Selling advertising, providing a service or product to meet a demand, paying wages and taxes—these are economic activities.  Economics can be defined as the study of human efforts to satisfy seemingly unlimited wants through the use of limited resources.  Resources include natural materials such as land, water, minerals, and trees.  Resources also include such human factors as skills, knowledge, and physical capabilities.  There are never enough resources to produce all the goods and services people could possibly want.  Therefore, people in every nation must decide how these resources are to be used.  Governments generally regulate this economic activity.

The Role of Economic Systems

Governments around the world provide for many kinds of economic systems.  All economic systems, however, must make three major economic decisions: (1) what and how much should be produced; (2) how goods and services should be produced; and (3) who gets the goods and services that are produced.  Each major type of economic system in the world—capitalism, socialism, and communism—answers these questions differently.

Capitalism

At one end of the spectrum is an economic system in which freedom of choice and individual incentive for workers, investors, consumers, and business enterprises is emphasized.  The government assumes that society will be best served by any productive economic activity that free individuals choose.  This system is usually referred to as free enterprise, or capitalism.

Pure capitalism has five main characteristics: (1) private ownership and control of property and economic resources; (2) free enterprise; (3) competition among businesses; (4) freedom of choice; and (5) the possibility of profits.

Origins of Capitalism

No one person invented the idea of capitalism.  It developed gradually from the economic and political changes in medieval and early modern Europe over hundreds of years.  Two important concepts laid the foundation for the market system that is at the heart of capitalism.  First is the idea that people could work for economic gain.

Second is the idea that wealth should be used aggressively.  Major changes in the economic organization of Europe began with the opening of trade routes to the East in the thirteenth century.  As trade increased, people began to invest money to make profits.  By the eighteenth century, Europe had national states, a wealthy middle class familiar with money and markets, and a new attitude toward work and wealth.  Included in this new attitude were the ideas of progress, invention, and the free market.  The free market meant that buyers and sellers were free to make unlimited economic decisions in the marketplace.
 

In 1776, Adam Smith, a Scottish philosopher and economist, provided a philosophy for this new system.  Smith described capitalism in his book The Wealth of Nations. From the writings of Smith and others came the basic idea of laissez-faire economics.  Laissez-faire, a French term, means “to let alone.” According to this philosophy, government should keep its hands off the economy.  In laissez-faire economics, the government’s role is strictly limited to those few actions needed to ensure free competition in the marketplace.  In theory, what does a free-enterprise economy mean?  In a free-enterprise or pure market economy, economic decisions are made by buyers

(consumers) and sellers (producers).  Sellers own businesses that produce goods or services.  Buyers pay for those goods and services that they believe best fit their needs.  Thus, the answer to the question of what to produce is determined in the marketplace by the actions of buyers and sellers, rather than by the government.  Competition plays a key role in a free-enterprise economy.  Sellers compete with one another to produce goods and services at reasonable prices.  Sellers also compete for resources.  At the same time, consumers compete with one another to buy what they want and need.  These same consumers in their roles as workers try to sell their skills and labor for the best wages or salaries they can get.

Free Enterprise in the United States

No nation in the world has a pure capitalist system.  The United States, however, is a leading example of a capitalist system in which the government plays a role.  For the most part, the government’s main economic task has been to preserve the free market.  The national government has always regulated American foreign trade, and it has always owned some property.  Nevertheless, the government has tried to encourage business competition and private property ownership.

Governmental Influence

Since the early 1900s, however, the national government’s influence on the economy of the United States has increased in several ways.

First, as the nation’s government has grown, it has become the single largest buyer of goods and services in the country.  Second, since the early 1900s, the United States government has increasingly regulated the economy for various purposes.  The Meat Inspection Act and Pure Food and Drug Act were early attempts by government to protect the consumer.

Since then, many laws have been passed giving the government a role in such areas as labor-management relations, the regulation of environmental pollution, and control over many banking and investment practices.

Third, the Great Depression of the 1930s left millions of Americans without jobs.  The national government set up the Social Security system, programs to aid the unemployed, and a variety of social programs.  In addition, the government began to set up public corporations like the Tennessee Valley Authority that competed directly with private companies to provide services such as electricity.

Mixed-Market Economy

Today the American economy and others like it are described by economists as mixed-market economies.  A mixed-market economy is an economy in which free enterprise is combined with and supported by government decisions in the marketplace.  Government keeps competition free and fair and protects the public interest.

Even though it is a mixed-market economy, the American economic system is rooted deeply in the idea of individual initiative—that each person knows what is best for himself or herself.  Further, it respects the right of all persons to own private property.

Finally, it recognizes that freedom to make economic choices is a part of the freedom of political choice.

What is Capitalism?

Socialism

Under the second type of economic system—socialism—the government owns the basic means of production, determines the use of resources, distributes the products and wages, and provides social services such as education, health care, and welfare.  Socialism has three main goals: (1) the distribution of wealth and economic opportunity equally among people; (2) society’s control, through its government, of all major decisions about production; and (3) public ownership of most land, of factories, and of other means of production.

The basic ideas behind modern socialism began to develop in the nineteenth century.  Industrialization in Europe caused several problems.  A class of low-paid workers lived in terrible poverty, slums grew in cities, and working conditions were miserable.  In reaction to these problems, some socialists rejected capitalism and favored violent revolution.

Others planned and built socialist communities where laborers were supposed to share equally in the benefits of industrial production.

Democratic Socialism

The socialists who believed in peaceful changes wanted to work within the democratic political system to improve economic conditions, under a system called democratic socialism.

Democratic socialists believe that both the economy and society should be run democratically—to meet public needs, not to make profits for a few. They believe that to achieve a more just society, many structures of our government and economy must be transformed through greater economic and social democracy so that ordinary Americans can participate in the many decisions that affect our lives.

Democracy and socialism go hand in hand. All over the world, wherever the idea of democracy has taken root, the vision of socialism has taken root as well—everywhere but in the United States, because there many private and corporate interests have spread false ideas regarding what democratic socialism actually means.

Unlike classic socialism, democratic socialists do not want to create an all-powerful government bureaucracy, but neither do they want big corporate bureaucracies to control our society. Rather, democratic socialists believe that social and economic decisions should be made by those whom they most affect.

Today, corporate executives who answer only to themselves and a few wealthy stockholders make basic economic decisions affecting millions of people. Resources are used to make money for capitalists rather than to meet human needs. Democratic socialists believe that the workers and consumers and private interests should work together for the common good of the society.

What is democratic socialism and how is it different from classic socialism?
 

Communism Karl Marx (1818–1883), a German thinker and writer, was a socialist who advocated violent revolution.  After studying the conditions of his time, he concluded that the capitalist system would collapse.  He first published his ideas in 1848 in a pamphlet called The Communist Manifesto. He later expanded his ideas in his book called Das Kapital (1867).  Marx believed that in industrialized nations the population is divided into capitalists, or the bourgeoisie who own the means of production, and workers, or the proletariat, who work to produce the goods.  Capitalists are a ruling class because they use their economic power to force their will on the workers.  The workers, Marx argued, do not receive full compensation for their labor

because the owners keep the profits from the goods the workers make.  Marx believed that wages in a capitalist system would never rise above a subsistence level—just enough for workers to survive.

Class Struggles

Marx interpreted all human history as a class struggle between the workers and the owners of the means of production.  Friedrich Engels, a close associate of Marx, wrote: “Former society, moving in class antagonisms, had need of a state, that is, an organization of the exploiting class at each period for the maintenance of external conditions of production: ...  for the forcible holding down of the exploited class in the conditions of oppression.” —Friedrich Engels

Marx predicted that, as time passed, a smaller and smaller group of capitalists would control all means of production and, hence, all wealth.  Eventually the workers would rise in violent revolution and overthrow the capitalists.  The goal of this revolution was government ownership of the means of production and distribution.

Karl Marx first called his own ideas “scientific socialism.” He believed that in time, socialism would develop into full communism.  Under communism one class would evolve, property would all be held in common, and there would be no need for government.

In The Communist Manifesto, Karl Marx not only wrote that economic events would finally lead to communism by means of revolution, but in fact encouraged it:
 

“In short, Communists everywhere support every revolutionary movement against the existing social and political order of things. ...  Let the ruling class tremble at the Communist revolution.  The proletarians have nothing to lose but their chains.  Working men of all countries, unite!”

In Communist nations, government planners decide how much to produce, what to produce, and how to distribute the goods and services produced.  This system is called a command economy because decisions are made at the upper levels of government and handed down to managers.  In Communist countries this means that the state owns the land, natural resources, industry, banks, and transportation facilities.  The state also controls mass communication including newspapers, magazines, television, radio, and motion picture production.

Many nations have developed their own styles of communism.  The economy is a full-time responsibility of the People’s Republic of China, for example.  Government planners adopted a five-year plan that agreed with the goals of the Communist Party.

The plan specified, for example, how many new housing units would be produced over the next five years.  It also dictated where this housing would be built, what kinds of materials would be used, who would be eligible to live in the new housing, and how much rent they would pay.

Such planning removed economic freedom from individual builders, but also political freedom from consumers who were told where to live.  Because Communist countries sometimes fail to provide adequate standards of living, these governments have had to choose between change and revolt by the people.  China has begun to loosen its controls and decentralize some business decisions.

What is meant by a command economy?