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A common question, often asked by students studying the subject, is: What is capitalism? This can be a very complicated question, especially when one considers that there is more than one kind of capitalism. For this reason, an understanding of the basics of the market economy is essential before moving forward. The basic assumption of capitalism, of course, is that businessmen are the sole actors in any marketplace, with the government acting on their behalf to support their interests.

Of course, in a complex system such as capitalism, much more than meets the eye may be going on beneath the surface. While the businessman generally is the central actor, in some systems the government or the market can play a more active role. In some instances, for instance, it has been noted that large corporations have sought government intervention in order to protect themselves from foreign competition. More commonly, however, they seek support from the state for important services such as roads, bridges, and health care.

There are several theories about how the market operates. One prominent version of the standard economic model holds that it is a self-stabilizing, self-correcting, and competitive economy. The basic assumption here is that competition drives up prices and reduces the supply of goods, causing demand equilibrium (the level of goods that can be supplied at any time to meet demand) to be reached. This is why there is a long term tendency for economies to follow a “consolidating” pattern, with output becoming more balanced as it grows. According to this view, capitalism is inherently stable because it tends toward self-correction.

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Another model, called the “markets thinking” theory, assumes that the real functioning of the economy occurs in a competitive environment where consumers can exercise their freedom of choice in setting the price they pay for a particular good. In this economic system, consumers set market prices for different goods. For example, when consumers decide to purchase a new car, they do so because they believe that they can get a better deal by purchasing a new car than they would by purchasing an old or refurbished car. According to this school of thought, the presence of a free market increases accountability and enables people to be more self-aware of the risks and rewards they face by engaging in economic activity.

The “efficiency” school of thought, by contrast, believes that people will not be as economically motivated to make purchases if they do not perceive themselves as being financially constrained. For this reason, the theory goes, consumers will tend to buy when they are offered a bargain, rather than shop when markets are tight. A related concept, called the “utility principle,” also suggests that people will be more efficiently employed when companies or businesses to maximize the return on their invested capital. It therefore follows that capitalism is an economic system where the firm with the best resources–in other words, the ability to invest sufficiently in raw materials and capital assets–will be the most successful.

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Another branch of economic thought, called “pragmaticism,” looks at economic activity as occurring in response to the public's expectations of that activity. If those expectations are unreasonable, then public opinion will be misinformed. Paradoxically, then, the opposite is also true. In an economy where people believe that they are getting a good deal, if the deal is not actually good, consumers may well not be motivated to spend money. This school of thought is very similar to the utilitarian view of the market, which holds that consumers act in their self-interest, but that it is not the central economic concern of the public to maximize the level of spending.

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