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Socialism vs. Capitalism

Two opposing schools of economic thought

What is Socialism vs. Capitalism?

In an economy, socialism vs. capitalism represent opposing schools of thought, and their central arguments touch on the role of government in the economy and economic equality among the citizens. Capitalists believe that the government is better off when the free market determines who wins and who loses.

 

Socialism vs Capitalism

 

On the other hand, socialists believe that the government is responsible for ensuring economic equality by introducing programs that benefit the poor such as free education, higher taxes for the rich, and subsidized healthcare systems. In a capitalist economic system, the work of managing resources is left to the private enterprises, and the free market is allowed to dictate the product prices.

The socialism vs. capitalism issue remains a sensitive matter today, particularly the extent of the government’s role in the conduct of a country’s economic affairs.

 

What is Socialism?

In socialist economies, the government owns and manages the economic resources such as money and other forms of capital. The citizens of the country work to generate wealth, which is then distributed to everyone. It is characterized by worker’s self-management of the means of production and is based on the premise that what is good for one citizen is good for all of them.

Everything that the people produce is a social product, and it is distributed to all citizens that participated in the production process. The government manages the education and healthcare systems, and the citizens pay for the resources through higher taxes.

 

How socialism works

A socialist economy ensures that the basic needs of the people are met. The basic needs include things like shelter, education, healthcare, economic security, etc. The government, as the entity managing the resources, can engage in the production of products or services that the people need even if it does not result in a profit to the government.

Even though few countries prefer socialism vs. capitalism, the former does come with some shortcomings. For example, when the government provides the basic needs of the people, the workers see fewer incentives to work hard to generate more income and wealth.

Also, when the government distributes wealth to everyone, the citizens who put more effort into the production process feel less connected to the income they generated. Looking at socialism vs. capitalism systems around the world, examples of socialist economies include the People’s Republic of China, North Korea, and Vietnam.

 

Advantages of socialism

  • The government treats the citizens as equals, and the wealth generated by employees is distributed equally to everyone.
  • The government manages the means of production, which ensures that there is fairness in resource utilization and distribution. Private enterprises are not allowed to exploit the means of production for their personal gains.
  • It diminishes class distinctions between the poor and the rich since wealth is distributed to everyone.

 

Disadvantages of socialism

  • State ownership of resources leads to inefficiencies since workers lack incentives to work hard and cut on costs of production.

 

Regulated vs. Free Market

 

What is Capitalism?

Capitalism is an economic system where private corporations own and operate the means of production for a profit. The owners of the wealth and properties in the economy make the decisions on how the resources will be utilized, while the prices of goods and services are determined by the competition in the free market economy.

Unlike in a socialist economy, the government exerts minimal control over what the private enterprises produce, when the product is produced, and the quantity to produce. The only role that the government plays in a capitalistic market is to enforce laws and regulations with the aim of creating a level playing field for businesses to operate.

 

How capitalism works

Private enterprises own the means of production, and they operate them for a profit. They incur costs in manufacturing commodities that are sold in the market at a higher price than the cost of production. The income they earn from the business allows them to purchase new raw materials, pay operational expenses and salaries, and still retain some earnings for reinvestment and expansion.

For large corporations, the management assumes the greater role of maximizing the shareholder value by investing in portfolios that earn the investors a high return on their investments. Corporations in capitalist economies are also treated the same way as individuals, and they can perform the same activities such as trading and suing as individuals. Also, capitalism gives businesses more incentives to work hard since they enjoy all the profits and wealth they generate from the economy.

 

Advantages of capitalism

  • Consumers enjoy a wider choice of products and services to choose from since this system allows firms to compete with other companies in the economy.
  • Businesses are given a greater incentive to work hard since they get to enjoy the profits they generate by using the means of production.
  • Greater market efficiencies since businesses are encouraged to find innovative ways of cutting on costs while retaining the quality of products.

 

Disadvantages of capitalism

  • Class distinction between the rich and the poor. The rich enjoy all the profits generated by the business while the poor are paid salaries and wages for working for the rich.
  • It allows firms to create monopolies in the supply of products or services. The monopolies can abuse their powers by charging higher prices at the expense of the consumer.

 

More resources

CFI is the official provider of the Financial Modeling and Valuation Analyst (FMVA)™ certification program, designed to transform anyone into a world-class financial analyst. To keep learning and developing your knowledge of financial analysis, we highly recommend the additional resources below

  • Demand Curve
  • Normative Economics
  • Oligopoly
  • Reaganomics

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