A capital good is a good used to produce other goods or services.
Capital is one of the factors of production. The other factors of production are entrepreneurial talent, labor, and land. Companies use all of the factors of production when providing a good or service. Economists separate capital into capital goods and financial (investment) capital. Capital goods include the machinery, land, or tools used to produce and distribute 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, which increases his income. Productivity is the output achieved per unit of input over a defined period. Before 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 yards per week.
Sometimes, a good can be a consumer good or a capital good. Its categorization depends on its use. For example, when a builder uses a pick-up truck to transport material to construct homes, the truck is a capital good. But 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 making such large investments. This commitment is why economists use capital spending as a leading economic indicator. Such investments can be a significant barrier to entry because they discourage other companies from entering an industry.
The recent improvement in robotics technology has replaced workers, causing many companies to consider whether investing in capital goods or labor is more efficient. For example, Philips Electronics employs one-tenth the number of workers at a plant in the Netherlands as 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 using robots to maintain production at 10,000 items. This improvement 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 purchasing robots (10,000 items per day divided by ten workers). Productivity gains in 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, published in The New York Times on August 19, 2012, to learn more about the impact of robots in replacing human workers.
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 leadership that elects to hoard money, buy food, and build 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 improves a nation’s productivity and pushes out its production possibility frontier, as illustrated in graphs 1 and 2 below.