Capitalism - Neoclassical Economic Theory

Neoclassical Economic Theory

Neoclassical economics explain capitalism as made up of individuals, enterprises, markets and government. According to their theories, individuals engage in a capitalist economy as consumers, laborers, and investors. As laborers, individuals may decide which jobs to prepare for, and in which markets to look for work. As investors they decide how much of their income to save and how to invest their savings. These savings, which become investments, provide much of the money that businesses need to grow.

Business firms decide what to produce and where this production should occur. They also purchase inputs (materials, labor, and capital). Businesses try to influence consumer purchase decisions through marketing and advertisement, as well as the creation of new and improved products. Driving the capitalist economy is the search for profits (revenues minus expenses). This is known as the profit motive, and it helps ensure that companies produce the goods and services that consumers desire and are able to buy. To be profitable, firms must sell a quantity of their product at a certain price to yield a profit. A business may lose money if sales fall too low or if its costs become too high. The profit motive encourages firms to operate more efficiently. By using less materials, labor or capital, a firm can cut its production costs, which can lead to increased profits.

An economy grows when the total value of goods and services produced rises. This growth requires investment in infrastructure, capital and other resources necessary in production. In a capitalist system, businesses decide when and how much they want to invest.

Income in a capitalist economy depends primarily on what skills are in demand and what skills are being supplied. Skills that are in scarce supply are worth more in the market and can attract higher incomes. Competition among workers for jobs — and among employers for skilled workers — help determine wage rates. Firms need to pay high enough wages to attract the appropriate workers; when jobs are scarce, workers may accept lower wages than they would when jobs are plentiful. Trade union and governments influence wages in capitalist systems. Unions act to represent their members in negotiations with employers over such things as wage rates and acceptable working conditions.