How Capitalism Works

Real Capitalism: The Practice

In Smith's model, there is a natural economic order that produces the greatest good. Government interference interrupts this natural order. His theory of capitalism plays out like this:

  • There is an owner class: The means of production (capital) are owned only by the few people (capitalists) who can pay for them. Modern means of production are things like machines, factories and land.
  • There is a working class: The people (laborers) who use capital to produce goods and have no ownership of that capital. Capitalists pay the laborers with wages (money), not with the products the laborers produce. The laborers use that money to purchase the goods they want. In this way, no one who purchases goods (the consumer) has any real connection to those goods.
  • Rational calculation for profit guides production: The capitalists try to judge the market and adjust production accordingly in order to realize the greatest possible profit.
  • Society is made up of consumers: Because people are disconnected from the goods they produce, the process of buying things, not of creating things, becomes the primary way in which people define themselves.
  • The more profit the capitalists bring in, the more goods they produce. The more goods the capitalists produce, the lower the price of those goods. The lower the price of goods, the more people can afford to buy, and the higher the standard of living throughout society.

The government's only real role in capitalism is to maintain peace and order so the economy can work without interruption. This laissez-faire (anti-interference) system of economics relies on interconnected, self-regulating networks of producers, consumers and markets that operate on the principles of supply and demand.

Essentially, when more people want something, supply goes down and price goes up. When fewer people want something, supply goes up and price goes down. In the end, it's all about finding a way to turn a profit. Profit results from obtaining or producing goods for less than you sell them for. This core value of capitalism dates back thousands of years to a practice known as mercantilism. On the next page, we'll look at how capitalism may owe its very existence to the spread of Islam from the Middle East to Europe.