Essentials of Capitalism

[Preamble | Manifesto | Agenda]

("borrowed" from


  • The framework for capitalism depends on understanding six assumptions

1. Private property

2. Freedom of enterprise & choice

3. Role of self-interest

4. Competition

5. Reliance on the price or market system

6. A limited role for government

1. Private Property

  • In general, property belongs to individuals, not the state
    • Individuals include businesses
    • We still have public (or government) ownership of some property
  • Individuals can:
    • Negotiate contracts to use their private property as they see fit.
      • This leads to exchange of property.
    • Have the right to bequeath or designate who receives property when they die.
  • Property rights act as an incentive to:
    • Invest and innovate
    • Exchange and economic growth
  • Property rights extend to intellectual property.
    • E.g., patents, copyrights
    • Many differences around the world
  • Nevertheless, there are some legal limits to the use of private property.
    • E.g., zoning laws

2. Freedom of Enterprise and Choice

  • Firms, owners of capital, workers, and consumers make choices about resource allocation.
    • Freedom of Enterprise - means that producers are free to choose
      • What economic resources they wish to use,
      • What goods or services they wish to produce, and
      • What markets they wish to sell to.
    • Freedom of Choice means for:
      • property owners can use their property as they wish.
      • workers can work at jobs they choose (assuming they are qualified).
      • consumers can buy the goods and services that satisfy their wants, subject to their income.
        • Consumer is king in the economy as they determine what the businesses will ultimately produce.

3. Role of self-interest

  • Each economic unit does what is best for it
    • Owners of property try to maximize their profit.
    • Workers try to maximize their income
    • Consumers try to maximize their utility [or satisfaction]

4. Competition

  • Large numbers of buyers and sellers
    • Acts to spread economic power within businesses and households
    • Individual households or firms are a small part of the total. Their actions do not affect the market as a whole.
  • Entry & exit
    • Flexibility to adjust to changes in consumer tastes, technology, resource supplies.

5. Markets & Prices

  • Market is a mechanism to bring buyers and sellers of a good or service together.
    • Acts as a communication system which tracks and balances individual choices.
    • Allows the various players in the system to make informed decisions.

6. Limited Government

  • Capitalism leads to an efficient use of resources.
  • Some believe that the market is self-regulating and government should limit its involvement.
  • In Chapter 5, we will study some limitations of capitalism that lead to a role for government.


  • Capitalism is marked by three other characteristics:

1. Extensive use of capital goods

2. Specialization and efficiency

3. Use of money

1. Extensive use of capital goods

  • State-of-the-art technology
    • Think of changes in farming
    • Look at the computer center
  • Extensive use of technology and capital
    • This means capitalism favors large scale production, complex equipment
  • Simply put, those who effectively use technology, tend to make more money.

2. Specialization and efficiency

  • Specialization allows for efficiencies in production
    • Consider your professors, they all have an area of expertise
  • Division of labor
    • This means human resources specialization
    • Take advantage of individual differences
    • Learning curve effects - we learn by doing
    • Avoid time lost in shifting tasks
  • Geographic Specialization - (land)
    • Concept of specialization extends to land.
      • Wheat, coal, oranges
      • Computers, medical devices?
    • Comparative Advantage
      • Specialization and trade can increase overall position of both parties if comparative costs for two products differs.
      • Concentrate on what you do best
      • Trade for other items with someone else

3. Use of Money

  • Medium of exchange
  • Acceptable by buyers and sellers
  • Facilitates trade in more items
  • Today it is paper
  • Tomorrow will it be e-money

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