THE BASIC ECONOMIC

PROBLEMS

By: Devie Mae Chico

BASIC ECONOMIC PROBLEMS

 If there is a central economic problem that is present across all countries, without any exception, then it is
the problem of scarcity. This problem arises because the resources of all types are limited and have
alternative uses. If the resources were unlimited or if a resource only had one single use, then the economic
problem would probably not arise. However, be it natural productive resources or man-made
capital/consumer goods or money or time, scarcity of resources is the central problem. This central problem
gives rise to four basic problems of an economy.
BASIC ECONOMIC PROBLEMS

 The basic economic activities depend on the production, distribution, and disposition of services and goods
that can fulfil human requirements.
 However, it is known that human wants and needs have no limit. But, resources that satisfy human wants are
scarce. This immensity of want and scarcity of resources gives birth to the central problems of an economy.
 In the history of modern human civilisation, every economy has faced and tried solving these problems.
What are the Basic Problems of an Economy?
THE BASIC ECONOMIC PROBLEMS

 What to produce
 How to produce
 For whom to produce
 What provision should be made for economic growth
1. What to Produce

This problem refers to the decisions regarding the selection of different commodities and the quantities that need
to be produced. Labour, land, machines, capital, equipment, tools and natural means of resources are limited. So,
it is not possible to fulfil society’s every demand. Therefore, it needs to be decided what goods and services are
required to be produced and what should be the quantity.
1. What to produce

 Furthermore, the central problems of an economy also depend on the classification of commodities based on
their degree of necessity – luxury and essential.
 In an economy, the produced goods are further classified into two segments, namely consumer goods and
producer goods or capital goods. Moreover, both these segments are again divided into single-use goods and
durable goods.
Two aspects to the problem, “what to produce”

 What Types of Goods to be Produced

- For example, every economy needs to decide on what consumer goods like rice, clothes, etc. and what
producer goods like tools, machinery, etc. are required to be produced to meet demand adequately.
 How Much Amount of Goods to be Produced
-The next challenge is to decide, in what quantity goods should be produced. It is a crucial aspect of any
economy, as proportionate distribution of resources for the production of different goods to maximally satisfy
wants is quintessential.
How to Produce

 The two majorly-used techniques are-

 LIT or Labour Intensive Technique
- This technique is used with the help of more number of labour and less involvement of capital.
 CIT or Capital Intensive Techniques
- On the other hand, the CIT technique involves more capital involvement and less utilisation of labour.
v-For instance, footwear can be manufactured either in factories where a large portion of manufacturing is
carried out by machines or by skilled teams of cobblers.
How to Produce

 The relative price and availability of labour and capital are the determining factors while selecting the
production technique. Moreover, some socio-economic objectives also need to be fulfilled by choosing the
techniques.Such objectives are providing employment and enhancing the standard of living in society. For
example, in countries like China, LIT is favoured as an ample number of labours are available. Contrarily,
the United Kingdom will prefer CIT due to the availability of capital and scarcity of labour.
For Whom to Produce

 One of the most crucial problems of the economy is to decide which commodities shall be produced for
which sections of society.
 For instance, essential goods and services are in demand from all sections of society, but only certain
sections of society have a demand for luxury commodities. At the same time, choices of goods and services
rest on prevalent tastes and preferences in an economy.
 Hence, considerations regarding the socio-economic conditions of a country or market are highly pertinent to
this problem.
What provision should be made for economic
growth?

 Can a society use all its resources for current consumption? Yes, it can. However, it is not likely to do so.
The reason is simple. If a society uses all its resources for current consumption, then its production capacity
would never increase.Therefore, the standard of living and the income of a member of the society will
remain constant. Subsequently, in the future, the standard of living will decline. Hence, society must decide
on the part of the resources that it wants to save for future progress.
 Lastly, it is important to know that other than resource allocation, central problems of an economy have two
more aspects – efficient utilisation of the resource and development of resources. Thus, to explain central
problems of an economy, one needs to delve into its core, i.e. choices concerning the limited resources
available to maximise socio-economic utility.
Parts of the problem

 Problem of allocation of resources

- 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 the 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 must be withdrawn from the
production of consumer goods. In the long run, however, [investment] in capital goods augments the production
of consumer goods. Thus, both capital and consumer goods are important. The problem is determining the
optimal production ratio between the two.
Parts of the Problem

-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 utilized 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 redistributing goods cannot make anyone better off without making someone else worse off. 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 must 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.َ
Parts of the Problem

 The problem of full employment of resources

- 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—not wasting resources or using them inefficiently. There are two types of employment of
resources:
 Labour-intensive
 Capital-intensive
Parts of the Problem

 In capitalist economies, however, available resources are not fully used. In times of depression, many people
want to work but can't find employment. It supposes that the scarce resources are not fully utilized in a
capitalistic economy.
Parts of the Problem

 The problem of economic growth

- If productive capacity grows, an economy can produce progressively more goods, which raises the standard
of living. 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 the economic problem is studied in the
economies of development.