What is Capitalism and
how does it work?
L/O – To understand the advantages and disadvantages of
the Capitalist system
Ideology
• Ideology = a system of ideas and
ideals, especially one which
forms the basis of economic or
political theory and policy.
• This year you will be studying the
different political and economic
ideologies that affected 20th
century history.
• This first is Capitalism which is
both a set of ideals (ideology) and
an economic system.
What is Capitalism?
• Capitalism = an economic system in
which the means of production
(capital) are privately owned and
goods and services are produced
for profit in a free market.
• People set up businesses using capital (land,
factories, wealth) in order to produce
goods/services to make money, thereby
creating more capital for themselves (profit
motive).
• Prices and distribution of goods are
determined by competition between
producers in a free market (supply/demand).
Free Market =
people are free
to use/sell their
private property
without outside
interference.
Profit Motive =
The desire to
produce goods in
order to gain
more wealth
(greed?)
What
happens if
there is no
competition
?
What is Capitalism?
• Capitalism relies on the voluntary
exchange of labour in return for
wages/capital. This is a mutually
beneficially arrangement.
• Individuals pursue their own self-interest
by working for wages but in doing so, they
promote the social interest of society by
helping others out.
• In a sense, Capitalism is based on greed
and self-interest (individualism) but it
actually benefits the whole of society.
What is Capitalism?
• Capitalists believe that governments should
NOT interfere with the economy. The free
market will distribute goods to people in the
most efficient and cheapest way.
• For example, what happens if there is
a shortage of baby milk?
• Do we need government then?
• Language, scientific knowledge and law all
grew out of free exchange & voluntary
production = principle of mutual benefit. The
Capitalist economy works in the same way.
Advantages/Disadvantages of
Capitalism
Advantages
• Best wealth creation tool
known to man
• Is the most efficient system
with less waste, produces
only what people demand.
• Increases standard of living
for many
• Is natural! Humans naturally
form capitalist economic
relations – based in human
nature – desire for selfpreservation and greed!
Disadvantages
• Capital can accumulate in
the hands of the few who
control production
(monopoly)
• Profit Motive forces
wages down, poor
w/conditions
• Can also lead to overproduction/recession and
unemployment
• Reduces the worth of a
human to a monetary
value – system is based
on greed! Which isn’t
good!
Who created modern Capitalism?
• Adam Smith (1723-1790) was a Scottish
political economist and moral
philosopher. In Wealth of Nations
(1776) he founded the modern
discipline of economics and provided
the rationale for free trade, capitalism
and libertarianism.
• Free market appears chaotic but is
guided by an ‘invisible hand’ to produce
the right amount of goods.
• If shortages occur (i.e. baby milk), prices
rise, establishing a profit margin that
provides an incentive for others to enter
production, leading to surplus again.
The system is therefore ‘self-regulating’.
(Doesn’t need management)
Who created modern Capitalism?
• Adam Smith attacked
government interference in
the economic process
(tariffs on imported goods)
• Government restrictions on
trade caused inefficiency
and high prices.
• Laissez-faire was needed
(let them do), let the free
market do what it wants!
Thus Capitalism is born.
History of Capitalism
• Capitalism evolved naturally in
many cultures around the world
but it was in Europe that Capitalism
first developed into its modern
form.
• The historical analysis of Capitalism
has shown that it developed in four
key stages:
1. Pre-Capitalist Feudal System (pre14th century)
2. Mercantilism/Merchant Capitalism
(14th-18th)
3. Industrial Capitalism (18th-20th)
4. Modern Capitalism (19th-20th)
The Feudal Economic System
• In Medieval Europe, a hierarchy of King,
Lords/Barons and Knights ruled all the
land and means of production. Wealth
came from ownership of land.
• Because Peasants were forced to work
for their Lord, they had no interest in
technological innovation. Because
Peasants produced to sustain their own
families, they had no interest in cooperating with one another.
• Peasants had no power, money or free
time to invest in their own capital (land).
Manorial/Feudal System
Feudal
System
The Feudal System
• As Lords owned the land, they relied
on force to guarantee that they were
provided with food. As they were not
producing food to sell on the market,
there was no competitive pressure to
innovate production.
• Lords spent all their wealth on military
equipment or lavish consumption, they
therefore had no incentive to invest in
developing new productive
technologies.
• Result = the Feudal System actually
prevented capitalism from growing!
The Feudal Manor (village area) was
self-sufficient which limited the
growth of a free-market.
How did Feudalism end?
• The Black Death and resulting Famine in
Europe meant that there was a severe
shortage of labour for agriculture.
• Peasants could now demand real wages
for their work instead of servitude. The
Lord’s needed them!
• Peasants therefore became WAGEEARNERS! They could rent their own land,
invest in their own capital and now had an
incentive to innovate production methods
to make more money.
• New technologies & exploration opened
up the world to trade in the 15th C. Richer
peasants, merchants and lords could invest
in new commodities and trade.
Merchant Capitalism
• Mercantilism = a system of trade for
profit. European merchants, backed by
governments, made profits from the
buying and selling of goods (which
were still largely produced by noncapitalist production methods)
• Under Mercantilism, the State
(government) became the regulator of
the economy, not the local guild.
• Merchants invested capital in
companies like the British East India
Company, seeking a return on
investment.
End of Merchant Capitalism
• These government-owned and
protected merchant companies became
very wealthy and dominated
international trade. It made their
governments very rich.
• However competition was non-existent
as governments tried to keep all profits
to themselves. There was no ‘freemarket’.
• The Industrial Revolution would soon
bring an end to government control of
the economy and its Merchant system.
Industrial Capitalism
• Industrial Capitalism = an economic
system that relies on investment of
capital in machines & technology that are
used to increase production of
marketable goods
• Adam Smith and other economic liberals
realised that more wealth could be
created with less not more government
interference in the economy.
• Government-owned merchant companies
held monopolies in trade and production.
There was little competition therefore no
desire to innovate production.
Industrial Capitalism
• The Industrial Revolution enabled a new
class of entrepreneurs to invest in new
production methods. The only thing that
held them back was government
regulation and control.
• The sheer speed of the revolution meant
that competition grew exponentially.
Governments decided to help this grow by
removing government barriers to trade
(laissez-faire economics) as suggested by
Adam Smith.
• Banks also grew as industry needed more
investment and finance than governments
could provide.
Modern Capitalism
• Private businesses could now create
more wealth than the governments
themselves.
• The need for big, strong
governments was reduced. The role
of government was now just to
ensure the smooth operation of free
markets.
• The State was now just a vehicle for
improving business conditions,
securing foreign markets and gaining
access to resources (colonialism).
‘The business of America is business.’
Need for an alternative?
• By the 20th century, it was clear that
Capitalism, whilst making businesses
fabulously wealthy, wasn’t working for
everyone.
• Laissez-faire economic policies reduced
government protection for workers. Wage
earners lived and worked in terrible
conditions, with wages reduced by
factory owners keen to boost profits.
• It seemed as if Capitalism was just
another method of exploitation,
benefiting a small minority who owned all
the capital. The people who owned the
wealth even seemed to control the
government through political parties and
pressure groups. Surely there was a
better system?