Eco - Basic Problems of an Economy & Role of Price Mechanism

Nature & Scope of Business Economics

UNIT 2: BASIC PROBLEMS OF AN ECONOMY AND ROLE OF PRICE MECHANISM

At the end of this Chapter, you will be able to:

1. Explain the Basic Problems faced by an Economy.

2. Describe how Different Economies Solve their Basic Economic Problems.

3. Explain the Role of Price Mechanism in Solving the Basic Problems of an Economy.

INTRODUCTION

As mentioned in the last unit, all countries, without exceptions, face the problem of scarcity. Their resources (natural productive resources, man-made capital goods, consumer goods, money and time etc.) are limited and these resources have alternative uses. For example, coal can be used as a fuel for the production of industrial goods; it can be used for producing electricity, for domestic cooking purposes and for many other purposes. Similarly, financial resources can be used for many purposes. If the resources were unlimited, people would be able to satisfy all their wants and there would be no economic problem. Alternatively, if a resource has only a single use, then also the economic problem would not arise. Every economic system, be it capitalist, socialist or mixed, has to deal with this central problem of scarcity of resources relative to the wants for them. This is generally called ‘the central economic problem’.

SUMMARY

1. The basic problem of scarcity gives rise to many of the economic problems.

2. Unlimited human wants and scarcity of resources lead to the central economic problems like what to produce, how to produce and for whom to produce.

3. The basic economic problems of what, how and for whom to produce are solved by different economies in different ways.

4. A capitalist economy uses the tool of price mechanism, a socialist economy uses the tool of central planning and a mixed economy uses a mix of both price mechanism and central planning to solve its basic economic problems.