Capital Goods

Capital goods are durable goods that are used to produce other goods and services rather than being consumed themselves. Factories, machine tools, trucks, computers, power plants, office buildings and business software are all capital goods. They are one of the factors of production, alongside labor and land, and they are often called physical capital.

In everyday business and finance, "capital" usually means money. Economists draw a line between that financial capital and the physical tools it buys. Spending on new capital goods is investment in the economic sense, and in national accounts it is recorded as gross fixed capital formation. Capital goods are contrasted with consumer goods, which households buy for their own use.

A baker's oven is a capital good; the bread is not. The oven is bought once and used thousands of times to make loaves that people eat. A delivery van, the shop itself and the till software are capital goods too.

The same item can fall on either side depending on who uses it and how. A car bought by a family for weekend trips is a consumer good. The same car bought by a taxi company to carry paying passengers is a capital good, because it is a tool for earning income.

• Structures. Factories, warehouses, offices, and much infrastructure such as roads, ports and power lines.
• Machinery and equipment. Machine tools, industrial robots, tractors, aircraft, ships and computers.
• Intellectual property products. Software, databases and research and development, which modern national accounts treat as investment because they produce value for years.
• Inventories of inputs. Sometimes grouped with capital in business accounts, although national accounts record changes in inventories separately from fixed capital.

Raw materials and parts that are used up in a single production run are intermediate goods, not capital goods.

Capital goods wear out or become obsolete, a loss economists call depreciation or consumption of fixed capital. The stock of capital grows only when new investment exceeds that loss. A simple rule links them:

• $K_t$ is the capital stock at the start of year $t$.
• $I_t$ is gross investment in new capital goods during the year.
• $\delta$ is the depreciation rate, written as a decimal.

Suppose a firm owns $100 million of equipment that depreciates at 10 percent a year and buys $15 million of new machines. Next year's stock is $100 + 15 - 0.10 \times 100 = 105$ million dollars. Net investment is $5 million; the other $10 million only replaced worn-out capital. If the firm bought less than $10 million, its capital stock would shrink.

In company accounts, capital goods appear on the balance sheet as property, plant and equipment, a kind of tangible asset. Their cost is not charged against profit all at once but spread over their useful life through depreciation charges, which is why a large equipment purchase lowers cash immediately but lowers reported profit only gradually. Tax rules on how fast that write-off may happen strongly influence when firms choose to buy.

More and better capital goods let each worker produce more, which is a central driver of productivity and living standards. Growth models since Robert Solow's work in the 1950s show that building up capital raises output, but with diminishing returns: each extra machine adds less than the last unless technological progress makes new capital more productive. That is why economists separate capital deepening from total factor productivity.

Spending on capital goods is the most volatile part of aggregate demand. Firms postpone big purchases when sales fall or credit tightens, and accelerate them when confidence and profits are high, so investment swings amplify the business cycle. Higher interest rates raise the cost of financing equipment, one channel through which monetary policy works. Analysts watch orders for capital goods as an early signal: in the United States, the Census Bureau's monthly report on durable goods includes "nondefense capital goods excluding aircraft", a series widely used as a gauge of business investment plans.

Capital goods industries are concentrated in a few economies, including Germany, Japan, China, the United States, South Korea and Italy, which export machinery and transport equipment worldwide. For developing countries, imported machinery carries new technology, so access to capital goods is closely tied to growth and to the balance of payments. Governments influence capital investment through tax rules that allow faster write-offs, investment subsidies and industrial policy. Economists debate whether such incentives raise total investment or mainly change its timing.

• U.S. Census Bureau: Manufacturers' Shipments, Inventories and Orders
• United Nations Statistics Division: System of National Accounts