Capital Good

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Definition of a Capital Good:

A capital good is a good used to produce other goods or services.

Detailed Explanation:

Capital is one of the factors of production, meaning it is used in the production of goods and services. The other factors of production are entrepreneurial talent, labor, and land. Capital can be broken into two categories - capital goods and financial (investment) capital. A capital good is the machinery, land, or tools used in the production and distribution of a good or service. Manufacturers use capital goods to improve productivity or increase the output per worker.

In the attached video, Chris owns a small landscaping business. He purchases a capital good (the weed eater) to improve his productivity and increase his income. Productivity is the output achieved per unit of input over a defined period of time. Prior to purchasing the weed eater, Chris served ten customers a week. The weed eater saves him 45 minutes per lawn and allows him to accept two more customers. The weed eater increases productivity by two lawns per week. 

Some goods, such as a pick-up truck, can be a consumer good or a capital good. Its categorization depends on its use. If used by a builder to transport material to construct homes, the truck is a capital good. When the truck is the household vehicle, it is a consumer good. Other examples of goods that could be either capital or consumer goods include personal computers, iPads, ovens, and microwaves. 

Purchasing capital goods can be a major investment for many businesses. Some specialized machinery may cost several million dollars. The management of these companies must be committed to future growth before committing to such large investments. This is why economists use capital spending as a leading economic indicator. Such investments can be a large barrier of entry, thereby discouraging other companies to enter an industry. 

The recent improvement in robotics technology has replaced workers, causing many companies to carefully consider whether it is more efficient to invest in capital goods or labor. For example, Philips Electronics employs one-tenth the number of workers at a plant in the Netherlands as it does in a similar plant in China. Robots have displaced humans by being more efficient. After all, robots require neither breaks nor overtime pay, resulting in improved productivity. Assume a plant has 100 workers who produce 10,000 items per day. Management reduces the labor pool to 10 workers while maintaining production at 10,000 items through the use of robotics. This is a tenfold increase in productivity because before the capital investment of robots the plant’s productivity was 100 items per worker (10,000 units divided by 100 workers). Productivity increased to 1,000 items per worker after the purchase of robots (10,000 items per day divided by 10 workers).  Productivity gains in the developed countries will offset the benefits of hiring less expensive workers in less developed countries. Fewer factories in developed countries will close. Read the attached article by Jeff Markoff that was published in The New York Times on August 19, 2012, to learn more about the impact of robots in replacing human workers.

Jeff Markoff - The New York Times

Investing in capital goods is not confined to industries. Countries may invest in capital goods to improve productivity. They may invest in improving education and infrastructure such as roads, airports, water, and sewer. A nation (and company) that invests in capital goods will expand its production possibilities frontier faster than a nation that adopts economic policies focused on producing services and consumer goods. Assume Country A has a leadership that elects to hoard money, buy food, and build large monuments honoring themselves. The leaders of Country B choose to invest in education, roads, and dams. Which country do you think will grow faster? If you said Country B, you are correct. The leadership of Country B has chosen to make capital investments. Investing in education and infrastructure improve a nation’s productivity, and pushes out its production possibility frontier, as illustrated in graphs 1 and 2 below.

Dig Deeper With These Free Lessons:

Capital and Consumer Goods – How They Influence Productivity
Factors of Production – The Required Inputs of Every Business
Production Possibility Frontier
Opportunity Costs – The Cost of Every Decision

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