Capitalism is an economic system in which the means of production and distribution are owned by private individuals or corporations. Labor, goods, and wealth are traded in markets, and profits from these exchanges go to owners. Capitalism became the dominant economic system in Europe after the end of feudalism, and since the Industrial Revolution has spread throughout much of the world.
Capitalism works through a framework of free markets. People are free to invest their capital, or money, in businesses for their own profit. Businesses decide what goods to produce and what price to set for these goods. The desire to reap the highest possible profit requires businesses to sell as many goods as possible for the lowest possible cost to themselves. Businesses reinvest some of their profits to improve their goods or to create new ones. They also compete with similar businesses for consumers. This competition is a driving force for innovation, encouraging the development of new and improved products as well as efficiency in production.
To maximize profits, businesses are constantly seeking to lower the costs of production. These costs include the price of materials and of labor. Seeing labor as a cost, businesses are motivated to keep wages as low as possible. At the same time, however, workers are an asset to a company because their skills are necessary to the process that generates the company’s profits. Workers whose skills are in high demand are worth more to employers and therefore earn higher incomes, while those with fewer or less-needed skills earn less.
In a capitalist economy, individuals are free to use their income as they choose. By purchasing goods, they create profits for businesses and also influence companies’ production decisions. For example, if large numbers of consumers buy relatively expensive SUVs rather than smaller and less expensive cars, manufacturing companies will continue producing greater numbers of SUVs. If consumers refuse to buy SUVs and purchase hybrid vehicles instead, businesses will lose money by continuing to produce SUVs and will turn instead to the production of more and better hybrids. Cycles of supply and demand, according to economic theory, are a normal part of the free market system. Capitalists argue that such cycles, in which economic recession is followed by recovery and expansion, are generally predictable and are self-regulating.
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