What Is Capitalism? History, Pros & Cons, vs. Socialism

What Is Capitalism?

Capitalism is an economic system in which private individuals or businesses own capital goods. At the same time, business owners employ workers who receive only wages; labor doesn't own the means of production but instead uses them on behalf of the owners of capital.

The production of goods and services under capitalism is based on supply and demand in the general market, also known as the market economy. This is in contrast to a planned economy or a command economy, in which prices are set through central planning.

The purest form of capitalism is free-market or laissez-faire capitalism. Here, private individuals are unrestrained. They may determine where to invest, what to produce or sell, and at what prices to exchange goods and services. The laissez-faire marketplace operates without checks or controls. Today, most countries practice a mixed capitalist system that includes some degree of government regulation of business and some extent of public ownership of select industries.1

Key Takeaways

• Capitalism is an economic system characterized by private ownership of the means of production, with labor being paid solely in wages.
• Capitalism depends on the enforcement of private property rights, which provide incentives for investment in and productive use of capital.
• Capitalism developed out of feudalism and mercantilism in Europe, and dramatically expanded industrialization and the large-scale availability of mass-market consumer goods.
• Pure capitalism can be contrasted with pure socialism, in which all means of production are collective or state-owned.

A capitalist society relies on the use of contracts, fair dealing, and tort law to facilitate and enforce private property rights.Investopedia / Zoe Hansen

Understanding Capitalism

Capitalism is one type of system of economic production and resource distribution. Instead of planning economic decisions through centralized political methods, as with socialism or feudalism, economic planning under capitalism occurs via decentralized, competitive, and voluntary decisions.

Capitalism is essentially an economic system in which the means of production—factories, tools, machines, raw materials, and so on—are organized by one or more business owners, also known as capitalists. Capitalists then hire workers to operate the means of production in return for wages. Workers have no claim on the means of production or on the profits generated from their labor; these belong to the capitalists.

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Thus, private property rights are fundamental to capitalism. Most modern concepts of private property stem from John Locke's theory of homesteading, in which individuals claim ownership by mixing their labor with previously unclaimed resources. Once owned, the only legitimate means of transferring property are through voluntary exchange, gifts, inheritance, or the re-homesteading of abandoned property.2

Private property promotes efficiency by giving the owner of resources an incentive to maximize the value of their property. The more valuable a resource is, the more trading power it provides the owner. In a capitalist system, the person who owns the property is entitled to any value associated with that property.

Why Private Property Rights Matter for 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. A capitalist society relies on the use of contracts, fair dealing, and tort law to facilitate and enforce these private property rights.