Solution to the Basic Economic Problems: Capitalistic, Socialistic and Mixed Economy!

Uneven distribution of natural resources, lack of human specialization and technological advancement etc., hinders the production of goods and services in an economy. Every economy has to face the problems of what to produce, how to produce and for whom to produce. More or less, all the economies use two important methods to solve these basic problems.

These methods are:

(a) Free price mechanism and


(b) Controlled price system or State intervention.

Price mechanism is defined as a system of guiding and coordinating the decisions of every individual unit within an economy through the price determined with the help of the free play of market forces of demand and supply. Such system is free from state intervention.

Price of goods and services are determined when quantity demanded becomes equal to the quantity supplied. Price mechanism facilitates determination of resource allocation, determination of factor incomes, level of savings, consumption and production. Price mechanism basically takes place in a capitalistic economy.

On the other hand, Controlled price mechanism is defined as a system of state intervention of administering or fixing the prices of the goods and services. In a socialist economy, the government plays a vital role in determining the price of the goods and services. The government may introduce ‘ceiling price’ or ‘floor price’ policy to regulate prices.


However, how a capitalist, a socialist and a mixed economic system solve their basic problems is given below:

1. Solution to Basic Problems in a Capitalistic Economy:

Under capitalistic economy, allocation of various resources takes place with the help of market mechanism. Price of various goods and services including the price of factors of production are determined with help of the forces of demand and supply. Free price mechanism helps producers to decide what to produce.

The goods which are more in demand and on which consumers can afford to spend more, are produced in larger quantity than those goods or services which have lower demand. The price of various factors of production including technology helps to decide production techniques or methods of production. Rational producer intends to use those factors or techniques which has relatively lower price in the market.

Factor earnings received by the employers of factors of production decides spending capacity of the people. This helps producers to identify the consumers for whom goods could be produced in larger or smaller quantities. Price mechanism works well only if competition exists and natural flow of demand and supply of goods is not disturbed artificially.

2. Solution to Basic Problems in a Socialistic Economy:


Under socialistic economy, the government plays an important role in decision making. The government undertakes to plan, control and regulate all the major economic activities to solve the basic economic problems. All the major economic policies are formulated and implemented by the Central Planning Authority.

In India, Planning Commission was entrusted with this task of planning. The Planning Commission of India has now been replaced by another central authority NITI Ayog (National Institution for Transforming India). Therefore, the central planning authority takes the decisions to overcome the economic problems of what to produce, how to produce and for whom to produce.

The central planning authority decides the nature of goods and services to be produced as per available resources and the priority of the country. The allocation of resources is made in greater volume for those goods which are essential for the nation. The state’s main objectives are growth, equality and price stability. The government implements fiscal policies such as taxation policy, expenditure policy, public debt policy or policy on deficit financing in order to achieve the above objectives.

The methods of production or production techniques are also determined or selected by the central planning authority. The central planning authority decides whether labor intensive technique or capital intensive technique is to be used for the production. While deciding the appropriate method, social and economic conditions of the economy are taken into consideration.

Under socialistic economy, every government aims to achieve social justice through its actions. All economic resources are owned by the government. People can work for wages which are regulated by the government as per work efficiency. The income earned determines the aggregate demand in an economy. This helps the government in assessing the demand of goods and services by different income groups.

3. Solution to Basic Problems in a Mixed Economy:

Practically, neither capitalistic economy nor socialistic economy exists in totality. Both the economic systems have limitations. Consequently, a new system of economy has emerged as a blend of the above two systems called mixed economy. Therefore, mixed economy is defined as a system of economy where private sectors and public sectors co-exist and work side by side for the welfare of the country.

Under such economies, all economic problems are solved with the help of free price mechanism and controlled price mechanism (economic planning).

Free price mechanism operates within the private sector; hence, prices are allowed to change as per demand and supply of goods. Therefore, private sector can produce goods as per their demand and their price in the market. The government may control and regulate production of the private sector through its monetary policy or fiscal policy.

On the other hand, controlled price mechanism (economic planning) is used for the public sector by the planning authority. The goods and services to be produced in the public sector, hence, are determined by the central planning authority.


Private sector determines the production technique or production method on the basis of factor prices, availability of technology etc. On the other hand, production technique or production method for the public sector is determined by the central planning authority. While determining the production technique for the public sector, national priority, national employment policy and social objectives are major considerations.

Private sector allocates its resources to produce those goods which are demanded by people who command high purchasing power. Although, production by the private sector is sometimes controlled and regulated by the government through various policies such as licensing policy, taxation policy, subsidy etc., the price determined by free price mechanism may go beyond the purchasing power of low or marginal income group.

Therefore, the government may undertake production of certain goods in its hands. The rationing policy is also introduced to provide essential goods at reasonable price to the poor people. The government, thus, ensures social justice by its actions in the mixed economy.