How Capitalism Works

Investing Image Gallery Traders work on the floor of the New York Stock Exchange. Even the United States doesn't have a true capitalist economy. See more investing pictures.
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For a lot of us, the real t­hrust of economics is our checking account bal­ance. But rec­ent events like the Enron debacle, the proposed privatization of Social Security and the subprime mortgage disaster have turned popular interest to economic principles in a way we usually see only in the wake of a stock market crash. Economics -- and more specifically, capitalism -- is hitting close to home.

The essence of capitalism is economic freedom. Practices like ill-conceived subprime lending and crippling corporate fraud are side effects of a system that revolves around the individual's right to pursue his or her financial goals without the government getting involved. Capitalism's key early thinker, Scottish political economist Adam Smith, may have wanted economics separat­ed from politics for its own good, but economics is nonetheless entwined with ideas about the individual's place in society. This connection has politics written all over it (witness the shouts of "Die capitalist pigs" heard around the world).

­There are really only two basic approaches to a modern (non-barter-based) economic system, although you'll find endless variations on these two approaches throughout the world. One type of economy is the free market economy. That's capitalism. The other is the planned economy, which some people call a command economy or a Marxist economy.

In this article, we'll explore capitalism: its roots, principles and effects, benefits and shortcomings. We'll find out how capitalism compares to the alternative method of doing business. Incidentally, the United States doesn't actually practice capitalism. No one does these days.