A:

When economists refer to capital, they usually mean the physical tools, plants and equipment that allow for increased work productivity. Capital comprises one of the four major factors of production, the others being land, labor and entrepreneurship. Common examples of capital include hammers, tractors, assembly belts, computers, trucks and railroads. The word "capitalist" refers to the owners of economic capital. During the onset of the Industrial Revolution, mass-producing capitalists started to become dominant employers. To paint those who owned factories as the "bad guys," early socialists created the term capitalist as an expression of derision. Economic capital is distinguished from financial capital, which includes the debt and equity accumulated by businesses to operate and expand.

The Economic Role of Capital

Capital is unlike land or labor in that it is artificial; it must be created by human hands and designed for human purpose. This means time has to be invested into capital before it can be useful. For example, the fisherman who fashions himself a rod must first divert time from other activities to do so.

In this sense, capital goods are the foundation of human civilization. Buildings need to be built, tools crafted and processes improved. By increasing productivity through improved capital equipment, more goods can be produced and the standard of living can rise.

Goods vs. Money

Ever-improving capital is important because of what follows it: cheaper and more bounteous goods. Note that money is not included among the factors of production. While money facilitates trade and stores value very effectively, individuals cannot eat, wear or be sheltered by their bank account balances. The ultimate aim of economic activity, work and trade, is to acquire goods, not money. Money is a means to afford goods. Better capital goods allow people to travel farther, communicate faster, eat better foods and save enough time from labor to enjoy leisure. Many countries have printed and inflated their way into poverty by losing focus on savings, investment and capital equipment in favor of money.

Capital Goods Production Process

Before a factory can be built or a car manufactured, someone must have saved enough resources to be able to survive the production process. This involves forgoing present consumption in favor of greater future consumption.

Every capital production process starts with savings. Savings help by generating investments. Investments eventually lead to finished goods and services. Traditionally, it is the role of the capitalist to first save and then assume risk by employing people in production processes before revenue is generated with finished goods. All of the factors of production interact with one another. Natural resources are transformed into capital goods by human labor and subjected to market risk through entrepreneurial activity.

Each factor of production is able to contribute to production processes and earn an income based on its use. The income for land is usually called rent. Labor receives wages. Employed capital goods and equipment receive interest, normally through their investment. Successful entrepreneurs receive profits. (For related reading, see: Why are the factors of production important to economic growth?)

RELATED FAQS
  1. Why are the factors of production important to economic growth?

    Find out why the factors of production are critical for real economic growth, where wages rise and consumer goods costs fall ... Read Answer >>
  2. What is the relationship between human capital and economic growth?

    Learn what human capital and economic growth are, how human capital is related to economic growth and see examples of the ... Read Answer >>
  3. What are the most important aspects of a capitalist system?

    Understand the main aspects of a capitalist system and how they contrast with the tenets of other types of economic systems, ... Read Answer >>
  4. What role does the government play in capitalism?

    Take a deeper look at the role of government in a capitalist economic system and about competing ideas about the proper amount ... Read Answer >>
  5. How is working capital different from fixed capital?

    Understand the differences between working capital and fixed capital, including definitions and examples of how businesses ... Read Answer >>
  6. The differences between capitalism and socialism

    One promotes free market conditions, the other incorporates elements of centralized economic planning. Read more to learn ... Read Answer >>
Related Articles
  1. Investing

    How Human Capital Can Affect You Financial

    Understand how human capital assists in capturing the entirety of an investor’s unique risks, returns and constraints is your best asset as you get older.
  2. Insights

    Main Characteristics of Capitalist Economies

    Commerce is based on the principles of capitalism, but there are few, if any, examples of pure capitalism except in theory.
  3. Small Business

    Explaining Cost Of Capital

    Cost of capital is the cost of funds used to finance a business.
  4. Investing

    Financial markets: Capital vs. Money Markets

    There are several key differences between capital markets and money markets as components of financial markets. Check out the similarities and differences between the two markets.
  5. Insights

    Pros and Cons of Capitalist vs Socialist Economies

    Capitalism relies on the markets. Socialism, on government planning. Each system has its pros and cons.
  6. Investing

    Your Human Capital Might Be Your Greatest Asset

    When allocating your assets, don't forget one of your most valuable assets - human capital.
  7. Investing

    Ares Capital (ARCC) to Buy Rival for $3.4 bln (ARCC, ACAS)

    Private equity firm Ares Capital inks deal to acquire smaller rival American Capital for $3.4 bln in stock and cash.
  8. Investing

    Advantages of Maintaining Low Working Capital

    Understand the benefits and advantages of maintaining low working capital as related to liquidity needs, capital allocation and operational efficiency.
  9. Investing

    Calculating Days Working Capital

    A company’s days working capital ratio shows how many days it takes to convert working capital into revenue.
RELATED TERMS
  1. Capitalism

    Capitalism is an economic system whereby capital goods are owned ...
  2. Physical Capital

    Physical capital is one of the three main factors of production ...
  3. Productivity

    Productivity measures the efficiency of production in macroeconomics, ...
  4. Factors Of Production

    Factors of production is an economic term to describe the inputs ...
  5. Capital Formation

    Capital formation is a term used to describe net capital accumulation ...
  6. One-Third Rule

    A rule of thumb that estimates the change in labor productivity ...
Trading Center