Capital

Capital are the goods, that were produced by previous stages of production, but do not directly satisfy consumer's needs; they are used in production to eventually produce consumer goods.

The Formation of Capital

In the simplest example of an economy (the "Robinson Crusoe economy"), a person can spend time producing consumer goods and consuming them. In order to produce capital goods, he must save, i.e. consume less than his means allow in the present. With capital, he can produce more and and so consume more in the future.

The creation of capital goods is called investment.

Capital in Production

Capital makes the production process more "roundabout"; in general are these methods are more productive than shorter, more direct methods. An actor will opt for longer, more roundabout methods so long as the enhanced output more than offsets the increased waiting time, which in itself is a disadvantage because of time preferences.

With­out the aid of capital, only goods with the shortest period of production are available. Goods with longer periods of production are not available unless capital goods are acquired.

There are two ways in which longer processes of production through the use of capital may increase productivity:

1. by making possible a greater production of the same good per unit of time; or
2. by making possible the production of consumer goods that were not available at all with a shorter process of production

The perishable nature of capital

All capital goods are perishable. The few products that are not perishable but permanent become, to all intents and pur­poses, part of the land. Otherwise, all capital goods are perish­able, used up during the processes of production. It can be said that capital goods are transformed into their products during production.

Some capital goods are used up in each production-event. Other capital goods are also used up, but not as suddenly; they may last many years. Each particular capital good has a different useful life and therefore a different rate of depreciation, of being used up.

Capital consumption

Because capital is perishable, it must be renewed, if man wishes to enjoy the fruits of higher production. Saving must be repeated over and over, capital could break down and be replaced in whole or be repaired and kept in shape.

Man can avoid the trouble of saving and enjoy a higher consumption now. But if the capital is not replaced, production will later drop. Instead of saving and maintaining capital structure, capital is consumed. In this case, time preference has led man to prefer more present consumption, in exchange for greater losses in fu­ture consumption.

Workers use capital goods to augment their labor to create consumption goods. Because of the time structure of production, it is possible to temporarily boost everyone's consumption, but only at the expense of maintaining the capital goods, which are so "consumed." At some point, reality sets in, and no "stimulus" policies can prevent a sharp drop in consumption.

In the boom period of the business cycle, people consume more - even while new, unsustainable investment projects are started. Sustainable projects initially require, that investors reduce their consumption and channel their savings into new projects. But during a boom induced by a central bank, there hasn't been real savings to fund the new investments. That's why the boom is unsustainable, but also explains why consumption increases at the same time as investment in new projects. This is impossible in the long run, but possible in the short run. What happens is neglect of maintenance on critical intermediate goods. A modern economy is very complex, and it can take years for an unsustainable structure to become recognized as such.

During the recession following the artificial boom period, resources need to get rearranged; certain projects need to be abandoned; and critical intermediate goods need to be replenished since they were ignored during the boom. It takes time for all the different types of materials, tools, and equipment to be furnished to resume normal growth. During that transition, the contribution of the labor of some people is so low that it's not worth it to hire them (especially with minimum-wage laws and other regulations). The result is unemployment.

See also: Austrian Business Cycle Theory

External links

• Capital on Wikipedia