Problems of an Economy

Problems of an Economy

Central Problems

Scarcity of resources is a result of the below two truths of life:

  1. Human needs and wants are unlimited and insatiable;
  2. Economic resources to fulfill these human needs are limited.

This implies that we cannot have everything we desire and we must make choices. This situation of making choices stems the central problems of an economy as illustrated below:

  • What to produce;
  • How to produce and
  • For whom to produce
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Central problems arise in an economy due to scarcity of resources having alternative uses in relation to unlimited wants.

Production Possibility Curve

The Production possibility curve (PPC) shows different combinations of production of two goods or services that can be efficiently produced by an individual or group with limited productive resources by transferring resources from one good or service to the other. Simply put this curve shows the trade-offs among choices one makes. For every choice made one can get more of something only by giving up something else which is nothing but the opportunity cost of the choice. The curve slopes downward from left to right.
As shown in the figure below an individual can have 5 units of computers and 11 units of food or 6 units of computers and 10 units of food for similar resources. Thus points Q, R, T and V all signifies different combinations of food and computer units with the same resources

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Opportunity cost

The opportunity cost of a resource is the return that can be had from the next best available alternative use. A farmer producing pulses can also produce wheat with the same resources. Therefore, the opportunity cost of pulses is the amount of the output of wheat given up. The opportunity costs are the costs of foregone alternatives.
At all points on the production possibility curve, producing lesser units of one good/service is essential to produce more units of the other good/service

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As shown in the figure above the opportunity cost between 5 and 6 computers is 1 food unit and between 9 and 10 computers are 3 food units. This implies that to get one more unit of computer from 5 to 6 the food units need to be forgone is 1 from 11 to 10