What is an Economic Problem?

This problem concerning the choice of resources is called the economic problem.

Definitions of Economics Problems

“The economic problem is concerned with the distribution of limited resources
for alternative needs of man and the use of resources to satisfy maximum needs.”

What are the Causes of Economics Problems?

Economic problems arise due to three main reasons:

.1- Unlimited Wants/Needs-

The needs of every human being are unlimited. No man can satisfy all his needs
completely. As a Matter of fact, wants of the man have been increasing day by day.

2- Limited or scarce resources –

Most of the resources (goods and services) that satisfying the needs of human being,
are limited or scarce. These substances are therefore called scarce because their
demand is greater than their supply. (Demand>Supply).

“Scarcity is the situation in which the availability of resources at a given time is

less than their demand.”

3-Alternative Uses-

Each resource can be used for more than one purpose. This is called alternative
use. Every individual and society have to choose which of their limited resources they
should use to satisfy their needs.

Central Problems of an Economy

Every economy has to face some basic economic problems. These problems are
called the central problems of an economy. According to Professor Samuelson every
economy faces the following 3 central problems-

1- Which to produce and how much to produce?

2- How to produce?

3- For whom to produce?

1- Which to produce and how much to produce?

The first and main economic problem or central problem of every economy is to
determine which goods and services are to be produced, so as to satisfy the maximum
needs of the people. Another name for this problem is the problem of choice.

An economy has to decide the following two things-I) An economy has to decide
which goods and services to produce?

II) It also has to decide in what quantity to produce those goods?

2- How to produce?

The second main central problem facing an economy is how to produce goods. This
problem is also called the problem of technology. There are two techniques to
produce goods. I) labour-intensive technology II) Capital-intensive technology

I) Labour Intensive Technique: In this technique labour is used more than capital or
machines. Example- agriculture.

II) Capital Intensive Technique: In this technique capital or machines are used
more than labour.

3-For whom to produce?

An economy also has to choose what to produce for? It means how to distribute
production among different individuals and households. This problem is called the
problem of distribution.

Extended version of the central problems of an Economy

Here are two more extended version of the central problems of an economy-

Fuller utilisation of resources?

Growth of resources?

4- Fuller utilisation of resources?

The next main problem of every economy is to make full use of all the means of
production or to provide full employment. But in reality the means of production,
Land, Labour and capital are not fully utilized. It is also called the problem of
efficient use of resources.

5- Growth of resources?

Another main problem of every economy is to increase the level of production. This
problem is called the problem of economic development. Economic development
means a continuous increase in the real income of every person.

DIFFERENT TYPES OF ECONOMIES

1-Capitalist Economy or Market Economy

A capitalist economy is a free economy in which producers are free to decide what,
how and for whom to produce. In a capitalist economy or a market economy, the
government has no control over economic activities. The main objective of this type
of economy is to earn profit.

Solution of Central Problems of an Economy under a Capitalist

Economy

In Capitalist or market economy, Producers will produce those goods and

services, whose demand is high and supply is low. They will earn more profits on
production of such goods and services.

2. Socialist Economy or Centrally Planned Economy

Socialist economy or central planning bound economy is that in which economic

activity control by a central authority or government. The main objective of the
Socialist economy is not to earn profits but is to maximize social welfare.
Solution of Central Problems of an Economy under a social
economy or centrally planned economy

In a socialist economy, such goods and services are produced which, in the opinion of
the government, are most useful to the society. Such techniques of production are
used , which are most useful to the society.

3- Mixed Economy

A mixed economy has the characteristics of both a capitalist economy and a socialist
economy. In these types of economies, economic activities are left to independent
market forces, but the government also maintains its control over the economy and
the market. The main objective of these economies is to increase social welfare
with maximum benefits.

Solution of Central Problems of an Economy under a mixed economy

In a mixed economy the decisions about what, how and for whom to produce are
taken on the basis of market forces as well as social welfare. Some areas of the
product that are free to take decisions aimed at maximizing profit, but taking into
account the social welfare in some areas are to be decided by the Government.

Production Possibility Curve-PPC

“Production Possibility Curve is a curve that represents the combination of two
goods produced. When a curve represent that a commodity(Good-X) is sacrificed
to produce an extra unit of another commodity(Good-Y), is known as Production
Possibility Curve.”

It also known as transformation line or transformation curve.

Assumptions of Production Possibility Curve

1- Fixed quantity of the means of production – The amount of factors of production
in an economy is fixed.

2- Full and efficient use of available resources- All the resources available in the
economy are being used fully and efficiently.

3-Stable/constant technology – The technology of production remains constant.

4-Two goods – In the study of production possibility curve, it is assumed that only
two goods are being produced.

Properties of Production Possibility Curve (PPC)

1- The slope of the production possibility curve is downwards.

The slope of the production possibility curve is from top to bottom from left to right.
If one commodity such as wheat is produced more, then the production of another
commodity such as cloth will be reduced.

2-The production possibility curve is concave to the origin.

The Production Possibility Curve is concave to the origin because of diminishing

production due to sacrifice for another production.

3-An elevated probability curve represents more means of production.

If a new production possibility curve becomes A1D1 in an economy, it means that the
means of production available in the economy have increased or the technology of
production has become better so that more production is possible.

Opportunity Cost
“Opportunity cost is the second best use of an economic good or resource or the
value of the opportunity or opportunity that has been discarded.

Marginal Opportunity Cost

The marginal opportunity cost of one additional unit of commodity X is the reduction
in the amount of production of good Y. Marginal opportunity cost = loss of production
of wheat (Y)/ profit of production of cloth (X)