Reading: Lesson 6 - Fundamentals of Capitalism

4.6.A - Fundamentals of Capitalism

1. PRIVATE PROPERTY

1. Some political-economy systems either do not permit ownership of property (communism) or may impose limitations on ownership (socialism). One of the basic features of capitalism is the right to private property, a right reserved to citizens by the Constitution. Other features include the right of each business to make a profit, to set its own prices, to compete, and to determine the wages paid to workers.
   
2. The principle of private property is essential to our capitalistic system. Private property consists of items of value that individuals have the right to own, use, and sell. Thus, individuals can control productive resources. They can own land, hire labor, and own capital goods. They can use these resources to produce goods and services. Also, individuals own the products made from their use of land, labor, and capital goods. Thus, the company that produces furniture owns the furniture it makes. The furniture company may sell its furniture, and it owns the money received from the buyer. The Guevara family owns a grocery store, the farm it purchased, and the food it produces and buys before selling it. And the family is entitled to make and keep its profits.
   
3. In a capitalist system, the incentive as well as the reward for producing goods and services is profit, which is computed by subtracting the total costs of producing the products from the total received from customers who buy them. The company making furniture, for example, has costs for land, labor, capital goods, and materials. Profit is what the furniture company has left after subtracting these costs from the amount received from selling its furniture.
   
4. The profit earned by a business is often overestimated by society. The average profit is about 5 percent of total receipts while the majority, 95 percent, represents costs. Consider a motel with yearly receipts of $500,000. If the profit amounts to 5 percent, then the owner earns $25,000; that is, $500,000 times 0.05. Costs for the year are 0.95 times $500,000, or $475,000. Some types of businesses have higher average profit percentages, but many businesses have lower profit margins or even losses. Owners, of course, try to earn a profit percentage that is better than average.
   
5. Being in business does not guarantee that a company will make a profit. Among other things, to be successful a company must produce goods or services that people want at a price they are willing to pay. Other fundamental features of capitalism deal with competition and the distribution of income.
   

2. PRICE SETTING

1. Demand for a product refers to the number of products that will be bought at a given time at a specific price point. Thus, demand is not the same as want. Wanting an expensive luxury car without having the money to buy one does not represent demand. Demand for a Mercedes is represented by the people who want it, have the money to buy it, and are willing to spend the money for it. There is a relationship between price and demand. With increased demand, prices generally rise in the short run. Later, when demand decreases, prices generally fall. For example, if a new large-screen TV suddenly becomes popular, its price may rise. However, when the TV is no longer in high demand, its price will likely drop.
   
2. The supply of a product also influences its price. Supply of a product refers to the number of like products that will be offered for sale at a given time and at a specific price point. If there is a current shortage in the supply of a product, its price will usually rise as consumers bid against one another to obtain the product. For example, if bad weather damages an apple harvest and apples are in short supply, the price of apples will go up. When apples become more abundant, their price will go down. Thus, price changes are the result of changes in both the demand for and the supply of a product.
   
3. Generally, changes in prices determine what is produced and how much is produced in our economy. Price changes indicate to businesses what is profitable or not profitable to produce. If consumers want more running shoes than are being produced, they will bid up the price of running shoes. The increase in the price makes production more profitable and provides the incentive for manufacturers to increase the production of running shoes. As the supply of the shoes increases to satisfy the demand for more shoes, the price of the shoes will fall. Because it is now less profitable to make these shoes, manufacturers will decrease their production of them.
   
4. Prices, then, are determined by the forces of supply and demand; that is, prices are the result of the decisions of individual consumers to buy products and of individual producers to make and sell products. Therefore, consumers help decide what will be produced and how much will be produced. Here is how supply and demand work in setting prices. Refer to the Figure below as you study this example of a producer planning to sell a sweatshirt. In the Figure below, the market price for the sweatshirt, $30, is shown where the supply line crosses the demand line. The market price is the price at which the producer can meet costs and make a reasonable profit. It is also the price at which consumers will buy enough of the product for the producer to make a reasonable profit. 
   

   
   

5. If demand drops, profit drops; but if demand increases, the producer’s profits may increase. If the profit gets quite large, other producers will enter into production with similar sweatshirts, which will then increase the total supply and lower the price. If the supply and demand lines never cross, the producer will not make the goods, because not enough consumers will want the product at the offered price and the profit reward disappears. If Juan Guevara grows a new type of pecan but only a small number of people buy them, he will lose money and stop growing those pecans.
   

6. In our free-enterprise system, sellers try to make a profit and buyers try to buy quality goods at the lowest possible prices. This conflict of interest between buyers and sellers is settled to the benefit of society by competition. Competition is the rivalry among sellers for consumers’ dollars. Competition in a free-enterprise system benefits society in many ways. To attract customers away from other sellers, a business must improve the quality of its products, develop new products, and operate efficiently in order to keep its prices down. Thus, competition serves to ensure that consumers will get the quality products they want at fair prices. In addition to benefiting consumers, competition benefits the country because it tends to make all businesses use our scarce productive resources efficiently. If a firm does not operate efficiently, it will fail because customers will buy lower-priced or higher-quality products from a firm that is operating efficiently. Often these competing firms are from foreign countries. Competition in our economic system also provides the chance for people to go into business for themselves and get a share of the profits being made by those already in business.
   

7. Price is one aspect of competition. Price competition occurs when a firm takes business away from its competitors by lowering prices for identical goods. Today, however, more and more competition takes place in the form of non-price competition. For example, a company attracts customers away from other sellers by providing products of better quality or by adding features to the product that competitors do not have. Or a company may attract customers away from competitors with unique and colorful product packaging. Another company may conduct an extensive advertising campaign to convince the public that its product is better than all other brands. All of these are effective devices used in non-price competition.
   

8. Competition is the opposite of monopoly. Monopoly is the existence of only one viable seller of a product. With no competition, a monopolist can charge unreasonably high prices and make extraordinary profits. For example, if a seller does not have to compete with other sellers for consumer dollars, it can usually increase profit by raising the price. Consumers have no choice. If they want that product, they must pay whatever price the monopolist sets.
   

9. Not only must all countries decide how scarce productive resources are to be used, but they must also decide how the goods produced will be divided among the people in the society. In a free-enterprise economy, the share of goods produced that an individual receives is determined by the amount of money that person has to purchase goods and services. People receive income—wages and salaries—by contributing their labor to the production of goods and services. People also receive income as interest on money that they lend to others, as rent for land or buildings that they own, and as profit if they are owners of businesses.
   

10. The amount of money an individual receives in wages or salary is determined by many factors, including an individual’s personal traits and abilities. The same factors that determine the prices of goods are also important factors in determining wages and salaries; that is, the amount of wages paid for a particular kind of labor is affected by the supply of and demand for that kind of labor. The demand is low and the supply is high for unskilled workers. Thus, the price (income) of unskilled workers is low. On the other hand, the demand for orthopedic surgeons is high in terms of the supply of orthopedic surgeons and the services they provide; therefore, their price (income) is high.