Central problems arise in an economy due to scarcity of resources having alternative uses in relation to unlimited wants.

The Central Problem of all economies is scarcity.

Limited Resources + Unlimited Wants = Scarcity

Scarcity forces individuals, firms governments and societies to make choices.

Three basic questions must be answered in order to understand an economic system:

What is produced?

Every society has some system or mechanism that transforms that society’s scarce resources into useful goods and services. Every society decides Whether to produce more of food, clothing, housing or to have more of luxury goods, Whether to have more of consumption goods or to have investment goods.

How is it produced?

Society decides the technology to be used in the production of goods and services. Whether it should be labor intensive or capital intensive. e.g. in India, we have unemployment and labour is easily available. so, choosing a labor intensive technique will help in providing jobs to unemployed.

For Whom is it produced?

Who gets how much of the goods that are produced in the economy? How should the produce of the economy be distributed among the individuals in the economy? Who gets more and who gets less? Demand is an important factor which determines for whom the things are produced but the society determines how the product is evenly distributed so that it fulfills the need of everyone in the society.

The Production Possibility Curve

The Production Possibilities Curve is a graphical representation showing various maximum combinations of output that can be produced with the limited economic resources in a fixed time period

Assumptions of the Production Possibilities Curve

·         Two goods are produced depicting choices and trade-offs for a nation.

·         Full employment and Full production are achieved allowing for maximum utilization of resources.

·         Short-run is the time frame over which resources cannot be improved or increased.

 

Explanation

·         The bow Shaped Curve is a number of Maximum combinations of product X and product Y that this hypothetical economy can produce in the short run.

·         More X can be produced only with the sacrifice of good Y.

·         The movement from a to b means less of good X produced. This will free up resources to produce more of good Y.

·         Notice that the movement from a to b on the X axis allows a movement from d to e on the Y axis. Both are maximum combinations but a choice must be made.

·         Notice that on the X axis, the distance from a to b and from b to c are essentially the same.

·         The first sacrifice of resources to X ( a to b ) and the second sacrifice of resources to X, ( b to c ) are represented by equidistant movements to the left

·         Notice that on the Y axis, the distance from 0 to d and from d to e are not the same. On the other hand, nations cannot produce a combination of X and Y that lies outside the curve. This is impossible in the short run due to some fixed resources such as land or capital.

·         The first sacrifice of resources to X ( a to b ) Yielded a large gain in production of Y. The second sacrifice of resources to X, ( b to c ) yielded a significantly smaller increase in the production of Y.