Capitalism is an economic system where private entities own the factors of production. The four factors are entrepreneurship, capital goods, natural resources, and labor. The owners of capital goods, natural resources, and entrepreneurship exercise control through companies. The individual owns his or her labor. The only exception is slavery, where someone else owns a person’s labor. Although illegal throughout the entire world, slavery is still widely practiced.
Characteristics of Capitalism
Capitalistic ownership means two things. First, the owners control the factors of production. Second, they derive their income from their ownership. That gives them the ability to operate their companies efficiently. It also provides them with the incentive to maximize profit.
Capitalism requires a free market economy to succeed. It distributes goods and services according to the laws of supply and demand. The law of demand says that when demand increases for a particular product, price rises. When competitors realize they can make a higher profit, they increase production. The greater supply reduces prices to a level where only the best competitors remain.
The owners of supply compete against each other for the highest profit. They sell their goods at the highest possible price while keeping their costs as low as possible. Competition keeps prices moderate and production efficient.
That means the laws of supply and demand set fair prices for stocks, bonds, derivatives, currency, and commodities. Capital markets allow companies to raise funds to expand. Companies distribute profits among the owners. They include investors, stockholders, and private owners.
Advantages of Capitalism
Capitalism results in the best products for the best prices. That’s because consumers will pay more for what they want the most. Businesses provide what customers want at the highest prices they’ll pay. Prices are kept low by competition among businesses. They make their products as efficient as possible to maximize profit.
Most important for economic growth is capitalism’s intrinsic reward for innovation. This includes innovation in more efficient production methods. It also means the innovation of new products. As Steve Jobs said, “You can’t just ask customers what they want and then try to give that to them. By the time you get it built, they’ll want something new.”
Disadvantages of Capitalism
Capitalism doesn’t provide for those who lack competitive skills. This includes the elderly, children, the developmentally disabled, and caretakers. To keep society functioning, capitalism requires government policies that value the family unit.
Despite the idea of a “level playing field,” capitalism does not promote equality of opportunity. Those without the proper nutrition, support, and education may never make it to the playing field.
In the short term, inequality may seem to be in the best interest of capitalism’s winners. They have fewer competitive threats. They may also use their power to “rig the system” by creating barriers to entry. For example, they will donate to elected officials who sponsor laws that benefit their industry. They could send their children to private schools while supporting lower taxes for public schools.
In the long term, inequality will limit diversity and the innovation it creates. For example, a diverse business team is more able to identify market niches. It can understand the needs of society’s minorities, and target products to meet those needs.
Socialism is an economic system where everyone in society equally owns the factors of production. The ownership is acquired through a democratically elected government. It could also be a cooperative or a public corporation where everyone owns shares. The four factors of production are labor, entrepreneurship, capital goods, and natural resources.
Socialism’s mantra is, “From each according to his ability, to each according to his contribution.” Everyone in society receives a share of the production based on how much each has contributed.
Workers receive their share after a percentage has been deducted for the common good. Examples are transportation, defense, and education. Some also define the common good as caring for those who can’t directly contribute to production. Examples include the elderly, children, and their caretakers.
Socialism assumes that the basic nature of people is cooperative. That nature hasn’t yet emerged in full because capitalism or feudalism has forced people to be competitive. Therefore, a basic tenet of socialism is that the economic system must support this basic human nature for these qualities to emerge.
These factors are valued for their usefulness to people. This includes individual needs and greater social needs. That might include the preservation of natural resources, education, or health care. That requires most economic decisions to be made by central planning, as in a command economy.
Advantage of Socialism
Under socialism, workers are no longer exploited, since they own the means of production. All profits are spread equitably among all workers, according to his or her contribution. The cooperative system realizes that even those who can’t work must have their basic needs met, for the good of the whole.
The system eliminates poverty. Everyone has equal access to health care and education. No one is discriminated against.
Everyone works at what one is best at and what one enjoys. If society needs jobs to be done that no one wants, it offers higher compensation to make it worthwhile.
Disadvantage of Socialism
The biggest disadvantage of socialism is that it relies on the cooperative nature of humans to work. It negates those within society who are competitive, not cooperative. Competitive people tend to seek ways to overthrow and disrupt society for their own gain.
A second related criticism is that it doesn’t reward people for being entrepreneurial and competitive. As such, it won’t be as innovative as a capitalistic society.
A third possibility is that the government set up to represent the masses may abuse its position and claim power for itself.
A mixed economic is a system that combines aspects of both capitalism and socialism. A mixed economic system protects private property and allows a level of economic freedom in the use of capital, but also allows for governments to interfere in economic activities in order to achieve social aims. According to neoclassical theory, mixed economies are less efficient than pure free markets, but proponents of government interventions argue that the base conditions such as equal information and rational market participants cannot be achieved in practical application.
Most modern economies feature a synthesis of two or more economic systems, with economies falling at some point along a continuum. The public sector works alongside the private sector, but may compete for the same limited resources. Mixed economic systems do not block the private sector from profit-seeking, but do monitor profit levels and may nationalize companies that are deemed impediments to the public good. The United States is mostly a free market economy, but it incorporates elements such as protection for agriculture and manufacturing through trade restrictions and subsidies. This makes the United States a mixed economy by definition.
Advantages and Disadvantages of a Mixed Economy
Many of the advantages of a mixed economy are found in a market economy. Goods and services are distributed where they are most needed, while allowing prices to measure supply and demand. Secondly, it rewards the producers who are the most efficient with the biggest profits, meaning consumers get the most value for their dollar. A mixed economy promotes innovation and improvement, and gives capital to those producers who are most efficient.
But if the market has too much freedom and liberty, it can make the environment less competitive sans support from the government. Furthermore, the country could accumulate more debt by creating government-subsidized industries — like defense or military — slowing down the economy.