we desire as individuals, households,

or even governments.

Time is scarce, therefore we have to make a choice on the way we spend the twenty

four hours in a day. Natural resources are scarce. For instance land in the high potential

areas of Kenya is only a certain area. Similarly the forest area in Kenya is scarce in the sense

we would want to have more forests, but forestland can also be cultivated because food

produced is scarce. Scarcity implies that a choice has to be made.

Economics is the science of choices. It can be defined as the social science that

studies the choices that we (human beings) make as we cope with scarcity (such as of natural

resources) and the institutions (such traditional norms of natural resource use and management

or government regulations (such as the pending forest bill) that have evolved and

continue to evolve to influence and reconcile our choices. Economic theory is the body of

knowledge that has been accumulated by observing human behaviour in the process of

making choices imposed by scarcity. This body of knowledge continues to be generated. It is

used as one way of analyzing some of the problems that face humanity by identifying and

organizing the facts pertaining to a specific problem with a view to suggesting or alternative

solutions and evaluating their possible.

Economics is divided into two broad areas: Micro- and Macroeconomics.

Microeconomics is the study of the choices the individuals (households) and businesses

(firms) in dealing with scarcity, the interaction of these decisions, and the effect of government

regulation on these decisions. The effect of individual, households, business firms and

government on the national and global economy constitutes the study of

Macroeconomics. For example, how will the maize market in Kenya be affected by free trade

among the three East African countries? How will reduction on the tax on paraffin and gas?