Microeconomics

Chapter 2
(PART 1)
Basic Economic Problems &
The Economic Systems
 INTRODUCTION
• Economics is the science of making
choice under conditions of scarcity.
• What are the basic issues about
which choices are to be made?
• Any society must make choices
about three important problems.
• They are the following:
 Basic Economic Problems
• What to produce, & in what
quantities?
• How shall goods be
Produced?
• For whom the goods be
produced?
What to produce, & how many?
• Food or weapons; if so, in what
quantities?
• Is it more rice and less sugar or
vice versa?
• Prioritize education or
employment?
 How to Produce?
• Electricity from the solar
power or from hydro power?
• Rice from traditional or
modern method of farming?
• Knowledge thru library or
internet?
For whom the goods be produced?
• For the upper bracket of
society?
• Or is it for the middle class?
• It can also be for the benefit
of the general public?
 Economic Problems
• These three basic problems are
interdependent.
• The society must make proper
choice about them in order to
meet the development
aspirations of people
satisfactorily.
 Economics Problems
• The above three questions are
common to all economies but
every economic system attempts
to make its own choice.
• The nature of a particular choice
in a particular society depends on
its specific economic system.
 ECONOMIC SYSTEM
• An economic system is a way of
answering these basic questions.
• Different economic systems answer the
above questions differently.
• An economic system refers to how the
different economic elements will solve
the central problems of an economy:
what, how and for whom to produce.
 ECONOMIC SYSTEM
• It refers to the production and
distribution of goods and services within
which economic activity takes place.
• It refers to the way different economic
elements, individual workers and
managers, productive organization such
as factories or firms and government
agencies are linked together to form an
organic whole.
 ECONOMIC SYSTEM
• Economic system consists
of various individuals and
their institutions like
banking, education,
factories, service provider
to cite among others.
 ECONOMIC SYSTEM
• The most general economic systems are:
• Traditional Economy;
•Capitalist Economy;
•Socialist Economy; and
• Mixed Economy.
 TRADITIONAL ECONOMY
• The basic problems are solved
by traditions and custom.
• It produces exactly to its
consumption requirements.
• It is a subsistence (survival)
economy.
 TRADITIONAL ECONOMY
• The means and ways of production are based
on customs, traditions and beliefs.
• A subsistence economy where one produces
only the things they need.
• There are not much of sales as there is only
small scale production.
• The same product will be produced by every
generation. The production techniques are
traditional.
 TRADITIONAL ECONOMY
• It is a very backward type of
economy. It is the production of
products; trading and distribution
of incomes are sanctioned by
customs. Thus, it also refers to the
traditional manner of doing
things, makes decisions on what,
how, and for whom to produce.
 TRADITIONAL ECONOMY
• The methods of production are
carried over by forefathers.
• Technological change and
innovation are closely
constrained because they may
clash with tradition and threaten
the social order.
 EX. OF TRADITIONAL ECONOMY
• Example: in Saudi Arabia, the
women are not yet liberated from
the house household chores.
• They are not permitted to work for a
career. So most of the commodity it
produces favors the men because
they are the labor force in
production.
 EX. OF TRADITIONAL ECONOMY
• Consequently, in Afghanistan because of
its tradition, they can afford to sacrifice
themselves for jihad or holy war.
• Since all men are assigned to be soldiers,
military weapons are must in their
economic activity.
• Women are no longer being sent to
school once they finish their elementary
grades.
 CAPITALIST OR MARKET ECONOMY
• This is an economic system in which
the production and distribution of
commodities take place through
the mechanism of free markets.
• ***Free Market – refers to an
economic market operating by free
competition.
 CAPITALIST OR MARKET ECONOMY
• Hence, it is also called as
market economy or free trade
economy.
• Each individual be it a producer,
consumer or resource owner
has considerable economic
freedom.
 CAPITALIST OR MARKET ECONOMY
• *Economic Freedom – anyone
can choose its own desire.
• An individual has the freedom
to buy and sell any number of
goods and services and to
choose any occupation.
 CAPITALIST OR MARKET ECONOMY
• The resources are privately
owned and the people
themselves make decisions.
• This is also known as
capitalism or free enterprise
economy and it follows the
laissez faire policy.
 CAPITALIST OR MARKET ECONOMY
• *LAISSEZ FAIRE – means a French
term which means let alone policy or
leave it alone.
• The economic problems are being
decided by the people who actively
participate in the interlocking
network of market and prices.
THE SALIENT FEATURE OF CAPITALISM

• RIGHT TO PRIVATE PROPERTY

• PROFIT – MOTIVE
• FREEDOM OF CHOICE
• MARKET FORCES
THE SALIENT FEATURE OF CAPITALISM
• RIGHT TO PRIVATE PROPERTY
• Individuals have the right to buy and
own property.
• There is no limit and they can own
any amount of property.
• They also have legal rights to use
their property in any way they like.
THE SALIENT FEATURE OF CAPITALISM
• PROFIT - MOTIVE
• Profit is the only motive for the
functioning of capitalism.
• Production decisions involving high risks
are taken by individual only to earn large
profits.
• Hence, profit-motive is the basic force
that drives the capitalist economy.
THE SALIENT FEATURE OF CAPITALISM
• FREEDOM OF CHOICE
• The question ‘what to produce?’
will be determined by the
producers.
• They have the freedom to decide.
• Similarly consumers have the
freedom to buy anything they want.
THE SALIENT FEATURE OF CAPITALISM
• MARKET FORCES
• Market forces like demand, supply
and price are the signals to direct
the system.
• Most of the economic activities
are centered on price mechanism.
THE SALIENT FEATURE OF CAPITALISM
• MARKET FORCES
• LOCATION,
• DEMAND,
• STATUS,
• ECON. STATUS,
• QUALITY,
• SEASON
DISADVANGES OF CAPITALIST OR
MARKET ECONOMY
 D.A OF CAPITALIST - INEQUALITY
• Capitalism creates extreme inequalities in
income and wealth.
• The producers, landlords, traders reap huge
profits and accumulate wealth.
• Thus the rich become richer and the poor
poorer.
• The poor with limited means are unable to
compete with the rich.
• Thus capitalism widens the gap between the
rich and the poor creating inequality.
 D.A OF CAPITALIST – LEADS TO MONOPOLY
• Inequality leads to monopoly.
• Mega corporate units replace smaller
units of production.
• Firms combine to form cartels and in this
process bring about reduction in number
of firms engaged in production.
• They often hike prices against the
welfare of consumer.
 D.A OF CAPITALIST –
MECHANIZATION & AUTOMATION

• Capitalism encourages
mechanization and automation.
• This will result in unemployment
particularly in labor surplus
economies.
 D.A OF CAPITALIST – WELFARE IGNORED

• In Under capitalism, private

enterprises produce luxury goods
which give higher profits and ignore
the basic goods required which give
less profit.
• Thus the welfare of public is ignored.
D.A OF CAPITALIST – EXPLOITATION OF LABOR

• Severe labor laws are enacted for the

exclusive profit-motive of capitalists.
• Fire and hire policy will become the
order of the day.
• Such laws also help to exploit the
labor by keeping their wage rate at
its lowest minimum.
 D.A OF CAPITALIST –
BASIC SOCIAL NEEDS ARE IGNORED

• There are many basic social sectors like

literacy, public health, poverty, drinking
water, social welfare, and social security.
• As the profit margin in these sectors is
low, capitalists will not invest.
• Hence most of these vital human issues
will be ignored in a capitalist system.
 SOCIALIST OR COMMUNISTIC ECONOMY
• In a socialist economy, the means of
production are owned and operated by
the State.
• All decisions regarding production and
distribution are taken by the central
planning authority.
• Hence the socialist economy is also
called as planned economy or command
economy.
 SOCIALIST OR COMMUNISTIC ECONOMY
• Social welfare is given importance;
• Equal opportunity is given to all.
• All such advantages have delivered
high level of human development.
• Some of the most successful socialist
economies are China, Cuba, Vietnam
and North Korea.
 BASIC CHARACTERISTICS FEATURES OF
SOCIALISM/COMMUNISM

• SOCIAL WELFARE MOTIVE

• LIMITED RIGHT TO PRIVATE PROPERTY
• CENTRAL PLANNING
• NO MARKET FORCES
 SOCIAL WELFARE MOTIVE
• In socialist economies, social or collective
welfare will be the prime motive.
• Unlike capitalism, profit will not be the
aim of policy making.
• The decisions will be taken keeping the
maximum welfare of the people in mind.
• Thus social well-being of people will be
the purpose of development.
LIMITED RIGHT TO PRIVATE PROPERTY
• The right to private property is limited
under socialist economy.
• All properties of the country will be
owned by the State.
• That is, the ownership is collective in
nature.
• No individual can accumulate too much
property as in the case of capitalism.
 CENTRAL PLANNING
• Most of the economic policy
decisions will be taken by a
centralized planning authority.
• Each and every sector of the
economy will be directed by well
designed planning.
 NO MARKET FORCES
• In a centralized planned system of
development, market forces have only a
limited role to play.
• Production, commodity and factor prices,
consumption and distribution will be
governed by development planning with
welfare motive.
 MERITS OF SOCIALIST/COMMUNISM
ECONOMY

• EFFICIENT USE OF RESOURCES

• ECONOMIC STABILITY
• MAXIMIZATION OF SOCIAL WELFARE
• ABSENCE OF MONOPOLY
• BASIC NEEDS ARE MET
• NO EXTREME INEQUALITY
DEMERITS OF SOCIALIST/COMMUNISM
• BUREAUCRATIC EXPANSION –
–Government Interference
• NO FREEDOM
– Absence of Economic Freedom
• NO COMPETITION
–Absence of Consumer’s Sovereignty
• ABSENCE OF TECHNOLOGY
–Limits Technological Innovation
 MIXED ECONOMY
• In a mixed economy, both public and
private institutions exercise economic
control.
• The public sector functions as a
socialistic economy and the private
sector as a free enterprise economy.
• All decisions regarding what, how and
for whom to produce are taken by the
State.
 MIXED ECONOMY
• The private sector produces and distributes goods
and services.
• It manufactures consumer and capital goods in
the interest of public welfare.
• A mixed economy possesses the freedom to hold
private property, to earn profit, to consume,
produce and distribute and to have any
occupation.
• But if these freedoms affect public welfare
adversely, they are regulated and controlled by
the State.
THE MAIN FEATURES OF MIXED ECONOMIC SYSTEM

• CO – EXISTENCE OF PUBLIC AND

PRIVATE SECTOR
• CONSOLIDATION OF MERITS OF
CAPITALISM AND SOCIALISM
• PLANNING
THE MAIN FEATURES OF MIXED ECONOMIC SYSTEM

• CO – EXISTENCE OF PUBLIC AND

PRIVATE SECTOR
• CONSOLIDATION OF MERITS OF
CAPITALISM AND SOCIALISM
• PLANNING
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