Central Problems of an Economy

Basic Economic Problem It is true that all income-earning and income-

spending activities form the subject-matter of economics.

Problem of choice This is the basic economic problem. Problem of choice
arises because of the presence of three inter-related facts, viz. ,
1. human wants are unlimited
2. means required to satisfy human wants are limited
3. means are capable of being put to alternative uses

Choice is to be exercised between the different uses. Economic problem is
essentially a problem of 'choice-making' or 'decision-making'.
Economics emerges whenever and wherever problems of choice and scarcity
arise.

Below is the Summary chart of the basic economic problem:















The problem of choice is basic to all individuals, all groups of
individuals, all sectors of economic activity, and even all the countries, whether
developed or developing.

Scarcity is universal: It applies to all:
Individuals
Organisations
Sectors of economic activity
Countries

Scarcity of resources poses a difficult problem of choice for every
economy. Every economy has to adjust unlimited ends and scarce means to
solve the problem of income, output and employment. These problems are
common to every economic system and are broadly known as the central
problems of an economy.


Central problems of an economy: The central problems of an economy
basically relate to the production of commodities, utilization of available
resources in the production of commodities, and distribution of commodities
produced in an economy.
All the problems centre around the concept of production. By production we
mean creation of utility. It includes all those activities that create a product or
service or any other object that helps satisfy some wants of an individual or a
group.

Problem of resource allocation is the need to economise the use of resources. By
economizing the use of resources we mean that the available resources should
be allocated among the different uses in such a way that the resources are put to
their best possible use.

Problem of resource allocation in an economy assumes the following three
forms :

1. what to produce ?
2. how to produce ?
3. for whom to produce?

What to produce ?. This problem is in fact the problem of allocation of scarce
resources among different competing uses.
Lets assume that an economy can produce only two goods say color TV sets
and computers for industry with the help of the given resources. If this
economy decides to use the whole of the resources in the production of CTVs, it
cannot produce any computers; similarly if whole of the resources are devoted
to the production of computers, it will not be in a position to produce any CTVs.
Another possibility is that it devotes a part of the resources to the production of
CTVs and a part to the production of computers.

Choice between capital-goods and consumer-goods We can also classify the
various goods into 2 categories as capital goods and consumer goods. Let us
assume that with the help of the given capital, an economy can produce more of
capital goods like iron and steel, cement, etc. , or alternatively the same capital
can go into the production of consumer goods like cloth, sugar and furniture.

How to produce ? This is another related problem that an economy is faced
with. This essentially is the problem of the choice of technique. The two broad
categories of production techniques can identified as labour-intensive technique
and capital-intensive technique.

A choice in favour of labor-intensive technique would mean that the economy
chooses to make better use of its available manpower; a choice in favor of
capital-intensive technique implies that an economy is anxious to build up fast
the infrastructure required for rapid economic growth.

For Whom to produce ? This is essentially the problem of distribution of
income between (a) the different groups of the society, and (b) the present and
the future.

As to income distribution between the different groups within a society an
economy has to find ways and means to get a distribution of income which
promotes social welfare.

The second related problem is the problem of choice between the present and
the future. If the economy has decided to produce capital goods with the help of
capital intensive technique of production, it implies that the society has chosen
to produce for future generations rather than for the present generations,
because building up of capital stock of the economy implies more production in
future than at present. Conversely, larger production of consumer goods reveals
society's preference for the present consumption to the future consumption.

'What', 'How' and 'For whom' are the three basic crucial questions. Every
economic system, be it a capitalist or a mixed economy, has to find an answer to
these questions.

Problem of Full employment of resources - This problem can be stated as
follows:

"Are the country's resources being fully utilized, or are some of them lying
idle?"

Resources are scarce. But at times, certain forces build up as a result of which
the fuller utilization of even available resources is not possible. The capacity to
produce, therefore, goes waster.

Problem of efficiency This problem can stated as follows:

"How efficient is the society's production and distribution?"

By efficiency we mean that the resources of the society are being put their best
possible use. In the situations like the following the resources would be said not
to be efficiently used or inefficiently used:

If through reallocation of resources between different uses, more of
at least one commodity can be produced without simultaneously producing
less of another.
If through redistribution of goods and services between the different
persons, at least one person can be made better off without simultaneously
making anyone worse off.

Problem of economic growth This problem can be stated as follows:

"Is the economy's capacity to produce goods and services growing from year to
year or is remaining static".

To accelerate the rate of economic growth an economy has to identify the
factors that either promote or retard growth. In other words, an economy has
to explore its growth potentialities so as to make it possible to expand the size
of production and consumption. For this purpose it would have to identify the
forces that promote growth.













CENTRAL PROBLEMS OF AN ECONOMY Human needs and wants are unlimited. Economic resources to
fulfil these human needs are limited. This implies that we cannot have everything we desire and we must make
choices. This situation of making choices stems the central problems of an economy. Scarcity means the
limitation of a resource in relation to the demand for the goods they can produce
CAUSES OF AN ECONOMIC PROBLEM UNLIMITED WANTS: Human wants are unlimited.As one
particular want is satisfied,another arises and this goes on endlessly.
Human wants are increasing day-by-day with the development of education,civilisation and knowledge.
In every society,there are innumerable wants which remain unsatisfied at a given time.
wants are competitive as they differ in intensity.
LIMITED MEANS: Goods and services that satisfy human wants are produced by the various factors of
production.ie: land,labour,capital and enterprise.
These resources are scarce while the wants are unlimited.
Due to scarcity of these resources,an economy cannot produce all the goods and services required by its citizens.
Thus,some wants will be unsatisfied.
MEANS HAVE ALTERNATE USES: Means are not only limited but they also have alternative uses. EX:
electricity can be used for cooking,entertainment,etc.
Thus, choise has to be made between different alternative uses. Making best use of the available scarce
resources is known as the problem of economising of resources.
BASIC PROBLEMS OF AN ECONOMY scarcity of resources is a common feature in all types of
economies,namely-developed,underdeveloped,opened,closed,capitalist,socialist,mixed,etc.
Thus,every economy has to face the problem of choise,which is called the central or the basic problems.
The three basic problems of an economy are:- 1. What to produce?
2.How to produce?
3. For whom to produce?
WHAT TO PRODUCE AND IN WHAT QUANTITIES? Remember that resources (land, labor, capital,
entrepreneurship) are scarce or limited. We cannot have everything; we must make choices. Which ones are
best? For allocative efficiency we should choose the combination of goods and services that creates the most
value or utility.
Every choice bears a cost. We cannot choose one option without forfeiting another. Suppose the choice is to
produce either a bag of potato chips or a tube of lipstick. If we choose the potato chips, we lose the lipstick. If
we choose the lipstick, we lose the chips. To an economist, true costs are what we must sacrifice or give up to
get something.
The economy has to choose between consumption goods(sugar,cotton,cloth,shoes,etc) and Capital
goods(machines,tools,factories,etc) Opportunity costs are the value that must be sacrificed or given up. They
also are the value of our next best alternative or opportunity. Why? Every time we make a choice, what we
sacrifice is our next best alternative.
HOW TO PRODUCE? It relates to the techniques of production to be employed while producing goods and
services.
Goods and services can be produced in 2 ways:- a) Using LABOUR intensive techniques( ie: more of labour
and less of capital will be used to produce goods and services)
b) Using CAPITAL intensive techniques(ie: more of capital and less of labour will be used to produce goods
and services) The economy has to decide whether the chosen goods and services should be produced using
automatic machines or handicrafts. Both have advantages as well as disadvantages.
MECHANISATION:-
Advantage- Increases the quantity and improves the quality of production.
Disadvantage- causes unemployement.
HANDICRAFTS:-
Advantage - Generates employement.
Disadvantage- The amount of goods produced are less.
FOR WHOM TO PRODUCE? The third problem of allocating of resources is the problem of distribution of the
produce among the various factors of production-ie: Land,Labour,Capital and Enterprise.
The economy has to decide who should get more and who should get less.
In India the poverty line is extensive so the problem of whom to produce arises as mass production for the poor
alone cannot take place as there are a few rich people too. Then arises the problem of how much to produce as
there cannot be an exact estimation of the number of rich and poor people on a daily basis and also what to
produce as there are many mass goods and many luxury goods The workers get some amount of the output
Some amount of the output is paid as rent for the land His capital has to be compensated He gets some profit For
ex: A farmer produces 10 tons of wheat. His output is allocated in a way that:- India is a South Asian country
that is the seventh largest in area and has the second largest population in the world. The land covers an area of
3,287,240 square km and the population stands at 1,202,380,000 people .
India is developing into an open-market economy.
The economy of India is the eleventh largest economy in the world by nominal GDP.
The country's per capita GDP= $3,176 (2009).
ndia's large service industry accounts for 57.2% of the country's GDP while the industrial and agricultural sector
contribute 28% and 14.6% respectively.
INTRODUCTION TO THE ECONOMY OF INDIA.
PROBLEM OF FULLER UTILISATION. There should be no wastage of scarce resources in the economy.
To get maximum production,the scarce resources need to be fully utilised. Unemployment of resources means
that the society is not able to produce all the goods and services that could have been produced with the
available resources. For ex: If a worker is not employed for a particular period, he does not contribute to the
output during THAT period of unemployment.
PROBLEM OF EFFICIENCY. This is the problem of how to obtain efficiency in the utilisation of resources
and distribution of what has been produced.
The economy is producing efficiently when it is not able to produce more of a particular commodity without
producing less of the other commodity.
PROBLEM OF ECONOMIC GROWTH. Human beings want higher and better standards of living fo which the
available goods and services need to increase over time.
Resources can be increased by two ways:-
By exploiting the unused resources.
By making technological advancements. This is one way an economy can get EVERYTHING without having
less of ANYTHING. For ex: Developed countries like USA,Canada,Japan etc are rich because of the resources
and advancements in technology. Where as Developing countries like India and pakistan have remained poor
due to the lack of technology and poor growth of resources.
A production-possibility curve or product transformation curve, is a graph that shows the different rates of
production of two goods and services that an economy can produce efficiently during a specified period of time
with a limited quantity of productive resources, or factors of production-land,labour,capital and enterprise.
Available resources can be used alternatively to produce different combinations of goods and services which are
known as production possibilities. The curve which depicts these alternative goods is called production
possibility curve.












Four parts of the problem[edit]
The economic problem can be divided into different parts, which are given below.
Problem of allocation of resources[edit]
The problem of allocation of resources arises due to the scarcity of resources, and refers to the
question of which wants should be satisfied and which should be left unsatisfied; in other words,
what to produce and how much to produce. More production of a good implies more resources
required for the production of that good, and resources are scarce. These two facts together
mean that, if a society decides to increase production of some good, it has to withdraw some
resources from the production of other goods; in other words, more production of a desired
commodity can be made possible only by reducing the quantity of resources used in the
production of other goods.
The problem of allocation deals with the question of whether to produce capital goods or
consumer goods. If the community decides to produce capital goods, resources will have to be
withdrawn from the production of consumer goods. However, in the long run, the investment on
capital goods will augment the production of consumer goods. Thus, both capital and consumer
goods are important. The problem is determining what the optimal ratio of production between
the two types of goods is.
The problem of all economic efficiency[edit]
Resources are scarce and it is important to use them as efficiently as possible. Thus, it is
essential to know if the production and distribution of national product made by an economy is
maximally efficient. The production becomes efficient only if the productive resources are utilised
in such a way that any reallocation does not produce more of one good without reducing the
output of any other good; in other words, "efficient distribution" means that any redistribution of
goods cannot make anyone better off without making someone else worse off. (See Pareto
efficiency.)
The inefficiencies of production and distribution exist in all types of economies. The welfare of the
people can be increased if these inefficiencies are ruled out. Some cost will have to be incurred
to remove these inefficiencies. If the cost of removing these inefficiencies of production and
distribution is more than the gain, then it is not worthwhile to remove them.
The problem of full-employment of resource[edit]
In view of the scarce resources, the question of whether all available resources are fully utilized
is an important one. A community should achieve maximum satisfaction by using the scarce
resources in the best possible manner; resources should not be wasted or used inefficiently.
However, in capitalist economies, the available resources are not fully utilised. In times of
depression, there are many people willing and wanting to work who go without employment. It
supposes that the scarce resources are not fully utilised in a capitalist economy.
The problem of economic growth[edit]
If the productive capacity of the economy grows, it will be able to produce progressively more
goods, which will result in a rise in the standard of living of the people in that economy. The
increase in productive capacity of an economy is called economic growth. There are various
factors affecting economic growth. The problems of economic growth have been discussed by
numerous growth models, including the Harrod-Domar model, the neoclassical growth models of
Solow and Swan, and the Cambridge growth models of Kaldor and Joan Robinson. This part of
economic problem is studied in the economies of development.
















The problem of scarcity of resources which arises before an individual consumer also arises collectively before an
economy. On account of this problem and economy has to choose between the following:
(i) Which goods should be produced and in how much 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 economics whether it is a
socialist economy like that of North Korea or a capitalist economy like that of America or a mixed economy like
that of India. Similarly, they arise in developed and under-developed economics alike.
1. What to produce?
There are two aspects of this problem firstly, which goods should be produced, and secondly, what should be
the quantities of the goods that are to be produced. The first problem relates to the goods which are to be
produced. In other words, what goods should be produced? An economy wants many things but all these cannot
be produced with the available resources.
Therefore, an economy has to choose what goods should be produced and what goods should not be. In other
words, whether consumer goods should be produced or producer goods or whether general goods should be
produced or capital goods or whether civil goods should be produced or defense goods. The second problem is
what should be the quantities of the goods that are to be produced.
Production of goods depends upon the use of resources. Hence, this problem is the problem of allocation of
resources. If we allocate more resources for the production of one commodity, the resources for the production of
other commodities would be less.
2. How to produce?
The second basic problem is which technique should be used for the production of given commodities. This
problem arises because there are various techniques available for the production of a commodity such as, for the
production of wheat, we may use either more of labour and less of capital or less of labour or more of capital.
With the help of both these techniques, we can produce equal amount of wheat. Such possibilities exist relating to
the production of other commodities also.
Therefore, every economy faces the problem as to how resources should be combined for the production of a
given commodity. The goods would be produced employing those methods and techniques, whereby the output
may be the maximum and cost of production be the minimum.
Broadly speaking, there arc two techniques of production-labour-intensive technique and capital-intensive
technique. Labour-intensive technique involves greater use of labour and capital-intensive technique involves
greater use of capital. Because of abundance of labour India would prefer labour-intensive technique. Similarly,
America will use capital-intensive technique because of abundance of capital.
3. For whom to produce?
The main objective of producing a commodity in a country is its consumption by the people of the country.
However, even after employing all the resources of a country, it is not possible to produce all the commodities
which are required by the people. Therefore, an economy has to decide as to for whom goods should be produced.
This problem is the problem of distribution of produced goods and services. Therefore, what goods should be
consumed and by whom depends on how national product is distributed among various people.
All the three central problems arise because resources are scarce. Had resources been unlimited, these problems
would not have arisen. For example, in the event of resources being unlimited, we could have produced each and
every thing we had wanted, we could have used any technique and we could have produced for each and
everybody.
Besides, what, how and for whom there are three more problems which are also regarded as basic problems.
4. The problem of efficient use of resources:
An economy has to face the problem of efficiently using its resources. Production can be increased even by
improving the use of resources. Resources will be deemed to be better utilised when by reallocating them in
various uses, production of a commodity can be increased without adversely affecting the production of other
commodities.
5. The problem of fuller employment of resources:
In many economies, especially in developing economies, there is a tendency towards under-utilisation of
resources. Resources lying idle or not being utilised fully is a recurring problem in many economies. This problem
is particularly acute in labour-abundant economies like that of India where large scale unemployment exists. In
many economies, a vital resource like land too remains under-utilised. Resources being relatively scarce, they
should not be allowed to remain idle as it is a waste.
6. The Problem of Growth:
The last problem is of growth. Every economy strives to increase its production for increasing standards of living
of its people. Economic growth of a country depends upon the fact as to what extent; it can increase its resources.
This problem is not confined to developing economies alone. It is also faced by developed economies which strive
for increasing their resources in order to increase the material comforts of their technically advanced societies.