Capital is defined by different people in different ways. Some say it is money invested and others say it is goods used for business. In economics, it means wealth i.e. used along with land and labour for producing future wealth or additional wealth. It is a “produced means of production” therefore this definition distinguishes capital from land & labour because the latter 2 are not produced factors of production therefore they are often known as primary or orginal factors of production but since it is a produced factor of production it is not a primary or original factor of production therefore it is all man-made resources used for further production of wealth. It has all the characteristics of wealth i.e. utility, scarcity, transfer ability and external to man. In addition to this it yields an income. It consist of produced goods that are not directly used to satisfy wants therefore it is that part of mans wealth other than land which yields income.
Characteristics of capital:
1. It is a man-made factor of production – It is a product of human effort working on natural resources. In order to create capital, saving & investment is necessary. It is not a free gift of nature.
2. Capital is durable – [except for circulating capital].
Capital provides service over a period of time. e.g. A machine once produced contributes to production over a period of time. It is not permanent like land or perishable like labour.
3. Capital has derived demand – Capital goods are not desired or produced for their own sake but used for further production. It satisfies wants indirectly. Therefore it has indirect utility.
4. Capital has a limited and useful life: – Every capital asset though durable does not last forever. It gets exhausted after rise for a number of years ie it is subject to wear and tear [depreciation] in the process of production and therefore has to be replaced. Thus it has a limited life. During its life span it is useful because increases efficiency of labour, enables production and increases the quantity of output.
5. Capital has a roundabout way of production – Capital has a greater and complex use. In order to produce capital, the current consumption is curtailed or postponed and the same resources, so saved, are diverted for production of additional capital good eg machinery tools equipment etc ie human labour along with natural resource produces capital. These capital goods are then used for further production ie to produce consumer’s goods and sometimes capital goods.
6. Supply of capital is relatively elastic – Since capital is a man made factor of production its supply can be adjusted and changed according to its requirement. Therefore it has a elastic supply.
7. Capital is productive: – because it increase efficiency in production and makes large scale production possible to meet the increasing demand.
8. Specialisation of production is possible through capital- Division of labour is possible.
9. Capital is a stock: – of producer’s goods which helps to produce other goods i.e. capital is a fund or a stock of wealth whereas income is a flow of wealth.
10. Capital is prospective: – i.e. people look forward to getting income by accumulating capital.
11. Capital is not permanent: – because it depreciates over a period of time and has to be replaced.
12. Interest and dividends- is the reward or price for the use of capital.
As J. S. Mill States, “Accumulated product of past labour destined for production of future wealth is capital”.
Classification of capital:
1. On the basis of durability of capital.
a) Fixed capital: includes productive asset e.g. factories, durable producer goods which can be used again & again. It is used slowly and continuously in the process of production. They are absorbed in production of the final product over a period of time. The amount of this capital remains the same irrespective of the output and money invested in fixed capital is recovered over a period of time when goods are sold in the market.
b) Working capital: also known as circulating capital which included raw materials, semi finished goods which are used up in a simple act of production. They are directly absorbed in production of the final product. The amount of this capital varies directly with the output and money invested in circulating capital is fully recovered when goods are sold in the market.
2. On the basis of mobility of a use.
a) Sunk of specific capital : It is capital used for a specific purpose and cannot be used for any other purpose.
e. g. A blast furnace, a machine producing ice etc is a sunk capital because it cannot produce anything else. It renders a particular task in a specific industry only. It has no alternative uses. Sunk capital is usually fixed and immobile.
b) Floating capital: can be put to several or alternative uses e.g. coal, fuel, electricity, money etc. It is non-specific capital, usually it is circulating or mobile.
3. On the basis of nature of a commodity:
a) Real capital: consists of productive physical assets e.g. machinery, tools equipment raw materials means of transport etc which are acquired with the help of money capital to produce other goods and services.
b) Money capital: Value of real capital in terms of money or the purchasing capacity of money capital is real capital. It is capital invested in the forms of money capital eg money funds for investment in a business and for investment in share capital of a company ie money used for buying real resources which can be used in actual production.
4. On the basis of ownership:
a) Private or personal capital: – is the capital is owned by person or a group of person including their productive wealth e.g. productive assets, skill, talent etc.
b) Corporate capital: – is owned by a group of industries e.g. all productive assets of a joint stock companies & other corporate companies.
c) Social of Public capital: – It is the capital of the community as a whole.
e.g. Roads, railways, canals, dams etc.
d) National capital: is the total capital of the country i.e. the sum total of private & public capital without double – counting.
5. On the basis of uses of the commodity
a) Auxiliary capital: It is also known as instrumental capital because it includes those goods that are used to assist labour in production. e.g. tools, equipments, etc.
b) Consumption capital: indicates goods which gives a direct satisfaction to workers e.g. foods, clothes, residential tenants etc.
Money & capital:
Money by itself cannot produce anything. It has to be converted into productive goods therefore money is not capital. It represents a claim on goods & services produced in a community i.e. it can be converted into real capital (producer’s goods). It is therefore a real capital is a factor of production.
Money has no productivity or utility by itself. It is its purchasing power which gives it utility & productivity.
An increase in the supply of money need not necessarily increase (real capital) unless more and more real capital goods are available.
Foreign currency is capital because it can be used to get foreign goods from foreign countries.
The term capital formation in developing countries is often extended to include human capital which refers to human skills and knowledge through education, improvement of health, increase in expenditure on science and technology and training labour and therefore capital formation should include physical asset as well as human skills because the latter helps in promoting production and generating wealth and therefore capital formation includes both material and human capital.
The concept of human capital is more relevant in the developing countries where labour in uneducated, untrained, unhealthy therefore its productivity and efficiency is low. Here if the government spends money on the training & education & increase expenditure on science and technology undertakes health and hygiene improvement programmes then efficiency and productivity of human capital can be improved therefore rapid economic development becomes impossible.
Mobility of capital
Demand for capital:
1. Producer: – Demands capital to meet different types of expenses and to increase profits.
2. Consumer: – Demands capital to bridge the gap between income and expenses
e.g. higher purchase schemes, consumers demand capital to hold cash on hand to meet unforseen expenditure.
3. Government: – Demands capital to bridge the gap between income and expenses for investment in public sector and to meet unexpected expenses.
Supply of capital
1. Increase in saving: – i.e. willingness and ability to save.
2. Increase in number of financial institutions.
3. Creation of real capital.
Reward for capital is interest.
1. It is paid for the use of capital and capital can be created only through savings therefore in order to induce people to serve out of their current consumption a compensation is given to savers of capital i.e. a rate of interest is offered.
2. It is a sacrifice of present consumption in order to increase consumption in future. This future return is interest.
Gross and net interest
Normally what a person pays as interest is known as gross interest in economics because it includes.
1. An insurance against risk (loan may not be returned)
2. Reward for management (to keep an account of capital rent to remind to debtors through post or person etc.)
3. Incovenience (A loan may not be returned on time or the lender may not get it when he needs it)
4. Pure or net interest i.e. the actual interest on capital.
Therefore Gross interest = An insurance against risk + Reward for management + Pure or net interest.
Net Interest = Gross Interest – (Insurance against risk + reward for management + Inconvenience+ pure/net interest)
Differencies in Pure or Net Interest :-
It occurs because of
1. Differences due to distances.
2. Differences due to time period.
3. Differences due to amount of loan.
4. Monopoly in the money market (specially, locally)