Central Problems Of An Economy

 

Every economy whether it is developed or developing, must face three central problems -

 

1. What to produce

2. How to produce

3. For whom to produce

 

So the first question that arises here is why do economies face these problems, the answer is -

 

1. We have unlimited wants

2. We have limited sources to fulfill all our wants

3. And, resources have alternative uses

 

[Explanation - Resources have alternative uses

The central problems of economy arises only because resources have alternative uses.

For Example - If farming land could be used only for the production of rice and no other crop then where is the problem. Just grow rice and relax! The problem arises because farming land can be used for the production of different crops, like wheat, rice and bajra ]   

 

 

What to produce

 

This can be studied in two dimensions

 

- What goods are to be produced in an economy

- In what quantity goods are to be produced

 

What goods are to be produced ?

 

We know that our wants are unlimited, but our resources to fulfill our wants are limited, so a big question what goods should we produce with our limited resources ?

 

We can broadly classify goods as

 

1. Consumers goods

Example - beverages, clothing, shoes, smartphones, etc

 

2. Producers goods/capital goods

Example - Buildings, machinery, tools, etc

 

The production of both goods is necessary in an economy, consumer goods are necessary for the present consumption and producers goods are necessary for the future growth of economy.

 

If our limited resources are largely used for the production of consumers goods, the present generation will have a good quality of life but the future generation will suffer due to the lack of producers goods.

And if our limited resources are largely used for the production of producers goods, the future generation will have a good quality of life but the present generation will suffer due to the lack of consumers goods.

 

In what quantity goods are to be produced ?

 

After deciding what goods are to be produced consumer or producer goods, the next question is in what quantity goods are to be produced ?

 

As we know that our resources are limited, it means that more of consumers good means less of producers good and more of producers good means less of consumers goods.

 

Here it is important to understand the concept of opportunity cost

 

Opportunity cost - The loss of potential gain from other alternatives when one particular alternative is chosen over the other  

 

[If you want to know more about opportunity cost pleas click on the link -  https://econ313.blogspot.com/2021/01/opportunity-cost.html]

 

How to produce

How to produce means, which type of production method we should use -

 

1. Labour intensive method

In labor-intensive method, more labor is used in the process of production. This method is mostly used in countries with less capital and it helps to reduce unemployment.  

 

2. Capital intensive method

In capital intensive method more capital is used in the process of production. This method is mostly used in countries with less labor and it helps to accelerate GDP growth.

 

Here the main reason behind this problem is scarcity of resources. The countries which have less capital the fuller utilisation of labour is not possible as employment of labour needs capital. And the countries which have more capital but less labour the fuller utilisation of capital is not possible as they need labour to utilise their capital.

 

For whom to produce 

 

As we know that our resources are limited, so we cannot produce goods for all the sectors of society.

 

1. The rich sector

The rich sector of society consumes expensive goods, which means more profit. More profit will increase the investment and thus implying GDP growth.

 

2. The poor sector

The poor sector of the economy consumes low-cost goods, which means low profit. Low profit means low investment and thus low GDP growth.

 

If we produce more good for the poor sector of the society it will reduce inequality, but GDP growth will be sacrificed.

 

Thank You 

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