Understanding Basic Economic Problems and Economic Systems

Basic Economic Problems

In view of the scarcity of resources at our disposal and the unlimited ends we seek to achieve, the economic problem lies in making the best possible use of our resources so as to get maximum satisfaction in the case of the consumer and maximum profit for the producer. Hence, economic problem consists in making decisions regarding the ends to be pursued and the goods to be produced and the means to be used for the achievement of certain ends.

Fundamental Problems facing an economy (Basic Economic Problems)

What to Produce?

The first major decision relates to the quantity and the range of goods to be produced. Since resources are limited, we must choose between the different alternative collection of goods and services that may be produced. It also implies the allocation of resources between the different types of goods and services, e.g. consumer goods and capital goods.

How to Produce?Having decided on the type of goods to be produced, we must next determine the techniques of production to be used e.g. labour-intensive or capital-intensive. Firms will only use the most efficient and cheapest method of production.

How much to Produce?The community must decide on how much of each good should be produced. The major function of any economic system is to determine in some way the actual quantities and varieties of goods and services that will best meet the wants of its citizens.

For whom to Produce?This means how the national product is to be distributed, i.e. who should get how much. This is the problem of the sharing of the national product.

ECONOMIC SYSTEMS

The way the economy of a country functions varies with the type of economic system adopted by the government. An economic system refers to the way in which the resources of a country, namely natural and human resources are used to produce goods and services, and the manner in which these goods and services produced are distributed for consumption.

FREE MARKET / MARKET ECONOMYThe Free market is an economic order where the resources are owned and controlled by private individuals. The government will not interfere in the allocation of the resources, but, their role would be to ensure law and order. A market economy can also be defined as an economic system where individuals without government intervention take all the main economic decisions. Countries which practice this system are USA and Canada. No government intervention/interference, Existence of consumer sovereignty, Freedom of enterprise and choice (right to own resources), Presence of competition, Businessmen are motivated by profits, The use of the Price Mechanism in allocating resources or making economic decisions.

Consumers can influence what goods are produced directly by their purchases. They can exercise consumer sovereignty and greater use of the price mechanism. Foreign investments may be encouraged due to non-interference from the government. They would expect higher returns on their investments. Efficiency may increase. Firms will only use the most cost-effective method of production.

There is a wide gap between the rich and the poor. This is due to the policy of non-intervention by the government. Private sectors may try to reduce costs by destructing the environment e.g. dumping toxic waste in rivers. Certain goods and services such as public and merit goods such as defense, health-care, and education may not be produced due to lack of profit and will lead to a fall in the standard of living. Since firms are guided by profit, undesirable goods such as cigarettes and alcohol will be produced and this leads to a wastage of resources.

PLANNED ECONOMYA planned economy is also known as a communistic or a central command economy. It is an economy that is controlled by the government. The state makes all decisions regarding the economic activities of the country. It is also defined as an economic system where all economic decisions are made by the government or central authority. Countries which practice this system are North Korea and Cuba.

Resources are controlled by the government. Consumer sovereignty does not exist. Absence of competition. There is no difference between the rich and the poor. There is no business freedom. Allocation of resources is done through the use of government policies.

Social justice. Under the command economy, the inequalities of income are reduced to the minimum and the national income is more equitably evenly distributed. Better allocation of resources. Productive resources of the nation are more economically and optimally allocated among the various productive uses. Central planning authority determines the allocation of resources with the aim of promoting social welfare and social security. Economic stability. Employ workers in order to keep them occupied although to do so may be unprofitable.

Misallocation of resources. Some commodities will be produced in excess and wasted and there may be a shortage of others. There will be no automatic indicator for the most economical allocation of the resources of the community among different industries. Loss of economic freedom. Freedom of enterprise disappears and free choice of occupation will go. Workers will be assigned certain jobs and they cannot change them without the consent of the planning authority. Lack of incentives. It is also feared that the incentive to work hard and stimulus to self-improvement will disappear altogether when personal gain or self-interest is eliminated. People will not give their best. Loss of consumer’s sovereignty. Consumers are unable to choose what they want because the state decides on how resources are to be allocated. Consumers will not be able to maximize their satisfaction. Government may produce goods that are not required by the public. These goods do not contribute to the general welfare of the consumers e.g. military equipment.

MIXED ECONOMY

Mixed economy is where both public sector (a state) and private sector work together to manage the economic affairs of the country. Some areas of economic activity are left entirely to private individuals and firms while the government intervenes in selected fields. Mixed economy is also defined as an economic system which has a mix of capitalist (free market) and socialist (planned economy) systems to solve the basic economic problems. Countries that practice this system are Malaysia, Singapore, India, and Thailand.

Both public and the private sectors work together to ensure economic growth. Economic problems are solved by the use of the price mechanism and government policies. The aim of production is to ensure maximum profit and to achieve social welfare. Reasons for government intervention in the free market system:

The role of the public sector is to complement the private sector by providing the infrastructure so that economic activities can be carried out.

The government will also intervene in particular industries, where:

It is not profitable for the private sector to produce such as public goods

It involves the provision of social services so as to increase the general standard of living for e.g. education and health-care services.

To avoid duplication and wastage of resources To reduce income inequality

To control the existence of monopolies. To maintain economic progress and development Economic stability