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INTRODUCTORY MICROECONOMICS
CENTRAL PROBLEMS OF AN ECONOMY

ECONOMICS
Economics is the study of how individuals, firms and governments make choices on allocating their
limited resources to satisfy their unlimited wants.

What is economics all about?

Economics is all about how people make choices. Choice means selecting one out of the various available
alternatives.
The need for making choices arises due to scarcity of resources. An individual cannot satisfy all of his
wants because the wants are unlimited and means to satisfy them are limited and the limited means have
alternative uses.
Hence, economics deals in selection in the conditions of scarcity of resources.

Characteristics of Resources
1. Scarcity
Scarcity of resources means that an economy does not have sufficient resources or means to satisfy all
of its wants.

2. Alternative Uses
Alternative uses means that a resource has many available options to be put to use. But it can be used
for only one purpose at a time. For example, a plot of land can be used to construct only one out of
residential complex, school, hospital, offices etc. at a time.

Economising of Resources
It refers to the use of scarce resources in such a manner that wastage is avoided and maximum output is
obtained. Economising of resources is needed because the resources are scarce or limited and they are to
be used to satisfy wants that are unlimited.

BRANCHES OF ECONOMICS
1. Microeconomics
The branch of economics, which studies the behaviour of individual economic units is called
microeconomics. Economics activities related to a consumer, a producer, a firm an industry or price
are studied under microeconomics.
Examples of microeconomic studies:
i. Determination of the price of its products by a firm.
ii. Determination of an individuals demand for a product.
iii. Pricing of a factor of production.

2. Macroeconomics
The branch of economics, which studies the aggregates and averages related to economy as a whole is
called Macroeconomics. National Income, Employment level, General price level are studied under
macroeconomics.
Examples of macroeconomic studies:
i. Determination of national income.
ii. Determination of the level of unemployment in the country.
iii. Determination of general price level.

Central Problems of an Economy

NATURE OF ECONOMICS

1. Economics as a Positive Science OR Positive Economics

A positive statement is a statement about what is and that contains no indication of approval or
disapproval.
Economics, as a positive science, analyses cause and effect relation between economic variables but it
does not pass any value judgments. It describes economic activities as neutral with regard to welfare
and silent about value judgment.

2. Economics as a Normative Science OR Normative Economics

A normative statement expresses a judgment about whether a situation is desirable or undesirable.
Economics, as a normative science involves value judgments and describes what the things should be.
It is concerned with welfare propositions.
When we say, prices are rising due to high demand; we make a positive statement that does not
involve a value judgment. But when we say demand should be reduced to control prices; we make a
normative statement indicating what is desirable.
ECONOMY
A system that provides living to the people is called an economy. It consists of shops, offices, hospitals,
and schools etc where people work to earn a living.

Central Problems of an Economy

Every economy, whether underdeveloped, developing or developed, faces certain problem in utilizing
their scarce resources in satisfying unlimited wants to the optimum level. Since these problems are related
to making choice between different alternatives, they are knows as Problems of Choice, and because they
are prevalent in every economy irrespective of the level of development achieved, they are called Central
or Fundamental Problems.
Problems of Choice or Central Problems of an Economy arise because of:
1. Scarcity of resources, and
2. Alternative uses of the resources.
3. Unlimited wants and their recurring nature.
In any given period of time each economy tries to solve the following problems of choice:
1. What to Produce?
This problem is, in fact, the problem of allocation of resources. It is also known as the problem of
choice of goods to be produced.
Therefore this problem is related to selecting those goods, for the manufacture of which the resources
are to be put to use. It involves two fold decisions:
i. Which goods to produce?

Central Problems of an Economy

The economy has to decide which goods and services are to be produced. For example, the
economy has to decide which among the consumer goods viz. wheat, cloth, sugar etc. and which
among the capital goods viz. machines, tractors etc. it has to produce.
ii. The quantity of goods to be produced.
Once the economy has decided upon the goods and services it has to produce, the next problem it
faces is the decision about the quantity of various goods it requires to produce.
2. How to Produce?
This problem is related to select the technique of production. There are mainly two techniques of
production:
i) Labour-intensive technique: In this technique, more labour and less capital is used for
production of goods and services, for example, handloom.
ii) Capital-intensive technique: In this technique, more capital or machinery and less labour is used
for production of goods and services, for example, power loom.
3. For whom to produce?
This problem is in fact the problem of distribution of income among factors of production who will
consume the goods and services produced. It is related to how much does each individual or factor of
production earn and how much wealth or assets does each have? It determines the purchasing power
of people, which depends upon the distribution of income from output among the factors of
production.
TYPES OF ECONOMIES
1. Market Economy
It is the system where means of production are privately owned and economic activities (production,
Consumption, distribution of income etc.) are guided by the operations of market. It is also called
Capitalist economy.
Features of Market Economy
Following are some important characteristics of a capitalist economy:
i. Private property
In this system the properties are owned and managed privately by the people. This property can
be transferred to their heirs.
ii. Price Mechanism
Demand and supply forces determine the prices of the commodity. Free flow of market forces
helps the producer to decide what to produce and how much to produce, how to produce and for
whom to produce. This price mechanism decides the economic activities such as production
consumption, distribution, investment and savings.
iii. Profit motive
Enterprises engage themselves in the economic activity to earn the maximum profits.
iv. Freedom of enterprises
An enterprise has the power to own a business without intervention of State or Government. An
individual can himself take decisions regarding what to produce, where and for whom to produce.
He takes decision with respect to availability of resources on the basis of his skills and
knowledge.
v. Self interest
Self interest is the prime motive in this system. All the market elements labour, consumer,
producer etc. are centered to their own interest to maximize their satisfaction.

Introductory Microeconomics

As the Government or State has very limited control on the decision making, it is guided by the self
interest of factors in economic activity. The self interest for the producer is maximization of revenues,
minimization of cost, thereby maximization of profits. For a consumer it is maximization of
satisfaction for his consumption basket.
Solution of economic problems in a Capitalist Economy
Price mechanism works through the demand supply forces and thereby the equilibrium price and
quantities. It solves the problem as follows.
i. What to produce?
Consumers decide on the basis of their preferences at what prices they are ready to buy what
amount of a commodity. It decides the demand for goods in the market. On the other hand,
producers decide on the basis of cost of production, what commodities and what quantities they
are ready to supply at different prices in the market. This determines the supply of the
commodities. Where these two forces (i.e. demand and supply) intersect each other, the price and
quantity of the commodity is determined.
ii. How to produce?
It is the problem of choice among technique of production. A producer will always employ the
cheapest technique to minimize his cost of production. The cost technique is based on the price of
inputs used in the production. Input prices are determined by the price mechanism. On the basis
of the prices of inputs, a producer decides the technique which is less costly.
iii. For whom to produce?
This is the problem of distribution of national income among the different section of its people.
In the capitalist system the share of a factor decides its share of national income. If the labour
class has larger share the necessities or common goods will be produced and if the capitalist class
has more share in the national income more luxurious goods will be produced. In this system,
distribution of income determines the distribution of goods and services.

2. Planned Economy
In a Planned Economy the means of production are collectively owned and decision regarding
planning, production, economic development are taken by the Central Planning Authority or state.
Features
i. Collective Ownership
In this case, Government is the representative of the society and all means of production are
owned by the society. No individual has any right on the property.
ii. Central Planning
All the economic decisions are taken by the central planning authority, which decides it through
economic plans.
iii. Govt. Control
All the economic planning takes place under control of government or State. Government has the
power to implement their plans without any interruption. State has full monopoly power so there
is no competition.
iv. Social welfare
The objective of the government is to maximize the social welfare of the people and not to earn
the economic profit.
v. Lesser scope of private sector
All the essential sectors are dominated by the public sector or Govt. There is very limited scope
for private sector.

Central Problems of an Economy

Solution of economic problems in a Socialist Economy

In the socialist economy the central problems will be solved through the state or central economic
planning. The central planning authority decides the amount of goods and services to produce
according to the requirement of the country and needs of its people. It ensures the minimum income
equality of the disposable income so that every individual can receive the minimum of the goods and
services. There could be different ways to achieve targeted output. The central planning authority
takes into consideration the social welfare aspect and development related gods for selecting a
technique of production.
3. Mixed Economy
It is the economy which comprise the attributes of both socialist as well as the capitalist economy.
Here both the sector private as well as public sectors control the economy and fully participate in the
economic activity. It gives economic freedom to private sector with government regulation or
intervention.
Government leaves the private sector to freely move and employs its resources where private sector is
not interested to employing its resources but essential for social welfare point of view.