The Advantages And Disadvantages Of Capitalism Economics Essay


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In the mid-1900s, sociologist Karl Marx coined the term "capitalism" which he implies to be any private ownership of property or enterprise. Today economists define capitalism as an economic system based on private ownership of the means of production and distribution of goods [1] , characterized by free competitive market and motivation by profit. It is next to impossible to locate a pure capitalist country today. Like any other system capitalism cannot be described as the ultimate system, due to its disadvantages, it is not a cure for every defect in human affairs or for eradicating all inequalities [2] . However, it is still in our society because of its ability to change and further develop countries.


Capitalism dates back as early as the primitive society. During this period, life was said to be simple and organized, "the good old days". Subsistence farming, hunting and fishing formed the basis of a primitive society. In this society all decisions were made by a tribal leader and his counselors. As a result of this decision-making process the barter system was developed. With the barter system it was possible to exchange one commodity for another. This system had its disadvantages, which were later recognized, since not all commodities could have been equally valued for the commodities in exchange.

Following the expansion of the primitive society was the slavery system. In this environment masters and slaves exist. Factors of production were owned by the masters and wealth was accumulated for the masters by the slaves through cultivation. Attempting to alleviate revolts a negotiation was made, slaves would be entitled to a portion of the produce if they continue to cultivate the land. This system now became known as Feudalism and the masters became known as Lords while the slaves became Serfs.

The earliest forms of capitalism - which we call "mercantilism" - originate in Rome, the Middle East, and the early middle Ages [3] . Mercantilism is an early modern European economic theory and system that actively supported the establishment of colonies that would supply materials and markets and relieve home nations of dependence [4] of other nations. As the Roman Empire expanded so did mercantilism. As time went on in Europe, mercantilism gradually evolved into economic practices that would eventually be called capitalism [5] . These economic practices are termed commercialism, industrialism and monopolism.


Property Rights: Capitalism is characterized by private ownership of all non-labor factors of production. The owners of these private properties have the power to control these factors of production as well as the goods and services produced from such inputs. The owners have the freedom to decide what to produce, how to produce and for whom to produce. The benefits owners are rewarded with from ownership of these resources are rent from the use of their land, wages for the use of their labor, interest as a return on their capital and profits from their entrepreneurial skills.

Co-ordination Structure: Co-ordination under capitalist economies has a market mechanism in which market forces of demand and supply are allowed to work in order to determine prices and output in the economy. The forces of supply and demand push prices upward or downward in response to the decisions of individual buyers and sellers. This mechanism is commonly referred to as Adam Smith's "Invisible Hand". Within this economic system there is no state intervention to ensure that economic activities are carried out properly and that economic goals are fulfilled.

Motivational Structure: As a result of the self-interest of many economic agents, within this economic system, the market is propelled by material incentives. Suppliers have an incentive to offer only those goods on which they expect to make a profit.

Decision-making Structure: There is no central decision-making mechanism. Market prices direct the actions of decentralized decision makers. The various private parties that possess property rights to products and resources decide by/among themselves what to produce, how to produce and for whom to produce.

Information Structure: The capitalist's information structure is decentralized because horizontal channels of information exists where information and decision-making is spread across the various agents in the economy who are on the same level.


According to Adam Smith, a capitalist economy works by means of the "Invisible Hand". The theory of the "Invisible Hand" states that within a free market enterprise, products are exchanged at a price solely determined by the mutual consent of buyers and sellers. Demands by consumers for products direct the allocation of resources to achieve consumers' utility maximization. Profit is financial (material) incentive to produce goods. This economic system ensures that shortages and surpluses do not last for long. When there is excess demand (shortage) prices in the market are likely to rise, as each buyer would now be willing to outbid the other for the scarce good demanded by many. At higher prices, suppliers are likely to increase their supply and thus equilibrium will be achieved in the market. Situations may also exist in the market where there is excess supply (surplus). The tendency here is for prices to fall as each supplier will attempt to win over customers from their rival firms. At these lower prices, consumers are likely to demand more. Therefore, equilibrium in the market is restored.

In Adam Smith's model he identifies the following:

There is an owner class: The means of production are owned only by the few people (capitalists) who can pay for them [6] . Marx refers to this group as the bourgeois (upper class).

There is a working class [7] : The people (laborers) who generate wealth for the owner class by producing goods and services and, in return, are paid wages by the Capitalists. This group has no ownership of the factors of production and Marx refers to this group as the proletarians (lower class).

Firms rationally aim to maximize profit and this is an incentive for production of these goods and services: The capitalists try to judge the market and adjust production accordingly in order to realize the greatest possible profit [8] .

In a pure capitalist economy, there is no state intervention which often means that the economy is free to make all economic decisions and adjust itself when necessary to remain in equilibrium.


In looking at the Performance under capitalism we evaluate the economy under the following performance criteria;

Economic Efficiency

Economic Stability

Income Distribution

Economic Growth


Being efficient is being able to accomplish a task with minimum expenditure on as many levels as possible. This performance criterion looks at how well the economy is able to allocate its resources to best maximize its production on goods and services while taking the welfare of individuals into consideration. A capitalist economy is efficient as it yields high levels of GDP, innovation is encouraged, and one is allowed to exercise freedom of choice.


Unemployment rate, inflation rate and real economic growth are some of the economic indicators used to determine economic stability within the economy. Economic stability in a capitalist market is unstable due to fluctuations in inflation, unemployment as well as real economic growth.


Capitalism renders unequal distribution of income in the economy. Income is distributed in accordance to the skills and qualifications an individual possesses. Those possessing the skills, qualifications as well as capital resources valued by the market will receive high incomes, whereas lower incomes will be allocated to persons without such skills and resources.


Economic growth can be measured as the increase in real GDP. Productivity is the key component, i.e. producing more at a lesser operational cost. Economic growth is said to be slow in a capitalist economy. With a steady rise in real GDP the economy is assumedly growing well. However, where there are fluctuations in the business cycle this may cause economic growth to be unstable suggesting that the economy maybe in or going through a recession.



Capitalism, as we are aware, is an economy where resources and firms are privately owned in free markets. Normally, this usually involves some government intervention to regulate certain aspects of the economy and protect private property [9] . Several advantages are included within a capitalist economy.

Foremost as Government intervention is kept at a limited level several issues that generally arise with government intervention including corruption, lack of a self-interest push force and poor circulation of information within the market is prevented allowing individual incentives to work as hard as possible to achieve as much as possible.

As the capitalist economy is dependent on the push factor of individuals, there is no limit to the level of wealth an individual can accumulate through progression within the economy.

Capitalism allows individuals choice both in commodity purchase and employment opportunities. It allows resources to be distributed according to consumer choice rearing the market in a more productive consumer friendly range.

Through capitalism firms are inclined to produce with greater efficiency, by cutting cost and improving efficiency becomes an aim to prevent losses in an industry where competition is high bettering the economy as a whole [10] .

In such industries company effectively respond to changes in consumer desires better the economy and improving efficiency. In attempts to ensure the highest possible level of productivity, financial incentives are provided to employees by companies so as to better improve self interest in company proficiency. This is beneficial on a global level as these countries generally become exemplary innovative fronts for improvement in technology and implications of productive changes.

As company proficiency improves so does the ability for people to move through social class as an increase in wealth is available. This pushes individuals to work harder in the interest of self-preservation to achieve more. Profit increase within the economy and personal industry, allows an expansion in wealth and company resources, resources that will be used so as to best benefit the company and in turn the economy by promoting foreign investment.

Individuals possess a freedom of choice to purchase and engage in virtually any and all economic activities with little restraint. Promoting trade among nations and individuals that will mutually profit persons with and the economy itself.

Profit maximization is a main priority within the capitalist's state; this can be produced via meeting consumer wants. This causes large suppliers of goods and services that are similar diversification in brands allow for customer distinction and individuality, catering for the necessary changes in desire for certain goods among the lower and higher income classes.


Within the capitalists state the consumer has all the power in the economy [11] because some people will always be able to work harder [12] , achieve more and eventually achieve dominance above others in the economy. Along with a lack of Government welfare and human nature several disadvantages would eventuality occur within the economy.

As dominance within the economy is formed by the elite few, wealth is recycled in this small percentage who has gained a monopoly through limited Government control. This normally occurs through construction of rules that limit the flexibility of the money flow between classes. Leading to exploitation in labor resulting in revolt and strike within the market negatively affecting the entire economy by halting and disrupting production.

Due to market being profit and demand driven, negative externalities such as pollution are generally ignored until they become a serious issue within the economy. This leads to a necessity to reduce the money supply in the economy to resolve these issues.

Firms that have been able to gain monopolies early within market development, pushes out smaller firms from entering due to the high level of competition where they may not be able to produce.


In today's world it is hard to pinpoint a pure capitalist state since many capitalist countries does not possess all the features of pure capitalism. A pure capitalist state is one with no government intervention and its demand and supply are left in what Adam Smith called "Invisible Hand". However, it's private ownership and a profit driven motive shows that such an economy is competitive in nature. Therefore the question still remains why it's impossible to locate a pure capitalist state? But does one exist or have ever existed before?

It was observed that over the years capitalism has pass through many phrases which forced capitalist economies to amend or adjust their rules under which they reside. These changes put capitalist states either more too pure socialism or more to pure capitalism.

Private ownership

Private ownership is one of the most important factors in capitalist state that adds fuel to a competitive and market oriented economy. Significant changes in the shares of public and private ownership of property can alter the nature of a capitalist economic system [13] . Indeed if the state owned a major share of existing property, we would no longer classify the system as capitalist."

Working participation

Owners of capital (proprietors, partners and shareholders) are rewarded out of their profits while workers are paid with wages which does not vary with profits. The higher the profits of a firm the greater the returns of proprietors, partners and shareholders whereas workers' wages remains fixed regardless of the fluctuation of profits.

If workers (driven by their own self-interest) were allow to increase profits of the enterprise operating within the capitalist state - this would considered that capitalism has evolved from its basic form.

It has change today - if workers' income depends on the profits of a firm then that becomes a self-motivation hence they would be more interest in the profitability of the firm.

Government intervention

Fiscal Policies: fiscal policy is discussed as government budget deficit (government expenditures less government revenue). It is also government spending or taxes to stimulate the economy. If aggregate income is too low (actual income is below potential income), the appropriate fiscal policy is expansionary fiscal policy [14] : increase the deficit by decreasing taxes or increasing government spending. If aggregate income is too high (actual income is above potential income), the appropriate fiscal policy is contractionary fiscal policy: decrease the deficit by increasing taxes or decreasing government spending. [15] 

Welfare: In the late 1930s and the 1940s, workers dominated the political agenda [16] . During this time the capitalist economies developed an economic safety net that included government funded programmes such as public welfare, unemployment insurance, and established an extensive set of regulations affecting all aspects of the economy." This safety net is frequently found in capitalist economies globally since its make available a form of security for the population (working class).

Minimum Wage Laws: Government has enforced the minimum wage law which also kept the market from operating by itself. The government causes wage rigidity [17] when it prevents wages from falling to equilibrium levels. Minimum-wage laws set a legal minimum on the wages that firms pay their employees. Since the passage of the Fair Labour Standards Act of 1938, the U.S. federal government has enforced a minimum wage that usually has been between 30 and 50 percent of the average wage [18] in manufacturing. For most workers, this minimum wage is not binding, because they earn well above the minimum. Yet for some workers, especially the unskilled and inexperienced, the minimum wage raises their wage above its equilibrium level. It therefore reduces the quantity of their labour that firms demand."


Over the years capitalism has evolved. Starting with the bartering system which led to slavery system, then the Feudalism followed by mercantilism then to capitalism. It was suggested by the classical school of economics that government role should not be removed from economic system but, its role should be limited only to protect individual rights and providing public goods and services. History reveals that government is necessary and its role has expanded. We cannot deny that without government intervention we would have fail. With government intervention capitalism has develop over the years. Government involve in the form of nationalization, welfare and fiscal policies and minimum wage laws which adds to the development of capitalism. In the world today pure capitalism is not practiced but rather a mix economy by former capitalist states like the United State where government plays a more important role in market decisions.

However, like everything else capitalism has its disadvantages such as negative externalities like pollution and diminishing non-renewable resources; a disproportionate distribution of wealth or income; and high unemployment rates and economic instability due to the cyclical nature of the capitalistic system. Additionally the main motives of firms was gaining a profit which lead to the misallocation of scarce resources and stagnation.

Even with consistent conflicts between upper and lower class, capitalism has survive. It survives from the elite's desire to remain in control of the means of production and, therefore, wealth. It causes exploitation between classes (the elite benefits at the expense of labour from the lower class) and was self-seeking since persons seek their own self-interests, regardless of the effects their actions have on others. This system found ways to suppress the working class and keep the bourgeois in dominant position in society.



Ellen Judy Wilson and Peter Hanns Reill, Encyclopedia of the Enlightenment (InfoBase Publishing, 2004)

Roger LeRoy Miller, Economics: Today and Tomorrow

Colander C. David, " Macroeconomics," Fourth edition, (New York: McGraw Hill Inc. , 2001)

Mankiw N. Gregory, "Macroeconomics," Fifth edition, (New York: Worth Publishers, 2003)


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