"Capital"

Economics Economics Questions
1

Hi folks,

I have been consistently perplexed by the use of the term “capital.” I understand what a capital good is, but the word “capital” used alone seems to have a slightly different meaning. I thought that I finally had my answer when I read Robert P. Murphy’s definition of capital in “Study Guide to Human Action: a Treatise on Economics,” but the definition introduces more confusion than clarification.

"Economic calculation rests on the notions of capital and

income. The capital associated with a particular enterprise is the

estimated sum of money that could be raised if all of the assets

were sold and all the liabilities were discharged. Income is the

amount of consumption that a particular collection of goods can

yield without lowering the capital. If income exceeds consumption,

the difference is saving. If consumption exceeds income,

the difference is capital consumption (Study Guide, PDF p. 126)."

(I’m also having trouble adjusting the font.) So the actual definition of the term “capital” seems to be straightforward enough, as the estimated monetary sum which can be acquired when the assets of an enterprise are sold and its liabilities are met (“discharged”). Robert’s definition of income, though, throws me off. This logjam extends to Robert’s definition of savings, which depends on the definition of income and the term “consumption,” which also seems to have a meaning different to the one to which I am accustomed. At the end of the day, I’m more confused than when I went in to reading this paragraph. Can anyone clarify?

Thanks.

Egon

2

If he would have said capital value instead of just capital, would that have been less confusing to you?

3

Say you have a factory that makes pickles. You could sell the whole factory and pay off all your debts and be left with $10 Million. That is your capital.

If you don’t sell the factory, it will make pickles which you will sell, and you wind up with $100,000 in your pocket. That is your income.

You have a family and spend money to feed them. The amount you spend is the consumtion. There are three possibilities.

  1. If you spent say $90,000, then your consumtion [90K] is less than your income [100K], so you have 10K unspent in your pocket. That 10K is your savings.

  2. If you spent 100K, then your consumption equals your income. Your savings is zero. He doesn’t mention this case.

  3. If you spent 500K then your consumption [500K] is more than your income [100K]. Where did the extra 400K come from for you to spend? You either sold machinery from the factory to lavish gifts on your wife, or you borrowed money, or both. In any case it will lower the $10M number that was your initial capital. Because Capital = value of factory minus debts.

Hope that helps.

4

Ahh, I see. It makes sense to me now. I had to read the sentence over a few times in juxtaposition with your explanation. Thanks all.