How capitalism works
A number of factors influence economic decisions under capitalism. The most important factors are (1) individuals, (2) businesses, (3) the market, (4) income, and (5) the government.
Individuals influence the economy as consumers, workers, and investors. For example, if consumers show by their purchases that they prefer small cars to large cars, dealers will order more small cars and fewer large ones. Manufacturers, in turn, will step up production of small cars and cut production of large cars. Private investors provide much of the money that businesses need to grow. Businesses try to influence what consumers buy through advertising and by creating new and improved products.
The driving force of a capitalist economy is the desire for profits.The desire for profits, called the profit motive, ensures that companies produce the goods and services that consumers are willing and able to buy. To succeed, businesses must sell enough of their products at a price high enough to yield a profit. A firm may lose money instead of earn a profit if sales fall too low or costs run too high. The profit motive also encourages firms to operate efficiently. By saving time, energy, and materials, a firm can cut its production costs. Lower production costs can lead to greater sales and profits.
Business plays a large role in determining how fast a capitalist economy grows. An economy grows when it increases its production of goods and services. Growth requires investment in buildings, equipment, and other resources used to increase production. In a capitalist nation, businesses decide for themselves when and how much to invest for this purpose.
The market is a term used by economists for places and situations in which people buy and sell goods and services. In a capitalist economy and in black markets which often exist where an economy is tightly controlled by government, the prices of goods and services are determined mainly by such market conditions as supply and demand and competition. Prices tend to change when supply and demand are unequal. Generally, the market forces prices to fall when supply exceeds demand and to rise when demand exceeds supply.
Capitalist economies depend on competition to discourage companies from charging unreasonable prices. A firm that charges lower prices or improves the quality of its products can take buyers away from its competitors. Without competition, a monopoly or cartel may develop. A firm has a monopoly when it supplies the total output in a market. A monopoly can limit output and raise prices because it has no fear of competition. A cartel is a group of companies that band together to control output and raise prices. Many countries have laws that prohibit monopolies and cartels. Smaller firms that cannot afford losses cannot compete.
Income in a capitalist economy depends chiefly on the supply of and demand for skills that society values most. People who have skills that are in scarce supply and worth a lot in the market can attract high incomes. Competition among employers for workers and among workers for jobs also helps set wage rates. Businesses need to pay wages high enough to attract the workers that they need. When jobs are scarce, however, workers may accept lower wages than they would when jobs are plentiful.
The government in a capitalist nation allows individuals to use their property largely as they wish and to work where they please. The government generally permits companies to set wages for their workers and prices for their products. The government also performs a number of important economic functions. For example, it issues money, supervises public utilities, and enforces business contracts. Laws protect competition and forbid unfair business practices. Government agencies regulate standards of service in such industries as airlines, pharmacies, and radio and television broadcasting.
Problems of capitalism
Capitalism allows much personal freedom and provides a high standard of living for many people. But capitalism also creates problems. These problems include (1) economic instability, (2) inequalities in the distribution of wealth, and (3) neglect of the public interest.
Economic instability. Capitalist economies experience ups and downs. Sometimes they grow rapidly and produce widespread prosperity. Capitalist nations also have suffered a number of severe business slumps, leading to high unemployment.
Inequalities in the distribution of wealth. Some people in capitalist countries can afford many luxuries. But others lack adequate food, housing, and other necessities. This unequal distribution of wealth results largely from capitalism's emphasis on individual economic freedom. To a great extent, people are free to enjoy--or suffer from--the results of their economic decisions. Such decisions are influenced by ability, ambition, and willingness to take risks. But racial and sexual discrimination and differences in education and inherited wealth also contribute to inequalities in income distribution. Some government welfare programmes aid the poor in capitalist nations. But many needy people rely on help from relatives and private charities.
Neglect of the public interest. Most companies in a capitalist economy try to earn as much profit as they can. But sometimes government actions are necessary to ensure that the profit motive works in the public interest. For example, low-cost housing, community health facilities, and other public services usually become profitable only with government financial support. Also, without government regulations, many industries might pollute the air, water, or soil, rather than introduce expensive pollution controls.
