[Commerce Class Notes] on Central Problems of an Economy Pdf for Exam

Production, Distribution, and Exchange of goods and services are among the basic economic activities of life. During the period of these economic activities, every society has to suffer from scarcity of resources and it is the scarcity of resources that arises the problem of choice. The scarce resource of an economy has several usages. In other words, every society decides how to use scarce resources optimally? The problems of an economy are often summarized in the following three ways:

()

What are the Three Central Problems of an Economy?

The three Central Problems of an Economy are?

These are known as central problems because every society has to face them and look for its solutions. Let us understand these three central problems in detail.

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 resources are limited. So, it is not possible to fulfil society’s every demand. Therefore, it is important to decide what goods and services are required to be produced and in what quantity? For example, if Rita has a piece of land, she needs to think about what crop she should produce on her land. Let us consider that she can grow either Jowar or wheat. Given that the natural resource i.e. land is limited, she needs to choose whether she wants to use the land to produce Jowar or wheat or both. Once Rita has taken the decision regarding the goods to be produced,  she needs to think about the quantity of the crop that she would like to produce. For example, 5 quintals, 10 quintals, or 100 quintals. This problem of ‘what to produce and in what quantities to produce is almost faced by everyone in society. Also, an economy needs to make decisions regarding whether it wants to use its scarce resources to produce consumer goods or producer goods. Also, to what extent should luxury goods be produced in comparison to producer goods? Also, the economy may be faced with the question of how many civilian goods and defense goods need to be produced. The problem of what to produce and in what quantities to be produced can be solved by a government that retains the authority to allocate resources in different areas of production. Alternatively, it can be solved based on the preferences of people in an economy and on the price of goods and services available in the market.

2. How to Produce?

This problem is about the choice of techniques that need to be adopted and used in the production of goods and services. The two majorly-used techniques are-

LIT or Labour Intensive Techniques

In this technique more units of labor in proportion to capital are used in the production process.

Capital Intensive Techniques

On the other hand, the Capital Intensive Technique involves more capital and less utilization of labor. 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.

The solution to the problem of how to produce is based on the amount of quantity that needs to be produced for a given level of resources. At the same time, the cost of using a technique to produce goods is equally very important.  A producer will use that particular technology which is available at minimum cost.

3. 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.

Lastly, it is important to know that other than resource allocation, central problems of an economy have two more aspects – efficient utilization of the resource and development of resources. Thus, to explain the central problems of an economy, one needs to delve into its core, i.e. choices concerning the limited resources available to maximize socio-economic utility.