No one has trouble seeing tha production of economic goods can result from use of such inputs as labor and land (including in the latter term natural resources generally). These are often called "primary factors of production," for the reason that neither land nor (these days) labor is regarded as a result of the economic process but instead exists by virtue of physical and biological rather than economic factors.Capital, which is the word often used to refer to capital goods generally, is a rather different kind of production factor. A capital good differs from the primary factors in that it represents an input that is itself the output of the economy.
Capital goods, then, represent produced goods that can be used as factor inputs for further production, whereas labor and land are primary factor inputs not usefully thought of as being themselves produced by the economic system.
[Some qualifications will be evident. Land can sometimes be made by drainage or filling in; this is true of much of Chicago's lake front and Boston's Back Bay. Natural resources such as minerals are laid down by nature, but it may take much economic effort to locate, use, and process them. Therefore they come to have some of the properties of capital goods. Even if one abandons in the Western world a Malthusian theory of population, whereby people seem to be given a cost of production not unlike that of machines, one realizes that the process of education consists of investing in people, thereby making them more productive factors of production. When you see a medical school graduate, you are in a certain sense looking at a chunk of capital or an economic production factor that is partially capital.]
Just as wages and rent are the factor-prices of primary labor and land, the 4 or 6 or 10 per cent interest rate per annum can be usefully regarded as the factor-price that rewards and rations society's scarce supply of various capital goods and investment projects. In that an interest rate is a percentage per unit of time (per year or month or decade), it calls our attention to another way of looking at capital -a way that stresses the special relationship between capital and the passage of time.
Let us resurvey the important economic role of capital. If men had to work with their hands on barren soil, productivity and consumption would be very low indeed. But gradually over time our economic system has been able to amass a tremendous stock of instruments of production, factories and housing, goods in process, and drained and fertilized land.
Men learned very early that the simple, direct methods of production can be improved upon by using time-consuming indirect methods. We who are inside the economic system are not conscious of how roundabout productive processes have become. An outside observer would be struck with the fact that almost no one in our system seems to be producing finished goods. Almost everyone is seen to do work of a preparatory nature, with final consumption a distant future goal. The farmer spends his time in fattening hogs, the truck driver in carrying them toward the last stage of consumption. A steel worker prepares pig iron, part of which will become a hammer to build a house; another bit will become part of a pig-iron furnace, which in turn will prepare pig iron to be used in making further hammers and more pig-iron furnaces, and so forth.
Each person may be unaware of the roundabout character of production: all he has to do is to perform his own job and not worry himself as to where his output will ultimately go or whence come the raw materials to which his activity has added value. Once all the circular paths were established and activity became synchronized, even an outside observer of the system might not notice its complexity. In such a steady state each day might look like the previous one, and it might appear that the work of each day was producing the output of that same day.
Such a view is partially an optical illusion. Time was required to get the process going in the first place. Human and nonhuman resources had to be put to work for a long time before any output came from each new process. It is as of one had to charge a huge battery for some time to get the voltage up before a bulb could be lit. Gradually a steady state is reached when one is putting electricity in (charging) and receiving light in return. Finally, if one stopped the input of electrical charge, one might not incur the penalty of losing the light for some time until the battery has run down. Similarly, in the economic world, it is possible to stop replacing capital goods and loaf for a while and still hope to leave output undiminished for a spell while we "live off capital" or "milk capital".
The fact that it takes time to get things started and synchronized is important. It explains why society does not automatically replace all direct processes by more productive indirect ones, and all indirect processes by still more indirect processes. The advantage in doing so is balanced by the initial disadvantage of having to forego present consumption goods by directing resources from current production to uses that will bear fruit only after some time.
To the extent that people are willing to save -to abstain from present consumption and wait for future consumption- to that extent society can devote resources to new capital formation. [We shall later see that, sometimes in our modern monetary economy, the more people try to save, the less capital goods are produced; and paradoxically, that the more people spend on consumption, the greater the incentive for businessmen to build new factories and equipment.] And to the extent that people are unconcerned as to the future, they may at any time try to "dissave" -to snatch present pleasures at the expense of the future. How? By diverting resources away from the endless task of replacing and maintaining capital and to the job of producing extra present-day consumption goods. There is an old Chinese proverb:
We may summarize as follows: Economic activity is future-oriented. By the same token, current economic consumption is largely the consequence of past efforts. Current productive efforts, so to speak, produce for the future, in order to repay the past for present consumption. Also, in progressive societies some fraction of current productive efforts is devoted to the new or net capital formation, whereby current consumption is sacrificed to increase future production.
Let us resurvey the important economic role of capital. If men had to work with their hands on barren soil, productivity and consumption would be very low indeed. But gradually over time our economic system has been able to amass a tremendous stock of instruments of production, factories and housing, goods in process, and drained and fertilized land.
Men learned very early that the simple, direct methods of production can be improved upon by using time-consuming indirect methods. We who are inside the economic system are not conscious of how roundabout productive processes have become. An outside observer would be struck with the fact that almost no one in our system seems to be producing finished goods. Almost everyone is seen to do work of a preparatory nature, with final consumption a distant future goal. The farmer spends his time in fattening hogs, the truck driver in carrying them toward the last stage of consumption. A steel worker prepares pig iron, part of which will become a hammer to build a house; another bit will become part of a pig-iron furnace, which in turn will prepare pig iron to be used in making further hammers and more pig-iron furnaces, and so forth.
Each person may be unaware of the roundabout character of production: all he has to do is to perform his own job and not worry himself as to where his output will ultimately go or whence come the raw materials to which his activity has added value. Once all the circular paths were established and activity became synchronized, even an outside observer of the system might not notice its complexity. In such a steady state each day might look like the previous one, and it might appear that the work of each day was producing the output of that same day.
Such a view is partially an optical illusion. Time was required to get the process going in the first place. Human and nonhuman resources had to be put to work for a long time before any output came from each new process. It is as of one had to charge a huge battery for some time to get the voltage up before a bulb could be lit. Gradually a steady state is reached when one is putting electricity in (charging) and receiving light in return. Finally, if one stopped the input of electrical charge, one might not incur the penalty of losing the light for some time until the battery has run down. Similarly, in the economic world, it is possible to stop replacing capital goods and loaf for a while and still hope to leave output undiminished for a spell while we "live off capital" or "milk capital".
The fact that it takes time to get things started and synchronized is important. It explains why society does not automatically replace all direct processes by more productive indirect ones, and all indirect processes by still more indirect processes. The advantage in doing so is balanced by the initial disadvantage of having to forego present consumption goods by directing resources from current production to uses that will bear fruit only after some time.
To the extent that people are willing to save -to abstain from present consumption and wait for future consumption- to that extent society can devote resources to new capital formation. [We shall later see that, sometimes in our modern monetary economy, the more people try to save, the less capital goods are produced; and paradoxically, that the more people spend on consumption, the greater the incentive for businessmen to build new factories and equipment.] And to the extent that people are unconcerned as to the future, they may at any time try to "dissave" -to snatch present pleasures at the expense of the future. How? By diverting resources away from the endless task of replacing and maintaining capital and to the job of producing extra present-day consumption goods. There is an old Chinese proverb:
"He who cannot see beyond the dawn will have much good wine to drink at noon, much green wine to cure his headache at dusk, and only rain water to drink for the rest of his days."
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