The central problems of an economy – (1) what to produce? (2) how to produce? and (3) for whom to produce?, can be solved through adopting certain mechanisms in different types of economies. A Capitalist economy gives the solution of central problems of an economy through the price mechanism, while a Socialist economy gives the solution of central problems of an economy through planning and in mixed economy through price mechanism and economic planning.
Market or Capitalist Economy
A market economy is a free economy. Every activity in a market economy is influenced by a profit motive. Producers are free to choose the solution of central problems of an economy which are – ‘what to produce?’, ‘how to produce?’ and ‘for whom to produce?’. The producers take this decision based on the demand and supply forces in the market solely with the purpose of maximizing profits.
The producer will produce those commodities which are in high demand but low in supply. Such goods will fetch higher price and profits to the producer. The price of a commodity is determined by the interaction of the forces of demand and supply i.e., between consumers and producers in the commodity market. The producer will use those inputs which will keep the cost of production as low as possible, so that he can fetch higher profits. Also, the producers will produce goods for those people who can afford to pay the high price. Poorer sections of the society are often ignored.
The workers select those jobs which pay maximum wages. The consumer also prefers to buy those commodities which provide maximum satisfaction. In the same way as the price of a commodity, price of the factors of production is determined in the factor market.
Centrally Planned or Socialist Economy
In a centrally planned or socialist economy, all the decisions relating to the central problems of an economy are taken by the appointed government or some central authority. All decisions are taken with the aim to maximize social welfare. The central authority adopts a planned development economy as a solution of central problems of an economy. Those goods and services are produced which the central authority thinks would be in the best interests of the society. The technique of production will be adopted which is more socially useful. For example, in a situation of mass unemployment, labor intensive techniques will be adopted rather than capital intensive techniques. Affordable goods will be produced for the poorer section of the society even if they do not yield profit. Social welfare is a higher priority than profit maximization.
A mixed economy has the merits of both capitalist and socialist economies. The social welfare as well as the market forces are both taken into consideration while taking decisions regarding the solution of central problems of an economy. In certain areas of production, the producers are free to take decisions according to the market forces with a view to maximize profits. In certain other areas the government or central authority takes control and takes decisions based on social welfare. For example, in India producers are free to produce textile or steel and other such products with the objective to maximize their profits, but ‘Railways’ are the monopoly of the government. The government provides transport services at nominal rates so that poorer section of the society can avail them. Thus, India is an example of Mixed Economy.
Microeconomics Class 12 Notes – Chapter 2