Capitalism is an economic system characterized by a particular combination of institutions. These institutions put in place different sets of laws and social customs regulating the production and distribution of goods and services in an economy.
Key economic institutions include private property (people owning things), markets (where goods could be bought and sold) and governments (institutions controlling production and distribution). Societies with governments that take on this role are called centrally-planned economies.
Markets are a means of transferring goods or services from one person to another. In most markets, the transfers are voluntary: transfers are mutually beneficial.
Firms consist of one or more individuals, owning a set of capital goods used in production. The firms pay wages and salaries to employees. The goods and services are properties of the owners of the firm, and the owners sell the goods and services on markets to make profit.
The rise of capitalism vastly improved living standards, for several reasons:
- competing firms resulted in strong incentives to develop and adopt new technology, and to invest in capital goods that would have been beyond the reach of small-scale family enterprises
- workers specialized in the tasks they performed, resulting in increased labour productivity. Specialization can only occur when a person is able to obtain the goods and services they need by other means.
Hence, markets have allowed cooperation on a global scale. On the other hand, market competition provides a mechanism for weeding out those who under-perform. Capitalism is the first economic system in which membership of the elite often depends on a high level of economic performance.
Capitalism is supported by:
- Private incentives for cost-reducing innovation
- Firms with proven ability to produce goods at low cost
- Public policy, for the production of essential goods and services that would not be provided by private firms
- A stable society