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2. Basic Problems

The document discusses the basic economic problems faced by all economies due to the scarcity of resources, which include decisions on what to produce, how to produce, for whom to produce, and provisions for economic growth. It emphasizes that every economic system, whether capitalist, socialist, or mixed, must address these central problems. Additionally, it introduces the concept of an economic system as the arrangement for the production and distribution of goods and services within a society.

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8 views

2. Basic Problems

The document discusses the basic economic problems faced by all economies due to the scarcity of resources, which include decisions on what to produce, how to produce, for whom to produce, and provisions for economic growth. It emphasizes that every economic system, whether capitalist, socialist, or mixed, must address these central problems. Additionally, it introduces the concept of an economic system as the arrangement for the production and distribution of goods and services within a society.

Uploaded by

paadhi1223
Copyright
© © All Rights Reserved
Available Formats
Download as PDF, TXT or read online on Scribd
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1.16 1.

16 BUSINESS ECONOMICS

UNIT - 2: BASIC PROBLEMS OF AN ECONOMY


AND ROLE OF PRICE MECHANISM

LEARNING OUTCOMES

After studying this unit, you would be able to:


 Explain the Basic Problems faced by an Economy.
 Describe how Different Economies Solve their Basic Economic
Problems.
 Explain the Role of Price Mechanism in Solving the Basic Problems of
an Economy.

2.0 BASIC PROBLEMS OF AN ECONOMY


As mentioned in the last unit, all countries, without exceptions, face the problem of scarcity.
Their resources (natural productive resources, man-made capital goods, consumer goods,
money and time etc.) are limited and these resources have alternative uses. For example, coal
can be used as a fuel for the production of industrial goods; it can be used for producing
electricity, for domestic cooking purposes and for many other purposes. Similarly, financial
resources can be used for many purposes. If the resources were unlimited, people would be
able to satisfy all their wants and there would be no economic problem. Alternatively, if a
resource has only a single use, then also the economic problem would not arise.

Every economic system, be it capitalist, socialist or mixed, has to deal with this central problem
of scarcity of resources relative to the wants for them. This is generally called ‘the central
economic problem’. The central economic problem is further divided into four basic
economic problems. These are:
 What to produce?
 How to produce?
 For whom to produce?
 What provisions (if any) are to be made for economic growth?

© The Institute of Chartered Accountants of India


1.17 1.17
NATURE AND SCOPE OF BUSINESS ECONOMICS

What to
produce?

Central What provisios


How to
Economic are to be made
produce?
Problems for economic
growth?

For whom
to
produce?

(i) What to produce?: Since the resources are limited, every society has to decide which
goods and services should be produced and how many units of each good (or service)
should be produced. An economy has to decide whether more guns should be
produced or more butter should be produced; or whether more capital goods like
machines, equipment’s, dams etc., will be produced or more consumer goods such as,
cell phones will be produced. Not only the society has to decide about what goods are
to be produced, it has also to decide in what quantities each of these goods would be
produced. In a nutshell, a society must decide how much wheat, how many hospitals,
how many schools, how many machines, how many meters of cloths etc. have to be
produced.
(ii) How to produce?: There are various alternative techniques of producing a
commodity. For example, cotton cloth can be produced using handlooms, power
looms or automatic looms. Production with handlooms involves use of more labour
and production with automatic loom involves use of more machines and capital. A
society has to decide whether it will produce cotton cloth using labour- intensive
techniques or capital-intensive techniques. Likewise, for all goods and services, it has
to decide whether to use labour- intensive techniques or capital - intensive techniques.
Obviously, the choice would depend on the availability of different factors of
production (i.e. labour and capital) and their relative prices. It is in the society’s interest
to use those techniques of production that make the best use of the available
resources.
(iii) For whom to produce?: Another important decision which a society has to take is
‘for whom’ it should produce. A society cannot satisfy each and every want of all the
people. Therefore, it has to decide on who should get how much of the total output of
goods and services, i.e. How the goods (and services) should be distributed among

© The Institute of Chartered Accountants of India


1.18 1.18 BUSINESS ECONOMICS

the members of the society. In other words, it has to decide about the shares of
different people in the national cake of goods and services.
(iv) What provision should be made for economic growth?: A society would not like to
use all its scarce resources for current consumption only. This is because, if it uses all
the resources for current consumption and no provision is made for future production,
the society’s production capacity would not increase. This implies that incomes or
standards of living of the people would remain stagnant, and in future, the levels of
living may actually decline. Therefore, a society has to decide how much saving and
investment (i.e. how much sacrifice of current consumption) should be made for future
progress.
We shall now examine the term ‘economic system’. An economic system refers to the sum
total of arrangements for the production and distribution of goods and services in a society.
In short, it is defined as the sum of the total devices which give effect to economic choice. It
includes various individuals and economic institutions.
You must be wondering how different economies of the world would be solving their central
problems. In order to understand this, we divide all the economies into three broad
classifications based on their mode of production, exchange, distribution and the role which
their governments plays in economic activity. These are:

© The Institute of Chartered Accountants of India

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