This section is from the "Elementary Principles of Economics" book, by Richard T. Ely and George Ray Wicker. Also available from Amazon: Elementary Principles Of Economics: Together With A Short Sketch Of Economic History
Definition. The third factor in production, the secondary or derived one, is capital. Much as hydrogen and oxygen produce water, land and labor produce capital. Itself neither land nor labor, capital is derived from the two, and is a new thing with properties of its own. In everyday speech the word " capital" is often used loosely to describe things which are technically not capital at all. Thus the word is often used to include land, because, in many respects, to the man engaged in a business enterprise there is little difference between his land and his machinery. Yet technically the two should be sharply distinguished. Again, business ability is often described as personal capital, and there is a certain sense in which this figurative expression has a value ; but it should always be remembered that such language is only figurative. Land is nature ; capital is a human product. Labor is in-dissolubly connected with the personality of the laborer ; capital is a material thing resulting from that labor. Capital as a factor of production, then, may be defined as consisting of those intermediate products which are used for the purpose of further production.
The Function of Capital. Capital is " the medium through which the two original productive powers exert their instrumentality." It includes not only all the man-made aids to production, such as buildings, machinery, and tools, but also all those unfinished goods, such as hides and bar iron, which enter into further production. These partly manufactured materials are technically spoken of as in the "process of ripening." They are to be distinguished from goods which have passed through the final stage of production, and are in the hands of consumers. Such goods are no longer capital, although from their wise use new capital may result.
The function of capital may be expressed as follows: It enables men to utilize more completely nature's materials and forces by the substitution of roundabout methods of production for direct ones; and it accomplishes this result by furnishing the tools for such roundabout methods, and by making possible a longer interval between the initial effort and the final effect, or consumption. Roundabout methods are almost without exception more efficient than direct ones, but these methods require tools or machinery and a lengthened period of production. Thus, a man may lift a heavier weight by the roundabout method of using a lever, instead of relying upon his unaided strength, since in this way he summons nature's forces to his aid. And every improvement in machinery means a more roundabout method of applying labor. Capitalistic production, therefore, as it develops, shows a continual increase in the number of steps between the initial movement and the final product, and, as a general rule, an increase in the length of the interval.1
1 The teacher must remember that it is impossible in an elementary treatise to enter into detailed explanations and qualifications of every statement and principle. The authors leave large latitude to him in this direction. Improvements sometimes seem to shorten processes, but when we go far enough back in our studies, we shall find that the rule given above is correct as a general principle and calls attention to one of the most remarkable and significant principles of capitalistic production. A threshing machine threshes grain rapidly, but to apply the above principle aright, we have to think of all the steps involved in the production of the machine and the length of the process. The roundabout methods, of course, are not an end but a means to an end.
The Origin of Capital. It is often said that capital is the result of saving, but such a statement of the case is at least misleading. Saving, as such, is a merely negative act and cannot produce a positive result. In order that we may save, we must first have something to save, that is, we must produce, and, moreover, we must produce something more than is sufficient for existence; in other words, we must have a surplus. If such a produced surplus is laid by or saved, it may become capital.
Methods of Capital Formation. Such savings do become capital when they are devoted, directly or indirectly, to furthering production. One of the simplest ways in which saved surplus may be transformed into capital would be illustrated by the case of a fisherman who should use part of the catch of one period to subsist him while in a later period he worked at a canoe, or net, or other device for increasing the product of his future labor. In advanced communities the process is usually much more complex. The farmer, for instance, who wishes a self-binder, pays for it directly with money. But the money has been received in return for a saved surplus of his farm products. Meanwhile, those who have been working on the manifold processes which result in the finished farm machine, have been subsisted out of a surplus which has been advanced to them. The case is the same with the manufacturer.
He may sell his products and consume at once the resulting means, or he may consume less than all, and with his remaining means may purchase from others the forms of capital of which he stands in need. Or, having all the machinery needed, he may invest his surplus in the stock of some company, in which case the company will use it for the purchase of needed capital. In all of these cases the use of money obscures the nature of the transaction, which is at bottom only the turning of labor from the production of finished consumption goods to the production of capital goods.
Results of the Use of Capital. It remains for us to say a few words regarding the results of the use of capital. First of all, (1) capital makes possible an increased amount of product. Things that could be produced by hand and without capital can be produced in much greater quantities when capital is present. In the second place, (2) capital makes possible certain utilities which we could not enjoy at all without it. Thus, the enjoyment of oysters and shell-fish at great distances from the coast would be impossible without the capital engaged in transportation. Finally, (3) capital makes possible in many cases a higher quality of product than could exist in its absence.
Representative Goods. One class of goods, if they may be so called, must be especially distinguished from capital in the technical sense of the word. We refer to what are known as " representative " goods, which are not, strictly speaking, goods at all, but only signs of the ownership of goods. Notes, mortgages, bonds, and stock certificates are not goods ; they simply represent ownership. Neither are franchises a part of social capital. When a city grants to a company a franchise for the construction and opera tion of a street railway, it does not thereby directly create new capital. It merely grants permission to the company to make use of existing social capital or to create social capital.
Fixed and Circulating Capital.It has been common among economists to classify capital as fixed and circulating. Circulating capital is that which can be used but once, or in one round of operations. Its entire value passes over into the value of the finished product. Fixed capital, on the other hand, is capital which lasts through a succession of operations, only a part of its value passing over into the product with each use. Thus, the raw materials and the partly finished goods used in manufacturing are examples of circulating capital, while the factory building and the machinery are fixed capital.
Free and Specialized Capital. A somewhat similar classification is that of free and specialized capital. Even more than is commonly the case with such classifications, these words must be understood as pointing only to relative ideas. Specialized capital is that which by its form or circumstances can be used for only one productive process, or at most for a very limited number of such processes. Free capital, on the other hand, is capital which can be applied to any one of a considerable number of productive operations. Thus coal, iron, and leather are relatively free forms of capital, while railways, canals, and many forms of machinery are relatively specialized. The practical importance of the difference lies in the fact that free forms of capital can more readily adjust themselves to changes in the social demand for goods. Thus, if too great an amount of a nation's capital is converted into fixed and specialized forms, into railways, for example, the mistake is not easily or quickly corrected, and the entire production of the country must suffer in consequence of the bad adjustment. Such disproportionate investment of capital in fixed and specialized forms is believed by many economists to be the most important single cause of industrial crises.
1.Of the three factors of production, land and labor are primary
and original, while capital is secondary and derived.
2.Land furnishes " standing room," fertility, and natural treasures.
3.Labor means human exertion of mind or body undergone with the object of creating utilities.
4.The efficiency of labor depends upon the efficiency of the individual laborers, and upon the efficiency of their organization.
5.Capital consists of intermediate products used for further production.
6.The formation of capital involves saving or " abstinence."
1.Mention some of the checks upon population. How does the
standard of life affect the increase of population ?
2.Why should land be distinguished from capital ? To which class do the buildings upon land belong ? The fertilizer that was used five years ago ?
3.What advantages flow from roundabout processes of production ? Mention some of the steps in the development of indirect processes in the production of wheat.
4.Distinguish between free and specialized capital; between fixed and circulating capital. What are representative goods ?
Böhm-Bawerk, E. von: Positive Theory of Capital, Bk. I, Ch, II, pp. 17-23. Clark, J. B.: The Distribution of Wealth, Ch. IX, pp. 116-123. Commons, J. R.: The Distribution of Wealth, Ch. III. One of the best discussions of the law of increasing and diminishing returns.
Marshall, A.: Principles of Economics, Bk. IV, Ch. I, § 1. Mill, J. S.: Principles of Political Economy, Bk. I, Ch. I, §§ 1-4. Smart, W.: Introduction to the Theory of Value.