UNIT – 1 NATURE OF ECONOMIC PROBLEM
The economic problem , sometimes called the fundamental economic problem , is one of the fundamental economic theories in the operation of any economy. It asserts that there is scarcity, that the finite resources available are insufficient to satisfy all human wants. The problem then becomes how to determine what is to be produced and how the factors of production (such as capital and labour) are to be allocated. Economics revolves around around methods methods and possib possibili ilitie tiess of solvin solving g the economi economicc proble problem. m. The economi economicc problem is most simply explained by the question "How do we satisfy unlimited wants with limited resources?" The premise of the model of the economic problem is that human wants are constant and infinite due to the constantly changing demands (often closely related related to changing demographics demographics)) of the population. population. However, However, resources resources in the world to satisfy human wants are always limited to the amount of natural resources or human resources (human capital) available. The economic problem, and methods to curb it, revolve around the idea of choice in prioritizing which wants can be fulfilled.
Definition: Accor Accordin ding g to Robe Robert rt Awh, “Econ “Econom omic ic probl problem em is the prob proble lem m relat relatin ing g to the the necessity of the choosing what, how and for whom to produce and how to achieve economic growth.”
Concepts in the economic problem 1. Wants While the basic needs of human survival are important in the function of the economy, human wants are the driving force which stimulates demand for goods and services. In order to curb the economic problem, economists must classify the nature and different wants of consumers, as well as prioritize wants and organize production to satisfy as many wants as possible. One of the assumptions made in economics and the methods which attempt to solve the economic problem is that humans are overall greedy, and thus the market must produce as much as possible to satisfy them. These wants are often classified into individual individual wants (which depend on the individual preferences and an individual's purchasing power parity) and collective wants (those of entire communities). Things such as food and clothing can be classified as either wants or needs, depending on what type of good and how often.
2. Choice The economic problem fundamentally revolves around the idea of choice. Due to the limited resources available, businesses must determine what to produce first to satisfy demand. Consumers are obviously the biggest influences of this choice, as the goods which they want must also fit within their budgets and purchasing power parity. Different economic models place choice in different hands. Socialism asserts that (at least) some economic choices are best made for the greatest good of society if they are made at the societal level for everyone, e.g. via a government agency. Communism takes this further and argues that most or even all major economic choices should be made through central planning by the government. Only by constructing a cohesive plan that takes the good of everyone into account, so the thinking goes, can the best allocation of resources be
achieved. Capitalism argues for a more laissez-faire approach, wherein the role of the government is to protect the property rights of individuals and companies so that they can have the confidence to undertake the economic activity (and risks) risks) that will create the most value. In a free-market economy without the constraints of government wage and price price control controls, s, propone proponents nts of market market capital capitalism ism argue argue,, resour resources ces are automa automatic tically ally allocated toward the things that society, collectively, values most. If a good or service is overvalued (i.e., the price is too high), the surplus will force providers of the good or service to lower their prices or to re-allocate their capacity to produce something more worthwhile. If the supply of a good or service is inadequate, rising prices increase the value and so cause more production capacity to be directed toward the item. Adam Smith's The Wealth of Nations has been an extremely influential book for this school of thought. Causes of Economic Problem: Unlimited wants: 1. Human wants that can be satisfied by consuming goods and services and unlimited. No individual can fully satisfied his wants. Wants of all the members of society cannot be fully satisfied in a given time. In reality, human wants have been multiplying day in and day out. It is therefore, be said that at any given time there do exist innumerable unsatisfied wants in a community. Example want to Home theatre systems, deluxe cars, LCD TV.
2. Limited Needs: Large numbers of goods and services are needed to satisfy human wants. To satisfy hunger one needs bread, fruit or milk. Accordingly goods and services satisfying human wants are divided into two parts: Free goods a) One has not to pay any price to get these goods and services. Example air, sunshine etc. b)
Economic goods: One has to pay price to get economic goods and services. services. They are also called as scares means. Example bread, fruit or services doctor and lawyers etc.
The means to satisfy wants are classified into four categories: Land referes to all those natural resources which are free gift of nautre. Example A. land, minearls, forest etc. B. Labour referest oa ll thoes physical and mental activiites which are used in the prodution of goods and services. Example service of a domestic servant or of an engineer. C. Capital referes to the man made means of production. Example machines, tools etc. Enterprise refers to risk taking and conducting of business of an entrepreneur as D. a result of which it becomes possible to organize o rganize production. All the factors of production that is land, labour, capital and entrepreneur are scarece. It means there supply is not unlimited but some price has to be paid for their availablity. availablity. Scarcity is the root cause of economic problem.
Another peculiarity of means of production is that they have alternative uses. Example timber used for making furniture, sport goods etc. it is because of alternative uses of means that a problem of choice arises. In order to gain one alternative the other alternative that we forego is the opportunity cost of gained alternative. In short, scarcity of means and their alternative uses are main cause of origin of economic problem.
CENTRAL ECONOMIC PROBLEMS OF AN ECONOMIC SYSTEM: Following are the main central economic problem: p roblem: 1. What to produce and how much to produce? First problem that every economy faces is what goods and services be produced with the scarce resources so that maximum wants of the people people are are satisf satisfied ied.. The main cause cause that that gives gives rise rise to this this problem is that resources are scarce in relation to their wants. In fact fact,, it is the the prob proble lem m of allo alloca cati tion on of sc scar arce ce resou esourrces. ces. The The alloca allocatio tion n of scarc scarce e resour resources ces among among alter alternat native ive uses uses is called called resource resource allocation. Every economy has to make a choice as to what wants can be satisfied and what can be foregone. fo regone. In other words, for a rational allocation of resources resources a society must set priorities among their needs. Wants which are decided to be satisfied call for two more decisions:
a) What goods goods and service services s are to be produced? produced? Which of the consumer goods like sugar, cloth, vegetable oil etc. are are to be prod produc uced ed and and whic which h of the the good goods s lik like mach machin ines es,, trac tracto tors rs etc. etc. are are to be prod produc uced ed? ? If the the econ econom omy y aims aims at satisfying present wants, then more of consumer goods will be produced. On the contrary, if the economy aims at increasing present production capacity to satisfy more wants in future, then stress will be laid on the production of capital goods. b) How much much to produce? produce? When an economy decides about the goods and services it is to produce, it alos decides about the quantity of the same to be produced. How much quantity of consumer goods and how much of capital goods be produced? This decision requires information regarding regarding production possibility of different commodities with the given given resou resourc rces es.. Such Such infor informat mation ion can be summar summarize ized d in the production possibility curve. 2. How to produce? This problem is based on the first problem itself. Having decided what what to prod produc uce e and and how how much much to prod produc uce, e, the the next next deci decisi sion on relat elates es to how how to prod produc uce. e. This This probl problem em is conc concer erne ned d with with the the choice of technique. Three questions arises in this context:
a) How to make use of resources in the production of those goods
and services which are wanted by the people and how to prevent the the us use e of resou esourc rces es in prod produc ucin ing g thos those e goods goods and serv servic ices es which are not wanted by the people. b) Economy is also to ensure that those firms, which are producing
such goods and services, as are decided to be produced must get the relevant resources to produce them, in ample measure. In other words, economy producing wheat and cloth must select such farmers and firms as are willing to produce these goods. These These farme farmers rs and firms firms must must be amply amply provi provided ded with with those those means of production, which are essential for the production of these tow goods. c) The The econ econom omy y will will also also have have to dete determ rmin ine e the the most most effi effici cien entt combina combinatio tion n of the resou resourc rces es requi require red d for the produc productio tion n of a given level of output of goods decided to be produced. In other words, it will have to decide on the most appropriate technology to be adopted. This problem also arises because of the scarcity of means of production. Had mean of production been available in plenty then any technology could have been adopted. But in different economies different types of means are scarce. That is why different economies adopt different technology. 3. For whom to produce? Thi This s prob proble lem m deal deals s with with the the ques questi tion on as to how how an econ econom omy y distributes its total production among different economic units. How consumer goods be distributed in the household sector or among differ different ent consum consumers ers of the econom economy y. In other other words, words, how much much share out of total production or national income be given to each factor of production, that is, wages to laborers, interest to capitalist, rent to landlord and profit to the entrepreneur. 4. How to achieve fuller utilization of resources? In the problem an economy has to decide the extent to which it is willing to utilize its resources. For instance, if the economy makes largelarge-sca scale le explo exploita itatio tion n of its minera minerall resour esources ces like like coal, coal, iron, iron, petroleum etc. in the present p resent then the availability of these resources resources in the future will go down. So every economy has to decide about the scale of utilization of its resources. Having decided about the lev level of util utiliz izat atio ion n of its resou esourrces, es, the the econo conom my make akes a deter determin mined ed bid to remov remove e involu involunta ntary ry unempl unemploym oyment ent as well well as excess capacity c apacity.. 5. How to achieve efficiency I production and distribution? distribution?
Accordi According ng to Pareto, areto, “efficien “efficientt productio production n refers refers to a situation situation in which production of good cannot be increased unless production of another good is decreased. Similarly, efficient distribution refers to
a situ situat atio ion n in whic which h cons consum umpt ptio ion n of an indi indivi vidu dual al cann cannot ot be increased unless consumption of another individual is decreased. 6. How to accelerate economic growth? Thi This s probl problem em refers efers to the the prob proble lem m of econ econom omic ic grow growth. th. Ever Every y economy is keen to raise the standard of living of its people. In under developed countries it is possible only by breaking the vicious circle of poverty and raising the level of savings, investment or the rate of capital formation. To To increase the rate of economic growth in a count country ry,, its its soci social al and and inst instit itut utio iona nall facto factors rs lik like, owne owners rshi hip p of means means of produ producti ction, on, land land refor reforms ms and techni technique ques s of produ producti ction on must undergo a radical change
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