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Central Problems of an Economy
The problem of scarcity of resources which arises before an individual consumer also arises
collectively before an economy. On account of this problem and economy has to choose
between the following:
(i) Which goods should be produced and in how much quantity?
(ii) What technique should be adopted for production?
(iii) For whom goods should be produced?
These three problems are known as the central problems or the basic problems of an economy.
This is so because all other economic problems cluster around these problems.
1. What to produce?
There are two aspects of this central problem— firstly, which goods should be produced, and
secondly, what should be the quantities of the goods that are to be produced. The first problem
relates to the goods which are to be produced. In other words, what goods should be produced?
An economy wants many things but all these cannot be produced with the available resources.
Therefore, an economy has to choose what goods should be produced and what goods should
not be. The priority has to be made between consumer or producer goods; or general or capital
goods; or civil goods or defence goods. The second problem is what should be the quantities
of the goods that are to be produced. Production of goods depends upon the use of resources.
Hence, this problem is the problem of allocation of resources. If we allocate more resources
for the production of one commodity, the resources for the production of other commodities
would be less.
2. How to produce?
The second central problem faced by any economy is which technique should be used for the
production of given commodities. This problem arises because there are various techniques
available for the production of a commodity such as, for the production of wheat, we may use
either more of labour and less of capital or less of labour or more of capital. With the help of
both these techniques, we can produce equal amount of wheat. Such possibilities exist relating
to the production of other commodities also. Therefore, every economy faces the problem as
to how resources should be combined for the production of a given commodity. The goods
would be produced employing those methods and techniques, whereby the output would be the
maximum and cost of production would be the minimum
3. For whom to produce?
The main objective of producing a commodity is its consumption in the economy. However,
even after employing all the resources of an economy, it is not possible to produce all the
commodities which are required. Therefore, an economy has to decide as to for whom goods
should be produced. This problem is the problem of distribution of produced goods and
services. Therefore, what goods should be consumed and by whom depends on distribution of
National Product. All the three central problems arise because resources are scarce. Had
resources been unlimited, these problems would not have arisen. For example, in the event of
resources being unlimited, we could have produced each and every thing we wanted, we could
have used any technique and we could have produced for each and everybody. Besides, what,
how and for whom there are three more problems which are also regarded as basic problems.
Explanation of these Problems using Production Possibility Curve
Professor Samuelson used the
concept of the production
possibility curve to explain the
economic problem of a society. A
production possibility curve is the
locus of all such combinations of
two commodities which can be
produced in a country with its
given resources and technology.
In the Figure, P0P’0 is the
production possibility curve of a country. It shows different combinations of paddy (X) and
natural rubber (Y) which of the country can produce with its available resources and
technology. It can choose any such combination like N or T which lies on this curve.
1. Limited Resource: Here, the combination point N shows 0Y1 amount of natural rubber and
0X0 amount of paddy. Again, the combination point T shows 0Y0 amount of natural rubber
and 0X1 amount of paddy. Thus, point N shows relatively higher amount of natural rubber as
compared to point T. It implies that if the country wants to produce more of paddy, it has to
reduce the production of natural rubber. This shows the limited availability of natural resources.
Due to this reason, the country cannot choose any such combination like ‘H’ which lies beyond
the production possibility curve.
2. Problem of ‘What to Produce and in What Quantity’: This curve also reflects the
problem of ‘what to produce’. If the country uses all of its resources for the production of only
natural rubber, then the maximum possible production of natural rubber will be OP0. In that
case, there will be no production of paddy. Similarly, if the country uses all of its resources for
the production of paddy then, the maximum possible production of paddy will be OP’0. But in
that case, the production of natural rubber will be zero.
3. Efficient Utilisation of Available Resources: If the country chooses the combination point
M, i.e., if it produces 0X0 of paddy and 0Y0 of natural rubber then it would indicate inefficient
utilisation of resources. Here, the country can increase the production of paddy from 0X0 to
0X1 by keeping the production of natural rubber unchanged at 0Y0 (i.e., the country can move
from point M to T). Similarly, in this situation, the country can also increase the production of
natural rubber from 0Y0 to 0Y1 by keeping the production of paddy unchanged at 0X0 (i.e.,
the country can move from point M to N.). Thus, if the country chooses any combination of X
and Y on the production possibility curve, it implies efficient utilisation of available resources.
However, if it chooses any combination that lies below that curve, it would indicate inefficient
utilisation or underutilisation of existing resources.
4. Improvement in Technology and Increase in the Amount of Resources: If new resources
are available or if the level of technology is improved (e.g., application of high-yielding
varieties of seeds, better methods of cultivation, better irrigational facilities, etc.) then the
whole production possibility curve will shift outward. This is shown by P1P’2 curve in Figure
In that case, the country can produce more of both X and Y commodities.

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Central Problems of Economy.docx

  • 1. Central Problems of an Economy The problem of scarcity of resources which arises before an individual consumer also arises collectively before an economy. On account of this problem and economy has to choose between the following: (i) Which goods should be produced and in how much quantity? (ii) What technique should be adopted for production? (iii) For whom goods should be produced? These three problems are known as the central problems or the basic problems of an economy. This is so because all other economic problems cluster around these problems. 1. What to produce? There are two aspects of this central problem— firstly, which goods should be produced, and secondly, what should be the quantities of the goods that are to be produced. The first problem relates to the goods which are to be produced. In other words, what goods should be produced? An economy wants many things but all these cannot be produced with the available resources. Therefore, an economy has to choose what goods should be produced and what goods should not be. The priority has to be made between consumer or producer goods; or general or capital goods; or civil goods or defence goods. The second problem is what should be the quantities of the goods that are to be produced. Production of goods depends upon the use of resources. Hence, this problem is the problem of allocation of resources. If we allocate more resources for the production of one commodity, the resources for the production of other commodities would be less. 2. How to produce? The second central problem faced by any economy is which technique should be used for the production of given commodities. This problem arises because there are various techniques available for the production of a commodity such as, for the production of wheat, we may use either more of labour and less of capital or less of labour or more of capital. With the help of both these techniques, we can produce equal amount of wheat. Such possibilities exist relating to the production of other commodities also. Therefore, every economy faces the problem as to how resources should be combined for the production of a given commodity. The goods would be produced employing those methods and techniques, whereby the output would be the maximum and cost of production would be the minimum 3. For whom to produce? The main objective of producing a commodity is its consumption in the economy. However, even after employing all the resources of an economy, it is not possible to produce all the commodities which are required. Therefore, an economy has to decide as to for whom goods should be produced. This problem is the problem of distribution of produced goods and services. Therefore, what goods should be consumed and by whom depends on distribution of
  • 2. National Product. All the three central problems arise because resources are scarce. Had resources been unlimited, these problems would not have arisen. For example, in the event of resources being unlimited, we could have produced each and every thing we wanted, we could have used any technique and we could have produced for each and everybody. Besides, what, how and for whom there are three more problems which are also regarded as basic problems. Explanation of these Problems using Production Possibility Curve Professor Samuelson used the concept of the production possibility curve to explain the economic problem of a society. A production possibility curve is the locus of all such combinations of two commodities which can be produced in a country with its given resources and technology. In the Figure, P0P’0 is the production possibility curve of a country. It shows different combinations of paddy (X) and natural rubber (Y) which of the country can produce with its available resources and technology. It can choose any such combination like N or T which lies on this curve. 1. Limited Resource: Here, the combination point N shows 0Y1 amount of natural rubber and 0X0 amount of paddy. Again, the combination point T shows 0Y0 amount of natural rubber and 0X1 amount of paddy. Thus, point N shows relatively higher amount of natural rubber as compared to point T. It implies that if the country wants to produce more of paddy, it has to reduce the production of natural rubber. This shows the limited availability of natural resources. Due to this reason, the country cannot choose any such combination like ‘H’ which lies beyond the production possibility curve. 2. Problem of ‘What to Produce and in What Quantity’: This curve also reflects the problem of ‘what to produce’. If the country uses all of its resources for the production of only natural rubber, then the maximum possible production of natural rubber will be OP0. In that case, there will be no production of paddy. Similarly, if the country uses all of its resources for the production of paddy then, the maximum possible production of paddy will be OP’0. But in that case, the production of natural rubber will be zero. 3. Efficient Utilisation of Available Resources: If the country chooses the combination point M, i.e., if it produces 0X0 of paddy and 0Y0 of natural rubber then it would indicate inefficient utilisation of resources. Here, the country can increase the production of paddy from 0X0 to 0X1 by keeping the production of natural rubber unchanged at 0Y0 (i.e., the country can move from point M to T). Similarly, in this situation, the country can also increase the production of natural rubber from 0Y0 to 0Y1 by keeping the production of paddy unchanged at 0X0 (i.e., the country can move from point M to N.). Thus, if the country chooses any combination of X and Y on the production possibility curve, it implies efficient utilisation of available resources.
  • 3. However, if it chooses any combination that lies below that curve, it would indicate inefficient utilisation or underutilisation of existing resources. 4. Improvement in Technology and Increase in the Amount of Resources: If new resources are available or if the level of technology is improved (e.g., application of high-yielding varieties of seeds, better methods of cultivation, better irrigational facilities, etc.) then the whole production possibility curve will shift outward. This is shown by P1P’2 curve in Figure In that case, the country can produce more of both X and Y commodities.