Scarcity and Choice as Economic Problems (With Diagram)

The Problem of Scarcity:

We live in a world of scarcity. People want and need variety of goods and
services. This applies equally to the poor and the rich people. It implies that
human wants are unlimited but the means to fulfil them are limited. At any
one time, only a limited amount of goods and services can be produced. This
is because the existing supplies of resources are extremely inadequate. These
resources are land, labour, capital and entrepreneurship.
These factors of production or inputs are used in producing goods and
services that are called economic goods which have a piece. These facts
explain scarcity as the principal problem of every society and suggest the
Law of Scarcity, The law states that human wants are virtually unlimited and
the resources available to satisfy these wants are limited.
The Problem of Choice:
Since are live in a world of scarcity, a society can produce only a small
portion of goods and services that its people want. Therefore, scarcity of
resources gives rise to the fundamental economic problem of choice. As a
society cannot produce enough goods and services to satisfy all the wants of
its people, it has to make choices.
A decision to produce one good requires a decision to produce less of some
other good. So choice involves sacrifice. Thus every society is faced with
the basic problem of deciding what it is willing to sacrifice to produce the
goods it wants the most.
For instance, the more roads a country decided to construct the fever
resources will there be for building schools. So the problem of choice arises
when there are alternative ways of producing other goods. The sacrifice of
the alternative (school buildings) in the production of a good (roads) is
called the opportunity cost.
There are a number of problems that can arise from choices that are made by
people, whether they are individuals, firms or government. Choices or
alternatives (or opportunity cost) are illustrated in terms of a production
possibility curve.
A production possibility curve shows all possible combinations of two goods
that a society can produce within a specified time period whose resources
are fully and efficiently employed.
PP1 is the production possibility curve in Fig. 1 which shows the problem of
choice between two goods X and Y in a country. Good X is measured on the
horizontal axis and Good Y on the vertical axis. PP cue shows all
combinations of X and Y good that can be produced by the country with all
its resources fully and efficiently employed.
If the country chooses to produces more of X good, it would have to
sacrifice the production of some quantity of Y good. The sacrifice of some
quantity of Y good is the opportunity cost of producing some extra quantity
of good X.

The PP1 curve is downward sloping because to produce more of good X

involves producing less of Y good in a fully employed economy. Moving
from point В to D on the PP { curve means that for producing XX, more
quantity of good X, YY quantity of good Y has to be sacrificed.
Both point’s В and D represent efficient use of country’s resources. Point R
which is inside the bounder of PP curve implies inefficient use of resources.
Point К which is outside the boundary of PP X curve is an unattainable
combination because the country does not possess sufficient resources to
produce two combination of X and Y goods.
Central Problems of an Economy:
The resources are scarce; the society has to make a number of choices.
There are fee main categories of choices that a society must make:
1. What to goods and services produce and in what quantities?
2. How to produce these goods and services?
3. For whom to product them?
4. How efficiently are the resources being utilized?
5. Is the economy growing?
Causes of 6 Economic Problems That Arises from Problem of Scarcity
The following are the main questions which have been asked by the
economists from time to time.
It is worth remembering that all these fundamental questions arise because
of the basic problem of scarcity confronting an economy.
1. What goods are produced and in what quantities by the productive
resources which the economy possesses?
2. How are the different goods produced? That is, what production methods
are employed for the production of various goods and services?
3. How is the total output of goods and services of a society distributed
among its people?
4. Are the use of productive resources economically efficient?
5. Whether all available productive resources of a society are being fully
utilized, or are some of them lying unemployed and unutilized?
6. Is the economy’s productive capacity increasing, declining or remaining
static over time?
The six questions listed above have been the concern of economic theory
from time to time. As said above, all of them arise from the fundamental
problem of scarcity. All economies whether they are capitalist, socialist or
mixed, must take decision about them. Economic theory studies how these
decisions are arrived at in various societies.
It is worth mentioning that economic theory has been mainly evolved and
developed in the framework of capitalist institutions where free market
mechanism plays a dominant role in solving the above basic problems.
Therefore, mainstream economic theory assumes free market system and
explains how the above six problems are solved by it and with what degree
of efficiency.
We shall explain below above six problems and questions in detail and
see how they are related to the problem of scarcity.
1. The Problem of Allocation of Resources:
The first and foremost basic problem confronting an economy is “What to
produce” so as to satisfy the wants of the people. The problem of what goods
are to be produced and in what quantities arises directly from the scarcity of
resources.
If the resources were unlimited, the problem of what goods are to be
produced would not have arisen because in that case we should have been
able to produce all goods we wanted and also in the desired quantities. But
because resources are in fact scarce relative to human wants, an economy
must choose among various goods and services. Wants for those goods
which society decides not to produce will remain unsatisfied. Thus the
question of selecting goods for production implies which wants should be
satisfied and which ones to be left unsatisfied.
If the society decides to produce a particular good in a larger quantity, it will
then have to withdraw some resources from the production of other goods
and devote them to the production of the good which is to be produced more.
The greater the quantity of a good which is desired to be produced, the
greater the amount of resources allocated to that good. The question of what
goods are produced and in what quantities is thus a question about the
allocation of scarce resources among the alternative uses.
Thus, with the given scarce resources, if the society decides to produce one
good more, the production of some other goods would have to be cut down.
For instance, at times of war, when the society decides to produce more war
goods like guns, jet planes and other armaments, some resources have to be
withdrawn from the production of civilian goods and devoted to the
production of war goods. Because of the scarcity of resources we cannot
have more ‘guns’ and more ‘butter’; some ‘butter’ has to be scarified for the
sake of more ‘guns’.
What determines the allocation of resources and what are the results of
attempts made to change the allocation has occupied the minds of
economists from the very beginning of our economic science. Whatever the
type of economy, be it capitalist, socialist or mixed, a decision has to be
made regarding allocation of resources.
In a capitalist economy, decisions about the allocation of resources or, in
other words, about what goods are to be produced and in what quantities are
made through the free-market price mechanism. A capitalist or free-market
economy uses impersonal forces of demand and supply to decide what goods
are to be produced and in what quantities and thereby determines the
allocation of resources.
The producers in a free-market economy, motivated as they are by profit
considerations, take decisions regarding what goods are to be produced and
in what quantities by taking into account the relative prices of various goods.
Therefore, the relative prices of goods, which are determined by free play of
forces of demand and supply in a free market economy, ultimately determine
the production of goods and the allocation of resources.
The branch of economic theory which explains how the relative prices of
goods are determined is called Microeconomic Theory or Price Theory and
has been the concern of economists from the earliest days of economics.
2. Choice of a Production Method:
There are various alternative methods of producing goods and a society has
to choose among them. For example, cloth can be produced either with
automatic looms or with power looms or with handlooms. Similarly, fields
can be irrigated (and hence wheat can be produced) by building small
irrigation works like tube wells and tanks or by building large canals and
dams.
Therefore, it has to decide whether cloth is to be produced by handlooms or
power looms or automatic looms. Similarly, it has to decide whether the
irrigation has to be done by small irrigation works or by large canals.
Obviously, it is a problem of the choice of production techniques. Different
methods or techniques of production would use different quantities of
various resources.
For instance, the production of cloth with handloom would make use of
relatively more labour and less capital. On the other hand, production with
automatic looms uses relatively more capital and less labour. Therefore,
production with handlooms is a labour-intensive technique while production
with automatic looms is a capital-intensive technique of producing cloth.
Thus, a society has to choose whether it wants to produce with labour-
intensive methods or capital-intensive methods of production.
More generally, the problem of ‘how to produce’ means which combination
of resources is to be used for the production of goods and which technology
is to be made use of for their production. Scarcity of resources demands that
goods should be produced with the most efficient method. If the economy
uses its resources inefficiently, the output will be less and there will be
unnecessary loss of goods which otherwise would have been available.
The choice between different methods of production by a society depends on
the available supplies and the prices of the factors of production. The
criterion for the choice of a method of production should therefore be the
cost of production per unit of output involved in various methods. We have
noted above that economic resources are scarce relative to demand. But
economic resources are unequally scarce; some are more scarce than others.
Therefore, it is in society’s interest that those methods of production be
employed that make the greatest use of the relatively plentiful resources and
economizes as much as possible on the relatively scarce resources.
Why one method of production is used rather than another and consequences
of the method used are dealt with in the Theory of Production. In the theory
of production we study the physical relationship between inputs and outputs.
This physical relationship between inputs and outputs along with prices of
factors goes to determine the cost of production. Cost of production governs
the supply of goods which together with demand for them determines their
prices.The theory of production thus becomes a part of microeconomic
theory (i.e. theory of price) and will be explained in detail in the present
work.
It is worth noting here that the choice of technique of production is dealt
with not only in microeconomic theory but is also an important issue in the
theory of economic growth. This is because the choice of a production
technique determines not only the cost of production of a commodity but
also the surplus which can become a source for further investment. The
greater the surplus, the higher the rate of investment and therefore the higher
the rate of growth of output and employment. An eminent economist. Prof.
Amartya Sen, currently of Harvard University, has analysed the choice of
technique as an important issue in economics of growth of the developing
countries.
3. The Problem of the Distribution of National Product:
This is the problem of sharing of the national product among the various
individuals and classes in the society. The question of distribution of
national product has occupied the attention of economists since the days of
Adam Smith and David Ricardo who explained the distribution of national
product between different social groups such as workers and capitalists in a
free market society. Who should get how much from the total output of
goods and services is a question concerning social justice or equity.
Economists’ interest in this subject has increased very much’ in recent years.
It is important to note that the distribution of national product depends upon
the distribution of money income. Those people who have larger incomes
would have larger capacity to buy goods or to use Prof. Amartya Sen’s
phrase, would have larger entitlement for goods and hence will get greater
share of output. Those who have low incomes would have less purchasing
power to buy things and will therefore be able to obtain a small share of
output. More equal is the distribution of income, more equal will be the
distribution of national product.
Now, the incomes can be earned either by doing some work or by lending
the services of one’s property such as land, capital. Labour, land and capital
are factors of production and all of them contribute to the production of
national product and get prices or rewards for their contribution. The
question as to how the prices or rewards of factors of production are
determined is the subject-matter of the Theory of Distribution.
After the marginalist revolution in economic theory, theory of distribution
has been boiled down to the theory of factor pricing which is an important
part of the price theory or what is now popularly called microeconomic
theory. The old division of factors into land, labour and capital is retained in
modern economic theory but their old association with ‘social classes’, such
as capitalist and working classes as was made by classical economists has
been given up.
The theory of distribution viewed as the theory of pricing of factors of
production is merely an extension of the theory of price or value. Prof. A. K.
Dassgupta rightly remarks “Distribution appears an extension of the theory
of value, being just a problem of pricing of factors of production. The two
aspects of the economic problem are then integrated into a unified and
logically self-consistent system.
Value of commodities is derived in the ultimate analysis from utility, and
value of factors derived from productivity imputed by the commodities
which they help in producing. The old tripartite division of factors into land,
labour and capital is retained but their old association with social ‘classes’ is
lost. Factors are conceived as just productive agents independently of the
institutional framework within which they operate.”
The theory of distribution viewed as the theory of factor pricing deals with
the functional distribution of income rather than the personal distribution of
income, since it explains only how the prices of factors, that is, wages of
labour, rent of land, interest on capital and profits of entrepreneur are
determined. But the question which we raised, namely, “how the national
product is distributed among the various individuals that comprise a society”
is not fully answered by the theory of functional distribution.
It is the personal distribution of income that determines who would get how
much from the national product. Now, the income of a person depends not
only on the price of a factor he owns and the amount of work he does but
also on how much property or assets in the form of factors of production
such as land and capital he owns. Private ownership of the means of
production is a sine qua non of the capitalist system.
Therefore, the personal distribution of income is greatly affected by the
distribution of the ownership of property. A person who owns a large
amount of property will be enjoying a higher income. In the free market
capitalist economies because of the large inequalities in the ownership of the
property there are glaring inequalities of income. As a result, the distribution
of national product is very much unequal in capitalist economies.
In recent years, the governments of the capitalist countries, like U.S.A.,
Great Britain have taken various steps to reduce inequalities of income and
property and have accordingly tried to influence the distribution of national
product. Since the distribution of the ownership of property is an
institutional factor. We shall, therefore, confine ourselves to the analysis of
the theory of functional distribution which is an integral part of the
microeconomic theory.
4. The Problem of Economic Efficiency:
Resources being scarce, it is desirable that they should be most efficiently
used. It is therefore important to know whether a particular economy works
efficiently. In other words, whether the production and distribution of
national product decided by an economy is efficient. Having asked what and
how goods are being produced and how the total national product is
distributed, it is but proper to ask further whether the production and
distribution decisions of an economy are efficient ones.
The production is said to be efficient if the productive resources are
allocated among production of various goods in such a way that through any
reallocation it is impossible to produce more of one good without reducing
the output of any other good. The production would be economically
inefficient if it is possible by rearranging the allocation of resources to
increase the production of one good without reducing the output of any
other. Likewise, the distribution of the national product among individuals
of a society is efficient if it is not possible to make, through any
redistribution of goods, some individuals or any one person better off
without making any other person worse off.
It is not enough to allocate resources efficiently for production among goods
and distribute then efficiently among individuals for consumption. The
achievement of these production and distribution efficiencies will not ensure
maximum well-being if the economy is producing goods which do not
correspond to the preferences of the people.
For attaining economic efficiency, product-mix, that is, allocation of
resources among production of various goods should be in accordance with
the preferences of people, given their incomes. If the economy is producing
wrong-mix of goods, then through reallocation of resources among them it
will be possible to make some people better off without any one worse off.
Economic Efficiency Vs. Technological Efficiency:
It is important to note here the difference between technological efficiency
and economic efficiency. Technological efficiency prevails when a firm,
industry or an entire economy utilises its available resources fully and most
effectively and thereby produces maximum possible output of goods and
services with the given amount of resources. That is, a firm or industry or an
economy is said to have achieved technological efficiency when it is having
greatest possible rates of physical output from available inputs, given the
existing technology.
It is worth noting that a society that has achieved technological efficiency,
that is, making full and most effective use of its available resources may not
have attained economic efficiency. Economic efficiency is achieved by a
society only when there prevail efficient allocation of resources between
products and also efficient distribution of products between any pair of
individuals in a society so that through any re-organisation of production and
exchange it is not possible to make some people better off without making
any one worse off.
Besides the economy may have achieved technological efficiency in the use
of its resources for the production of goods but its pattern of production may
not conform to the consumers’ preferences so that there are long queues
outside the markets or stores selling commodities whose level of production
has been quite insufficient or inadequate as compared to the wants of the
consumers for them.
Such was the case in erstwhile USSR before the collapse of communism in
late nineteen eighties. In our opinion, it is the failure to achieve economic or
allocative efficiency which was the chief economic cause of the downfall of
communism in erstwhile USSR and East European countries.
It may however be noted that attainment of economic efficiency also
involves the achievement of technological efficiency. This is because if
technical efficiency in the use of resources is not achieved, it would then be
possible to make some people better off by increasing production through
fuller and better utilisation of resources without making others worse off.
Thus with the achievement of economic efficiency a society not only
produces the largest possible output with the available resources but also
allocates its resources for the production of goods in such a way that
conforms to consumers’ preferences. It may be noted that the concept of
economic efficiency explained above was put forward by the Italian
economist Vilfredo Pareto (1848-1923) and is therefore also called Pareto
Optimality.
5. The Problem of Full Employment of Resources:
Whether all available resources of a society are fully utilized is a highly
significant question because answer to it would determine whether or not
there will exist involuntary unemployment of labour as well as of capital
stock. In view of the scarcity of resources to satisfy all wants of the people,
it may look strange to ask a question whether or not all available resources
of a community are being fully utilized.
This is because resources being scarce, a community will try to use all the
available resources to achieve maximum possible satisfaction of the people.
Thus a community will not consciously allow the resources to lie idle. But in
a capitalist free market society it so happens that at times of depression
available resources are not fully utilised.
At times of depression, many workers are rendered unemployed; they want
to be employed but no jobs are there for them. At such times, factories
which can employ people are there, but they are not working. Thus, at times
of depression in capitalist economies, even the scarce available resources are
not fully employed.
This question assumed great importance in economic theory during the
depression of nineteen thirties when, on the one hand, about 25 per cent of
labour force in the USA, Britain and other industrialised countries was
rendered unemployed and, on the other, a number of factories representing a
lot of capital stock remained idle and unused. How did it come about became
a controversial question at that time.
An eminent British economist, J.M. Keynes put forward a different
explanation from the then popularly held view advocated by neo-classical
economists led by A. C. Pigou. Thanks to J.M. Keynes who in his book
“General Theory of Employment, Interest and Money “published in 1936,
explained what caused such involuntary unemployment of resources.
Keynes’ explanation was that unemployment of labour at that time was
found not because money wages were fixed at higher levels by the activities
of strong labour unions and intervention of the Government but because of
the fall in aggregate effective demand for goods and services.
His theory of deficiency of effective demand causing recession and resulting
in involuntary unemployment of labour and underutilisation of capital stock
has played an important role in the formulation of economic policies to
control fluctuations in economic activity. Keynesian analysis has greatly
widened the scope of economic theory and improved our understanding of
the working of the capitalist economic system which suffers from large
fluctuations in economic activity.
This branch of economic theory which deals with the problem of
employment of resources (and thus with the determination of national
income) is called Macroeconomic Theory. This macroeconomic theory has
been greatly developed beyond the Keynesian perception in recent years and
several alternative models of macroeconomics have been put forward.
6. The Problem of Economic Growth:
It is very important to know whether the productive capacity of an economy
is increasing. If the productive capacity of the economy is growing, it will be
able to produce progressively more and more goods and services with the
result that the living standards of its people will rise. The increase in the
capacity to produce goods over time is called economic growth. Now, the
analysis of the factors on which the rate of economic growth depends has
interested economists since the days of Adam Smith who in his book.
“An Enquiry into the Nature and Causes of the Wealth of Nations “threw
light on the subject. But after the classical economists and with the advent of
marginalism the economists’ interest in the problem of economic growth
almost disappeared and the marginalist theory of relative prices and resource
allocation with its emphasis on scarcity and choice occupied the central
position in economic theory for a long time. In the thirties and forties, with
the publication of Keynes’ General Theory of Employment, Interest and
Money, the problem of depression and business cycles occupied the minds
of the economists.
But the need for balanced equilibrium growth rate in the developed capitalist
countries on the one hand and the urge to remove mass poverty, hunger and
chronic unemployment in the developing countries after their achievement of
political independence have once again aroused the interests of economists
in the problems of economic growth and numerous growth and development
models have been put forward.
Some of these growth models such as Harrod- Domar model. Neo-classical
growth models of Solow and Swan, Cambridge growth models of Kaldor and
Joan Robinson etc. have been propounded to explain and analyse the growth
problem of the industrialised developed countries. Likewise, to initiate and
accelerate the process of growth in developing countries, the various theories
and models of growth and development have been offered.
However, it is worth noting that till 1980s the concept of economic
development generally implied the active intervention of the government and
the public sector in the field of production. And, with the fall of communism
in the USSR and East European countries and dismal experience of the
working of public sector in the developing countries, the trend all over the
world today is to adopt market friendly approach to development. To what
extent free-market economy approach would generate greater economic
growth and ensure economic efficiency in the developing countries, only the
future will tell.
Two Views about Development Economics:
However, it is worth mentioning that in the scope of development economics
today we are not only concerned with the promotion of growth of GNP
(gross national product) and raising standards of material living of the
people at the present but also with bringing out the adverse and disastrous
consequences of depletion of natural resources.
Besides, economists are also interested in preventing environmental
pollution which occurs through reckless industrialisation and economic
growth. If the interests of the future generation are to be promoted, the
resources, especially energy resources, have to be conserved and also if
quality of life has to be improved, the environment has to be protected and
saved from pollution.
It is with this regard that the concept of sustainable growth or sustainable
development has been put forward which implies that if severe damage is
done to the environment and resources and if because of reckless
industrialisation resources are not conserved for future, economic growth in
the future will be limited.