Capitalism is the free market economic system based on the work ethic, private ownership, innovation and entrepreneurship. The investment of capital, and production, distribution, income, and prices are determined not by government (as in socialism) but through the operation of a competitive market where decisions are voluntary and private rather than regulated and mandated by government (see, e.g., the law of supply and demand).
One self-regulating feature of capitalism is competition, which helps maintain fair market value for goods and services. However, unrestrained or pure capitalism may sometimes create a positive feedback loop in which a small number of individual accumulations of capital grow ever larger, eventually becoming so few as to limit effective competition, thus ceasing to strictly be free-market capitalism. In this regard, pure capitalism is unstable. Modern political systems have developed regulation mechanisms in an attempt to render capitalism more stable, including anti-trust regulation, trade tariffs, etc.
Since the fall of communism, and the advent of information technology, capitalism is becoming increasingly widespread.
Adam Smith described the operation of capital accumulation through the productive powers of labor as such,
|“||Whatever a person saves from his revenue he adds to his capital, and either employs it himself in maintaining an additional number of productive hands, or enables some other person to do so, by lending it to him for an interest, that is, for a share of the profits. As the capital of an individual can be increased only by what he saves from his annual revenue or his annual gains, so the capital of a society, which is the same with that of all the individuals who compose it, can be increased only in the same manner.||”|
Smith goes on to describe how the productive powers of labor employed by the owner of a capital allow laborers to reproduce with a profit the value of their maintenance, over and above their own consumption, which then allows for an additional set of hands to be employed. Smith observes labor is the original purchase price for all the wealth of the world,
|“||The real price of every thing, what every thing really costs to the man who wants to acquire it, is the toil and trouble of acquiring it. What every thing is really worth to the man who has acquired it, and who wants to dispose of it or exchange it for something else, is the toil and trouble which it can save to himself, and which it can impose upon other people. What is bought with money or with goods is purchased by labour, 2 as much as what we acquire by the toil of our own body. That money or those goods indeed save us this toil. They contain the value of a certain quantity of labour which we exchange for what is supposed at the time to contain the value of an equal quantity. Labour was the first price, the original purchase-money that was paid for all things. It was not by gold or by silver, but by labour, that all the wealth of the world was originally purchased; and its value, to those who possess it, and who want to exchange it for some new productions, is precisely equal to the quantity of labour which it can enable them to purchase or command.||”|
Real wealth consists not in money, but in the things money will exchange for,
|“||In order to put industry into motion, three things are requisite; materials to work upon, tools to work with, and the wages or recompense for the sake of which the work is done. Money is neither a material to work upon, nor a tool to work with; and though the wages of the workman are commonly paid to him in money, his real revenue, like that of all other men, consists, not in money, but in the money's worth; not in the metal pieces, but in what can be got for them.||”|
Since wealth does not consist in money, gold, or silver, and labor is the original purchase price, Smith explains how the capitalist system is then put into motion, complete with natural incentives, only Smith does not use the word "capital" here to describe what is needed. Smith explains how a "store of goods", or "stock sufficient to maintain" the original capitalist entrepreneur is necessary;
|“|| When the stock which a man possesses is no more than sufficient to maintain him for a few days or a few weeks, he seldom thinks of deriving any revenue from it. He consumes it as sparingly as he can, and endeavours by his labour to acquire something which may supply its place before it be consumed altogether. His revenue is, in this case, derived from his labour only. This is the state of the greater part of the labouring poor in all countries.
But when he possesses stock sufficient to maintain him for months or years, he naturally endeavours to derive a revenue from the greater part of it; reserving only so much for his immediate consumption as may maintain him till this revenue begins to come in. His whole stock, therefore, is distinguished into two parts. That part which, he expects, is to afford him this revenue, is called his capital. The other is that which supplies his immediate consumption 
The division of labor is the necessary condition that gives rise to the productive powers of labor that allows for large scale economic growth. By "division of labor", Smith is referring to "specialization of labor", where each worker acquires specific knowledge to apply to a specific task.
|“|| In that rude state of society in which there is no division of labour, in which exchanges are seldom made, and in which every man provides everything for himself, it is not necessary that any stock should be accumulated or stored up beforehand in order to carry on the business of the society. Every man endeavours to supply by his own industry his own occasional wants as they occur. When he is hungry, he goes to the forest to hunt; when his coat is worn out, he clothes himself with the skin of the first large animal he kills: and when his hut begins to go to ruin, he repairs it, as well as he can, with the trees and the turf that are nearest it.
But when the division of labour has once been thoroughly introduced, the produce of a man's own labour can supply but a very small part of his occasional wants. The far greater part of them are supplied by the produce of other men's labour, which he purchases with the produce, or, what is the same thing, with the price of the produce of his own. But this purchase cannot be made till such time as the produce of his own labour has not only been completed, but sold. A stock of goods of different kinds, therefore, must be stored up somewhere sufficient to maintain him, and to supply him with the materials and tools of his work till such time, at least, as both these events can be brought about.
As the accumulation of stock must, in the nature of things, be previous to the division of labour, ...in order to give constant employment to an equal number of workmen, an equal stock of provisions, and a greater stock of materials and tools than what would have been necessary in a ruder state of things, must be accumulated beforehand.
|“||When the division of labour has been once thoroughly established, it is but a very small part of a man's wants which the produce of his own labour can supply. He supplies the far greater part of them by exchanging that surplus part of the produce of his own labour, which is over and above his own consumption, for such parts of the produce of other men's labour as he has occasion for. Every man thus lives by exchanging, or becomes in some measure a merchant, and the society itself grows to be what is properly a commercial society.||”|
Capitalism and Society
Historically, capitalism has fostered freedom and an increase in the standard of living and human rights, and vice versa. Societies that have tried non-capitalist systems inevitably fall into tyranny.
For example, Venezuela, while not a perfect country before Hugo Chavez, had freedom and wealth unprecedented in its history. As Chavez has nationalized industries, he has also centralized power for himself, becoming a dictator.
Capitalist societies also generally have higher standards of living compared to their non-capitalist counterparts in terms of per capita GDP, education, healthcare, and poverty rates. China, for instance, has been growing extremely prosperous since it began opening its economy to capitalism in the 1980s.
However, some capitalist societies also have seen progressively larger gaps between the upper and middle classes develop, such as the United States where the top twenty percent owned eighty-seven percent of the financial wealth and eighty percent of the total wealth, despite having the largest GDP in the world.
Thanks to Capitalism, billions of people have been able to pull themselves out of poverty. Capitalism has lead to the greatest reduction in human misery. As capitalism provides more opportunities to people, as research has shown that when people earn their way out of poverty it is much more empowering and enduring than being supported by the government.
“Historical evidence speaks with a single voice on the relation between political freedom and a free market. I know of no example in time or place of a society that has been marked by a large measure of political freedom, and that has not also used something comparable to a free market to organize the bulk of economic activity.”
"Underlying most arguments against the free market is a lack of belief in freedom itself." --Milton Friedman, Capitalism and Freedom, 1962.
"If an exchange between two parties is voluntary, it will not take place unless both believe they will benefit from it. Most economic fallacies derive from the neglect of this simple insight, from the tendency to assume that there is a fixed pie, that one party can gain only at the expense of another."
--Milton Friedman, Free to Choose
“Capitalism is essentially the economic system of poor people. That’s what allowed the people that came from humble origins of the world to have economic rights the way only nobility and the high bourgeoisie had it before. So capitalism is essentially a tool for poor people to prosper.”—Hernando de Soto, PBS Interview, March 30–31, 2001
(cf: Values - Free Enterprise)
"The only real cure for poverty is production". Henry Hazlitt, from Man vs. the Welfare State.
"The first condition for the establishment of perpetual peace is the general adoption of the principles of laissez-faire capitalism."—Ludwig von Mises, The Ultimate Foundation of Economic Science
"There are two methods, or means, and only two, whereby man's needs and desires can be satisfied. One is the production and exchange of wealth; this is the economic means. The other is the uncompensated appropriation of wealth produced by others; this is the political means."—Albert Jay Nock, Our enemy, the State
"Businessmen are the symbol of a free society — the symbol of America."—Ayn Rand
- Adam Smith, An Inquiry into the Nature and Causes of the Wealth of Nations, Book II, Chapter 3, Paragraph 15, Of the Accumulation of Capital, or of Productive and Unproductive Labour, First Edition 1776.
- Adam Smith, Wealth of Nations, Book II, Chapter 3, Paragraph 22.
- 'Everything in the world is purchased by labour.'—Hume, 'Of Commerce,' in Political Discourses, 1752, p. 12
- Adam Smith, An Inquiry into the Nature and Causes of the Wealth of Nations, Book I, Chapter 5, Paragraph 2, Of the Real and Nominal Price of Commodities, First Edition 1776.
- Adam Smith, An Inquiry into the Nature and Causes of the Wealth of Nations, Book II, Chapter 2, Paragraph 37, Of Money Considered as a particular Branch of the General Stock of the Society, or of the Expence of Maintaining the National Capital , First Edition 1776.
- Adam Smith, An Inquiry into the Nature and Causes of the Wealth of Nations, Book II, Chapter 1, Paragraphs 1 & 2, Of the Division of Stock , First Edition 1776.
- Adam Smith, An Inquiry into the Nature and Causes of the Wealth of Nations, Book II, Introduction, Paragraphs 1, 2, & 3 Of the Nature, Accumulation, and Employment of Stock,, First Edition 1776.
- Adam Smith, An Inquiry into the Nature and Causes of the Wealth of Nations, Book I, Chapter 4, Paragraphs 1 Of the Origin and Use of Money, First Edition 1776.