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Characteristics and Functions of Capital



There are four factors of production, namely land, labor, capital and organization. Without adequate capital, the remaining factors of production cannot perform their functions properly. In history, there are many examples for failure of business just because of inadequate capital or capital mismanagement. In order to handle capital of a business effectively, it is appropriate to understand its peculiarities and functions.

Characteristics of Capital

Capital, as a factor of production, has certain special characteristics. They are:

Capital can be obtained by postponing the present consumption. This means that when people save money, it becomes capital. Therefore, capital is a direct result of savings as well. If savings in a country is high, the capital will also be high.

Capital is not a natural resource. According Knut Wicksell, capital is a saved labor that is accumulated in the course of years. Therefore, capital is man-made resource over a period.

Capital can be increased or decreased according to your will and wish. Therefore, capital is variable.

Fixed machines in an industry are also known as capital. When you use machinery continuously, it is subject to normal wear and tear. Therefore, capital depreciates.

Capital is a dependent factor. It means that capital alone cannot produce anything. Capital should work with other factors of production in order to produce any goods. At the same time, other factors cannot function without capital also. Therefore, we can say that capital is a passive factor.

Among the four factors of production, capital can mobile very easily. Land cannot move from one place to another. Labor moves but not in a perfect sense. Entrepreneurs also do not move very easily. However, capital moves from one place and another very easily.

Capital helps to improve productivity of other factors of production. A good machine can improve the productivity of a laborer.

Capital does provide you with income if you utilize it properly.

Functions of Capital

Capital is necessary for the following functions in any industry:

  • Firstly, capital is the source of wages to laborers.
  • Secondly, capital acts as an incentive and helps to improve the productivity of land and labor.
  • Thirdly, without capital, purchase of raw materials and capital formation (infrastructure and machines) are not possible.
  • Fourthly, allied amenities such as transportation and communication are not possible without adequate capital.
  • Fifthly, capital helps to improve sales by facilitating effective marketing.

Capital as a Factor of Production

Both wealth and capital are interrelated. Wealth is a broad term, which includes everything from man-made to gifts of nature. However, capital is a small portion of wealth. At the same time, capital can be used to accumulate wealth.

Relationship between capital and wealth

Wealth includes two goods: (a) goods used for present consumption and (b) goods used to produce other commodities. The first category of goods is known as consumer goods. Examples of consumer’s goods are television, car, bike, books and so on. Consumer’s goods satisfy human wants directly. The second category of goods is known as producer’s goods or capital goods or capital. Examples for capital goods are raw materials, machineries, roads, dams, railways and so on. It is obvious that producer’s goods or capital is essential to produce consumer’s goods. Because of this reason, capital is a part of wealth. According to Prof. Fisher, capital is the product of past labor, but is used as a means to further production. Hence, we can say that all wealth does not come under capital, but all capital comes under wealth.

Capital versus Income

What is the relationship or difference between capital and income? Let us look at this concept in monetary terms. Suppose you earn $1,000 per month. You have $10,000 in your bank account, which yields $100 as interest per month. Now your total earnings per month are $1,100. This is your income. The amount in the bank account i.e., $10,000 is capital. Income is an inflowing one, which is closely associated with time element. On the other hand, capital is a fixed one, which yields income. Therefore, capital is different from income.

Capital versus Money

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Do you think money and capital are similar? The answer is that both capital and money are entirely different from each other. Money just denotes currency and coins. Of course, it becomes capital when it is ready for investment. For instance, money in your hand cannot become capital as it is meant for only circulation as of now. At the same time, if the same money is deposited in a bank, it becomes capital because your savings is ready for investment now. Hence, not all money is capital.

Capital versus Land

Both capital and land are factors of production. Both capital and land are wealth. Both capital and land cannot be consumed directly. Both capital and land are essential to produce consumer’s goods and producer’s goods. Hence, we tend to claim that both capital and land are similar in nature. However, it is not true because of the following basic differences between the two factors of production:

Characteristics of Land:

- Gift of nature

- Supply of land is inelastic irrespective of time

- It is not man-made and hence, there is no cost of production involved

- It is immobile

- It is permanent but can take different forms because of natural process

Characteristics of Capital:

- It is man-made

- Supply of capital may be inelastic in short-run, but elastic in the long-run

- It is product of past labor and hence, there is cost of production involved

- It is mobile

- It is not permanent and can be depleted

Hence, we cannot treat capital and land identically.

© 2012 Sundaram Ponnusamy


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