Capital

(Redirected from Capital stock)

Capital is anything that has value. Capital must be generated and is then used to create wealth through investment. Capital can come in many forms such as physical capital and human capital.[1] Capital differs from money, in that, money is used to purchase goods and services whereas capital is used to generate wealth, or more money. The difference is not black and white however, money can be financial capital and is invested thereby generating more wealth.

Physical Capital

Figure 1. The construction of Shasta Dam on the Sacramento River in Northern California, USA in June 1942.[2] This dam is an example of physical capital.

Physical capital is anything tangible or human-made that can be used to produce goods and services and generate wealth, it includes both fixed capital, capital stock and uncompleted works such as a dam (See figure 1) under construction that will eventually produce electricity for sale.[3] In order for a firm to sell its goods and services, it must produce them and in order to do that a firm must acquire physical capital.

In the case of an energy firm that is building a hydroelectric dam, it first must acquire the physical dam and all the components that make electricity before they can sell the electricity for a profit. Once the dam is built, the firm can sell the electricity that is generated on the market.

Human Capital

Human capital refers to the value of labour that accrues above the level of "unskilled" labour, it is the special skills, knowledge and training possessed by the employees of a firm that are used to generate wealth.[4] Like all capital, human capital has to be generated at some point. It may be a student who pays to attend university to obtain a degree in petroleum engineering. A firm may hire that person to use those skills to generate profit for the firm. The student has invested in an education to generate human capital in the form of a knowledge of petroleum engineering and it has value to the firm which has invested in the human capital of the students knowledge.

It can also come in the form on job training whereby the firm invests money in the training of its employees to give them new skills and expand their human capital. If a firm hires a general labourer then that employee is not counted in the human capital of the firm. If the firm pays for special training for the employee to learn skills specific to a job then the employee could be counted in the human capital of the firm as it has invested to increase the value of the employee.

Capital Stock

This is the total value of physical capital belonging to a certain entity, it can be a region, country, firm or of a specific industry. The total value is the current value of the physical capital minus the initial cost of acquisition, and any ongoing costs accrued up to that point.[5]

For example, a petroleum company builds an oil refinery where crude oil is processed and the facility costs the firm $100 million. Ten years later, when determining the capital stock of the firm, the value of the refinery is determined to be:

Cost to Build -$100m
Operating Cost -$10m av. per year, $100m total
Retrofit Cost -$25m
Gross Revenue $50m av. per year, $500m total
Net Value $275m

The process of adding to the capital stock is called capital formation. The amount of capital formation needed to begin the production of goods and services is called the fixed capital.

Desired Capital Stock

This is the amount of capital that a firm needs to maximize their profits, and is determined by comparing the cost and benefit of adding an additional unit of capital to their capital stock.[6] If the benefit from adding the additional unit is greater than the cost of such, then the firm will add the unit, and if the cost is greater, the firm will not add the unit. If a firm analyzes their capital stock to be of a net cost to the firm, then they can sell units until they are at an equilibrium of capital stock.

If the same firm builds a second oil refinery beside the first but it only operates a quarter of the time that the first does because there is not enough demand for the products it produces then it will count as a net cost in the stock capital of the firm:

Cost to Build -$100m
Operating Cost -$10m av. per year, $100m total
Retrofit Cost -$25m
Gross Revenue $12.5m av. per year, $125m total
Net Value -$100m

To correct the imbalance in their capital stock, the firm might sell the refinery to another firm. For more on this see diminishing marginal returns.

References

  1. "A Dictionary of Economics" published Oxford University Press, 2013. Edited by John Black, Nigar Hashimzade, and Gareth Myles Online version accessed [August 17th, 2017].
  2. https://en.wikipedia.org/wiki/File:Shasta_dam_under_construction_new_edit.jpg
  3. J.Black, N. Hashimzade, and G. Myles. (2009) "Capital." [Online], Available: http://www.oxfordreference.com/view/10.1093/acref/9780199237043.001.0001/acref-9780199237043-e-2343?rskey=KruATn&result=1, 2009 [May 16, 2016]
  4. A. Goolsbee, S. Levitt and C. Syverson. ‘’Microeconomics’’. New York: Worth Publishers, 2013, pp. 645.
  5. J.Black, N. Hashimzade, and G. Myles. (2009) "Capital Stock." [Online], Available: http://www.oxfordreference.com/view/10.1093/acref/9780199237043.001.0001/acref-9780199237043-e-1402?rskey=X0mnpT&result=1, 2009 [May 16, 2016]
  6. A. B. Abel, et al. Macroeconomics, 6th ed. Toronto, Canada: Pearson, 2011, pp. 120.

Authors and Editors

Haydon Armstrong, Lyndon G., Jason Donev
Last updated: August 29, 2017
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