A capitalist economy is an economic system and mode of production in which the means of production and trade are entirely or largely privately owned and operated for profit. Also known as capitalism, a capitalist economy is a system in which a country’s trade and industry are controlled by private owners for profit rather than by the government or the state.
So, we can say that the three important principles of capitalism are:
- Private Ownership
- Profit Driven
- Free Market
Solutions of the Central Problems of the Economy under a Capitalist Economy
What to produce?
In this economy, the producers or the capitalists will only produce goods that fetch them high profit as they tend to produce goods that are high in demand and low in supply as they can sell them at a higher price.
For whom to produce?
The capitalists will only produce for those people who can afford the goods at a high price. Poorer sections of the society are often ignored and thus creating a major socio-economic gap.
How to produce?
The capitalists will only use such factors of production or a combination of factors of production which will keep their production cost as low as possible so that their profits are maximized.
The capitalist economy runs on a simple equation that money is invested to generate more money.
The capitalist economy runs on the Laissez Faire policy, which states that the government or the state should not intervene with private businesses as long as equal rights of the individuals are respected, i.e., this policy believes that economic success is more likely the fewer governments are involved in the forces of production, distribution, and exchange of the business.
The price of a product in such an economy is determined by the demand and supply of goods or services.
Features of Capitalism
Free play of market forces
Capitalist economies are those economies where the economic activities such as buying and selling or production and consumption are left to the free will of the market forces, the capitalists are free to produce those goods and services that can maximize their profits.
Consumers, in a capitalist economy are free to buy goods and services by their preferences and liking, as a result, they can maximize their satisfaction.
Minimal interference from the government
In a capitalist economy the forces of demand and supply are allowed to function freely without any intervention from the government, this is also known as Laissez-Faire. Capitalists believe that a free market will always create the right amount of supply to meet demands and the prices will adjust accordingly. The prices are set by the relative prices of goods and services.
Customer exercises their choice upon the goods and services by comparing their choices across different goods depending on their relative price, and so does the capitalist, who choose among the different inputs depending on their relative cost.
However, we must also know that a completely government-free capitalist economy only exists in theory, in real life, capitalists do need minimal government intervention, to frame policies and regulations on the protection of the environment, human rights of labor, etc.
The economic agents are driven by the prime motive of profit maximization. Companies don’t exist only to satisfy customers’ needs. Even though some goods or services are meant to satisfy needs, they will only be available if people have the resources to pay for them and if there is a benefit for the producer. The profit motive gives a capitalist the drive to undertake activities that will yield net economic gain.
Due to the profit motive, people are induced to invent, innovate, and take risks that they may not otherwise pursue, lest they get put out of business by more efficient and better-priced competitors.
The capitalist economy is usually divided into two classes. The class which owns the factors of production and distribution is known as the owner (capitalists), and the working class sells their labor to earn wages from the capitalists.
Competition leads companies and owners to strive to be better than their competitors, true capitalism needs a competitive market. We know that without competition only monopolies exist, where the seller is the price setter, which contradicts the rules of capitalism, which states that the market forces of demand and supply set the prices for goods and services.
Not only that, competition ensures a better quality of products and services and gives birth to innovation. Competition is also beneficial to customers as it results in lower prices as businesses try to cut their costs to lure more customers.
Pros and Cons of Capitalism
Capitalism promotes innovation
The need to remain profitable encourages innovation in a capitalist economy. The business invests in research and development, tries new ways to reduce the cost of production, and forms different ways to use factors of production which reduce wastage. Even employee tries to remain productive and upskills themselves so that they are retained by the company.
Capitalism encourages competition
With a high level of competition, firms have to optimize their processes and have to provide customers with the best experience in terms of both goods and services possible to stay competitive in the long run. They will also try to form and cater to a new market segment which may result in diversification of the market.
Capitalism helps improve GDP
Market frictions are minimized through capitalism, and this economic concept can also help to increase the overall GDP in a country. As production processes can work optimally and also the overall output will be much higher compared to an economic state of socialism in which there might be many different frictions present in the system.
Lowers consumer prices
When there is a high level of competition as there usually is, in a capitalistic economy, the price consumer has to pay for product and services will decrease, as companies and firms will try to undercut each other to gain market share. In turn general public will be able to buy quite cheap products i.e., an average consumer will be able to afford plenty of things from his or her salary.
Better quality of products
Capitalism not only leads to lower prices, but rather it can also contribute to a better quality of products. Firms under a capitalist economy, have to compete for customers regularly, and to beat the local competition, companies may have to provide a better product and service quality, which in turn will greatly benefit customers.
Excessive focus on consumption
Capitalism is that it also leads to an excessive focus on material consumption by promoting that material consumption is a good thing and that every one of us should consume as much as possible. This is extremely harmful; to society and the environment.
Increasing wealth gap
As the wealth is in the hands of few people private property can be passed on from one generation to another. Therefore, those who inherit capital can enjoy high income even without any effort. They have access to the best private education and jobs. This creates inequality of opportunity as well as inequality of opportunity.
As there is minimal intervention from the government there is poor people will often not get sufficient support from the government and will have a quite hard time getting out of their misery and in turn, the socio-economic divide will keep widening.
Workers get exploited
Workers have a hard time climbing the social ladder as they are often trapped in the circle of low wages and insufficient education opportunities, as they are paid extremely low wages, but also make them work overtime without compensating them for their additional work.
In a Capitalist economy there are higher unemployment rates in times of economic downturns. In fact, in times of economic recessions, companies can fire people much easier in capitalist systems since the restrictions for laying off workers will be quite limited
Examples of Capitalist economy
This country is the hub of economic development due to its economy being very open to global trade and investments. There are no restrictions and tariffs on goods imported to Hong Kong. Therefore, Hong Kong is also referred to as one of the most competitive economies in the world.
Despite being a geographically small country the economy of this country is very developed, this country’s economy values transparency and is applauded globally for having little to no corruption. Singapore is a large exporter of electronics, chemicals, and medical devices, among other things. Its stock exchange is also a major trading hub for companies operating in Asia.
Exports and imports make up a little over half of the country’s GDP. New Zealand’s economy is very open to trade and investment. The country’s economy thrives off of agricultural exports, especially to countries like China, Australia, and the U.S. New Zealand is a large producer of dairy products, like milk, cheese, and butter. They also export meat and produce. Tariffs on these goods are low.
Switzerland makes its money from money. The country’s financial services sector is the largest part of the economy. Part of this is due to the economy’s openness and low corporate tax rates. Switzerland also has a vibrant manufacturing sector. It specializes in precision manufacturing that requires highly skilled labor. This includes the production of products that require higher technology.