There are several different types of economic systems employed by nations. Two such types, socialism and capitalism are the most common. Capitalism is often referred to as a free market economy in its purest form; a common type of socialism is communism.

Embedded in these economic systems are political and social elements that influence the degree of purity of each system. In other words, many capitalist nations have elements of socialism interwoven. So even though there are different degrees or levels of commitment to the ideals of capitalism, there are several traits that are common among all capitalists.

Key Takeaways

  • Capitalism is an economic system that focuses on a free market to determine the most efficient allocation of resources and sets prices based on supply and demand.
  • Socialism is often presented as the opposite of capitalism whereby there is no free market and the allocation of resources is determined by a central body.
  • Capitalism has many unique features, some of which include a two-class system, private ownership, a profit motive, minimal government intervention, and competition.
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Understanding Capitalist Economy Traits

Two-Class System

Historically, capitalist society was characterized by the split between two classes of individuals: the capitalist class, which owns the means for producing and distributing goods (the owners), and the working class, who sell their labor to the capitalist class in exchange for wages.

The economy is run by individuals (or corporations) who own and operate companies and make decisions as to the use of resources. But there exists a “division of labor” that allows for specialization, typically occurring through education and training, further breaking down the two-class system into sub-classes (e.g., the middle class). 

Private Ownership

Further extrapolating from the two-class system where one class owns the means of production is private ownership. In capitalist economies, there exists a private sector that owns, property, plants, and equipment. The owners of production decide how to run their businesses, how much to produce, and how many people to hire.

Nationalization is the transfer of private ownership to state ownership, which is what happened in Russia once it became the Soviet Union. Conversely, when the Soviet Union collapsed, privatization occurred, which is the transfer of business and industry from state ownership to private ownership.

This stands in stark contrast to socialist economies, where there is no private ownership. The government controls all means of production and through central planning determines how much is produced and how all resources are allocated.

Profit Motive

Companies exist to make a profit. The motive for all companies is to make and sell goods and services only for profits. Companies do not exist solely to satisfy people's needs. Even though some goods or services may 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 leads to the accumulation of wealth and is a prime factor in providing individuals to work and innovate. This innovation advances society with the introduction of new technologies and cheaper goods.

Minimal Government Intervention

Capitalist societies believe markets should be left alone to operate without government intervention, an idea known as laissez-faire. True capitalists believe that a free market will always create the right amount of supply to meet demand and all prices will adjust accordingly.

Free-market capitalists also believe that any government intervention, for example through regulations or labor laws, hinders the efficiency of a free market economy, leading to inefficiencies that hurt both society and the economy.

However, a completely government-free capitalist society exists in theory, only. Even in the United States, the poster child for capitalism, the government regulates certain industries, such as the Dodd-Frank Act for financial institutions.

By contrast, a purely capitalist society would allow the markets to set prices based on demand and supply for the purpose of making profits only, without much consideration to the condition of the working class or any other negative externalities.

Competition

True capitalism needs a competitive market. Without competition, monopolies exist, and instead of the market setting the prices for goods and services, the seller is the price setter, which is against the conditions of capitalism.

Competition leads companies to strive to be better than their competitors, so that they may gain a larger portion of the market share for their given product or service, increasing their profits, which often leads to innovation to edge out the competition. As discussed before, this innovation furthers society in terms of technology and thought. Competition is also beneficial to consumers as it results in lower prices as businesses seek to make themselves more attractive when compared to their competitors.

The Bottom Line

Capitalism in its purest form is a society in which the market sets prices for the sole purpose of profits. Any inefficiency or intervention that reduces profit-making will be eliminated by the market. In a capitalist economy, individuals have the right to choose any occupation they wish and own property, plant, and equipment to start businesses. They are allowed to conduct the business as they see fit while competition with other businesses leads to lower prices and innovation.