ISC Class 11

1. SOLUTIONS TO THE BASIC
ECONOMIC PROBLEMS IN
DIFFERENT ECONOMIES

2.  Economic problems are solved through
price mechanism in a capitalist
economy
state machinery of central planning in a
socialist economy and
price mechanism with active
intervention and regulation of the state
in a mixed economy.
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3. SOLUTIONS TO BASIC PROBLEMS IN A
CAPITALISTLIC ECONOMY (CAPITALISM)
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Price Mechanism

4. What is Price Mechanism?
“Price mechanism is the mechanism in which
prices play a key role in directing the
activities of producers, consumers and
resources suppliers.”
• There are two important elements of price
mechanism: (1) Prices,
(2) Markets.

5. •Prices-
* Goods and services have prices - Why?
* Producers are willing to sell goods and services
only if they get appropriate prices.
*The services of various factors of production
carry their prices.
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6. Prices are determined through the impersonal
market forces of demand and supply.
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Buyers (Demand)
• create the demand for
goods and services
• competition among the
buyers to buy goods
and services.
Sellers (Supply)
• offer supply of these
goods and services to
meet the wants of the
buyers
• competition among the
sellers to sell goods
and services.

7. Price determination through price mechanism

8. Equilibrium price
“Equilibrium price is the price at which quantity
demanded equals quantity supplied.”
It is through the interaction of the competitive
forces of demand and supply that the equilibrium
price of a good,
a service or
a factor service is
determined.
Prices respond to changes in demand and supply.

9. Market
In economics a market means. “a system or
set-up in which the buyers and sellers of a
commodity are able to interact and
communicate with each other and strike a
deal, i.e., price and the quantity to be
bought and sold.”

10. Types of Market
(i) Goods markets are those markets where
goods and services are bought and sold.
(ii) Factor markets are those markets where
factor services are bought and sold, such as
labour market, capital market, etc.

11. Capitalism and Price mechanism
• Price mechanism acts as the coordinating
agency.
• Economic decisions are taken and
implemented through price mechanism.
• It is an automatic functioning mechanism.
• All economic decisions taken by a large
number of individuals through the market
prices are coordinated automatically.
• Thus price mechanism functions without
conscious control by any controlling agency in
capitalism.

12. Functions of Price Mechanism
• The level of economic activities
• Co-ordination of economic decisions
• Guiding force to consumers
• Determination of factor income
• Guide to producers
• Allocation of resources
• Determination of savings
• Bringing flexibility in the economy

13. Solution to the Basic Problems through
Price Mechanism
1. What and how much to produce?
• The consumer is regarded as a sovereign
(king)
• The basic objective of the producers is to earn
maximum profits.
• Producers will like to produce those goods and
services which yield higher profits
• An increase in the demand for a particular
commodity will lead to a rise in its price. A
rise in the price of a commodity, given the
cost of production, will lead to more profits

14. Effect of Increase & Decrease in Demand
Price
ProfitProduction
Demand

15. 2. How to produce ?
• The basic objective of the producers is
to earn maximum profits.
• A producer must minimize the cost of
production
• The cost of a technique of production
is determined by the prices of inputs
and the input prices are determined
by price mechanism in the factor
market

16. Technique of production to be used
•The producer chooses that technique of
production which is least costly.
•The cheapest way of producing a commodity
depends on relative resource prices:
If labour is relatively cheaper than capital, the
producer will adopt a labour-intensive technique
if capital is cheaper than labour, capital-
intensive technique, will be employed by the
producer.

17. 3. For whom to produce?
•Distribution of total output of goods and services
depends upon the distribution of income.
•Incomes of different individuals as determined by
price mechanism determines the distribution of
goods and services.
•As a result of this unequal distribution of income,
the distribution of goods is also very much unequal.
•The rich people get a larger share of the national
product.
•The poor people with low incomes, receive a
smaller share of the national product.

18. Conditions Required for Price mechanism
to Play its Role
• Existence of competition
• Costs reflecting the sacrifice
• Demand reflecting the needs
• Mobility of resources
• Correct anticipation of demand
• Non economics conditions
• No interference by the government

19. An evaluation of price mechanism
1. Solving economic problems
2. Coordinating and organising force
3. Promotes social welfare
4. Preservation of individual
freedom

20. Limitations of Price Mechanism
1. Decline of competition
2. Consumers' sovereignty
3. Individuals may not be the best judge
4. Social welfare may not be maximised
5. Inequalities in distribution of income & wealth
6. Economic instability
7. Neglect of low-profit areas
8. Production of public utilities neglected

21. SOLUTION TO BASIC PROBLEMS IN A SOCIALISTIC
ECONOMY (SOCIALISM)
1. What to Produce and How Much to Produce
Planning authority makes an estimation of the
available economic and human resources.
It takes into account:
a) the requirement of the economy for various.
goods and services.
b) the needs of the people and the national
priorities.
c) adequate amount of commodities to be made
available to the people.

22. 2. How to Produce?
It has to take into account
• the economic efficiency of the
techniques.
• the social objectives and development
goals
It has to ensure that
• economic resources of the country are
fully utilised.

23. 3. For Whom to Produce?
•All productive resources are owned by the
government.
•People work only as labourers and earn income in the
form of wages only.
•a skilled worker gets higher wages than an unskilled
worker
•administered price mechanism operates in a socialist
economy.
•The government also distributes various goods,
particularly essential goods at fixed or controlled
prices through ration shops or fairprice shops

24. Basic principle of distribution
“From each according to his
capacity and to each according
to his work is the basic principle
of distribution of income in a
socialist economy.”

25. SOLUTION TO BASIC PROBLEMS IN A MIXED ECONOMY
1. What to Produce?
• Consumers preferences influence the production
decisions of the firms.
• Production in the private sector is also
controlled and regulated by the government
through the monetary, fiscal and price control
policies.
• In the public sector, it is the planning authority
that decides what to produce and how much to
produce keeping in mind the overall national
objectives.

26. Fiscal Policy and Monetary Policy
• Fiscal policy refers to the policy of the
government regarding taxation, public
borrowing and public expenditure.
• Monetary policy refers to the policy of
the central bank relating to the
availability of credit and the interest
rate thereon.

27. 2. How to Produce?
• In the private sector it is the price mechanism
that solves the problem of how to produce.
• Firms will choose the method of production on
the basis of factor prices. Profit motive
motivates them to choose the least costly or the
most efficient technique of production.
• In the public sector, the problem of how to
produce is solved by the planning authority and
the government.
• the planning authority is influenced not only by
the input prices, but also by the objectives of
generating more employment opportunities,
promoting economic growth, etc.

28. 3.For Whom to Produce?
• The decision for whom to produce is taken
by the government.
• The main objective of the government is
that adequate quantity of necessities must
be produced.
• The government controls production in the
private sector as well to achieve this
objective so as to ensure the availability of
necessities.