What are Capital Goods?

Capital goods are like the supplies you buy for DIY Christmas cards…

The scissors, glue, paper, and glitter you get at your local craft store are like capital goods, in that you use them to create something else and pass the finished product along to its final owner. Similarly, capital goods are the tangible, man-made items, often purchased from another company, used to make a final product.

Capital goods are one of the four factors of production (the components necessary to produce a good) — land, labor, capital, and entrepreneurship. Capital goods are the man-made physical items that go into creating a product or offering a service.

Just about every industry uses capital goods. In agriculture, capital goods can include machinery and farming vehicles. In factories, the machinery and tools are capital goods. For white-collar industries, capital goods typically include computers and office supplies.

Many different items fall under the umbrella of capital goods. First, capital goods can be fixed assets that a company owns. These items, often known as property, plant, and equipment (PP&E) for accounting purposes, are significant investments for companies and usually appear as assets on their balance sheets. Examples include plants, office buildings, manufacturing machinery, and vehicles. Spending to purchase these assets is known as capital expenditures (CapEx).

Capital goods also consist of smaller tools and supplies that companies use. These items aren’t usually valuable or expensive enough to appear as assets on a balance sheet, but they certainly provide value to the company. These may include hammers, drills, and other tools for a construction company, or medical instruments for a doctor.

Capital goods can also include infrastructure, as long as it is used in the production of a good or service. For example, air traffic control equipment is an example of a capital good that aviation companies use.

Finally, core capital goods, according to the US Census Bureau, are all capital goods with the exception of defense equipment and aircraft. The sale of these goods is one of the primary indicators that economists look to when measuring future economic growth.

A share of stock is not a capital good. For something to be a capital good, it must be a tangible, man-made item used in the production of another good or service. Stock shares aren’t tangible items. When you purchase a stock, you’re buying a chunk of ownership in a company, not a physical item used to produce something consumers buy.

All capital goods are tangible, human-made items. Items that are used to make other products but are found in the natural world aren’t capital goods, but rather raw materials. Typically, companies buy capital goods from other companies that manufacture them.

Another feature of capital goods is that they are used in the production of other goods and services. Something might be a capital good if it’s sold to a business, which uses the item to provide other goods or services. But if a consumer buys the item for personal use, it’s not a capital good.

A final feature of a capital good is that they are not used up immediately in the production process. If the item is depleted right away, then it’s either an intermediate good (meaning a partially finished good will later become a final product) or a raw material.

For example, chefs use a stove, pots, and pans again and again when preparing food. These are capital goods. But ingredients, like fresh tomatoes, are immediately used up during cooking, so they aren’t capital goods.

Capital goods are just one of the components that go into the production of goods and services. Economists point to four factors of production as necessary to producing all goods: land, labor, capital, and entrepreneurship. Capital goods are just one piece of the production puzzle.

The land consists of the natural resources that go into making goods and services. This includes a lot more than just land — It’s anything that comes from the land. That could be resources such as water and oil, as well as agricultural products and lumber. These goods are the raw materials that go into production.

The next factor of production is labor, which consists of the human capital required to make goods and services. Every industry needs a labor force of some kind. Anytime you walk into a business, all of the employees are a part of the labor resource.

The third factor of production is capital (aka capital goods). When discussed as a factor of production, capital does not mean money. Rather, it’s the physical assets that allow workers to be productive.

The final factor of production is entrepreneurship. For the other three factors of production (land, labor, and capital) to result in a successful business, an entrepreneur has to bring them all together. This is the person whose innovation leads to the creation of goods and services to earn a profit.

While a capital good is one that a company uses in the course of its business, a consumer good has reached its last stop. Consumer goods are items sold to and used by consumers with no future business use.

Whether something is a capital good or a consumer good often depends not on the item itself, but on how the buyer will use it. For example, if your neighbor buys a snowblower to clear his driveway in the winter, the tool is a consumer good. But if that neighbor uses the machine for his snow removal business, then it’s a capital good. The product is the same — It just comes down to how the buyer uses it.

Separating the two types of goods is also relevant for measuring inflation and deflation (a general rise or decrease in prices). The Bureau of Labor Statistics estimates inflation using the Consumer Price Index (CPI), which looks at the price of consumer goods over time.

Capital goods serve a critical role in the economy. When companies invest in capital goods, they expand their ability to create products and services. This allows businesses to make a profit and hire employees, and can result in economic growth for society as a whole.

Investing in the innovation of capital goods has its perks as well. When a company or country can get ahead of the curve on the capital goods it uses, it might develop a competitive advantage (meaning a factor that gives a company a leg up on its competitors) over others in the industry.

Capital goods are also necessary for the economy as a whole. While some companies contribute to the economy by selling consumer goods, others do so by creating capital goods. Those companies create jobs in their communities and provide tax revenue for the government, just like other companies do.

Capital goods also play a big role in certain industries. In sectors where an entrepreneur has to invest millions or billions of dollars in capital goods to get started, barriers to entry are high. This can lead to a natural monopoly, which is when a company emerges as the only competitor because of the nature of the market. An example is a utility company — Most localities only have one utility company because of what it takes to get started.