What are the four central problems of an economy and how do they arise?

Human wants are unlimited but the resources through which goods and services are produced to satisfy these wants is limited or scarce. This involves the problem how to use scarce resources for the achievement of maximum possible satisfaction of the people.

Thus scarcity of resources is the root cause of all economic problems. Resources are scarce in relation to what we demand. In view of this scarcity of resources, a society cannot produce unlimited quantities of goods and services.

The scarcity of resources makes us decide how the different goods should be produced, what production method should be employed for the production of goods so that the available resources should have best possible use. If the available resources were abundant the problem of how goods should be produced would not arise and consequently which ever method efficient or inefficient would not have poured problem for the economy.

Scarcity of resources gives rises to four central problems which every economy has to solve them. These basic or central problems are,

(i) What to produce

(ii) How to produce

(iii) For whom to produce

(iv) How much to grow

(i) What to produce:

The community has to decide which goods and in what quantities are to be produced. The society has to choose among numerous consumer goods and decide about allocation of resources between them. The society has to make a choice between necessities and luxuries.

The decision about the allocation of resources between consumer goods and capital goods is very important from the point of view of economic growth. Society has to determine the specific quantity of capital goods and consumer goods.

Once the goods to be produced have been decided, the society must attach proper weights to each of the good it chooses to produce. For example wheat and hospitals are selected to be produced. But the goods cannot be produced unlimitedly.

Then society would decide how much wheat, how many hospitals are to be produced. Only the question of what quantity of above goods is to be produced should be kept in mind.

2. How to produce:

After the society has decided what to produce the next problem arises as how to produce. This means which technique of production is to be used. The society is to decide what combination of resources is too applied for the production of goods. There are various techniques of production available in the economy. Each technique uses a different combination of resources.

For example cotton cloth can be produced either by handloom, or by power loom. The techniques of handloom require more labour relative to capital. Thus it is labour intensive techniques. On the other hand power loom involves more capital relative to labour. Thus it is capital intensive technique.

The choice between different techniques depends on the available supplies of different factors of production. Resources being scarce, goods should be produced with the most efficient methods. Inefficient use of resources will involve smaller output. Thus that technique should be followed which would ensure best use of the resources available abundantly.

3. For Whom to Produce:

For whom to produce means how the national product is to be distributed among the members of the society. In view of the scarce resources and output, the society has to decide who should get how much from the total national output.

In a free market economy the money income of a person decides how much share he is to receive from the national output. The greater the income, the greater the share of output.

Money income is obtained in two ways. Firstly, money income is obtained by selling one’s labour services. Secondly income can be made from property such as land and other forms of capital, in form of rent, interest and profits. Difference in the ownership of property leads to difference in income.

How the national income is to be distributed is a burning issue in the minds of economists. According to Karl Marx, the distribution of national income should be on the basis of from each according to his ability to each according to his needs. Another view is that each individual should get income equal to the contribution he makes to the national production.

4. How much to grow:

The scarce resources should not be spent for consumption goods only. Resources should be allocated for the production of capital goods. If the resources are not allocated for investment future production will suffer a serious setback. If no provision is made for future, the future productive capacity and the level of living will decline. That is why a society would provide for its growth of productive capacity.

Thus a part of the productive resources should be devoted to the production of capital goods and promotion of research activity. More capital accumulation means sacrifice of some current consumption. Thus a society has to decide how much saving and investment should be made for future economic progress.