essential central problems of an economy

Human wants are unlimited but resources to meet these wants are limited. These limited resources can also be put to alternative uses. Scarcity of resources creates the problems of choice making. This is the problem of making the best use of resources.

An economy may also be compared with an individual. Looked at from the point of view of an economy, the scope extends to the adjustment of unlimited wants and scarce means to solve the problems of income, output and employment. These problems are common to every economic system. In every economy, economic resources are limited whereas wants are unlimited.

This is why; every economy has to face the following basic problems. They are the central problems of an economy.

A. Allocation of Resources

The available resources of the economy may be used to produce various goods for different groups and in different manner. It requires that decisions regarding the following should be made.

1. What to produce:

Resources are limited and wants are unlimited. Every demand of every individual cannot be satisfied. Hence the economy has to decide what goods are to be produced and to what extent. What and how much to produce are interrelated. “Guns or butter” is a classic way of describing this dilemma of choice.

Again, the economy has to decide how much resources should be allocated for the production of consumer goods and how much for capital goods. Amongst the consumer goods, the economy will have to decide on the allocation of necessities versus luxuries. The choice between consumer goods and capital goods involves the choice between the present and the future. The economy has to make a choice between the immediate less important wants and more important wants in future.

2. How to Produce:

How to produce refers to the technique of production to be adopted. It means how goods are to be produced. Goods can be produced in large-scale industries or in small scale, village and cottage industries. The economy has to decide between automatic machines and handicrafts. There are various alternative methods of producing a good and the economy has to choose among them.

Different techniques of production would use different quantities of various resources. Production of cloth by handloom is called labor-intensive technique of production.

On the other hand, production of cloth by power loom is called capital-intensive technique of production. The choice between different techniques of production would depend on the factor supply situation and the price of the factors. Resources are scarce. But some resources are more scarce than others.

Hence, those techniques of production should be employed that make the greatest use of the relatively plentiful resources and economies as much as possible the relatively scarce resources. A country with a large population will prefer labor-intensive technique more than a country with a limited population.

3. For whom to produce:

For whom to produce means how the national product is to be distributed among the members of the society. In other words, it means who should get how much of the total amount of goods and services produced in the economy.

Thus the third problem is the problem of the sharing of the national product. The distribution of the national product or income is as important as its generation. Distribution of the national product depends on the distribution of the national income. The more equal is the distribution of income the more equal will be the distribution of the national product.

There is no society where all members enjoy the fruits of production equally. The organization of the economic system determines the distribution of shares among different sections of the society. Under capitalism, the decision is taken on the basis of the purchasing power of the consumers.

The socialistic economy takes decisions regarding goods and services to be produced on the basis of the requirements of the individuals. From the point of view of equity, distribution of the national product or income on the basis of equality seems to be the best. But this may adversely affect the incentive to produce more. This may reduce the size of the national product. Economists have attempted to answer this question from different angles.

B. The problem of Efficiency:

A very important question that can be asked about the working of an economy is: Are the resources being used efficiently. Since resources are limited, it is obviously desirable that they should be most efficiently used. This means that the production and distribution of the national product should be efficient. Production is said to be efficient, if it is not possible to produce more of one goods without reducing the output of ant other goods in the economy. Likewise, distribution is said to be efficient if it is not possible to make any one person better off without making any other person worse off through any redistribution.

C. The problem of Full employment of Resources:

Our means and resources are limited. So they should be fully and properly used. Resources should be wasted. The problem with the economy is how to use its available resources like land, labor, capital and other resources. Resources should be used in such a way that maximum production with minimum efforts and minimum or nil wastage be made possible. Economic development will be obstructed if certain resources remain idle.

The Great Depression of 1930’s bears an eloquent testimony to this fact. Since 1930s economists have started thinking of fuller utilization of limited resources. Under utilization of resources is considered a national waste. Problems of fuller utilization of resources are studied under welfare economics.

D. The Problem of Growth or Resources:

It is also important to know whether the productive capacity of an economy is increasing, static or declining. The increase in productive capacity of an economy overtime is called economic growth. The basic problem of underdeveloped economies is to expedite the pace of their economic growth. In these economies, the rate of economic development must be faster than the rate of growth of population. This will ensure the reasonable standard of living of the people.

In this connection, the economy has to decide about the rate of capital formation, investment and saving. Developed countries are able to achieve higher annual rate of growth than the underdeveloped ones. Thus, the problem of growth is of great importance to all countries. Questions regarding the growth of resources are discussed under Development Economics.

The economic theory is classified as Micro and Macro economic theory by Prof. Ragnar Frisch of Oslo University in 1933. Microeconomics deals with the situation of allocation of resources in the market economy. In such economy the question of ‘what”, ‘how’ and ‘for whom’ to produce are decide on the basis of price mechanism. In a market, economy goods and services are freely bought and sold. Micro means small.

Microeconomics studies the particular aspect of an economy. It deals with the pricing of products. It is elective. On the other hand, Macroeconomics deals with the fuller utilisation of resources. It is aggregative economics. Macro means large or whole. It studies the economic system as a whole. It deals with other general problems of inflation, savings, investment, output, employment etc. It studies the economic system as a whole. The next four chapters of this book constitute the subject matter of microeconomics.