UNIT – 1

NATURE OF ECONOMIC PROBLEM

The economic problem, sometimes called the fundamental economic problem, is one
of the fundamental economic theories in the operation of any economy. It asserts that
there is scarcity, that the finite resources available are insufficient to satisfy all human
wants. The problem then becomes how to determine what is to be produced and how the
factors of production (such as capital and labour) are to be allocated. Economics revolves
around methods and possibilities of solving the economic problem. The economic
problem is most simply explained by the question "How do we satisfy unlimited wants
with limited resources?" The premise of the model of the economic problem is that
human wants are constant and infinite due to the constantly changing demands (often
closely related to changing demographics) of the population. However, resources in the
world to satisfy human wants are always limited to the amount of natural resources or
human resources (human capital) available. The economic problem, and methods to curb
it, revolve around the idea of choice in prioritizing which wants can be fulfilled.

Definition:
According to Robert Awh, “Economic problem is the problem relating to the
necessity of the choosing what, how and for whom to produce and how to achieve
economic growth.”

Concepts in the economic problem

1. Wants
While the basic needs of human survival are important in the function of the economy,
human wants are the driving force which stimulates demand for goods and services. In
order to curb the economic problem, economists must classify the nature and different
wants of consumers, as well as prioritize wants and organize production to satisfy as
many wants as possible. One of the assumptions made in economics and the methods
which attempt to solve the economic problem is that humans are overall greedy, and thus
the market must produce as much as possible to satisfy them. These wants are often
classified into individual wants (which depend on the individual preferences and an
individual's purchasing power parity) and collective wants (those of entire communities).
Things such as food and clothing can be classified as either wants or needs, depending on
what type of good and how often.

2. Choice
The economic problem fundamentally revolves around the idea of choice. Due to the
limited resources available, businesses must determine what to produce first to satisfy
demand. Consumers are obviously the biggest influences of this choice, as the goods
which they want must also fit within their budgets and purchasing power parity. Different
economic models place choice in different hands. Socialism asserts that (at least) some
economic choices are best made for the greatest good of society if they are made at the
societal level for everyone, e.g. via a government agency. Communism takes this further
and argues that most or even all major economic choices should be made through central
planning by the government. Only by constructing a cohesive plan that takes the good of
everyone into account, so the thinking goes, can the best allocation of resources be
achieved. Capitalism argues for a more laissez-faire approach, wherein the role of the
government is to protect the property rights of individuals and companies so that they can
have the confidence to undertake the economic activity (and risks) that will create the
most value. In a free-market economy without the constraints of government wage and
price controls, proponents of market capitalism argue, resources are automatically
allocated toward the things that society, collectively, values most. If a good or service is
overvalued (i.e., the price is too high), the surplus will force providers of the good or
service to lower their prices or to re-allocate their capacity to produce something more
worthwhile. If the supply of a good or service is inadequate, rising prices increase the
value and so cause more production capacity to be directed toward the item. Adam
Smith's The Wealth of Nations has been an extremely influential book for this school of
thought.

Causes of Economic Problem:

1. Unlimited wants:
Human wants that can be satisfied by consuming goods and services and unlimited. No
individual can fully satisfied his wants. Wants of all the members of society cannot be
fully satisfied in a given time. In reality, human wants have been multiplying day in and
day out. It is therefore, be said that at any given time there do exist innumerable
unsatisfied wants in a community. Example want to Home theatre systems, deluxe cars,
LCD TV.

2. Limited Needs:
Large numbers of goods and services are needed to satisfy human wants. To satisfy
hunger one needs bread, fruit or milk.

Accordingly goods and services satisfying human wants are divided into two parts:
a) Free goods
One has not to pay any price to get these goods and services. Example air,
sunshine etc.

b) Economic goods:
One has to pay price to get economic goods and services. They are also called as
scares means. Example bread, fruit or services doctor and lawyers etc.

The means to satisfy wants are classified into four categories:

A. Land referes to all those natural resources which are free gift of nautre. Example
land, minearls, forest etc.
B. Labour referest oa ll thoes physical and mental activiites which are used in the
prodution of goods and services. Example service of a domestic servant or of an
engineer.
C. Capital referes to the man made means of production. Example machines, tools
etc.
D. Enterprise refers to risk taking and conducting of business of an entrepreneur as
a result of which it becomes possible to organize production.

All the factors of production that is land, labour, capital and entrepreneur are
scarece. It means there supply is not unlimited but some price has to be paid for
their availablity. Scarcity is the root cause of economic problem.
 Another peculiarity of means of production is that they have alternative uses.
Example timber used for making furniture, sport goods etc. it is because of
alternative uses of means that a problem of choice arises. In order to gain one
alternative the other alternative that we forego is the opportunity cost of gained
alternative. In short, scarcity of means and their alternative uses are main cause of
origin of economic problem.

CENTRAL ECONOMIC PROBLEMS OF AN ECONOMIC SYSTEM:

Following are the main central economic problem:

1. What to produce and how much to produce?

First problem that every economy faces is what goods and services
be produced with the scarce resources so that maximum wants of
the people are satisfied. The main cause that gives rise to this
problem is that resources are scarce in relation to their wants. In
fact, it is the problem of allocation of scarce resources. The
allocation of scarce resources among alternative uses is called
resource allocation. Every economy has to make a choice as to what
wants can be satisfied and what can be foregone. In other words, for
a rational allocation of resources a society must set priorities among
their needs. Wants which are decided to be satisfied call for two
more decisions:

a) What goods and services are to be produced?

Which of the consumer goods like sugar, cloth, vegetable oil etc.
are to be produced and which of the goods like machines,
tractors etc. are to be produced? If the economy aims at
satisfying present wants, then more of consumer goods will be
produced. On the contrary, if the economy aims at increasing
present production capacity to satisfy more wants in future, then
stress will be laid on the production of capital goods.

b) How much to produce?

When an economy decides about the goods and services it is to
produce, it alos decides about the quantity of the same to be
produced. How much quantity of consumer goods and how much
of capital goods be produced? This decision requires information
regarding production possibility of different commodities with the
given resources. Such information can be summarized in the
production possibility curve.

2. How to produce?
This problem is based on the first problem itself. Having decided
what to produce and how much to produce, the next decision
relates to how to produce. This problem is concerned with the
choice of technique. Three questions arises in this context:
 a) How to make use of resources in the production of those goods
and services which are wanted by the people and how to prevent
the use of resources in producing those goods and services
which are not wanted by the people.

b) Economy is also to ensure that those firms, which are producing

such goods and services, as are decided to be produced must get
the relevant resources to produce them, in ample measure. In
other words, economy producing wheat and cloth must select
such farmers and firms as are willing to produce these goods.
These farmers and firms must be amply provided with those
means of production, which are essential for the production of
these tow goods.

c) The economy will also have to determine the most efficient

combination of the resources required for the production of a
given level of output of goods decided to be produced. In other
words, it will have to decide on the most appropriate technology
to be adopted. This problem also arises because of the scarcity
of means of production. Had mean of production been available
in plenty then any technology could have been adopted. But in
different economies different types of means are scarce. That is
why different economies adopt different technology.

3. For whom to produce?

This problem deals with the question as to how an economy
distributes its total production among different economic units. How
consumer goods be distributed in the household sector or among
different consumers of the economy. In other words, how much
share out of total production or national income be given to each
factor of production, that is, wages to laborers, interest to capitalist,
rent to landlord and profit to the entrepreneur.

4. How to achieve fuller utilization of resources?

In the problem an economy has to decide the extent to which it is
willing to utilize its resources. For instance, if the economy makes
large-scale exploitation of its mineral resources like coal, iron,
petroleum etc. in the present then the availability of these resources
in the future will go down. So every economy has to decide about
the scale of utilization of its resources. Having decided about the
level of utilization of its resources, the economy makes a
determined bid to remove involuntary unemployment as well as
excess capacity.

5. How to achieve efficiency I production and distribution?

According to Pareto, “efficient production refers to a situation in
which production of good cannot be increased unless production of
another good is decreased. Similarly, efficient distribution refers to
 a situation in which consumption of an individual cannot be
increased unless consumption of another individual is decreased.

6. How to accelerate economic growth?

This problem refers to the problem of economic growth. Every
economy is keen to raise the standard of living of its people. In
under developed countries it is possible only by breaking the vicious
circle of poverty and raising the level of savings, investment or the
rate of capital formation. To increase the rate of economic growth in
a country, its social and institutional factors like, ownership of
means of production, land reforms and techniques of production
must undergo a radical change

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