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Unit 2 Nature of Economic Problem

Unit 2 Nature of Economic Problem

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Published by qyani
Notes as per syllabus MD University Rohtak
Notes as per syllabus MD University Rohtak

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Published by: qyani on Sep 06, 2009
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12/12/2012

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UNIT – 1NATURE OF ECONOMIC PROBLEM
The
economic problem
, sometimes called the
fundamental economic problem
, is oneof the fundamental economic theories in the operation of any economy. It asserts thatthere is scarcity, that the finite resources available are insufficient to satisfy all humanwants. The problem then becomes how to determine what is to be produced and how thefactors of production (such as capital and labour) are to be allocated. Economics revolvesaround methods and possibilities of solving the economic problem. The economic problem is most simply explained by the question "How do we satisfy unlimited wantswith limited resources?" The premise of the model of the economic problem is thathuman wants are constant and infinite due to the constantly changing demands (oftenclosely related to changing demographics) of the population. However, resources in theworld 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 curbit, 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 thenecessity of the choosing what, how and for whom to produce and how to achieveeconomic 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. Inorder to curb the economic problem, economists must classify the nature and differentwants of consumers, as well as prioritize wants and organize production to satisfy asmany wants as possible. One of the assumptions made in economics and the methodswhich attempt to solve the economic problem is that humans are overall greedy, and thusthe market must produce as much as possible to satisfy them. These wants are oftenclassified into
individual wants
(which depend on the individual preferences and anindividual'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 onwhat type of good and how often.
2.
Choice
The economic problem fundamentally revolves around the idea of choice. Due to thelimited resources available, businesses must determine what to produce first to satisfydemand. Consumers are obviously the biggest influences of this choice, as the goodswhich they want must also fit within their budgets and purchasing power parity. Differenteconomic models place choice in different hands. Socialism asserts that (at least) someeconomic choices are best made for the greatest good of society if they are made at thesocietal 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 thegovernment is to protect the property rights of individuals and companies so that they canhave the confidence to undertake the economic activity (andrisks) that will create themost value. In a free-market economy without the constraints of government wage and price controls, proponents of market capitalism argue, resources are automaticallyallocated toward the things that society, collectively, values most. If a good or service isovervalued (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 moreworthwhile. If the supply of a good or service is inadequate, rising prices increase thevalue and so cause more production capacity to be directed toward the item. AdamSmith'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. Noindividual can fully satisfied his wants. Wants of all the members of society cannot befully satisfied in a given time. In reality, human wants have been multiplying day in andday out. It is therefore, be said that at any given time there do exist innumerableunsatisfied 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 satisfyhunger 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 asscares 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. Exampleland, 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 anengineer.C.
Capital
referes to the man made means of production. Example machines, toolsetc.D.
Enterprise
refers to risk taking and conducting of business of an entrepreneur asa result of which it becomes possible to organize production.All the factors of production that is land, labour, capital and entrepreneur arescarece. 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 onealternative the other alternative that we forego is the opportunity cost of gainedalternative. 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 servicesbe produced with the scarce resources so that maximum wants of the people are satisfied. The main cause that gives rise to thisproblem is that resources are scarce in relation to their wants. Infact, it is the problem of allocation of scarce resources. Theallocation of scarce resources among alternative uses is calledresource allocation. Every economy has to make a choice as to whatwants can be satisfied and what can be foregone. In other words, fora rational allocation of resources a society must set priorities amongtheir needs. Wants which are decided to be satisfied call for twomore 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 atsatisfying present wants, then more of consumer goods will beproduced. On the contrary, if the economy aims at increasingpresent production capacity to satisfy more wants in future, thenstress 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 toproduce, it alos decides about the quantity of the same to beproduced. How much quantity of consumer goods and how muchof capital goods be produced? This decision requires informationregarding production possibility of different commodities with thegiven resources. Such information can be summarized in theproduction possibility curve.2.
How to produce?
 This problem is based on the first problem itself. Having decidedwhat to produce and how much to produce, the next decisionrelates to how to produce. This problem is concerned with thechoice of technique. Three questions arises in this context:

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