Role of Capital in Economics

In this article we will discuss about the role of capital in economics.

Capital, the produced means of production, is indispensable for the creation of wealth. Capital is essential if a country is to produce the huge quantity of various goods and services necessary for consumption today. If an economy is to produce more, it needs to add to that capital—that is, it must invest. It, indeed, plays a very important role in production.

The role of capital can be understood from the following description of its various functions:

1. Supply of money-capital:

Capital, particularly money-capital, enables the producer to buy essential raw materials, machinery and equipment which are needed for production. Money-capital is also necessary for meet­ing daily requirements of the producers and for paying wages and rent.

2. Role of fixed capital:

Fixed capital (i.e., tools and machineries, factory buildings, etc.) play a vital role in increasing the production of both con­sumer and capital goods. It constitutes the base of production, as other factors cannot work without fixed capital.

3. Aiding labour:

Machineries, tools and implements, raw materials, etc. aid labour to produce goods; these things also increase the productivity of labour and of other factors. Labourers, working with better and improved type of implements can produce more goods than what they can produce without these.

4. Provision of subsistence:

Capital provides labourers with subsistence during the period of production. Production today is a long-drawn-out process; it takes a long time for the manufacture to complete the task of production. Capital enables the producer to make payment to the workers when production is not yet complete. So, workers get their means of subsistence during the period of production.

5. Roundabout production:

The use of capital makes the capitalistic method of production more complex and roundabout. It involves the creation of capital goods at first and then the workers produce consumption goods with the help of these capital goods; it makes production, based on capital, a roundabout process.

6. Continuity of production:

The use of money-capital helps the produc­ers in continuing the work of production; the producer is not required to wait for the realisation of the value of the goods produced.

7. Lengthening the period and structure of production:

Owing to round­about process involved in the capitalistic method of production, the period of production becomes longer. The more capital-intensive method of pro­duction is followed, the longer becomes the period for producing finished goods.

8. Economic growth:

The production of more and more capital goods for increasing the rate of capital formation is highly essential for accelerating the rate of economic growth in the developing economies like India. It is so because capital goods are the creators of other goods.

Capital is a man-made resource. Any product of labour-and-land which is reserved for use in further production is capital. Business capital is usually divided into two types; that which is used up in the course of production and that which is not.

Working capital consists of the stocks of raw materials, partly finished goods, and finished goods held by producers. These stocks are just as important to efficient production as are the machines and buildings. Stocks are held so that production can proceed smoothly when deliveries are interrupted, and unexpected additional orders for finished goods can be met without altering production schedules.

This type of capital is sometimes called circulating capital because it keeps moving and changing. Materials are changed into finished goods which are then exchanged for money and this, in turn, is used to buy more materials.

Fixed capital consists of the equipment used in production — buildings, machinery, railways and so on. This type of capital does not change its form in the course of production and move from one stage to the next — it is ‘fixed’. We also refer to real capital as money or financial capital.

Financial capital refers to cash as opposed to physical assets of a company. Companies can have a various of types of capital. The principal distinction is between share capital and loan or debenture capital. Share capital is subdivided between ordinary and preference shares with the holders of ordinary shares being the owners of the company. They accept more risk than the owners of other classes as their dividends are paid last.

Capital for industrial and commercial enterprises may be classified as either loan (debt) capital or risk (equity) capital. Loan capital consists of those funds advanced (by creditors) at fixed or variable rates of interest which may or may not be secured by some kind of mortgage on the assets of the company.

Risk (owners) capital is that part of the capital stock which is raised by the sale of shares. Companies which operate in industries where the market for the product is subject to continuous fluctuation would not take the risk of having a high proportion of loan capital.

Loan (outsiders’) capital is more appropriate to firms operating in stable markets and which have a large part of their assets in the form of land and buildings which are good subjects for mortgages (e.g., brewery companies). Another feature of loan capital is that borrowing money in this form does not affect the pattern of ownership of the business. An issue of ordinary shares, of course, will cause the ownership of the business to be more widely dispersed.

Conclusion:

The conclusion is that the role of capital is very useful in production. Its importance is not diminished even in the socialistic econo­mies where, though capitalists are eliminated, the use of capital goods is not minimised. As K. E. Boulding has put it, “The essential measure of the success of the economy is not production and consumption at all, but the nature, extent and quality and complexity of the total capital stock, includ­ing in this the state of human bodies and minds included in the system.”