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Central or Basic problems of an Economy

Updated on October 16, 2012

Central or Basic problems of an Economy

Central problem of an economy or basic problem of an economy is the problem of allocation of resources having alternate uses with regard to demand. Before allocating resources, we have to study the demand for the goods and services. We have to allocate more resources to the goods and services which are high in demand. The fundamental problem of an economy is is the allocation of resources or making choices among alternative uses of scarce resources. Prof. Samuelson defines central problems as “What, how and for whom to produce it?”

The central problems of an economy is the allocation of resources. We can divide these problems into three. They are:

  1. What to produce?

  2. How to produce?

  3. For whom to produce?

A society has many requirements. The requirements of goods and services very from place to place and society to society. A vegetarian society needs more farms for cultivating vegetables. Non-vegetarian society needs more animal husbandry facilities and poultry farms. Land needs to be allocated for these purpose in the right proportion so that requirements of vegetarians and non vegetarians are adequately supplied. Since the same resources can be utilized for different purposes, choice of utilization is possible. And because of this choice of utilization is possible, society has to decide what is to be produced? This is the problem of production of commodities. Another problem is how to produce or how to allocate the resources. For whom to produce or what is the demand of goods is the third problem of production.

What to produce and in what quantity?

Shall we produce food or cloth? More food or less cloth? Or less food and more cloth? Wheat or rice? Gun or Butter? These are the some questions to be asked and answered before allocating resources to maintain balance in the economy. In case of more wheat, more resources will have to be diverted from rice. Because the economy cannot have more wheat and more rice at the same time. Likewise, a society has to decide between consumer goods like rice, sugar, wheat, cloth etc., and producer goods like tractors, machines, tools, trucks etc.

Another option in front of the society is whether to produce necessity goods or luxury goods. However, all goods cannot be produced with the limited resources. Maximum aggregate or total utility of the goods is the guiding principle for solving this problem.

How to produce?

Choosing the method or technique of production is the next problem. Since the commodity can be produced in more than one method, this problem arise. Shall we use small scale production or large scale production? Shall we use labor intensive technique or capital intensive technique i.e. more labor and less capital as against less labor and more capital. For example cloths can be manufactured by using sophisticated machines or by using hand weaving. Hand weaving need more labor but the machine weaving need more capital and less labor. In such situations we adopt techniques which cause least possible cost to produce per unit of commodity. We prefer the most efficient technical method which uses least amount of scarce resources at macro level. The basic idea is by employing less resources with less cost and produce maximum quantity of goods or service to satisfy the needs of the society.

For whom to produce?

This is the problem of who gets how much of the goods that are produced or how should output be distributed among those who have helped to produce it. Production is possible by utilizing the factors of production such as, land labor, capital and enterprise. The out put of the production is to be distributed among the factors of production in the form of rent, wages, interest and profit. It can be distributed in the form of goods or of money. Money income is to be distributed on the basis of contribution of each individual factor in production. Production is carried out for the purpose of distribution of income generated from the production to the individuals involved in the production. Who is paid how much is also a choice problem. This problem is solved through the free market price mechanism in the private sector. Reward to the factors involved in the production is determined in the free market. This form of distribution of income is called the theory of functional distribution. All the persons in the society should get a minimum level of consumption of goods and services produced.

Above problems are not separate or independent of each other. They are the different forms of the same basic problem to make a choice among alternative uses of scarce resources to obtain maximum satisfaction.

There are two more economic problems associated with the Central problems of an economy. They are:

  1. Problem of full and efficient use of resources

  2. Growth of resources.

The fundamental problem before an economy is to make a choice among the alternative uses of scarce resources for obtaining maximum satisfaction. All other problems are the different subdivisions of the fundamental problem of an economy.


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