Basic Problem of an Economy & Role of Price Mechanism (Part - 2) CA CPT Notes | EduRev

Business Economics for CA Foundation

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CA CPT : Basic Problem of an Economy & Role of Price Mechanism (Part - 2) CA CPT Notes | EduRev

The document Basic Problem of an Economy & Role of Price Mechanism (Part - 2) CA CPT Notes | EduRev is a part of the CA CPT Course Business Economics for CA Foundation.
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SOCIALIST ECONOMY
The concept of socialist economy was propounded by Karl Marx and Frederic Engels in their work ‘The Communist Manifesto’ published in 1848. In this economy, the material means of production i.e. factories, capital, mines etc. are owned by the whole community represented by the State. All members are entitled to get benefit from the fruits of such socialised planned production on the basis of equal rights. A socialist economy is also called as “Command Economy” or a “Centrally Planned Economy”. Here, the resources are allocated according to the commands of a central planning authority and therefore, market forces have no role in the allocation of resources. Under a socialist economy, production and distribution of goods are aimed at maximizing the welfare of the community as a whole.
Some important characteristics of this economy are:
(i) Collective Ownership: There is collective ownership of all means of production except small farms, workshops and trading firms which may remain in private hands. As a result of social ownership, profit motive and self- interest are not the driving forces of economic activity as it is in the case of a market economy. The resources are used to achieve certain socio-economic objectives.
(ii) Economic planning: There is a Central Planning Authority to set and accomplish socio- economic goals; that is why it is called a centrally planned economy. The major economic decisions, such as what to produce, when and how much to produce, etc., are taken by the central planning authority.
(iii) Absence of Consumer Choice: Freedom from hunger is guaranteed, but consumers’ sovereignty gets restricted by selective production of goods. The range of choice is limited by planned production. However, within that range, an individual is free to choose what he likes most. The right to work is guaranteed, but the choice of occupation gets restricted because these are determined by the central planning authority on the basis of certain socio-economic goals before the nation.
(iv) Relatively Equal Income Distribution: A relative equality of income is an important feature of Socialism. Among other things, differences in income and wealth are narrowed down by lack of opportunities to accumulate private capital. Educational and other facilities are enjoyed more or less equally; thus the basic causes of inequalities are removed.
(v) Minimum role of Price Mechanism or Market forces: Price mechanism exists in a socialist economy; but it has only a secondary role, e.g., to secure the disposal of accumulated stocks. Since allocation of productive resources is done according to a predetermined plan, the price mechanism as such does not influence these decisions. In the absence of the profit motive, price mechanism loses its predominant role in economic decisions. The prices prevailing under socialism are ‘administered prices’ which are set by the central planning authority on the basis of socio-economic objectives.
(vi) Absence of Competition: Since the state is the sole entrepreneur, there is absence of competition under socialism. The erstwhile U.S.S.R. is an example of socialist economy. In today’s world there is no country which is purely socialist. North Korea, the world’s most totalitarian state, is another prominent example of a socialist economy. Other examples include China and Cuba.

Merits of Socialism
1. Equitable distribution of wealth and income and provision of equal opportunities for all help to maintain economic and social justice.
2. Rapid and balanced economic development is possible in a socialist economy as the central planning authority coordinates all resources in an efficient manner according to set priorities.
3. Socialist economy is a planned economy. In a socialistic economy, there will be better utilization of resources and it ensures maximum production. Wastes of all kinds are avoided through strict economic planning. Since competition is absent, there is no wastage of resources on advertisement and sales promotion.
4. In a planned economy, unemployment is minimised, business fluctuations are eliminated and stability is brought about and maintained.
5. The absence of profit motive helps the community to develop a co-operative mentality and avoids class war. This, along with equality, ensures welfare of the society.
6. Socialism ensures right to work and minimum standard of living to all people.
7. Under socialism, the labourers and consumers are protected from exploitation by the employers and monopolies respectively.
8. There is provision of comprehensive social security under socialism and this makes citizens feel secure

Demerits of Socialism 
1. Socialism involves the predominance of bureaucracy and the resulting inefficiency and delays. Moreover, there may also be corruption, red tapism, favouritism, etc.
2. It restricts the freedom of individuals as there is state ownership of the material means of production and state direction and control of nearly all economic activity.
3. Socialism takes away the basic rights such as the right of private property.
4. It will not provide necessary incentives to hard work in the form of profit.
5. Administered prices are not determined by the forces of the market on the basis of negotiations between the buyers and the sellers. There is no proper basis for cost calculation. In the absence of such practice, the most economic and scientific allocation of resources and the efficient functioning of the economic system are impossible.
6. State monopolies created by socialism will sometimes become uncontrollable. This will be more dangerous than the private monopolies under capitalism.
7. Under socialism, the consumers have no freedom of choice. Therefore, what the state produces has to be accepted by the consumers.
8. No importance is given to personal efficiency and productivity. Labourers are not rewarded according to their efficiency. This acts as a disincentive to work.
9. The extreme form of socialism is not at all practicable.

THE MIXED ECONOMY

The mixed economic system depends on both markets and governments for allocation of resources. In fact, every economy in the real world makes use of both markets and governments and therefore is mixed economy in its nature. In a mixed economy, the aim is to develop a system which tries to include the best features of both the controlled economy and the market economy while excluding the demerits of both. It appreciates the advantages of private enterprise and private property with their emphasis on self-interest and profit motive. Vast economic development of England, the USA etc. is due to private enterprise. At the same time, it is noticed that private property, profit motive and self-interest of the market economy may not promote the interests of the community as a whole and as such, the Government should remove these defects of private enterprise. For this purpose, the Government itself must run important and selected industries and eliminate the free play of profit motive and self-interest. Private enterprise which has its own significance is also allowed to play a positive role in a mixed economy. However, the state imposes necessary measures to control and to regulate the private sector to ensure that they function in accordance with the welfare objectives of the nation.

Features of mixed economy 
(i) Co-existence of private and public sector: The first important feature of a mixed economy is the co-existence of both private and public enterprise. 

In fact, in a mixed economy, there are three sectors of industries:
(a) Private sector: Production and distribution in this sector are managed and controlled by private individuals and groups. Industries in this sector are based on self-interest and profit motive. The system of private property exists and personal initiative is given full scope. However, private enterprise may be regulated by the government directly and/or indirectly by a number of policy instruments.
(b) Public sector: Industries in this sector are not primarily profit-oriented, but are set up by the State for the welfare of the community.
(c) Combined sector: A sector in which both the government and the private enterprises have equal access, and join hands to produce commodities and services, leading to the establishment of joint sectors.

Mixed economy has the following merits available to capitalist economies and socialist economies.
1. Economic freedom and existence of private property which ensures incentive to work and capital formation.
2. Price mechanism and competition forces operating in the private sector promoting efficient decisions and better resource allocation.
3. Consumers are benefitted through consumers’ sovereignty and freedom of choice.
4. Appropriate incentives for innovation and technological progress.
5. Encourages enterprise and risk taking.
6. Advantages of economic planning and rapid economic development on the basis of plan priorities.
7. Comparatively greater economic and social equality and freedom from exploitation due to greater state participation and direction of economic activities.
8. Disadvantages of cut-throat competition averted through government’s legislative measures such as environment and labour regulations.

However, mixed economy is not always a ‘golden path’ between capitalism and socialism. It suffers from substantial uncertainties. Mixed economy is characterised by excessive controls by the state resulting in reduced incentives and constrained growth of the private sector, poor implementation of planning, higher rates of taxation, lack of efficiency, corruption, wastage of resources, undue delays in economic decisions and poor performance of the public sector. Moreover, it is very difficult to maintain a proper balance between the public and private sectors. In the absence of strong governmental initiatives, the private sector is likely to grow disproportionately. The system would then resemble capitalism with all its disadvantages. 

SUMMARY 
  • The basic problem of scarcity gives rise to many of the economic problems.
  • Unlimited human wants and scarcity of resources lead to the central economic problems like what to produce, how to produce and for whom to produce.
  • The basic economic problems of what, how and for whom to produce are solved by different economies in different ways.
  • A capitalist economy uses the tool of price mechanism, a socialist economy uses the tool of central planning and a mixed economy uses a mix of both price mechanism and central planning to solve its basic economic problems. 

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