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What is 'Capitalism'

Capitalism is an economic system in which capital goods are owned by private individuals or business partners. The purest form of capitalism is free market or laissez-faire capitalism, in which private individuals are free to determine where to invest, what to produce or sell, and at which prices to exchange goods and services. Most modern countries practice a highly regulated and mixed capitalist system.

BREAKING DOWN 'Capitalism'

Functionally speaking, capitalism is simply one process by which the problems of economic production and resource distribution might be resolved. Instead of planning economic decisions through centralized political methods, as with socialism or feudalism, economic planning under capitalism occurs via decentralized and voluntary decisions.

Capitalism and Private Property

Private property rights are very important in capitalism. For individuals or businesses to deploy their capital goods confidently, a system must exist that protects their legal right to own or transfer private property. To facilitate and enforce private property rights, capitalist societies tend to rely on contracts, fair dealing and tort law.

Capitalism, Profits and Losses

Profits are closely associated with the concept of private property. By definition, an individual only enters into a voluntary exchange of private property when he believes the exchange benefits him in some psychic or material way. In such trades, each party gains extra subjective value, or profit, from the transaction.

A capitalist earns the highest profit by using capital goods most efficiently while producing the highest value good or service. In this system, value is transmitted through those prices at which another individual voluntarily purchases the capitalist's good or service. Profits are an indication that less valuable inputs have been transformed into more valuable outputs. By contrast, the capitalist suffers losses when capital resources are not used efficiently and instead create less valuable outputs.

Capitalism and Individual Liberty

Capitalism grew out of the remnant of feudal Europe in conjunction with a philosophical movement towards liberal individualism. The economic freedoms of capitalism matured alongside democratic political freedoms and the theory of natural rights. However, not all capitalist systems are politically free or encourage individual liberty.

Milton Friedman, an economist and advocate of capitalism and individual liberty, wrote in "Capitalism and Freedom" (1962) that "capitalism is a necessary condition for political freedom. Clearly it is not a sufficient one."

Capitalism and Economic Growth

By creating incentives for entrepreneurs to siphon away resources from unprofitable channels and into areas where consumers most highly value them, capitalism has proven a highly effective vehicle for economic growth.

There is no historical evidence of any society experiencing compound economic growth prior to the rise of capitalism in the 17th and 18th centuries. Research suggests global per-capita income was unchanged between the rise of agricultural societies through approximately 1750, when the roots of the first Industrial Revolution took hold.

In subsequent centuries, capitalist production processes greatly enhanced productive capacity. More and better goods became cheaply accessible to wide populations, raising standards of living in previously unthinkable ways.

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