BASIC ECONOMIC PROBLEMS AND THEIR SOLUTIONS | MICRO ECONOMICS

What are basic economic problems and their solutions? Classical economists uphold the opinion that there is always full employment in the economy of a country under Laissez-faire capitalism. This is so because price mechanism or the interaction of the free forces of demand and supply automatically rationalize the allocation of resources.

BASIC ECONOMIC PROBLEMS AND THEIR SOLUTIONS

The basic economic problems which come up to be automatically settled through the role of price mechanism are as under:
1)         How are the productive resources allocated?
2)         How is the level of production determined?
3)         How is national product distributed?
4)         How is the   capacity of the economy maintained / developed.

1) ALLOCATION OF RESOURCES: Productive resources can be alternatively used. They can either be used to produce agricultural commodities or they can be diverted to produce industrial Where will the resources bc allocatéd? This problem is automatically solved by the role of price mechanism in a capitalist society. For example, if the prices of industrial goods are rising relative to agricultural commodities, entrepreneurs will prefer to make investment in the industrial sector in an attempt to achieve maximum profit. For this they will offer higher rewards to factors of production in order to attract them in the industrial sector. Naturally more resources will be allocated in the industrial sector than agriculture.
2) DETERMINATION OF LEVEL OF PRODUCTION: What should be the level of output to be produced by a firm? This problem too is solved by the role of the price mechanism in a laissez-faire economy. The quantity of output to be produced depends on the demand for it and also on its supply which is determined by the amount of capital required to produce it. The products which are largely demanded and have an extended market, are under large-scale prÜction which requires a huge amount of capital for investment. Conversely, the prÜcts which are locally demanded are produced at a small scale. Entrepreneurs determine the level of their output to be produced with a view to maximise profits. The profit is maximized only when the marginal revenue (MR) of the additional or last unit of output sold is equal to marginal cost (MC) of the additional unit of output produced. When MR== MC the output produced by a firm is automatically determined.
3) DISTRIBUTION OF OUTPUT: How is national product distributed among different sections of society? This problem is also solved by the role of price mechanism in a capitalist society. Each factor of production is paid according to its marginal revenue product (MRP) which, particularly in a third world country, leads to unequal distribution of wealth. For fair distribution of wealth, monetary and fiscal measures are required to be adopted and in this regard Govt. intervention can be justified in the Keynesian sense.
4) MAINTAINING PRODUCTIVE CAPACITY OF THE ECONOMY: Classical economists who uphold micro economic policies, believe that there is always full employment in the economy of a country and whenever there are lapses from full employment, there will always be an automatic tendency to restore the stationary equilibrium at full employment. Hence there is no question of overproduction and general unemployment in a laissez-faire economy. Therefore, to maintain or develop the productive capacity of the economy, abundant or cheaper factor of production is required to be employed more than the relatively scarce and expensive tåctor. For example, if it is a labour abundant economy, labour intensive technique of production will suit more and if it is a capital abundant economy, capital-intensive techniques would be required to maintain the productive capacity of the economy.