1 | Economics

INTRODUCTION
Scarcity and choice are the basic problems in any economy. This concept was
introduced by Prof. Lionel Robbins in 1932. Human wants are unlimited but
resources to meet these wants are limited and scarce. The need to satisfy of
unlimited wants with limited means creates problem of choice making. The basic
economic problem arises mainly due to the two reasons:
Human wants are unlimited
Resources to satisfy human wants are scarce.
The nature of human wants is such that they never come to an end. As long as
man is alive, his wants go on increasing. All wants which cannot be fulfilled by the
limited resources lead to the origin of basic economic problem in all types of
economies.

Concept of Scarcity
Scarcity refers to the condition of insufficiency where the human beings are
incapable to fulfill their wants in sufficient manner. In other words, it is a situation
of fewer resources in comparison to unlimited human wants. Human wants are
unlimited. We may satisfy some of our wants, but soon new wants arise. Scarcity is
taken in a relative sense rather than absolute sense when we say that the
resources are scarce, it does not mean that they are not available, but they are
limited in comparison to human wants.

We need goods and services to satisfy our wants. For this purpose, we need
productive resources that may be classified as land, labor, raw material,
machinery, capital etc., which are limited. Hence, it is impossible to produce a
sufficient amount goods and services so as to satisfy all wants of people. Thus,
scarcity explains this relationship between limited resources and unlimited wants
and the problem therein.
Thus, economic problems arise because the resources we need are scarce. These
scarce resources have many alternative uses. For example- a land can be used to
construct a factory building or to make a beautiful park or to raise agricultural
crops. So, it is very essential to think how limited resources can be used
alternatively to satisfy more of wants of people to get maximum satisfaction as
possible.
Scarcity is not just only an individual problem, it is also a problem of a country. The
problem of scarcity is present not only in developing countries but also in highly
developed countries such as U.S.A., Canada, Japan etc. A man is poor because the
resources available to him are scarce. A country is poor because there is scarcity of
resources. Thus, scarcity is the heart of all economic problems.
Concept of Choice
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Choice is the process of selecting some goods or wants from a bundle of goods or
wants. Human wants are unlimited. So, people are unable to fulfill all their wants at
once since resources are limited. They can satisfy only some of their wants. Some
wants should be sacrificed to satisfy some other wants. Hence, people postpone
less urgent wants to satisfy more urgent wants. For example- a boy desiring a book
does not visit cinema hall. A girl desiring to buy new dress does not visit night club.
If human wants were limited or resources unlimited, there would be no scarcity and
there would be no problem of choice. Because of scarcity we are forced to choose.
Thus, the problem of choice deals with utilization of scarce resources in such a way
that it satisfies human wants in the best possible way.
Unlimited wants and limited resources lead to economic problem and problem of
choice which can be shown as follows:

Unlimited Human Wants with different priorities

Limited Resources having alternative uses

Problem of Scarcity due to unlimited wants & limited resources

Scarcity

Problem of Choice

Allocation of Resources

Allocation of
Resources

Allocation of resource means scientific management of resources in the production,

distribution and exchange. It deals with how much of resource is necessary in what
sector. It is the basic problem of every economy. We can satisfy only limited wants
because we have limited resources. So, these limited resources are used in such a
manner that the satisfaction derived from it is maximum. As the resources are
limited in comparison to wants, the proper allocation of resources is necessary. The
proper allocation of resources deals with the following fundamental problems of an
economy:

1. What to produce?
This means what types* and amounts of commodities to be produced. Every
demand of every individual cannot be satisfied. So, before producing anything a
decision should be made as to what commodities are to be produced and to what
extent.
2. How to produce?
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This means which technique of production- labor intensive or capital intensive

techniques-to be selected. After decision of the quantity and type of goods to be
produced, we must next determine what techniques should be adopted to produce
commodity.
3. For whom to produce?
This means how the produced goods and services are to be distributed among
different income groups of people i.e. who should get how much. This is the
problem of the sharing of the national product.
4. Problem of full employment:
This means the efficient use of scarce resources, i.e. no waste or misuse of
resources. Since resources are scarce in relation to human wants, it is necessary to
utilize the available resources to achieve full employment for maximum possible
satisfaction.
5. Problem of growth:
This means how to achieve growth of income and resources. The growth of
resources is related to the increase in the level of production. Each economy is
faced with the problem of how to increase its production capacity. For this, the
economy has to decide about the rate of capital formation, investment and
savings.

Production Possibility Curve or Frontier (PPC/PPF)

Production possibility curve analyses graphically the problem of scarcity and choice
present in an economy. It shows the maximum possibility of production of different
combinations of two goods that an economy can produce with the given
technology and resources. It also analyses how much the production of one
commodity has to be decreased while increasing the amount of production of
another commodity. The curve is also known as product transformation curve
because when moving from one point to another, the use of resources from one
commodity transfers to the production of other commodity.

The concept of production possibility curve is based on the following assumptions:

The amount of factors of production is given.
The factors are used only for the production of two goods X and Y, where X
denotes capital goods and Y denotes consumer goods.
Production technique is given.
The factors are fully utilized.
Imperfect substitution between factors of production.
It is based on short-run.
Based on the above assumptions, the PPC can be explained with the help of table
and diagram as follows:
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Production Possibility Schedule

Production Good X Good Y

possibilities (In (In
thousands) thousands)
A 0 15
B 1 14
C 2 12
D 3 9
E 4 5
F 5 0
Point G shows the under
utilization of resources (i.e. some resources are unemployed)
Above table shows the various production possibilities of good X and good Y. If all
the resources are used for the production of good X, 5 thousand units of good X are
H
produced.
Point Similarly,
H is desirable if all thedue
but unattainable
resources are used
to the scarcity for the production of good Y, 15
of resources.
thousand Gunits of good Y are produced. These are the two extreme production

possibilities. In between these two extremes, there are many other production
possibilities like at combination B, one thousand units of good X and 14 thousand
units of good Y can be produced. Similarly, at combination C, D and E, the
production possibilities of good X are 2, 3 and 4 thousand units and good Y are 12,
9 and 5 thousand units. Therefore, it is clear that in a full employment economy,
more of oneGoods goodX can be obtained only by cutting down the production of other
goods. For example, if the producer produces within the combination C, the
producer is ready to sacrifice 2 units of Y for the production of one more unit of X.
The production possibility curve has been shown in the following figure:

Y
Production possibility curve/Frontier
18
A
15

Goods Y

14 B

C
12

D
9

5 R

F
X
O 1 2 3 4 5

In the above figure, good X is measured along X-axis and goods Y is measured
along Y-axis. AF is PPC which is derived by joining the different production
possibilities points A, B, C, D, E and F of good X and good Y. Each point of PPC
shows the efficient zone of production (technically efficient combination).
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The point G lies inside the PPC which shows a possibility of increasing the
production of two goods because at this point the resources are underutilized. But
point H lies outside PPC which shows that the production amounts of two goods X
and Y as implied by this point are beyond the reach of the economy because there
is scarcity of resources.

Shift in PPC
Production possibility curve (PPC) shifts either downward or upward. The PPC shifts
upward or downward due to the following reasons:
Change in capital: Increase in capital increases the quantity of production
due to which PPC shifts upward. And if capital investment decreases, the
production will also decrease which causes downward shift in PPC.
Change in labor force: If efficiency of labor force is increased then
production of goods will also increase. As a result, PPC shifts upward. And if
there is overburden of labor force, production will decrease. As a result, PPC
shifts downward.
Change in technology: If the production technique is improved, the
production will increase. This brings upward shift in PPC. And if old technology
is used in production process, production will decrease and PPC shifts
downward.
Change in time period: PPC can shift due to the change in time period. In
the long-run, economy can gain efficiency leading to an increase in
productivity. As a result, PPC shifts upward. The following figure shows the
upward shift and downward shift in PPC:
A'' Y
A
A' h

Goods Y

F' F F''

X
Goods X

In the given diagram, AF curve shows the original production possibility curve
(PPC). When PPC shifts forwards (due to the above mentioned reasons) it becomes
A"F". This rightward shift in PPC indicates the increment in the productive capacity
of the economy. Similarly when PPC shifts backwards it becomes A'F' and shows the
decrease in the productive capacity of the economy.

MEANING OF ECONOMIC SYSTEM

Economy is the organized system of human activity involved in the production,
consumption, exchange, and distribution of goods and services in an area. It also
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refers to the way in which resources, especially those in shortage, are managed in
a competent and appropriate manner. An economic system is a system
of production and exchange of goods and services as well as allocation of resources
in a society. It includes the combination of the various institutions, agencies,
entities and consumers that comprise the economic structure of a given
community.
According to Prof. Loucks, "An economic system consists of those institutions which
a given people or nation or a group of nations have chosen or accepted as the
means through which their resources are utilized for the satisfaction of human
wants."

FEATURES OF AN ECONOMIC SYSTEM

There are certain features fundamental to an economic system.
1. A Group of People: An economy has a population base. It deals with human
beings. An economic system always implies a group of people who are living in a
particular territory. It enquires how a given people are engaged in the organization
of production for the satisfaction of their wants.

2. Organization of Production: An economic system irrespective of its form

exists due to the fundamental fact that there is a scarcity of economic resources,
through which goods and services can be produced. Had there been no scarcity of
productive resources there would have been no economic system.

3. Organization of the Process of Consumption: Mere production is not

enough. In any society production is aimed at the satisfaction of material wants.
This aim may be the satisfaction of present wants or the satisfaction of future
wants of the society. This necessitates a pricing process or economic calculation.

4. Institutions: An economic system consists of an assemblage of economic

institutions. An institution simply means a way of doing something or a way of
managing something. Economic institutions reflect all the organizations and human
groupings devised to help us provide a flow of goods and services to the members
of a society.

5. Flexibility: The economic systems are not static but dynamic. Economic
systems being man-made are subject to alteration. They are created, destroyed,
replaced, moulded by the members of a society in different capacities. For
example, capitalism may be replaced by socialism or mixed economic system.

TYPES OF ECONOMIC SYSTEM

Economists generally recognize three distinct types of economic system. They are:
1. Market Economy or Capitalism
2. Command Economy or Socialism
3. Mixed Economy

MARKET ECONOMY OR CAPITALISM

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A market economy is an economic system in which productive resources or factors

of production are owned by private individuals. The key feature of a free market
economy is that market forces dictate what is produced, in what quantities, at what
price, and for which consumers. Resources are privately owned by individuals and
companies. Profit and return on investment are the main drivers of businesses.
In this type of economic system, the government intervention in the economy is
minimum so that economic activities are mostly unplanned and uncoordinated.
Scarce resources are allocated through the market or price mechanism, i.e. through
the market forces of demand and supply. The market forces determine a price for
every product which signals to its buyers and sellers what their decision needs to
be. Adam Smith called the market mechanism as 'invisible hand' that allocates
resources efficiently. Market economy is also known as capitalism, free enterprise
system, laissez fairre and so on.

According to Professor Loucks, "Capitalism is a system of economic organization

featured by the private ownership and the use for private profit of men-made and
nature-made capital."

FEATURES OR CHARACTERISTICS OF MARKET ECONOMY

The main features of market economy are as follows:
1. Private Property: The right of private property is a major feature
of market economy. The right of private property means economic or
productive factors such as land, factories, mines, etc. are under private
ownership and the owners have right to own, control and dispose these means
of production.

2. Freedom of Enterprise and Choice: There is freedom of enterprise and

choice in market economy. Freedom of enterprise means that individuals are
free to buy and hire economic resources, to organize these resources for
production and to sell their product in market of their own choice.
Freedom of choice means that workers are free to enter into any occupation for
which they are qualified and consumers are also free to buy any type of goods
and services which they feel appropriate for their wants.

3. Competition: In the free market economy, competition exists between sellers

or producers of similar consumer goods and services to attract customers,
among the workers to get jobs and among the buyers to obtain goods to
satisfy their wants. Competition promotes best use and efficient allocation of
resources in the free market economy.

4. Consumers' Sovereignty: Under the market economy, consumers are

supreme. The goods and services are produced according to the demand of the
consumers. They have a wide range of goods and services to choose to satisfy
their wants.

5. Self-interest: The free market economy is based on the principle of self-

interest. It means that individuals should be free to do as they wish. Each unit
in the economy attempts to what is the best for itself. Firms act in such a way
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which leads to maximum profits or minimum losses. Workers move to those

occupations which offer them highest wages. Consumers spend their income
on those things which gives them maximum satisfaction.

6. Market Mechanism: The free market economy functions through price

mechanism. It means that economic problems are solved through the
operation of prices in the market. Both buyers and sellers make decision on the
basis of price of the product in the market.

7. Limited Role of Government: Since the free market economy functions

through market mechanism and most of its problems are solved by markets
and price, there is little role government can play. The role of government is to
maintain law and order and create infrastructures which help to increase
production and overall economic development. The government adopts
Laisezz faire policy.

8. Profit Motive: In the free market economy, economic activities are under
taken with the aim of earning profit. All the decisions regarding what to
produce, how much to produce and for whom to produce are taken on the
basis of profit and not on the basis of social welfare.

9. Absence of Central Plan: The capitalist system is essentially characterized

by the absence of a central plan. The activities of the numerous economic
units in a capitalist system are not guided, coordinated or controlled by a
central plan. Freedom of enterprise, occupation and property rights rule out the
possibility of central plan. Resource allocation and investment decisions in a
free market economy are influenced by market forces rather than by the State.

10. Freedom to Save and Invest: The freedom to save is implied in the freedom
of consumption. The right to save is supported by the right to transmit wealth
so that the choice between present and future consumption is not limited to
the adult life of one person. The freedom to save, inherit and accumulate
wealth is, therefore, a right which is perhaps more typical for the private
enterprise system.

ADVANTAGES OF MARKET ECONOMY

1. Entities Act In Their Best Interest: Since there is no government influence,

the consumer and the manufacturer are each able to act in ways that benefit
their best overall interest. Consumers are able to search for the lowest prices
in conjunction with the best quality, while manufacturers can worry strictly
about profits, without having to follow any sort of government regulation.

2. More Efficient Production: Market economy is all about producing the

products needed without wasting resources unnecessarily. As a result, this
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makes for much more efficient production from manufacturers. Since supply
and demand is what regulates the marketplace, there is very little wasted
production. A company will not produce products unless they know there is a
definite consumer lined up.

3. Economic Development: A market economy encourages an increased bond

between manufacturers and consumers. The system rewards those who are
innovative, which increases expansion. When this happens, a nations expands
and the standard of living is raised for all classes.

4. Customers Drive Choices: In a free market economy, the customers make

the ultimate decision on which products succeed or fail. When presented with
two products that offer similar benefits, customers vote with their purchases
and decide which product will survive. Customers also determine the ultimate
price point for a product, which requires producers to set product prices high
enough to make a profit, but not so high that customers will hesitate to make a
purchase.

5. Incentive for innovation: A free market economy is driven by individual

innovation and the notion that hard work and ingenuity will be rewarded by
success. All businesses exist to make a profit. Therefore, in the free market
system, a successful business makes a consistent profit in a field of
competitors. The concept of competition is an important component of a free
market system.

6. Better products at best price: Competition in the marketplace provides the

best possible product to the customer at the best price. When a new product
is invented, it usually starts out at a high price, once it is in the market for a
period of time, and other companies begin to copy it, the price goes down as
new, similar products emerge. In a competitive market, the poor versions of
the product or the overpriced will be pushed out of the market because
consumers will reject them.

7. Freedom of choice: The biggest advantage of free market economy is that it

gives the people the power of choice. They have greater freedom to choose
how they want to spend their income. They have wide range of goods and
services to choose.
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8. Quick response to peoples wants: Free market responds quickly to the

peoples wants: Thus, firms will produce what people want because it is more
profitable whereas anything which is not demanded will be taken out of
production.

9. Automatic adjustment mechanism: The market economy is self adjusting.

Any disequilibrium in the market is automatically corrected through the free
interplay of the forces of demand and supply.

10. Maximizes Welfare: The automatic working of the price mechanism under
capitalism brings efficiency in the production and distribution of goods and
services without any central plan, and promotes the maximum welfare of the
community.

DISADVANTAGES OF MARKET ECONOMY

1. Increased Production Costs: In a market economy, the supplier is not the

one who typically foots the bill for production costs. Instead, this bill is handed
down to the consumer. The supplier usually does not take care of costs that are
attributed to the production of their goods. For example, an increase in
pollution as the result of production becomes the consumers problem, not the
manufacturers.

2. Needed Regulations Do Not Occur: Manufacturers and consumers are not

always able to come to a consensus agreement that works for all parties
involved. Supply and demand can be tough to negotiate in certain instances
and without the ability to ask a government for help, a market economy can
suffer in these sorts of cases. To be able to ensure order, an economy needs a
government that is able to intervene.

3. Market Driven By Want, Not Need: When the consumer receives an

increased say in what drives the market, they will often choose by want,
instead of need. This leads to a serious discrepancy when goods receive
different value based on the concepts of supply and demand. This is why
allowing the consumer to play a role in driving product values can be
problematic.
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4. Dangers of Profit Motive: The primary objective for any company in a free
market economy is to make a profit. In many cases, companies may sacrifice
worker safety, environmental standards and ethical behavior to achieve those
profits.

5. Market Failures: When a free market economy spins out of control, the
consequences can be severe. From the Great Depression of the 1930s to the
real estate market crash of 2008, market failures have devastated the lives of
millions in lost income, unemployment and homelessness. Many of these
failures have stemmed from those seeking short-term profits over slow and
steady gains, usually aided by loose credit, highly-leveraged assets and
minimal government intervention.

6. Development of monopolies and oligopolists: Lack of ideal conditions and

absence of government intervention makes free market mechanism ineffective
in many ways. Monopolies and oligopolies develop, and may act against the
interest of the consumer. The consumers are exploited due to the emergence
of monopolies and oligopolists.

7. Increase in disparities: it has no mechanism to reduce the disparities

between the haves and have nots. It just creates a system in which everyone
ears as per his ability. Actually because of the imperfection in market
mechanism, free economy tends to further increase the disparities between
people.

8. Distorted investment priorities: The investment priorities get distorted, as

wealth gets directed into what will earn the largest profit and not into what
most people really need. So public health, public education, and even dikes for
periodically swollen rivers receive little attention.
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9. Consumption of harmful goods may be encouraged: Free market

economy might find it profitable to provide goods which are in demand and
ignore the fact that they might be harmful for the society.

10. Consumption of harmful goods may be encouraged: Free market

economy might find it profitable to provide goods which are in demand and
ignore the fact that they might be harmful for the society.

SOCIALISM OR CENTRALLY PLANNED ECONOMY

In a centrally planned economy, factors of production are owned by the
government and welfare of the people is the prime concern. The government is
actively involved in economic activities which also include determining the price at
which exchange of goods and services takes place. The economy is operated by
the public authority according to a general economic plan for the benefit of the
entire community.
In a planned economic system, the central problems of what, how and for whom to
produce are solved by the government through a process of planning. The
government plans or decides which goods and services are required for the
economy and how much of these need to be produced. The government also
decides the methods of production and accordingly this determines the allocation
of resources. The government also distributes the mix of goods and services
produced to different sections of society, keeping welfare objective in mind.

MIXED ECONOMY
Mixed Economy can be defined as a form of organization where the elements of
both capitalist economy and socialist economy are found. There is mixture of
private and public ownership of the factors of production. Some economic decisions
are taken by private sector and some by the government. In a mixed economy,
government regulates the working of the market through legislation, or by
providing some goods and services through state enterprises..

The mixed economy refers to such an economic system wherein two the sector
exist and function for achieving national objectives. The two sectors are the public
sector and private sector. Both these sectors exist and function for achieving
national objectives. Both these sectors make the economic system of the country.
One side there is freedom of enterprise, private ownership and profit earning. On
the other side there is government guidance and control so as to stop evil
economic, pressures. Most countries today have adopted mixed economic system
for greater economic prosperity and welfare.