An economy uses the factors of production, such as land, labor, and capital, to produce goods and services. In a command economy, the government decides what products and services will be produced. In a capitalist society, the availability of goods and services is determined by the market, where sellers sell their product or service to buyers who are willing to pay their price. Although command and capitalist economies have much in common, the major difference between them, and why capitalist economies are much more efficient, is that the people in a capitalist society have freedom:
- the freedom to buy or sell whatever they choose;
- the freedom to own the factors of production so that they can produce what they want; and
- the freedom to work for whomever they want doing whatever they want.
People always work in their self-interest, both in capitalist and command economies. Under a capitalist economy, people work to maximize their wealth, either by selling their labor to the highest bidder or by earning profits through the creation of a business. When people maximize their wealth, they maximize the wealth of the entire economy, since they will earn the highest wages or the highest profits by providing what society wants, which economists call the efficient allocation of resources.
Under a command economy, people do not have the right to own the factors of production, since the allocation of resources is determined by the government. Even wages and some jobs are determined by the government. Promotion in a command economy often depends on political connections rather than on one's ability to either work or to manage a business. Therefore, since people have limited freedom, they pursue their self-interest by taking advantage of the economy in any way that they can, such as by stealing, and by satisfying the needs of their local leaders, who, in turn, must satisfy the needs of their superiors. Corruption is often much more rampant in a command economy because it is often the only way to maximize one's wealth. This, in turn, undermines the economy as a whole, which is why communist countries are far less productive in their use of resources. This explains why people had to wait in long lines for consumer staples in communist Russia, while the Communists allocated most of the factors of production to the military for the aggrandizement of the leaders. Even though Russia is a major military power, it is an economic midget, with a GDP lower than little South Korea. (Since Russia measures its own GDP, even that low figure may not be reliable, since there have been reports that the GDP of Russia and other corrupt nations are inflated by their leaders.) There is no incentive to work hard in the interest of society, because the rewards are often determined by the higher ups, not by one's ability to efficiently produce a desirable product or service.
Competition requires independently acting sellers and buyers in any market, where no one has the ability to set prices. Competition also requires that buyers and sellers are able to enter or leave markets freely. A freely competitive market limits the economic power of any one buyer or seller.
One of the greatest advantages of a free market system is that it promotes competition. Competition allows efficient businesses to prosper and inefficient businesses to go out of business. Business owners must be effective at managing their business and must also learn the best ways to produce a product or service. This often leads to innovation, where a business may learn a new method of producing a product or service more cost effectively.
Because businesses must compete for the best resources to be an efficient producer, they must offer the highest wages to workers best able to do the jobs required by the business. Therefore, the workers themselves will be able to earn the highest wages by doing what they do best, since that is the way that they can win and keep their job from the competition of other job applicants.
Since businesses seek to earn the highest profits, they must not only provide society with what it wants most, but also with the greatest efficiency — otherwise more efficient businesses will increase their market share at the expense of the inefficient businesses.
The allocation of products and services in a free market system is determined by the desire of the people. Businesses that are most successful at using the factors of production to produce these products or services at minimum cost will be most successful. What the market wants is measured by the amount of money that people are willing to pay for a product or service.
Money serves as a unit of account, which provides information about which products and services are most desirable, since they will command a price high enough for the seller to earn a profit. Money also allows sellers to determine their cost of business and how much profit they are earning. Products and services that produce the highest profits will be the ones that are supplied.
Right of Private Property
The right of private property is central to any capitalist economy. It not only allows people and businesses to own the factors of production so that they can be efficiently allocated, but it also incentivizes people to work, since it will often lead to more money which can be used to buy more property. People will also maintain and improve their properties, since it increases the value to them, and will command a higher price when they sell their property. In a command economy, where the government owns most of the property, the people have little interest in maintaining or improving it.
Division of Labor
Money is used as a medium of exchange, which facilitates trade. Trading allows an economy to benefit from the division of labor, where each worker works on a specific task.
A division of labor greatly improves productivity. Since individuals differ considerably in their abilities, a division of labor allows people to specialize in what they do best, instead of having to produce everything they need to survive. Furthermore, doing the same thing every day improves their skills.
Specialization also saves time because workers can use the best tools to do their specific job, they can stay focused at the task on hand, and they can stay in one location. No time is wasted going from one task to another.
Factors of production — especially land, climate, and mineral resources — vary geographically in quantity, ease of access, pricing, and quality. Therefore, as is true for businesses and individuals, economies work best that specialize in the production of those goods and services for which it has a comparative advantage. For instance, different agricultural products can be grown with differing levels of efficiencies throughout the world, since different crops require different climates, rainfall, and different types of soil. So if farms in one country must use irrigation to produces crops, then they will be at a serious disadvantage in the international agricultural market to farms in countries where adequate rainfall eliminates the need for irrigation.
Hence, individuals, businesses, and economies will be more successful if they produce products or services where they have a comparative advantage, which, of course, promotes the most efficient allocation of scarce resources.