Capital and income from capital

Capital comprises all manufactured resources, such as machines, tools and buildings, which are used in production of other goods and services. This includes the entire range of durable equipment, from hammers, saws and other simple tools, to aircraft, ships, electronic computers and nuclear reactors.

The characteristic of a capital good that makes it different from other goods is that it is created with the specific aim of producing goods and services. Consumer goods satisfy wants directly, whereas capital goods, which are used in the production of consumer goods, satisfy wants indirectly. Capital goods also differ from raw materials and intermediate goods in the sense that they are not used up immediately in the process of production. They are used over and over again in the process of production.

An economist's use of "capital" differs from that of the man in the street. If the economist refers to capital, he or she means "real" capital ("equipment") and not money. Money is not a resource that can be used directly in production. However, money does make it possible to purchase capital and other goods.

One reason why capital goods are scarce is that saving, which is abstaining from consumption, is a necessary prerequisite for capital formation or investment. This means that people are not buying and consuming as many goods and services as they otherwise would, so that resources are released from the production of consumer goods and made available for the production of capital goods. If a community insists on using all its factors of production for producing consumer goods, obviously it cannot produce any capital goods at all.

Capital goods play a vital role in creating production capacity. The more machines, factories and tools we have, the more goods and services we can produce. The better the quality of these machines and so forth, the more productive we can be; and the more productive we are, the higher our economic growth will be.

The reward for capital is the interest payment that the owner of capital receives for making his or her capital available for production. This is expressed as an annual percentage of the amount loaned to purchase the capital goods and is called the interest rate. In the case of a loan of R1 000 000 and an interest payment of R100 000, the interest rate received is equal to 10% per annum since R100 000 ÷ R1 000 000 x 100 = 10%. The interest rate is determined in the financial and capital markets.