The main problem of an economy is of economizing scarce resources. In this sense, economics is the study of the allocation of scarce resources to alternative ends. The problem of scarcity arises because human wants are numerous and the means to satisfy them are limited. This leads to the problem of choice—of selecting alternative uses to which scarce resources can be put. The solution to this problem of allocating scarce resources lies in the pricing system which exists in every economic system, whether it is capitalist, socialist or mixed. The economic system must hence solve the following problems.
What to Produce
Since resources are scarce, the society has to decide about the goods to be produced: rice, cloth, roads, television sets, power, buildings and so on. Once the nature of goods to be produced is decided, then their quantities are to be decided. How many kilograms of rice, how many millions meters of cloth, how many kilometers of roads etc? Since the resources of the economy are scarce, the problem of the nature of goods and their quantities has to be decided on the basis of priorities or preferences of the society. If the society gives preferences to production of more consumer goods now, it will have less in the future. A higher priority on capital goods implies less consumer goods now and more in the future. Thus it is like making a trade-off between the amount of consumption to be sacrificed now and the prospect of increased consumption in the future.
How to Produce
A good or service can be produced with different combinations of factors of production. If land is available in abundance, it may have extensive cultivation. If land is scarce, intensive methods of cultivation may be used. If labour is in abundance, it may use labour-intensive techniques, while in the case of labour shortage, capital-intensive techniques may be used. The technique to be used also depends upon the type and quantity of goods or services to be produced. For the production of capital goods and large outputs, expensive machines and complicated techniques are required. On th other hand, simple consumer goods and small output require small and less expensive machines and comparatively simple techniques. In deciding how to produce goods and services, the economy should choose those combinations of factors and techniques of production which result in the minimum cost to produce each unit of the a good or service, bring about an efficient allocation of resources and increase the overall productivity 1
of the economy.
The third basic problem of the society is how should goods produced in the economy be distributed among the consumers. The allocation of consumer goods among households takes place on the basis of exchange. Whosoever possess the means to buy the goods may have it. A rich person may have a larger share of the goods he requires, and a poor person may have lesser quantities of the goods he needs.
The distribution of income is determined by the quantity of resources contributed by a family in the form o services of labour, land and capital towards production and by the prices these services command in the market. The government also influences income distribution through taxation and transfer payments. If taxes are heavy, disposable income is less in the hands of taxpayers. Income increases for those who receive social security payments from government. Taxes and social security payments tend to reduce inequalities. Thus the economy has to take decisions about the distribution of income and production of such goods and services which lead to maximum social welfare.
