Features of Capitalist economics: trade and specialization, money and capital.

This article presents the three distinct features of any capitalist economy. Furthermore it explains the role of government in capitalist economies, which can be considered to be either fiscal policy or monetary policy.

Trade and specialization

• specialization occurs, when people and countries concentrate their efforts on a particular set of tasks – it permits each person and country to use its best advantage its specific skills and resources
• division of labor – dividing the production into a number of small specialized steps or tasks, this leads to division of labor and specialization which increases productivity
• Individuals and countries then voluntarily trade goods in which they specialize for others’ products. This increases the range and quantity of consumption and has the potential to raise everyone’s living standards.

Money

• is the medium of exchange; proper management of the money supply is one of the major issues for government macroeconomic policy in all countries
• specialization permits people to concentrate on particular tasks; money allows people to trade their specialized outputs

Capital

• Capital is a produced factor of production, a durable input which is itself an output of the economy
• Capital is major factor of production; land and labor also called primary factors of production; their supply is mostly determined by noneconomic factors. It is important to note that capital itself has to be produced, before using it!
• Economic activity involves forgoing current consumption to increase our capital; every time an investment is made, the future productivity and consumption is enhanced. By sacrificing current consumption, a society can push its PPF outward
• Market economy , capital is typically privately owned; income from capital goes to individuals à the ability of individuals to own and profit from capital is what gives capitalism its name!
  • Property rights define the ability of individuals or firms to own, buy, sell and use the capital goods and other property in a market economy; these rights are enforced through the legal framework

The economic role of government

1. Governments increase efficiency by promoting competition (imperfect competition, Monopolies, Market power), curbing externalities (involuntary imposition of costs and benefits on others outside an exchange relationship) and providing public goods.
   • Extreme example of positive externality is a public good
     Private provision of public goods will be insufficient; government is necessary to produce sufficient quantities
   • Public goods are commodities for which the cost of extending the service to an additional person is zero and which is impossible to exclude individuals from enjoying.
     Private goods: exclusion and competition from/in consumption
     Common good: competition but no exclusion from consumption
     Club goods (e.g. tollbridge): exclusion but no competition
     Public good: no competition no exclusion
   • Public goods are paid for by taxes; taxes are not prices, since everybody has to pay them, even if one cares about that good or not!
   • A public good is hard or impossible to produce for a private profit
2. Governments promote equity, by using tax and expenditure programs to redistribute income toward particular groups.
   à markets do not necessarily produce a fair distribution of income; it might produce inequalities in the “for whom”, that are not acceptable
   • Progressive taxation
   • Transfer payments
3. Governments foster macroeconomic stability and growth through fiscal policy and monetary regulation.
   • Fiscal policy: power to tax and the power to spend
   • Monetary policy: determining the supply of money and interest rates; these affect investment in capital goods

What is a market? Who solves the three fundamental questions?

A market is a mechanism through which buyers and sellers interact to set prices and exchange goods and services à in a market system, there are gains from trade! Through trade, one attains a good because he imposes a higher value on the good!

Prices coordinate the decisions of producers and consumers in a market. Higher prices tend to reduce consumer purchases and encourage production. Lower prices encourage consumption and discourage production. Prices are the balance wheel of the market mechanism.

Market equilibrium: At market equilibrium everybody who was willing to exchange goods has done so. Markets are steadily solving the three fundamental questions! 
--> they balance all the forces operating on the economy, markets are finding a market equilibrium of supply and demand.

How are the fundamental questions solved?

• What
  - Through the daily consumption decisions, the kind of goods and services, that will be produced is determined
  - Firms are motivated by the desire to maximize profits by producing the desired goods
• How
  - determined by the competition among the producers; best way for producers to meet price competition and maximize profits is to keep costs at a minimum by adopting the most efficient methods of production
• For whom (who is consuming and how much)
  - depends in large part on the supply and demand for the factors of production à they determine the wage rates, land rents, interest rates and profits; by adding up the all revenues a individual receives for his factors of production, one attains the persons market income

Core determinants of the shape of our economy are the dual monarchs of tastes and technology

• Tastes determine to a large extent the point on the PPF
• Technology limits the choices of the consumers to the points within and on the PPF

Adam Smiths discovery

• „by pursuing his own interest, he frequently promotes that of soceity more effectually than when he really intends to promote it“
• under limited conditions, a perfectly competitive economy is efficient
• however, there are market failures
  - Monopolies and other forms of imperfect competition
  - spillovers and externalities outside the marketplace