Central Problems Of An Economy

Every economy in the world faces the economic problem of unlimited wants and limited resources. This economic problem gives rise to people making choices about how they would like to use scarce resources.

This economic problem gives rise to the central problems of an economy which are –

  • What to produce and in what quantities?
  • How to produce?
  • For whom to produce?

These are called central problems because every economy has to face them and seek solutions to them. Collectively, these central problems are called the Problem of Allocation of Resources.



What to produce and in what quantities?

The fact that resources are scarce leads to the problem of ‘what to produce’ and in what quantities to produce.

An individual producer needs to decide on how to employ the sources that are available to her for production. For example, if Lata, a farmer has a piece of land, she needs to think about what crop she would like to produce on her land. Let us assume that she can grow either sugarcane or wheat. Given that her land is limited, she needs to choose whether she wants to use the land to produce sugarcane or wheat or both. Once Lata has taken this decision she needs to think about the quantity of the crop that she would like to produce. For example, 10 quintals, 20 quintals or 50 quintals.

This problem of ‘what to produce’ and in what quantities to produce is faced by all economies.

  • An economy needs to choose whether it wants to use its resources to produce consumer goods or producer goods.
  • Alternatively, to what extent should luxury goods be produced in comparison to necessities or goods of mass consumption?
  • An economy may also be faced with the question of how much of civilian goods to be produced and how much of defence goods to be produced.

In other words, scarce resources require economies to decide the combination of goods and services they should produce.

The problem of what to produce and in what quantities to be produced can be solved by a government that decides the allocation of 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 in market.


How to produce?

Choosing the technique of production relates to the problem of ‘how to produce’. By technique of production we mean the different combination of factors of production that can be used to produce a good.

Generally all goods can be produced through different methods of production. Various methods of production require different combinations of factors of production. A technique of production could be either labour-intensive or capital-intensive.

  • In a production process when more units of labour are used in proportion to capital, it is termed as a labour-intensive technique.
  • Alternatively, when the proportion of capital used is more than labour, the production process is called a capital-intensive technique.

Let us understand this with the help of some examples. On Lata’s farm, she has the choice of using different combinations of labour and capital to produce her crop.

  • If she chooses to do the ploughing, sowing, harvesting and threshing with her bullocks and employing people, then she is using a labour-intensive technique.
  • On the other hand, if she uses machines such as tractor, harvester and thresher to do the same work, then she is using a capital-intensive technique of production.

Similarly, in cloth production the use of hand-loom is a labour intensive technique to produce cloth whereas the use of power-loom is a capital-intensive technique of production of cloth.

The solution of the problem of how to produce is based on the extent of output that is produced for a given level of resources –

  • Any producer would like to maximize the level of output from the available resources.
  • At the same time cost of using a technique is equally very important. A producer will use that particular technology which is available at least cost.


For whom to produce?

The problem of ‘for whom to produce’ relates to how the value of the produced output of an economy gets distributed amongst different people.

People do not receive the output they produce as their compensation. The output is sold and the money is earned in the production process. This money is paid as income to people for the work they have done in the production process. This income, in turn, is used by people to satisfy their wants. Hence, the problem of for whom to produce tells us how the different factors of production are compensated for their work.

In our example, once Lata’s crop is harvested and sold, she needs to pay the various factors of production for their services. The labour will be paid wages, land will be paid rent, capital (in the form of machinery) will be paid interest. Lastly, Lata will earn profit as an entrepreneur for organising the factors of production and undertaking some risk of running the production activity.



Bibliography : NIOS – Economics

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