Which of the following provides an example of the knowledge problem in economics?

• A. A central planner struggles to allocate resources efficiently because they lack information about individual preferences and local conditions.
• B. Consumers respond to a decrease in the price of a good by buying more of it.
• C. A firm increases production after observing a rise in market prices.
• D. A government sets a minimum wage to improve worker welfare.

Answer: (A)

Verified step by step guidance

1. Understand the concept of the knowledge problem in economics: it refers to the difficulty central planners face in efficiently allocating resources because they lack detailed information about individual preferences, local conditions, and specific circumstances.
2. Identify the key elements in each option that relate to information availability and decision-making: check if the scenario involves a central authority trying to allocate resources without sufficient information.
3. Analyze the first option: a central planner struggles to allocate resources efficiently due to lack of information about individual preferences and local conditions. This directly illustrates the knowledge problem because it highlights the information gap faced by planners.
4. Review the other options: consumers responding to price changes, firms adjusting production based on market prices, and governments setting minimum wages do not primarily illustrate the knowledge problem, as they involve decentralized decision-making or policy interventions rather than information constraints faced by planners.
5. Conclude that the first option is the best example of the knowledge problem because it explicitly describes the challenge of making efficient economic decisions without adequate information.