In common parlance when we speak of “capital” we often mean “wealth”. In economics, capital is classically defined as the machines, tools, buildings, and other long lasting physical equipment that we use to turn raw materials into the goods and services we consume.

Modern economic theories have defined other forms of capital as factors of production. For example, the workforce of a business will have special knowledge and skills which are also required to produce goods and services and which, like physical capital, would take considerable time and money to assemble. This is called “human capital’. There are other “intangible” assets which are counted as capital in accounting, such as intellectual property which includes patents and trademarks, and “goodwill” which includes your relationship with your clients built over time^[1]. Then there are financial assets which don’t directly enter into the productive process, but which also count as capital on a balance sheet.

There are three very broad classifications of businesses used by the US Bureau of Labor Statistics in collecting economic statistics such as employment. Goods producing industries such as manufacturing and construction employ about 7% of US workers, agriculture less than 2%, and “services” 85%^[2]. So services, which may not use a lot of physical capital such as machines, are a very large part of our economy now. Since our main interest in capital is in looking at the relationship between productivity changes and income, we will clearly need to look at both physical capital and human capital. A law firm (a service) clearly doesn’t need a lot of physical capital beyond fancy conference tables, as most of their capital is human capital and goodwill.

Like other factors of production, the “price of capital” is determined by supply and demand.  If a company wants to buy a new and improved piece of machinery, it could borrow the required money from a bank. The bank would charge the prevailing interest rate adjusted for risk. The business will buy the equipment as long as the return on the equipment exceeds the costs including interest payments.

We will look at capital accumulation in the wealth sense later when we look at real world data on income and wealth inequality.

^[1] Goodwill isn’t shown on a balance sheet unless purchased by acquiring another company.

^[2] “Employment by Major Industry Sector.” 2020. September 1, 2020. https://www.bls.gov/emp/tables/employment-by-major-industry-sector.htm.