UNIT 1: FUNDAMENTAL PROBLEMS OF ECONOMIC SYSTEMS

1.0 Objectives

• Explain the problem of scarcity of resources for satisfying ever-increasing wants of a society.

• State the meaning and nature of an economic system.

• Describe the concept of economic entities.

• Explain the concept of factors of production and their main types and characteristics.

• State the source, nature, and relevant details of fundamental problems of an economy.

• Describe the production possibility curve.

• State issues relating to allocation of resources between investment and consumption, and between private and public goods.

• Explain the methods of resource allocation in a market economy, a socialist economy, and a mixed economy.

1.1 INTRODUCTION

• This unit introduces fundamental problems faced by every economy.

• Understanding these problems aids comprehension of economic reasoning and theories.

• Key topics include an economic system, fundamental problems of economy, factors of production, and resource allocation.

1.2 AN ECONOMIC SYSTEM

1.2.1 Concept of Scarcity

• Scarcity drives all economic activity, characterized by:A. Unlimited wants/endsB. Scarce resources/means

• A. Unlimited Wants:

  • Individuals have wants that must be satisfied. Those unsatisfied cause discomfort.

  • Wants differ per person and can change with various factors, e.g., health, income.

  • Characteristics include:

    • Recurrence: Once satisfied, wants emerge again (e.g., hunger).

    • Emergence of new wants leads to unlimited desires.

• B. Scarce Means:

  • Resources for fulfilling wants are limited, creating scarcity even for wealthy individuals.

  • Choices must be made on how to fulfill demands, highlighting that resources have alternative uses.

1.2.2 An Economic System or Economy

• An economy encompasses methods and arrangements to address the imbalance between means and wants.

• It includes natural resources and man-made arrangements (production, trade, distribution).

• Economic systems vary by natural resources, societal structure, and historical context (e.g., Indian vs. British economy).

1.2.3 Economic Entities

• Decision-making units in an economy include individuals, households, firms, and government.

• Economic entities operate in various capacities (consumers, producers, investors).

1.3 FACTORS OF PRODUCTION

• Definition: Resources necessary to carry on production.

• Categories:

  1. Land

  2. Labour

  3. Capital

  4. Entrepreneurship

1.3.1 Land

• Encompasses all natural resources, including agriculture, minerals, and climate.

• Supply is fixed, and land cannot be increased, but its use can be varied.

1.3.2 Labour

• Refers to human physical and mental effort used in production.

• Key aspects:

  • Labour cannot be separated from workers, and its performance is time-sensitive.

  • Qualitative variation exists; not all workers have equal productivity.

1.3.3 Capital

• Man-made resources produced through labour, used to generate further production.

• Capital formation involves skill training and better health investment for productivity enhancement.

• Capital is distinct from consumption goods; it exists solely for production purposes.

1.3.4 Entrepreneurship

• The organizing function that combines inputs for production and assumes risk.

1.4 FUNDAMENTAL/CENTRAL PROBLEMS OF AN ECONOMY

• Basic problems due to scarcity of means include:i) What to produce?ii) How to produce?iii) For whom to produce?iv) Growth vs. saving/investment.

1.4.1 What to Produce?

• Due to limited resources, selective decisions on goods and services must be made.

1.4.2 How to Produce?

• Involves the allocation of productive resources; techniques of production vary.

  • Choose between labour-intensive vs. capital-intensive production methods.

1.4.3 For Whom to Produce?

• Distributing output among individuals and households.

  • In market economies, income is derived from ownership and employment of productive resources.

  • In socialist economies, income distribution aims to minimize inequalities.

1.4.4 The Problem of Growth

• Seeking to increase capital to enhance production capacity, balancing consumption and saving.

1.4.5 Choice between Public and Private Goods

• Public Goods: Non-restrictive; anyone benefits (e.g., national defense).

• Private Goods: Availability is restricted based on payment (e.g., food products).

1.4.6 The Problem of Merit Goods

• Goods considered highly desirable for society, such as education and healthcare, which may require state intervention for equitable access.

1.5 PRODUCTION POSSIBILITY CURVE

• The Production Possibility Curve (PPC) illustrates trade-offs between two goods, highlighting opportunity cost.

• Assumptions for PPC:

  • Fixed productive resources and efficient use of all resources.

1.6 ALLOCATION OF RESOURCES

• Each economy has methods for allocating productive resources based on its goals, principles, and institutional set-ups.

1.6.1 Resource Allocation in a Capitalist Economy

• Market-driven, where prices determine resource allocation.

1.6.2 Resource Allocation in a Socialist Economy

• Central planning decides production levels and resource distribution.

1.6.3 Resource Allocation in a Mixed Economy

• Combination of market and government intervention with public and private sectors coexisting.

1.7 LET US SUM UP

• Society faces ongoing scarcity and works to manage resources while satisfying unlimited desires. Different economic systems serve this purpose, leading to distinct characteristics.

1.8 KEY WORDS

• Definitions for key terms like Capital, Economic Entities, Production, Public Goods, etc. are provided to aid understanding.

1.9 ANSWERS TO CHECK YOUR PROGRESS

• Responses to self-assessment questions included at the end as a study aid.