Capitalism is an economic system in which private individuals or businesses own capital goods. At the same time, business owners (capitalists) employ workers (labor) who receive only wages; labor doesn’t own the means of production but instead uses them on behalf of the owners of capital.
The production of goods and services under capitalism is based on supply and demand in the general market—known as a market economy—rather than through central planning—which is known as a planned economy or command economy.
The purest form of capitalism is free-market or laissez-faire capitalism. Here, private individuals are unrestrained. They may determine where to invest, what to produce or sell, and at which prices to exchange goods and services. The laissez-faire marketplace operates without checks or controls. Today, most countries practice a mixed capitalist system that includes some degree of government regulation of business and ownership of select industries.1
- Capitalism is an economic system characterized by private ownership of the means of production, with labor solely paid wages.
- Capitalism depends on the enforcement of private property rights, which provide incentives for investment in and productive use of capital.
- Capitalism developed out of feudalism and mercantilism in Europe and dramatically expanded industrialization and the large-scale availability of mass-market consumer goods.
- Pure capitalism can be contrasted with pure socialism (where all means of production are collective or state-owned).
Functionally, capitalism is one system of economic production and resource distribution. Instead of planning economic decisions through centralized political methods, as with socialism or feudalism, economic planning under capitalism occurs via decentralized, competitive, and voluntary decisions.
Capitalism is essentially an economic system in which the means of production (i.e., factories, tools, machines, raw materials, etc.) are organized by one or more business owners (capitalists). Capitalists then hire workers to operate the means of production in return for wages. Workers have no claim on the means of production or on the profits generated from their labor—these belong to the capitalists
Capitalism and the Profit Motive:
Profits are closely associated with the concept of private property. By definition, an individual only enters into a voluntary exchange of private property when they believe the exchange benefits them in some psychic or material way. In such trades, each party gains extra subjective value, or profit, from the transaction.
The profit motive, or the desire to earn profits from business activity, is the driving force of capitalism. It creates a competitive environment in which businesses compete to be the low-cost producers of a certain good in order to gain market share. If it is more profitable to produce a different type of good, then a business is incentivized to switch.5
Voluntary trade is another, related mechanism that drives activity in a capitalist system. The owners of resources compete with one another over consumers, who, in turn, compete with other consumers over goods and services. All this activity is built into the price system, which balances supply and demand to coordinate the distribution of resources.1
A capitalist earns the highest profit by using capital goods (such as machinery, tools, etc.) most efficiently while producing the highest-value good or service. By contrast, the capitalist suffers losses when capital resources aren’t used efficiently and instead create less-valuable outputs.