The Basics of Capitalism for the GED Social Studies Test

By Achim K. Krull, Murray Shukyn

You should know some basics about capitalism for the GED Social Studies test. Under classic capitalism, government plays no role in the economy. Smith argues that “the invisible hand” of the market place will regulate the economy.

Ideally, capitalists produce goods to meet demand. If demand increases, increasing production to meet that demand is in the manufacturers’ self-interest. Prices respond to the demand for goods. If demand is high, prices will rise, and manufacturers will increase production. As more manufacturers enter that particular market, more goods enter the market.

As demand is satisfied and competition increases, prices will drop, and less-efficient manufacturers will leave the market. Having fewer producers will cause prices to rise again. Ideally, a balance will develop between prices and demand.

What does Adam Smith mean by “the invisible hand”?

  • (A) the hand of God

  • (B) government intervention

  • (C) the pressures of demand on prices and production

  • (D) economic regulations

Nothing in the text suggests a religious explanation, so Choice (A) is wrong. The text suggests that government plays no role in the economy, so Choices (B) and (D) are also wrong. The only answer the text supports is Choice (C), the pressures of demand on prices and production.

However, Smith wasn’t blind to the rapacious effects of unbridled capitalism:

In regards to the price of commodities, the rise of wages operates as simple interest does, the rise of profit operates like compound interest… . Our merchants and masters complain much of the bad effects of high wages in raising the price and lessening the sale of goods. They say nothing concerning the bad effects of high profits. They are silent with regard to the pernicious effects of their own gains. They complain only of those of other people.

What suggests that Smith left open the door to ideas of market regulations?

  • (A) Nothing in the text supports that statement.

  • (B) statements about merchants complaining about high wages

  • (C) statements about the bad effects of high profits

  • (D) complaints about government intervention

Choice (A) is wrong because Smith does in fact raise concerns. The text suggests Choice (B), but that choice doesn’t answer the question. Choice (D) isn’t supported by the text. Choice (C) is the correct answer; Smith states merchants never talk about the bad effects of high profits and are silent about the pernicious effects of their own gains.

Laissez-faire capitalism is an extreme version of capitalism whose proponents argue that the state should never interfere in any way with the economy. They want no government regulation of any kind, no minimum wages, no laws to prevent monopolies or price fixing, and no unions or any other restrictions.

Although the United States and many other democracies operate with a version of capitalism, none have totally unfettered capitalism. Government regulations of various kinds, including safety and human rights laws, environmental, and anticollusion laws, govern business operations and transactions to varying degrees.

There are no truly laissez-faire economies to date, not even the United States. All capitalist countries, including the United States, regulate banking and business, set minimum wages, and provide state-backed insurance and pensions. At what point these regulations become socialism is an open debate.