Basic Problems of An Economic and working of price Mechanism
An Economy IS a system which provides its people with means to work and earn a living around us, we see so many shops, offices, factories and firms. They all provide people to earn income They also help to produce goods and services. These institutions can be called an economy. For instance, the Indian economy consists of all sources of production in the field of agriculture, industry, banking, transport and communication etc.
Basic Problems of an Economy
Every man in this society has unlimited wants. These wants are food, cloth, tea, milk, sugar, house, T.V., VCR etc. This dist of wants are never ending. At the same, every individual tries to satisfy more and more of its wants. People work day and night to earn money in order to satisfy their unlimited wants. Here, a real problem arises, there are unlimited wants and limited resources. Moreover, we have alternative uses. This is the problem of CHOICE. It means every choice of individual becomes an ECONOMIC PROBLEM. Like an individual, an economy also has unlimited necds while resources at disposal are limited. The economy can not produce everything for its citizens. Therefore, it has to make best of its limited resources by allocating them judiciously. It decides what, how and for whom to produce: In short, for an economy, economic problem is the problem of RESOURCE ALLOCATION,
Definition of Economic Problem
Economic problem is concerned with the use of scarce resources among alternative human wants and in using these resources towards the end of satisfying wants as fully as possible.” Leftwich
Economic problem is essentially a problem arising from the necessity of choice, choice of manner in which limited resources with the alternative uses are disposed of. It is a problem of husbandry of resources.” Prof. Eric Roll
Science of administration of scarce resources in human society. ~Oscar Lange
An economic problem exists wherever scarce means are used to satisfy alternative ends. If means are not scarce, there is no problem ~ Milton Friedman
Causes Of Economic Problem
Prof. Robbins has given the following reasons for economic problems.
1. Unlimited wants.
Every person needs numerous goods and services to satisfy his wants. Nobody can satisfy his wants in absolute terms. In reality, human wants are increasing day by day.
2. Scarce Means.
Goods and services satisfying human wants are limited. These goods are scarce because their demand exceeds supply. These goods have alternative uses.
3. Means have alternative uses.
Means arc not only limited but also have alternative uses. Hence, choice has to be made for different alternative uses. For example, electricity can be used for lighting lamps, or for cooking food or for operating T.V., refrigerators etc. Similarly there are many resources which have got their alternative uses. This characteristic makes our resources scarce. Thus, every economy has to choose better alternative uses of resources to which they can be put. If the limited resources had only been specific in use, there would have been no problem of choice. But, in actual practice, things are not so.
Central Problem Of An Economic System
Central problem of an economy can be discussed in the following way
(a) Problem of allocation of resources which consists of
(i) How to produce
(ii) What to produce
(iii) For whom to produce
(b) Problem of Efficient or Full utilisation of resources
(c) Problem of Growth of Resources
(d) Problem of Economic Growth.
Let us give a brief description of the above four arguments.
Problem of allocation of resources
1. What to Produce.
The first basic problem of an economy is to decide what type of goods it should produce. The requirements of every economy are unlimited while the resources to satisfy these requirements are limited. These resources are capable of being put into alternative uses. Once the nature of goods to be produced has been determined, then there arises the problem of determining the quantities of these goods i.e. how many quintals of wheat, how many million metres of cloth, how many refrigerators, how many T.V.s. etc. have to be produced. Since the resources of the economy are scarce, the nature of goods and their quantities has to be decided on the basis of the preferences of the society. If society gives priority to the production of more consumer goods now, it will have less in future. A higher priority on capital goods implies less consumer goods now and more in the future.
2. How To Produce.
The other related problem of the economy is how to produce the goods. This problem is essentially concerned with the choice of technique of production 1.e. either the labour intensive techniques or the capital intensive techniques are to be adopted. If, in an economy, labour is available in abundance, it may use labour intensive techniques. On the other hand, if labour is scarce, capital intensive techniques may be used. Moreover, technique to be used also depends on the type and quantities of goods to be produced. For instance, in order to produce capital goods, complicated and expensive machines and techniques are required. On the other hand, for simple consumer goods small and less expensive machines are required . While choosing between different methods of production, those methods should be adopted which bring about an efficient allocation of resources and, thereby, increase the overall productivity in the economy.
3. For Whom to Produce.
The third central problem of the economy is the allocation of goods among the members of the society. The problem “For Whom to Produce ” is related to the manner in which the national product will be distributed among different individuals and classes of persons. The allocation of goods among the households takes place on the basis of exchange. The choice in this case would be whether to produce for the benefit of a few rich persons or for providing for the needs of a large number of poor and unprivileged persons, In a poor country like India, if a large proportion of the national product consists of T.V. sets, motor cars, refrigerators, superfine cloth etc., then the economy 1s said to be producing for the sake of the rich. On the other hand, any economy which wants to benefit the maximum number of persons would first try to provide for the necessities of the entire population and only after this job is accomplished will gradually shift to the production of comforts and luxuries
(b) Problem of Efficient or Full utilisation of resources.
A very significant question that can be asked about the working of an economy is: Are the resources being used efficiently ?
Since Resources are scarce, it is obviously desirable that they should be most efficiently used, ie, the production and distribution of the national product should be efficient. Production is called to be efficient, if it is not possible to produce more of one good without reducing the Output of other goods in the economy. In the same way, the distribution is efficient if it is not possible to make anyone person/persons better off without making any other person/persons worse off through any redistribution system.
(c) Problem of Growth of Resources.
Another important issue to know is whether the productive capacity of an economy is increasing, static or declining. The increase in productivity of an economy over time is called economic growth. For under-developed economies their basic problem is how to accelerate the pace of their economic growth. Even developed countries would not like to do so. In fact, they are able to achieve a higher annual rate of growth than the under-developed oncs. The problem of growth is thus not peculiar to the under-developed countries. But, it is quite crucial to all those countries whether developed or underdeveloped, whether free market or centrally planned.
(d) Problem of Economic Growth.
Presently every economy whether rich or poor is now facing the problem of economic growth. Its aim is rapid economic growth in order to raise the living standard of its people. It also means that the rate of economic growth should be higher than the growth of population. Therefore, the economy decides regarding the rate of saving and investment. But, we should remember that less developed countries face the problem of unemployment and poverty. They want to get rid of these problems at the earliest.
To conclude, we must note that there are two branches of modern economic theory i.e. Micro Economic Theory and Macro Economic Theory. Micro theory known as price theory, deals with the allocation of resources in the market economy. Thus, what to produce, how to produce and for whom to produce is decided as the basis of price-mechanism. On the other hand, macro theory deals with the fuller utilisation of resources. It studies the growth of resources along with other problems such as unemployment, poverty, inflation and other such problems.
PRODUCTION POSSIBILITY CURVE
The economic problem of scarcity and choice, can be easily and clearly explained with production possibility frontier or curve, Production possibility curve or production frontier refers graphically to all the possible combinations of maximum amounts or two good can be produced with the available productive résources of an economy In short, production possibility curve is a curve which shows all possible combinations of two goods that can be produced by making full use of given resources and technology in an economy.
We know that an economy always faces the problem of resource allocation i.e. makıng a choice of its resources. Again there is a maximum limit to the quantity of goods and services which an economy can produce with full use of its available resources and technology.We also know that an increase in the production of one commodity reduces the production of another commodity. In this way available resources can be used alternatively to produce different combinations of goods and services. This is known as production possibility. The curve that shows these alternatives is called the production possibility curve.
Let us assume that two commodities are to be produced, say, cloth and wheat. If all the resources are put to produce cloth, then the maximum amount of cloth will be produced per year, depending on the quantitative and qualitative resources and the technological efficiency. Let us now further suppose that within the existing conditions only 5 million metres of cloth can be produced, with all the resources at our command. Alternatively, if all the resources are used for the production of wheat, we can produce 15 million tonnes of foodgrains. In between these two extreme possibilities, there are many other alternatives. Thus we shall have to scarcities one for the other. This fact is clear from the Table No. 1
Diagramme Representation With the help of above table, we can show production possibility curve in respect of cloth and wheat Economy can produce maximum million metres of cloth or 15 million quintals of wheat, In diagramme 1, on OX axis, we have, measured cloth in million metres while on OY axis, we have taken what into million quintals. The concave curve AF shows the join of various possible combinations which gives a curve known as transformation curve or production possibility frontier Each production possibility curve is the locus of output combination which is obtained from given factors or inputs. Similarly B, C, D and E show the different combinations for two different goods i.e. cloth and wheat. combinations for two different goods 1.C. cloth and wheat. The economy has to choose out of these various combinations, which can be produced by existing resources and technology. They are also known as Technologically, Efficient or Optimum Product Mix. Here we should remember that any combination beyond the AF curve does not possess sufficient resources.
The production possibility curve is based on certain assumptions
(a)The economy produces two commodities only
(b) The quantities and qualities of factors of production viz., land, labour capital etc. are fixed
(C) the techniques of production are Constantinople nokia snoof
(d) There is full employment in the economy and olt
(e) The prices of factors of production are constant.
Features of Production Possibility Curve
Production possibility. curve has two main features as explained under:
1. it stops downwards to right.
Production possibility curve slopes downwards to the right shows that the economy has to forgo some quantity of one commodity to get more quantity of other commodity. In figure when the economy moves from combination B to C, the economy has to give up two million quintals of wheat to get one million metres of additional cloth.
2. Concave to the origin.
Production possibility curve is concave to the origin: It shows the operation of the law of increasing opportunity cost. In figure when we move from A to B, the economy has to forgo one million quintals of wheat. Again when we move from B to C, economy is required to give up two million quintals of wheat to get one additional unit i.e. one million meters of cloth.
In order to achieve the highest production-possibility curve, it is important to choose the right techniques of production. This will also help to reduce the cost of production and induce best utilization of resources. In other words, it depends on the efficiency of factors of production The other factors which are responsible to attain maximum production are stated below
1. Choice between Labour Intensive Techniques and Capital Intensive Techniques.
First of all, the choice between the labour intensive techniques and capital intensive techniques is most crucial. Labour intensive technique of production means the use of more labour and less of capital. In under-developed economies where labour is in plenty and capital is relatively scarce, labour intensive technique is better. Capital intensive technique refers to the use of more capital and less labour. In economies where labour is relatively scarce, capital intensive methods of production are more suitable.
To produce more goods at a lesser cost of production, specialization is essential. Under specialization the right man is placed at the right place.
Specialization brings about under-noted advantages of modern and up-to-date capital assets.
(i) use of capital assets to its full capacity.
(ii) invention and innovations.
(iv) economical use of raw-materials.
3. Efficient Organisation.
Better organisation increases the magnitude of output and lower the cost of production. The factors of production should be employed so as to equalise their marginal productivity. This means that the allocation of the various factors should be made according to the principle of substitution.
Again the economy has to decide regarding the localization of the various films. In the matter of localization following factors are to be kept in consideration:
(i) natural advantages to the firms viz., facilities of raw material, power, transport, suitable climate etc.
(ii) economic advantages of the firms viz., nearness to the market, availability of cheap labour, capital etc.
(iii) other miscellaneous advantages like political patronage and reputation etc.
WORKING OF PRICE MECHANISM
Price theory operates in the price (or market) system or price mechanism. But what is the price system ?
The price system is a system of economic organisation in which each individual in his capacity as a consumer, producer and resource owner is engaged in economic activity with a large measure of freedom. In every society there are legal and social institutions. Individual economic actions must conform to them. In a free enterprise economy to which the price system primarily relates, the factors of production are privately owned. The raw materials, the machines, factories and farms are owned by individuals who are at liberty to dispose of them in accordance with the prevalent laws of the country. It means that individuals have the right to acquire, dispose off, or lease property at will. They have the freedom to enter into contracts, to borrow or lend at an agreed price. Individuals are free to choose any occupation, to buy and sell goods and services from anyone and to anyone based on mutual benefit. Thus the price system is a System of mutual exchanges and coordination which guides and organizes economic activity efficiently, and leads to an efficient allocation of resources.
However, the working of price mechanisms can be studied under three types of economic systems.
(a) Price Mechanism in a Free Economy.
(b) Price Mechanism in a Socialistic Economy.
(c) Price Mechanism in a Mixed Economy.
A. PRICE MECHANISM IN A FREE OR CAPITAL ECONOMY
The price mechanism works through supply and demand of goods and services in competitive markets. In turn, prices are determined. Prices determine the production of innumerable goods and services. They organise production and help in the distribution of goods and services, ration out the supply of goods and provide for economic growth. It works as undero.
1. What and How Much to Produce.
The main function of prices is to resolve the problems of what to produce and in what quantities. This involves allocation of scarce resources in relation to the composition of total output in the economy. As resources are scarce, the society has to decide about the goods to be produced: wheat, cloth, roads, television, power, buildings, and so on. Once the nature of goods to be produced is decided, then their quantities are to be decided. How many kilos of wheat, how many million metres of cloth, how many kilometres of roads, how many televisions, how many million kw of power, etc. Thus, the problem of the nature of goods and their quantities has to be decided on the basis of priorities or preferences of the society. If society gives priority to the production of more consumer goods now, it will have less in the future. A higher priority on capital goods implies less consumer goods now and more in the future.
This fact can be explained with the help of the production possibility curve. Let us suppose the economy produces capital goods and consumer goods. In deciding the total output of the economy, the society has to choose that combination of capital and consumer goods which is in keeping with its resources. It cannot choose the combination R which is inside the production possibility curve PP1 because it reflects economic inefficiency of the system in the form of unemployment of resources. Nor can it choose the combination K which is outside the current production possibilities of the society ; the society lacks the resources to produce this combination of capital and consumer goods, therefore, to choose among the combinations B, provides a guest level of satisfaction. If the society decides to have more capital goods, it Will choose combination B; and if it wants more consumer goods, it will choose combination D Thus, selection depends on the following factors
(i) Consumers have to pick and choose from the vast variety of goods offered to them. The urgency of desire for certain goods means that the consumers are prepared to pay a large sum of money and higher prices. It implies larger profits for producers producing these commodities. If consumers desire goods less urgently, it means their reluctances to spend more on them and they offer lower prices. Expecting a decline in profits, producers also bring smaller quantities of their products in the market.
(ii) When producers increase the supply of commodity without any regard to the wishes of the consumers, it will have a low value in their estimation and the lower will be its price. A small supply, on the other hand, increases the prestige of the commodity in the minds of consumers and they pay a higher price for it. Thus, the different prices which consumers pay for various commodities and services reflect their comparative values to them.
(iii) Prices also change with consumer’s tastes and preferences. Consumers register their preferences towards commodities by paying more for them and their distaste by offering less. If consumers show preference for auto-rickshaws and taxis in place of cycle- rickshaws and tongas, they offer lower prices for the latter. Some of the persons engaged in the latter trades will suck other occupations or may even start driving auto-rickshaws and taxis. Therefore, consumers’ tastes and preferences are also reflected in the prices of goods and services.
(iv) A change in the price of a commodity acts as a beacon light and a warning signal to the producer and the consumer. If the price of a commodity rises, it warns the consumers to buy less of it and at the same time it encourages the producer to produce more of it. High prices and prospects of larger profits attract new producers into the industry in the long run. Resource owners also shift their resources to this high priced industry Thus when all firms in the industry produce more, supply increases more than the demand and the price may tend to fall. On the contrary, the withdrawal of resources from the low-priced commodity brings a fall in its output. But the shifting of consumer- demand towards it, tends to raise its price in the long-run. This tendency continues till both the commodities are equally priced and offer the same profits to producers in the two industries.
(v) If the price of a commodity falls, it is a warning to the producers and consumers. Low price and low profits will induce producers to shift resources away from this industry to the high-priced industry. This long-run tendency will reduce supply and the demand will increase. As a result, prices tend to rise. On the other hand, supply increases in the high-priced industry as a result of shifting of resources into it. Demand being less, price tends to fall.
(vi) As the consumer is the sovereign, he sets the price and producers manufacture those commodities which he wants more. The more the producers produce, the larger the profits they carn and so do the resource owners. The fate of the producer is sealed if the consumer has no liking for his product and sets a low price. The producer, thus, reacts when the consumer acts and resource allocation takes place along with the production of goods.
2. How to Produce.
The next task of prices is to determine the techniques to be used for the production of articles. Prices of factor services are the rewards received by them. Wage is the price for the service of labour, rent is the price for the service of land, interest for the service of capital and profit for the service of entrepreneurs. Thus wages, rent, interest and profit are the prices paid by the cntrepre Europe for the services of the factors of production which make up the costs of production.
Every producer aims at using the most efficient productive process. An economically efficient production process is one which produces goods with the minimum of costs. Thus, the choice of a production process will depend upon the relative prices of the factor services and the quantity of goods to be produced.
A producer uses expensive factor services in smaller quantities relative to cheap resources. In order to reduce costs of production he substitutes cheaper resources for the dearer. If capital is relatively cheaper than labour, the producer will use capital-intensive production techniques. If labour is relatively cheaper than capital, labour-intensive production processes will be used. In less developed countries where labour is cheap, techniques involving more labour contribute to least costs; while in developing economies where labour is relatively expensive, a capital using and labour-saving techniques combine efficiency with minimum costs. Since one price for a single commodity prevails in a free enterprise economy, only economically efficient producers can continue in the industry. Those who are incapable of paying their minimum rewards (prices) will either close down or shift to the manufacture of some other commodity.
3. To Determine Income Distribution.
Another function of prices is to determine the distribution of income. In a free enterprise economy product-distribution and income-distribution are interdependent. It is a system of mutual exchanges where the producers and consumers are largely the same people. The owners of factories call their services for moncy and then spend that money to buy the goods produced by Tractor services. Producers sell goods and services to consumers for money and consumers receive income as owners of factor services. Thus income flows from owners of resources (consumers) to producers and back to consumers again.
Prices play an important role in this income flow. When the consumers buy commodities it is their cost of living. When producers sell commodities, it is their business receipts. What consumers receive as owners of factor-services, it is their personal income and when producers pay for factor-services, it is the cost of production. It means that the income of an individual depends upon the amount of resources owned by him and the evaluation of his resources in the minds of consumers. People owning large quantities of resources have high incomes and/or
They contribute more to the making of commodities which satisfy the consumers much. People owning small quantities of resources have low incomes and/or they contribute little to the making of commodities which add to consumer satisfaction. Such income differentials are, however, self-correcting. No individual can afford to receive a low income for long. So workers in the low-income category will seck employment in that industry which pays higher wages. The movement of workers from the lower-paying industry to the higher-paying industry results in the reduction of supply of the former industry and increase in the supply of the latter industry. Reduction in supply raises the price of the product, increases the profits of the producer and the incomes of the workers. On the contrary, increase in the supply of the other commodity lowers
its price reduces profits as well as the incomes of the workers. This process will continue till income differentials disappear altogether. In this way, prices not only determine income distribution but also brings its equality
4. To Utilise Resources Fully.
The price mechanism also helps in the full utilisation of the resources of an economy. Full utilisation of resources implies their full employment. This requires an increase in income through large investments, and ultimately to the equality of saving and investment. In a growing economy equality between saving and investment is brought about by reductions in interest rates. When the economy is nearing the level of full employment by an efficient use of resources, income grows at a rapid rate, and so do savings. But investment lags behind which can be raised to the level of savings by interest-free reductions. Thus the rate of interest acts as an equilibrating mechanism. Therefore, monetary and fiscal measures and physical controls are also required to influence the decisions of consumers and producers regarding saving and investment.
5. To Provide an Incentive to Growth.
Lastly, prices are an important factor in providing for economic growth. The impetus for improvement, innovation and development comes through the price mechanism. Higher prices and profits encourage large industrial concerns to spend huge sums on research and experimentation to improve and develop better techniques.
The adaptation of the economic system to change in wants, resources and technologies takes place through prices. if consumers want more of one commodity in preference to the other the price of the former rises. Resources move to that industry. Profits also increase.
Larger profits lead to the adoption of superior technology which lowers costs. Larger pots and low costs attract new producers who provide new capital. All this leads to capital formation. No doubt economic growth depends upon a number of other factors, yet prices play an important role in providing for economic growth with stability. This is explained in figure 4. In this diagram, the economy is stagnant at points inside the production possibility curve PP. For its economic growth, it has to be moved on to point A of the production possibility curve PP whereby the economy produces larger quantities of consumer and capital goods. This is possible through a higher rate of capital formation which consists of replacing existing capital goods with new and more productive ones by adopting morc efficient production techniques or through innovations. More growth leads to the outward shifting of the production possibility curve from PP to PP1. Point C represents this situation where large quantities of both consumer and capital goods are produced in the economy. In this way, economic growth enables the economy to have more of both the goods through higher prices, profits and incomes. Thus the price mechanism, working through supply and demand in a free enterprise economy acts as the principal organising force. It determines what to produce and how much to produce. It determines the rewards of the factor services. It brings about an equitable distribution of income by causing resources to be allocated in the right directions. It works to ration out the existing supplies of goods services, utilises the economy’s resources fully and provides the means for economic growth.
The price mechanism does not operate freely. It acts under certain restraints placed by the government in a free enterprise economy. Moreover, there are the “imperfections of competition which hinders the working of the price mechanism.
Let us identify these factors as below:
1. The government issues directives to producers to manufacture goods of different types and in fixed quantities which are required to meet the social wants.
2. Even the resource owners are not allowed to act freely. If the government wants the private sector to produce more for the future, then resources will be reallocated towards or the capital goods sector. People may also be asked to save more and consume less in the present.
3. The imposition of administrative controls, regulating the supplies of goods, rationing of commodities, issuing of licences, fixation of quotas, etc. are some of the methods which tend to modify the working of an automatic price system.
4. When the government fixes prices of goods and services of say sugar, cloth, steel, etc., and wages of workers, these act as constraints on the working of the free market mechanism.
5. Such measures as progressive income and wealth taxes, provision for social security, price support programme, giving of subsidies, credit facilities, etc., also interfere with the working of the price system.
6. Measures aimed at nationalisation of social services also tend to modify the price
system in favour of a fixed economy.
7. The price mechanism functions under the assumptions of perfect competition. But in the real world, competition is nowhere perfect.
8. The imperfections of competition also lead to the emergence of monopolies which result in wrong pricing, incorrect and wasteful resource allocation and monopoly profits.
9. The price mechanism has increased income inequalities instead of reducing them This is because supply and demand do not work properly. Production is guided by the demand of the flute and not by the needs of the poor. Resources are, therefore, directed towards producing luxury goods for the rich. This further leads to mal-distribution of income.
B. PRICE MECHANISM IN A SOCIALIST ECONOMY
The price mechanism has little relevance in a socialist economy as it is regarded as a distinguishing feature of a free market economy. In a socialist economy the various elements of the price mechanism costs, prices and profits- are all planned and calculated by the planning authority in accordance with the targets of the plan. Thus, rational economic calculation is impossible in a planned economy because unlike a free market economy the price mechanism is regulated and controlled. The various assumptions under which the price system works in a free market economy do not hold good in a socialist economy.
In a socialist economy, it is the central planning authority that performs the functions of the market. Since all the material means of production are owned, controlled and directed by the government, the decisions about what to produce are taken within the framework of a central plan. The decisions, as to the nature of goods to be produced and their quantities, depend upon the objectives, targets and priorities laid down by the central planning authority. The prices of the various commodities are also fixed by this authority. Prices reflect the social preferences of the common man. Consumers’ choice is limited only to the commodities that the planners decide to produce and offer.
The problem of how to produce is also decided by the central planning authority. It makes the rules for combining factors of production and choosing the scale of output of a plant, for determining the output of an industry, for the allocation of resources, and for the parametric use of prices in accounting.
The central planning authority lays down two rules for the guidance of plant managers.
(i) Each manager should combine productive goods and services in such a manner that the average cost of producing a given output is the minimum.
(ii) Each manager should choose that scale of output which equalises marginal cost with price.
Since all resources in the economy are owned and regulated by the government, the raw materials, machines and other inputs are also sold at prices which are equal to their marginal cost of production. If the price of a commodity is above its average cost, the plant managers will earn profits and if it is below the average cost of production, they will incur losses. In the former case, the industry would expand and in the latter case it would cut down production, and ultimately a position of equilibrium will be reached where price equals both the average cost and the marginal cost of production.
In cases where costs differ with plants, the plant manager’s produce up to the point where marginal cost (LMC) is equal to price (P AR = MR). In such a situation, it is only in the marginal plant that LAC = LMC =MR = AC = Pat point E1, as shown in figure 5(B). All other plants would carn extra revenue (profit) equal to PABE, as shown in figure 5(A) which would go to the government. The low cost units will subsidise the high cost units and in equilibrium total revenue and total cost would be the same for the industry as a whole.
But the problem lies how the central planning authority finds out the equilibrium market and accounting prices? Considering historically given prices, it can instruct the plant managers to regard them as correct prices. If they are wrong, surpluses or shortages will emerge. Prices will be readjusted. This process will continue until the equilibrium position is reached by trial and error. The process of trial and error would proceed on the basis of historically given prices which would necessitate relatively small adjustments in prices from time to time. Thus all decisions of the managers of production and of the productive resources in public ownership and also all decisions of individuals as consumers and as suppliers of labour are made on the basis of these prices. Consequently to these decisions the quantity demanded and supplied of cach commodity is determined. If the quantity demanded of a commodity is not equal to the quantity supplied, the price of that commodity has to be changed. It has to be raised if demand exceeds supply and lowered if the reverse is the case. Thus the central planning board fixes a new set of prices which serves as basis for new decisions, and which results in a new set of quantities demanded and supplied.
The problem for whom to produce is also solved by the state in a socialist economy. The central planning authority takes this decision at the time of deciding what and how much to produce in accordance with the overall objectives of the plan. In making this decision, social preferences are given weightage. In short, higher weightage is given to the production of those goods and services which are needed by the majority of the people over luxury items. They are based on the minimum needs of the people, and are sold at fixed prices through the government. Since goods are produced in anticipation of demand, an increase in demand brings about shortages and this leads to rationing.
Thus, the problem of income distribution is automatically solved in a socialist economy because all resources are owned and regulated by the state. All interest, rent and profit are fixed by the state and go to the state exchequer. As regards wages, they are also fixed by the state according to the amount and quality of work done by an individual. Each individual is paid according to his ability and work. Economic surpluses are deliberately created and invested for capital formation and economic growth.
C. PRICE MECHANISM IN A MIXED ECONOMY
A mixed economy solves the problem of what to produce and in what quantities in two ways.
(I) The market mechanism (i.e. forces of demand and supply) helps the private sector in deciding what commodities to produce and in what quantities. In those spheres of production where the private sector competes with the public sector, the nature and quantities of commodities to be produced are also decided by the market mechanism
(ii) The central planning authority decides the nature and quantities of goods and services to be produced where the public sector has a monopoly. In the case of consumer and capital goods, commodities are produced in anticipation of social preferences. Prices are fixed by the central planning authority on the principle of profit-price policy.
There are administered prices which are raised or lowered by the state. For public utility services like electricity, railways, water, gas, communications, etcThe state fixes their rates or prices on a no-profit no- loss basis.
The problem of how to produce goods and services is also solved partly by the price mechanism and partly by the state. The profit motive determines the techniques of production in the private sector. At the same time, the central planning authority intervenes and influences the working of the market mechanism. The state guides and provides various facilities to the private sector for adopting such techniques of production which may reduce costs and maximise output. It is the state which decides where to use capital-intensive techniques and where to use labour-intensive techniques in the public sector.
The problem for whom to produce is also decided partly by the market mechanism and partly by the central planning authority. In the private sector, it is the market mechanism which determines what goods and services are to be produced on the basis of consumer preferences and incomes. Since A mixed economy aims at achieving growth with social justice, the allocation of resources is not left entirely. The state intervenes to allocate resources and for the distribution of income. For this purpose, it adopts social security programmes and levies progressive taxes on income and wealth. In the public sector, the state decides for whom to produce in anticipation of consumer preferences.
Indian Polity & Constitution MCQs SET:- 02
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Q8. According to the latest ‘World Bank’s Remittance Prices Worldwide Database’ report by the World Bank, which country became the world’s largest recipient of remittances by receiving USD 87 billion in 2021?