Capitalism is an
economic model designed to combat the problem that we don't live in a post scarcity society. Since most people consider a free market to be a core part of capitalism this article will also cover market economics.
Socialism is its biggest competitor.
The Rational Consumer
First of all, we must note that almost all capitalist models until the emergence of the Neo-Keynesian school assumed
a completely rational consumer. One that would always look for the best, lowest price before buying. This assumption is the basis for almost everything coming up.
Invisible Hand
The concept behind the invisible hand is if there are many companies competing to sell the same product then they can be as greedy as they want to and it will be as if an invisible hand is guiding society to prosperity. The many companies part is important and one of the reasons why businesses aren't necessarily pro-capitalism.
Supply and Demand
The price of something is determined by supply and demand. A higher quantity of a product means it is less likely a buyer will pay an outrageous amount of money for it because they can walk down the street and get it for a cheaper price. If the seller is the only one in possession of the product then that seller is the only way the buyer can get the product. If the buyer refuses to pay the seller's price the seller will just move onto a different customer who is willing to buy it.
If there is high demand for a product sellers can get more money out of the product because if desired badly enough buyers will pay whatever price. If there isn't high demand for a product sellers are forced to lower prices
* or expand advertising
in order to raise demand.
Higher demand for a product causes the price to go up. Less demand for a product cause the price to go down. Higher supply of a product causes the price to go down. Lower supply of a product causes the price to go up.
The level of supply is determined by the sellers and the level of demand is determined by the buyers. If there are many sellers of the same product and many buyers of the same product then determining prices is a bit like determining the weather. Individual sellers of a product have no control over the price of a product because if seller A cuts back their supply Seller B will increase their supply. Seller B is losing money over the reduced prices but is gaining money from selling the extra inventory.
Market Failures
Market failures are instances when the market left alone does not produce the most efficient system to be put in place. It is almost entirely agreed that market failures do exist. Left and Right-wing economists just have differing opinions on where they are. Due to market failures, the existence of the invisible hand is debated by capitalists and anti-capitalists alike. The general tendency is for the left to see more market failures and doubt the existence of the hand, especially due to income gaps.
Law of Diminishing Returns and how it affects supply
The Law of Diminishing Returns states that the higher quantity of a product you make within a certain period of time the higher the cost of making an individual piece of that quantity. As an example if it costs two dollars to produce a single bottle in one day, and it will cost more than four dollars to make two bottles in one day. For the sake of this example lets say it costs five dollars to make two bottles and each additional bottle costs an extra dollar to produce in one day.
As mentioned above individual sellers have no control over prices and have to accept whatever the market price is. Going with the above example if the market price for bottles is seven dollars then sellers will make a profit off the first five bottles they produce, make even on the sixth one, and lose money on any consecutive bottles made within one day. If an individual seller wants to make a profit from any bottles after the fifth one either the price has to go up or production costs have to be lowered. Additionally, the producer can slow down the rate of production to produce only a profitable amount of bottles per day.
As for why each additional product costs more to produce than the last, imagine you are starving so you go to a fast food restaurant and order burgers. The first few burgers you buy taste delicious and are quenching your hunger. After a while it becomes less rational to spend money on burgers because if you eat enough you'll puke. (This is a related concept called
marginal utility. Think of it this way: the utility, or satisfaction, that you gain from each burger decreases with each one you eat, until there is only a marginal amount to be gained from eating another one. At that point, you stop.)
Another analogy would be someone who owns an apple orchard. In a few hours her workers could go through and easily pick all the apples off of the bottom branches. The ones on the top branches however require more effort to get to. If a profit is to be made from those prices have to be increased. In a factory setting adding a few workers will increase productivity because they can specialize on specific tasks, but if you add enough workers, people will be bumping into each other. Some workers will also be standing around doing nothing because there aren't any tasks to do. Paying these workers their wages is a waste of the employer's money because no profit is coming from it. Whether all situations operate in this manner is debatable but it's a well-observed effect.
Economies of Scale
Economies of Scale refers to a situation where it is cheaper for a business to produce more of an item than less. Think of it as like buying in bulk, but for producers.
It costs a great deal to make one hand-built automobile, as it takes a few skilled workers a fairly long period of time to make it using hand tools and whatnot. Since this manufacture of only one unit of product takes a long period of time and uses skilled laborers (who earn more money than unskilled), the end product (a hand-built car) ends up costing a lot of money.
It costs far less to make one machine-manufactured automobile because of the economy of scale. This states that an efficient production process that makes the product faster with unskilled laborers can in turn make more product in a far shorter period of time and therefore cost less to make and sells for a lower price. The entire industrial revolution is built upon this concept.
For a good real-life example: look at a Ford Model T or a Volkswagen Beetle. Making either car by hand would result in a far slower turnout and a more expensive product, but the entire point of both vehicles was a cheaper product for the masses. They were cheaper because the more of them were made, the cheaper they became to manufacture: the beginning capital (factory construction, machinery purchase, etc.) was far greater than making a hand-built car, but the volume of the sales made up for it.
Role of government
Both economists and people in general are divided on the exact role the government should play in the economy. Some people-anarchists (See
Useful Notes/Socialism)-believe that existence of government can't be justified
at all, while others believe there are quite a few important roles governments can and should fill. Some of those roles include:
- Enforcing Property Rights: Stealing is wrong. Not only is theft generally agreed upon to morally damaging to the individual who steals, and causes suffering to those who are stolen from, but widespread theft (such as the looting that occurs in riots) creates massive market inefficiencies, and thus widespread theft would be a market failure. If someone desires a product they should pay the agreed-upon price. Fraud is considered a form of stealing (as theft by trick) so it would fall under this.
- Providing Public Services: Some things, such as lighthouses, well-maintained roads, fireworks shows, and clean air are considered impossible for an individual person or organization to make a profit from because property rights are near impossible to enforce on these things. The government however can pay for these things with tax money, which they can force everyone to pay. Whether they should do this is the subject of debate among the many different schools of economic thought. See below.
- Helping Out In Recessions: Recessions are viewed a a natural consequence of capitalism. The free market naturally goes through ups and downs. What you can do without abolishing capitalism outright, which isn't an option for the overwhelming majority of economists, is make the ups last as long as possible while making the downs last as little as possible. If the economy is bad enough, the government can either print more money or increase spending to boost the economy. See John Maynard Keynes and the Keynesian school below for more information on how this concept works in practice. On the other side of the coin, the Austrian School of Economics sees the root of the business cycle in over-expansion of the money supply and credit by governments, so they argue refraining from that is the cure instead.
- Regulating Monopolies and Oligopolies: The problem with monopolies is that due to the law of diminishing returns, it's impossible for them to make a profit making huge quantities of a product, so prices naturally stay high. The government can intervene in these situations and either force the company to break up, put a minimum limit on how much they have to produce, put a maximum limit on how much they can charge, and/or use tax money to reimburse the company for any lost profits if they increase supply. The problem with oligopolies is it reduces the likelihood that individual suppliers will renege on a deal to keep total supply in the economy as low as possible. The government can regulate these in a similar manner. Again, whether the government should regulate mono/oligopolies is debated. Though a moderate consensus is that governments should break up mono/oligopolies as well prevent them from forming, what constitutes a mono/oligopoly is not agreed upon. Further to the left, economists believe that the state should assume control of a mono/oligopoly if it is naturally occurring, such as in the generally agreed-upon case of water or energy suppliers (it is extremely hard to foster competition when actual land control is involved). Further to the right, it is argued that the side effects of the government trying to combat the mono/oligopoly will lead to far worse results than if just left alone.
- Regulating The Money Supply: Money is the lifeblood of a capitalist/market economy. If the amount of money circulating in the economy is higher than the demand for money it will cause inflation. If the amount of money circulating in the economy is lower than the demand it will cause deflation. Modern-day Austrians like Ron Paul do not believe the government should do this, but even among right-wing economists the need for the government to have a monetary regime is widely supported. (To wit, the person who has used the central bank in the US to increase the money supply most is Ben Bernanke, a Repubican.)
- Banning Products: Markets will produce whatever people are willing to pay for even if the product isn't good for society (think fast food, or cigarettes). In these cases, government intervention is the only way to stop production and consumption of them. This creates the black market problem however, such as in the case of illegal drugs. Black markets are viewed as market failures. Thus, whether banning the creation of certain products should happen is, again, hotly debated.
- Bailing Out Companies: Some companies are considered "too big to fail" . If they go under, their suppliers may have to lay people off or go under as well because of the lost business. The unemployed workers now have less money coming in and this could affect demand in other markets. In situations like this the government can preventively step in but this is very controversial. Opponents saying doing this prevents companies from learning from their mistakes and enforces the behavior that required the bailout in the first place, however, the people most often proposing a bailout are also the people most likely to support regulations that would prevent furhter occurences of that "bad behavior".
Key Capitalist Thinkers and Their Ideas (In Chronological Order of Appearance)
- Adam Smith: Wrote The Wealth of Nations, laying the philosophical foundations of the capitalist system. Low taxes, next-to-zero regulation, and the invisible hand are part of all his ideas.
- David Ricardo: Came shortly after and formulated the basis of trade theory by noticing the difference between comparative and absolute advantage. Absolute means a nation can simply produce more in a given time period, but comparative means that a nation can produce at less of a cost. Very few nations have an absolute advantage in trade, but having a comparative advantage in something is very useful (imagine that Brazil grows pineapples, Iceland catches cod and they trade with each other. Both parties benefit because of their specializations).
- Alfred Marshal: Discovered the concept of Supply and Demand and lent more credos to the invisible hand. His methods of quantifying the benefits of production and consumption are the basis of welfare economics. His most important work, Principles of Economics (mercifully, that's the full title) was the leading economic textbook for a very long time.
- Henry George: Could be seen as among the first left-leaning capitalists. He believed in general that people had property rights, but that nature was sacred and belonged to all people equally, and thus advocated public ownership of land. Without getting too technical, he also saw common ownership of land as a way to decrease poverty. His philosophy, which came to be known as Georgeism, is popular among environmentalists and green-politics activists. His most important work is Progress and Poverty: An Inquiry into the Cause of Industrial Depressions and of Increase of Want with Increase of Wealth: The Remedy (shortened: Progress and Poverty).
- Thorsten Veblen: Veblen's work focuses mostly on studying the relationship between individuals and social institutions in terms of economics. His most famous work is The Theory of the Leisure Class: An Economic Study of Institutions (shortened as The Theory of the Leisure Class).
- John Maynard Keynes: The first capitalist thinker to seriously propose extensive government intervention in the economy, or at least, the first with a serious following (see the Keynesian schools below). Despite his reputation in some circles as a leftist, he was definitely not a socialist. Whereas economists before Keynes were more focused on keeping inflation low, Keynes was obviously more focused on economic downturns. He proposed that deficit spending by government could be used as direct economic stimulus to help get economies out of recessions, and believed that regulation should be used to surgically remove the economic behaviors that caused the last recession. What Smith is to the basic free-market model, and microeconomics, Keynes is to the basic mixed-market model, and macroeconomics. His most important work is The General Theory of Employment, Interest, and Money (shortened: The General Theory) in 1936.
- Robert Solow: Found that economic growth comes not from adding more input (labor and capital) but through advances in technology. Another notable contribution is the introduction of the Neo-Classical growth model, also known as the Solan-Swan growth model. He is a Neo-Keynesian (see below).
- Paul Krugman: The face of modern Keynesian economics. Predicted the 2007-8 financial collapse in his most popular work The Return of Depression Economics. That said, his most important contributions have been in trade theory. (He is among the few leftists who are in full support of free trade.) His work fathered both new trade theory, and new economic geography, both of which are way to complex to begin to explain here. Depression Economics may be his most popular work, but his most important works are the papers in Journal of International Economics and Journal of Political Economy which introduced those two theories, which won him his Nobel prize. For the life of us, we can't find the names of those papers but rest assured they're overly long and filled with overly complex vocabulary. He is identified as a Neo-Keynesian, but says he's leaning Post-Keynesian these days.
Schools Of Thought
- Austrian School: Key thinkers include Ludwig von Mises, and Friedrich Hayek. Since we're trying to avoid massive technical details, imagine these guys as the free-market faithful to the core. Modern supporters include Ron Paul and his followers. This school is considered heterodox, which is a nice way of saying that most economists consider them completely wrong. Known for their dislike of central banking (ie. the Federal Reserve) and fiat currency (printing money, essentially) and backing of the gold standard (ie. the rate of inflation should be tied to the market value of gold or other commodities).
- Chicago School: Central thinker is Milton Friedman. The Chicago school has been noted for being very supportive of free-market fundamentals, but Friedman's more important contributions were to monetary theory, where he, in essence, supported massive government intervention. In short, monetarists are called so because they believe that the primary way the government should intervene in the economy is through controlling the money supply, and should otherwise be rather laissez-faire.
- Georgeists: Based on the thinking of Henry George. As noted, those mostly likely to be Georgeists in the modern age are environmentalists and green-politicians. Milton Friedman held the opinion that their land value tax proposal would be the least damaging method of taxation to the economy.
- Institutional Economics: Developed out of Thorsten Veblen's work. Studies the interactions between institutions and how that produces an economy. The earlier strain of this is considered Heterodox.
- New Institutional Economics: Much like Neo-Keynesians (see below), institutionalists were able to regain a lot of respect within the greater establishment by incorporating neoclassical analysis (to make that simple, "incorporating neoclassical analysis" generally just means taking a macroeconomic school and rooting it in the microeconomic basics).
- Keynesians or New Keynesians (sometimes called Old-Keynesians): First emerged as followers of Keynes during The Great Depression and post-war period. The influence of the Keynesian school and the success of Keynesian policies in practice led the post-war period until the early-70's to be referred to as, alternately, the "Golden Age of Capitalism" and "The Golden Age of Keynesianism". The original school lost support after Keynesian ideas played a key role in the "stagflation" of the 70's as predicted by Milton Friedman (see Chicago School) and after the "Lucas Critique" emerged noting that Keynesianism, as among the first macroeconomic schools of thought, had never bothered to root itself in microeconomic basics. Sub-schools emerged afterwards, including...
- Post-Keynesians: According to Keynes biographer Lord Skidlesky, this school is the closest to Keynes' thinking.
- Neo-Keynesians: Not to be confused with New Keynesians. Emerged in the 90's as a response to the Lucas critique by finding basis for Keynesian macroeconomics in microeconomics, though unlike other microeconomic-centric thinkers, they assume a number of market failures.
Although out of fashion for much of the 80s and 90s, when monetarism was in full swing, these days Keynesianism is arguably making something of a comeback thanks to the ongoing financial crisis which began in 2008. More economists have been making the argument that the recession was caused by a lack of government oversight and deregulation (their opponents vehemently deny this and claim government intervention was the root of the problem) and have supported strong regulation and deficit spending as a response. Ben Bernanke, head of the US Federal Reserve, was a prominent supporter of this view, as is Paul Krugman today.
- Social Democrats advocate use of the free market where it seems to work and use of government intervention where it doesn't (see role of government above). Whether Social Democrats are considered capitalists, socialists, or neither varies from person to person, even among Social Democrats themselves. Capitalism does allow for government intervention but social democrats are among the people mentioned above who see many market failures to correct.
