Central Problems of an Economy

The basic economic activities depend on the production, distribution, and disposition of services and goods that can fulfil human requirements. 

However, it is known that human wants and needs have no limit. But, resources that satisfy human wants are scarce. This immensity of want and scarcity of resources gives birth to the central problems of an economy.

In the history of modern human civilisation, every economy has faced and tried solving these problems.

What are the Central Problems of an Economy?

After the central problems of an economy introduction, it is important to understand all the underlined aspects of such problems. Following is a detailed discussion on the central problems that every economy faces.

  • Allocation of Resources

A problem that an economy predominantly faces is the allocation of resources. Due to the scarcity of available resources, it leads to the troublesome situation of assigning these limited resources to produce goods and services that can fulfil societal wants maximally. 

Thus, it is important to distribute the resources efficiently so that they can cater to produce several commodities to satisfy the needs of different socio-economic groups in various manners.

This decision needs to be taken depending on the three central problems of the economy. 

  1. What to produce

  2. How to produce

  3. For whom to produce

To know the answer to what are the central problems of the economy, the following discussion is necessary.

1. What to Produce

This problem refers to the decisions regarding the selection of different commodities and the quantities that need to be produced. Labour, land, machines, capital, equipment, tools and natural means of resources are limited. So, it is not possible to fulfil society’s every demand. Therefore, it needs to be decided what goods and services are required to be produced and what should be the quantity.

Furthermore, the central problems of an economy also depend on the classification of commodities based on their degree of necessity – luxury and essential. 

In an economy, the produced goods are further classified into two segments, namely consumer goods and producer goods or capital goods. Moreover, both these segments are again divided into single-use goods and durable goods.

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Thus, there are two aspects to the problem, “what to produce” –

  • What Types of Goods to be Produced

For example, every economy needs to decide on what consumer goods like rice, clothes, etc. and what producer goods like tools, machinery, etc. are required to be produced to meet demand adequately. 

  • How Much Amount of Goods to be Produced

The next challenge is to decide, in what quantity goods should be produced. It is a crucial aspect of any economy, as proportionate distribution of resources for the production of different goods to maximally satisfy wants is quintessential. 

2. How to Produce 

This problem is about the choice of techniques that need to be adopted and used in the production of goods and services. 

The two majorly-used techniques are-

  • LIT or Labour Intensive Techniques

This technique is used with the help of more number of labour and less involvement of capital.

  • CIT or Capital Intensive Techniques

On the other hand, the CIT technique involves more capital involvement and less utilisation of labour.

For instance, footwear can be manufactured either in factories where a large portion of manufacturing is carried out by machines or by skilled teams of cobblers. 

DIY: In the Above Example, Which Option is Labour Intensive, and Which Option is Capital Intensive?

The relative price and availability of labour and capital are the determining factors while selecting the production technique. Moreover, some socio-economic objectives also need to be fulfilled by choosing the techniques.

Such objectives are providing employment and enhancing the standard of living in society. For example, in countries like China, LIT is favoured as an ample number of labours are available. Contrarily, the United Kingdom will prefer CIT due to the availability of capital and scarcity of labour.

3. For Whom to Produce 

One of the most crucial problems of the economy is to decide which commodities shall be produced for which sections of society.

For instance, essential goods and services are in demand from all sections of society, but only certain sections of society have a demand for luxury commodities. At the same time, choices of goods and services rest on prevalent tastes and preferences in an economy. 

Hence, considerations regarding the socio-economic conditions of a country or market are highly pertinent to this problem.

Lastly, it is important to know that other than resource allocation, central problems of an economy have two more aspects – efficient utilisation of the resource and development of resources. Thus, to explain central problems of an economy, one needs to delve into its core, i.e. choices concerning the limited resources available to maximise socio-economic utility. 

To further discuss the central problems of an economy, students can participate in our live interactive classes. Alongside live classes, students can also find essential study materials and notes on different topics of commerce and economics on our website and app.

FAQ (Frequently Asked Questions)

1. Why is What to Produce a Problem in Every Economy?

Ans. - In every economy, the resource is limited. Thus, a society can’t satisfy all the wants of its people. Here, the economy has to make choices regarding what types of goods need to be produced and in what quantity. This choice-making factor crates problems in the economy.

2. Explain the Problem for Whom to Produce.

Ans. Due to the limited resources, an economy can’t fulfil the needs of everyone. Keeping that factor in mind, it is crucial to decide what goods would be produced for which sections of society.

3. What are the Three Fundamental Economic Problems?

Ans. – The three basic economic problems are regarding the allocation of the resources. These are what to produce, how to produce, and for whom to produce.