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15.1 Basic Concepts

(A) Meaning and Importance: Capital is the second important factor of production. Whereas labor is a human agent, capital is a material agent of production. Capital is, however, a controversial factor. This is because capital is composed of a large variety of heterogeneous goods. There are no uniform units for its measurement. It is difficult to determine the productivity of capital. Leaving aside such issues we will attempt to collect useful information about this chief agent of production. It is also difficult to find an accurate definition of capital. This is because capital is not confined to any set of goods as such; capital is a function that the goods perform. In the early 20th century, the Austrian economist, Bohm Bawerk defined capital as a produced means of production. Two things are remarkable in this definition.

i) Capital is an already produced means or factor of production. Machines, factory buildings, railway wagons etc. are examples of Capital. This suggests that capital, unlike land or labor, is not a natural agent of production. Since land and labor are used to generate capital, capital is said to be a result of past land plus labor (because land and labor are spent in producing capital). Therefore capital is sometimes called dead labor or past labor.

ii) Capital is also a means of production. There are a variety of produced goods such as sugar, milk, cloth, steel, electricity etc. which may not all be capital goods. All produced goods together constitute wealth. Total wealth can be used only in one of the two ways. It can be consumed immediately for the present satisfaction of wants or part of the wealth may be saved and used in further acts of production. When it is used in the second form wealth becomes capital. This makes it clear that it is not the goods themselves which are capital but it is the use of these goods that makes it capital. In this sense, capital refers to a function of goods rather than the goods per se.

(B) Investment Savings: Capital is a valuable agent of production. It tremendously enhances productive capacity. For instance, a fisherman, who can catch 10 fish per day with his own hands, can collect 50 or more fish with the use of a net. The use of a net thus enhances the fisherman’s catch. Modern machines play a similar role by enhancing productive efficiency in ever increasing proportions. This requires careful development of the supply of capital. The whole process is called capital formation. It begins with the act of saving. Right from the days of Adam Smith (1776) economists have recognized the importance of savings. They have often called it thrift. In order to make capital goods available, society must protect or set aside part of the wealth from being presently consumed. Since in modern times economic activities are carried out in money or currency units part of the income is to be saved. Such individual savings are collected by banks and other financial agencies. These collective savings are passed on to businessmen for the purpose of investment. The investors make use of borrowed savings either to purchase or construct new capital goods. Finally, such goods are used in productive activity. The entire process makes up for capital formation activity. Any flaw or delay in the process reduces final outcome of capital goods.

(C) Types of Capital: Capital is a functional concept and is not restricted to a specific set of goods. Therefore a variety of goods and services assumes the role of capital.

i) In the first place, there is physical capital and financial capital. All material agents of production such as plants and machinery, tools and equipment, power or energy resources, transport vehicles, etc. are physical forms of capital. When all economic activities are widely monetized there is an equivalent stream of financial or monetary capital. This takes a variety of forms. Financial investments can be made in time deposits of commercial banks or through purchase of bonds, shares, debentures (loan certificates), purchase of government securities, etc. All such investments are together known as portfolio investments. Share capital of companies or corporations is called equity investment. Households undertake such investment with a view to earn attractive interest or dividend income. Paper investment by itself must not be regarded as the final generation of capital goods. It is merely a step in that direction. Complete paper investment may not necessarily get converted into physical capital. Still it is an important part of the process of capital formation.

ii) A useful distinction is also made between physical capital and human capital. Just as investment is made in physical goods to enhance their productive capacity similar investment can be made in human beings to promote their efficiency. Over the past few decades the role of human capital has been specially emphasized. Prof. Schultz defines investment thus: Any expenditure on the upkeep and development of the physical and spiritual qualities of human members of society is called investment. It performs a similar function of improving future productive resources of society. It is also suggested that human capital and investment activity is superior and in the long run produces permanent gain to a greater extent. Health, education, nutrition, training, etc. are the types of facilities contributing to human capital development. The whole process is known as Human Resource Development (HRD) activity.

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15.1 - Basic Concepts
15.2 - Productivity of Capital
15.3 - Market Rate of Interest
15.4 - Investment Decisions

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