Modern economic systems
II] Capitalism:-

1. This system makes greater use of capital in the process of production and therefore it is known as capitalism.

2. It is also known as the “Laisser Faire Economy” i.e. a completely free economy where there is no government interference.

3. It is one of the most natural, automatic and logical mechanism to solve economic problems (i.e. the price or market mechanism). it exists in most of the countries in some form or another.

4. Classical economists like Adam Smith believe that the invisible hand of price mechanism or market mechanism brings about the maximum and economical allocation of resources.

5. The price mechanism guides all the economic activities.  Each individual has unlimited wants and needs a large number of goods and services for his satisfaction.  He cannot produce all these and therefore we see different people, farmers, industrialists, doctors, lawyers – providing different goods and services – food grains, commodities, medicine, advice etc. This has led to specialisation or division of work.

A price has to be paid or received for every good and service bought or sold respectively.

Therefore price received is a gain and price paid is a sacrifice.  Both gain and sacrifice are estimated in terms of money or price and therefore it is known as price mechanism.

6. Price mechanism is a continuous process, to maximise satisfaction.

Consumers generally demand goods and services with low prices and to maximise profits producers generally supply goods with higher prices.

As more goods are demanded prices will rise and as more goods are supplied, prices will fall therefore changes in demand and supply bring about changes in prices which imply changes in gains and sacrifices resulting into economic decisions about production and consumption and therefore price mechanism is known as the invisible hand.

Features of capitalism:-

1. There is no centralised planning.

2. There exists an institution of private property.  A person can hold private property and increase his private property and earn income from his private property.

3. There exists private ownership of resources, individuals or economic units (i.e. households and firms) can own all the factors of production.

4. Consumers have full freedom of what to consume. There is an assertion of self interest by the consumers. The government has no control over the consumer’s consumption expenditure and therefore there exists consumer’s sovereignty.

5. Consumers decide their consumption on the basis of their scale of preferences and the prices in the market. This guides the producer’s decisions of production.

6. The consumers also have the freedom to save and invest as they decide.

7. There exists the institution of private enterprise, and the producers have full freedom to decide what to produce and take other production decision.

8. Producers are free to save and invest as they like.

9. There is free competition in production i.e. new producers can enter the production process, existing producers can close their units.

Each producer will try to “capture the market” therefore every producer is alert and induced to bring about innovations changes, improvements in his methods of production so that he maximises his profits.

10. Production is profit motivated instead of being guided by customs, traditions and plans.

11. Producers select those methods of production which are the most efficient i.e. it minimises costs that are determined by the price mechanism.

12. Since producers try to minimise costs and maximise profits, production is undertaken for sale in the markets or production is market oriented.

13. The mutual competition among buyers will push up the voices and mutual competition among the sellers will push down the prices till the prices reach equilibrium.

14. In such a system there is perfect mobility of all the factors of production between various regions and different occupations.

15. Each factor of production will move towards getting maximum gains. So also labour and therefore labour has freedom of choice and occupation labour also can save and invest as it likes.

16. All the individual economic units, household firms etc. can autonomously enter exchange relationships on mutually acceptable terms.

17. While entering into exchange relations the guiding force is the relative products prices and factor prices which are solely influenced by the freely operating forces of demand and supply as the freely fluctuating market mechanism.

18. The consumers are willing to pay for the commodities on the basis of the urgency of their want and therefore the commodities preferred by them fetch a high price in the market leading to profits of the producers.

The producers will therefore divert the resources to the production of commodities preferred by the consumers (e.g. if consumers prefer wheat to rice resources will be re-allocated from production of rice to wheat and therefore prices and production of wheat will increase e.g. If consumers prefer synthetic fiber to natural fiber, there will be an increase in resources allocated for production of synthetic fiber therefore there will be a rise in production and prices of it).

19. Price mechanism therefore provides a link between consumers (for whom production takes place) and producers (who decide what to produce) because it takes into account the needs and preferences of the consumer as the production of goods and services is for the consumers satisfaction.

20. The price mechanism or market mechanism ensures proper or the most efficient allocation of resources based on desires and preferences of the consumer. It also allocates resources efficiently as each economic unit aims at maximising returns.

21. Functions of price mechanism — Price mechanism therefore is a

a) Coordinating device with internal consistency and an optimising instrument without any central direction.

b) Ensures optimum allocation of the community’s resources.

c) Guides all economic activity.

d) Harmonises conflicting inters of the buyers and sellers

e) Efficient allocation of work force as each gets a job to which he is best suited.

f) Curbs consumption to promote savings for economic growth or when a shortage is feared. A rise in price achieves this objective.

22. Money plays an active role and it is used for all transactions.

23. A stable and well organised government is necessary for the working of the price mechanism since it has to ensure an adequate supply of money and see that all the contracts and agreements are properly obeyed.

24. Merits:-

a) Economic liberty

b) Right to private property/wealth.

c) Freedom of choice – consumers, producers and labourers.

d) Encouragement to private enterprise

e) Protects the individuals self interest

f) Effective price mechanism i.e. optimum allocation of resources, incentive to work and produce,

g) Efficient production,

h) Competition

25. Demerits:-

a) Gives rise to inequalities in the distribution of income and wealth (social and economic injustice as capitalists exploit working class).

b) Emergence of monopoly.

c) Economic instability brought about by recurring economic crises.

d) Cut throat competition under monopolistic competition therefore huge wastes, particularly heavy expenditure on advertisements and competing rivals therefore it violates the very philosophy of competition and efficiency attributed to capitalism.

e) Prone to cyclical variations

f) Consumers sovereignty a myth.

g) Poverty

h) Unemployment

i) Unbalanced economic growth


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