Basic problem of an economy
Human wants are unlimited and instable. The resources needed to satisfy the wants are scarce. Thus, scarcity of resources leads to economic problems of the nation. Price mechanism plays an important role in answering the following question about the economy.
What and how much to produce – when the resources are limited, what does the society do. It determines which goods and services it wants to produce and in what quantity. This involves the allocation of scarce resources to produce a final product. Since the resources is limited, the society decides which goods to produce such as wheat, cloth, etc. And also determines the quantity (How many kilos of wheat, how many million metres of cloth, etc) required to produce. Thus, the production of goods and services depends on the preference of the society. If the society gives more preference to consumer goods now than capital goods, then consumer goods will have less preference in the future and capital goods will have more preference in the future.
How to produce – the production of goods is possible through various methods. For ex, cotton cloths can be produced by using handlooms, power looms, and automatic looms. Thus, the society chooses the techniques to produce the goods. The techniques depend on different factors of production and their prices. The factors of production are land, labour, capital. The wage, interest, rent and profit are the prices paid by the entrepreneur for the service of the factors of production which calculate the cost of production. Every producer aims at producing goods at minimum cost. The producer uses cheaper resources to reduce the cost of production. The producer uses capital-intensive production “process in case capital is cheaper than labour. In case the labour is cheaper than capital, labour-intensive production processes will be used.
From whom is the goods produced – the third problem is to allocate the goods among the members of the society. The producer and consumer are same people in the economy. Producer sells goods at a price to consumer and consumer receives income for their services from the producer. The allocation of consumer, luxury goods depends on the distribution of income. A rich person will purchase more luxury goods. A poor person will focus more on purchasing basic consumer goods.
How efficiently are the resources being used – the society have to check whether the resources are used fully or not. In case resources such as manpower, land and capital are lying idle, the society has to find ways to utilise them fully
Price Mechanism in a Socialist or Controlled Economy:
In a socialist society, the decision of what, how and from whom to produce is not guided by price mechanism. The decision is taken by the central planning authority assisted by various ministers, industries and state enterprises. The central planning authority decides what to produce and in what quantity based on the objectives, targets and priorities laid down in the plan. They also fix the price of the commodities.
Social preferences are given more weight age. Higher weight age is given on production of those goods and services which are needed by majority of people over the luxury items. Socialist economy solves the problem of income distribution as the resources are owned and regulated by the government.
Price Mechanism in a Mixed Economy:
In mixed economy, price mechanism will pay an equal role along with the planning authority. The problems of whet to produce and in what quantities are solved in two ways.
Firstly, price mechanism helps private sector in deciding what to produce and in what quantities. Secondly, central authority decides what to produce and in what quantities. Here the public sector has a monopoly. Prices will be fixed by the authority on profit-price policy or no-profit no-loss policy. For public utilities like water, gas, communication, etc the state fixes the rates on the basis of no profit no loss.
The problem of how to produce and in what quantity is solved partly by the price mechanism and partly by the state. The state guides the private sector in adopting the techniques of production to reduce cost and maximise output.
The problem of whom to produce is decided by price mechanism and central planning authority. The price mechanism helps private sector decides what goods to produce and in what quantity based on consumer preferences and income.
Mixed economy aims at achieving social justice growth as the allocation of resources is not left entirely to the price mechanism. The state enters in allocation of resources and distribution of income.
