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Capitalism is a type of economic system based on the private ownership and control of the factors of production—natural resources, human resources, capital goods, and entrepreneurship. In a capitalist economy the private sector, individuals and firms, are mainly responsible for answering the basic economic questions of what, how, and for whom to produce. Over the past several centuries the institutions and practices of capitalism have evolved. Capitalism is often referred to as the free enterprise system to emphasize the importance of marketplace freedoms.

Origins of Capitalism

The roots of capitalism date back to the twelfth and thirteenth centuries when European trading cities such as Florence and Ghent spearheaded lively trade in the Mediterranean region—the first serious challenge to Europe's parochial feudal system, a type of command economy. Over the next few centuries capitalism gradually expanded to regions in western and northern Europe, fed by the growth of international trade, industrialization, and changes in people's views.

The dramatic increase in international trade began with the rise of a merchant class in trading cities such as Venice and Florence in Italy, Bruges and Antwerp in Flanders, and London in England during the twelfth and thirteenth centuries. From the sixteenth century to the eighteenth century, the mercantilists gained a foothold in some powerful European countries, and had forged alliances with monarchs. These alliances resulted in an aggressive competition among the great powers to exploit profitable overseas markets and expand colonial empires. The economic goal was to achieve a favorable balance of trade and treasuries full of specie—gold and silver. At the same time these actions strengthened certain pillars of capitalism such as private property rights, profit incentives, and competitive markets.

A second factor that supported a rise in capitalism was the Industrial Revolution. The Industrial Revolution favored mechanized production over hand labor in the eighteenth and nineteenth centuries. The Industrial Revolution was born in England during the 1700s and soon spread to Germany, the United States, and other countries. The Industrial Revolution encouraged the rise of large corporations in the industrialized countries. These corporations, which were owned by stockholders, developed new technologies and created business opportunities for aspiring entrepreneurs. The industrialists also forged alliances with monarchs and received guarantees that basic capitalist principles would be protected—especially legal protections for private property and profits.

A third support for capitalism was a change in some people's worldview. One important change was rooted in the Protestant Reformation, which swept across large segments of northern and western Europe during the sixteenth and seventeen centuries. Embedded in this change were the economic virtues of hard work, individual initiative, thrift, productive enterprise, and economic rewards. Another shift in worldview occurred with the publication of Adam Smith's landmark book, An Inquiry into the Nature and Causes of the Wealth of Nations (1776). In The Wealth of Nations Smith extolled the benefits of a free market economy based on private sector decision making and the pursuit of one's own “self-interest.” These views popularized the concept of laissez-faire capitalism, which rejected most types of government intervention in the economy.

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