What Are the Most Important Aspects of a Capitalist System?

Many modern economies in the world are organized under the banner of capitalism. Some of the most important aspects of a capitalist system are private property, private control of the factors of production, accumulation of capital, and competition.

Put simply, capitalist systems are controlled by market forces where capital goods are owned by businesses and private individuals. This is in direct contrast to communism, which is a classless system that is controlled by the government. But what are some of the key features of capitalism? Here, we go over some of the main factors that describe a capitalist economy.

Key Takeaways

  • Capitalism is a system of economic production which is controlled by market forces rather than a central government.
  • Business owners acquire the means of production and hire workers who get paid for their labor under capitalist structures.
  • This system is defined by private property rights, capital accumulation and re-investment, free markets, and competition.
  • While capitalism helps propel innovation and prosperity in modern society, it can also create inequalities and contribute to market failures.
  • Capitalism is the direct opposite of communism, which is a system that is controlled by the government.

What Is Capitalism?

Capitalism is an economic system in which private individuals or corporations own capital goods. This includes things like factories, raw materials, as well as the means and/or tools of production. The production of goods and services is then based on supply and demand in the general market (a market economy) rather than through central planning (a planned or command economy).

Free market or laissez-faire capitalism is the purest form of capitalism. In this type of economic structure, private individuals are unrestrained. As such, they are free to determine where to invest their money, what to produce or sell, and at which prices to exchange their goods and services on the open market. As far as checks or controls are concerned, the laissez-faire system operates freely without them.

All decisions are voluntary and decentralized, and private property rights are of utmost importance when capitalism is at work. That's a major contrast with other systems, including communist societies. These structures are characterized by centralized political methods, planned economic decisions, and the sharing of wealth where no one individual benefits from property ownership.

Private Property

The right to private property is a central tenet of capitalism. A private citizen may purchase property from another private citizen at a mutually agreed-upon price rather than one dictated by the government. Citizens cannot accumulate capital if they:

  • Can't own anything
  • Fear the stuff they own can be easily stolen or confiscated
  • Cannot freely buy or sell the things they own and transfer that ownership to others

As long as the owner stays within the parameters of the law, which are generally broad in capitalist systems, the individual may do what they want with the property they own.

Private property rights are an important foundation of capitalist production. These rights clearly separate the ownership of the means of production from the workers who use them. For instance, an entrepreneur owns the factory and the machines used in it, as well as any finished products that are manufactured. An individual employed by the factory is only entitled to wages related to the work they do. They have no ownership rights to the property, equipment, or finished goods.

Prices are set by supply and demand rather than a central governing body in capitalist systems.

Factors of Production

Private enterprise controls the factors of production in capitalism, These factors include land, labor, and capital. Private companies control and deploy a mix of these factors at levels that seek to maximize profit and efficiency.

A common indicator of whether the factors of production are privately or publicly controlled is what happens to surplus product. In a communist system, any surplus product is distributed to society at large. Capitalist systems allow the producer to hold and use any surplus to achieve additional profit.

Accumulation of Capital

The centerpiece of a capitalist system is the accumulation of capital. As such, profits are the driving force behind any economic activity. Capitalists see amassing profits as a way to:

  • Provide a powerful incentive to work harder
  • Innovate more
  • Produce things more efficiently than if the government had sole control over citizens' net worth

This financial incentive is the reason capitalist economies see innovation as going hand-in-hand with their market system.

Karl Marx observed how capitalism was emerging in the wake of the industrial revolution. He understood the accumulation and re-deployment of capital, re-investing back into the company to expand production and efficiency, was a defining feature of capitalism.

Markets and Competition

Competition is the other vital attribute of a capitalist system. Private businesses compete to provide consumers with goods and services that are better, faster, and cheaper. The principle of competition forces businesses to maximize efficiency and offer their products at the lowest prices the market will bear, lest they get put out of business by more efficient and better-priced competitors.

Doing business with a particular company in a capitalist system is voluntary. The central government in a communist system, though, has effective monopolies in all industries. This means it has no incentive to operate efficiently or provide low prices because its customers do not have the option of looking elsewhere.

The main venue for this competition is the free market. A market is an abstract notion that broadly describes how the forces of supply and demand manifest through prices. If demand for some goods rises and the supply remains the same, the price will go up. When the price goes up, it sends a signal to producers that they should produce more because that product is suddenly more profitable. This increases the supply to meet the new larger demand, sending the price back down a bit. This process creates what economists call an equilibrium state that adjusts to fluctuations in supply and demand.

Most countries practice a mixed capitalist system that includes some degree of government regulation of business and ownership of select industries.

Problems With Capitalism

Capitalism, undoubtedly, is a major driver of innovation, wealth, and prosperity in the modern era. Competition and capital accumulation incentivize businesses to maximize efficiency, which allows investors to capitalize on that growth and consumers to enjoy lower prices on a wider range of goods. However, sometimes this doesn't work out as planned. Here, we consider only three of the problems associated with capitalism.

Asymmetric Information

For free markets to work the way they are intended as a hallmark of capitalist production, a major assumption must hold:

  • That the information must be perfect (i.e. all knowledge available is freely knowable)
  • Symmetry (i.e. everybody knows everything about everything)

In reality, this assumption does not hold, and this causes problems.

Asymmetric information (also known as information failure) occurs when one party to an economic transaction possesses greater material knowledge than the other party. This typically manifests when the seller of a good or service possesses greater knowledge than the buyer. But the reverse is also possible. Almost all economic transactions involve information asymmetries.

In some circumstances, asymmetric information may have near fraudulent consequences, such as adverse selection. This describes a phenomenon where an insurance company encounters the probability of extreme loss due to a risk that was not divulged at the time of a policy's sale.

For example, this asymmetrical flow of information constitutes adverse selection if an insured individual doesn't disclose that they smoke and that they engage in dangerous recreational activities. Rather than raise premiums for everyone, insurers use actuarial tools and conduct health screenings and charge different premiums to customers based on their (honestly-disclosed) risk profiles.

Wealth Inequality

Competitive markets and private corporations produce a winner-takes-all paradigm that leaves losers in the dust, which is a recurrent problem in capitalist societies. If two companies make chairs, and one does it more cheaply or efficiently, the laggard will either go out of business and lay off its employees, or the successful company may acquire the other and lay off many of the employees in that company.

More pressing is the fact that workers only receive wages, while business owners and investors enjoy the full share of all profits. As a company grows, the business owners get wealthier as they employ more workers. These employees work hard for meager wages in comparison to what top executives and owners receive. Over time, these disparities grow and grow.

Compounding the problem is that workers often need to work to earn the money necessary to survive and support themselves and their families. They have little choice but to work for relatively low wages just to make ends meet.

Crony Capitalism

Crony capitalism refers to a capitalist society that is based on the close relationships between business people and the state. The success of a business depends on the favoritism that is shown to it by the government in the form of tax breaks, government grants, and other incentives rather than the free market and rule of law.

In a practical sense, this is the dominant form of capitalism worldwide due to the powerful incentives faced by governments to extract resources by taxing, regulating, and fostering rent-seeking activity, and those faced by capitalist businesses to increase profits by obtaining subsidies, limiting competition, and erecting barriers to entry. In effect, these forces represent a kind of supply and demand for government intervention in the economy, which arises from the economic system itself. 

Crony capitalism is widely blamed for a range of social and economic woes. Both socialists and capitalists blame each other for the rise of crony capitalism. Socialists believe that crony capitalism is the inevitable result of pure capitalism. On the other hand, capitalists believe that crony capitalism arises from the need for socialist governments to control the economy.

Is Capitalism Good for the Economy?

Capitalism is an economic system that is defined by control over goods and services by private individuals and businesses. Proponents suggest that the economic freedom afforded by capitalism allows for more political freedom (i.e. less interference from the government). As such, markets are free since there is an absence of planning and production/distribution control. Critics say this only empowers the rich and makes them even wealthier. That's because supply and demand are what propel capitalist societies which puts more power in the hands of producers.

Are Democratic Socialist Economies Still Capitalist?

Some degree of capitalism is prevalent in democratic socialist societies. The goal of democratic socialist countries like Canada is equality. Although they have social welfare programs in place, they also encourage competition and ownership of property within limits. The government regulates the economy to a certain extent to ensure that all citizens have equal access to resources, goods, and services.

What Are Primary Characteristics of a Capitalist System?

Capitalism is an economic system that is controlled by market forces. It promotes and encourages businesses and private individuals to own capital goods. The main characteristics of this system include private ownership, the motive for profit, the ability for businesses to compete in the free market, and minimal intervention in government.

The Bottom Line

Most countries and their economies fall in between capitalism and something akin to socialism and communism. Some countries incorporate both the private sector system of capitalism and the public sector enterprise of socialism to overcome the disadvantages of both systems. These countries are referred to as having mixed economies. In these economies, the government intervenes to prevent any individual or company from having a monopolistic stance and undue concentration of economic power. Resources in these systems may be owned by both state and individuals.

Article Sources
Investopedia requires writers to use primary sources to support their work. These include white papers, government data, original reporting, and interviews with industry experts. We also reference original research from other reputable publishers where appropriate. You can learn more about the standards we follow in producing accurate, unbiased content in our editorial policy.
  1. International Monetary Fund. "What Is Capitalism?"

  2. National Geographic. "Resource Library: Communism."

  3. University of Alberta. "Oxford Handbook of Capitalism: Property Rights and Capitalism," Pages 2-3.

  4. Marxists Internet Archive. "Manifesto of the Communist Party and Its Genesis," Page 68-69.

  5. The Noble Prize. "Information for the Public: Markets with Asymmetric Information."

  6. The University of Chicago Press Journals. "Crony Capitalism," Page 105.

  7. The Canadian Encyclopedia. "Social Democracy."

Take the Next Step to Invest
×
The offers that appear in this table are from partnerships from which Investopedia receives compensation. This compensation may impact how and where listings appear. Investopedia does not include all offers available in the marketplace.
Service
Name
Description