Capital Goods and Their Effect on the Economy
Capital Goods Are a Key Part of Business Success
Capital goods are at the heart of every functioning economy. These goods are considered one of the primary factors of production, and it would be impossible to run a business without them.
But just what are they, and how exactly do businesses use them? This guide will help you understand their role in the economy.
What Are Capital Goods?
Capital goods are man-made, durable items businesses use to produce goods and services. They include tools, buildings, vehicles, machinery, and equipment. Capital goods are also called durable goods, real capital, and economic capital. Some experts just refer to them as "capital." This last term is confusing because it can also mean financial capital.
In accounting, capital goods are treated as fixed assets. They’re also known as “plant, property, and equipment.”
Capital goods are one of the four factors of production. The other three are:
- Natural resources, such as land, oil, and water
- Labor, such as workers
- Entrepreneurship, which is the drive to create new companies
Capital Goods Production in the United States
In the United States, the monthly durable goods orders report measures capital goods production. It reports capital goods shipments, new orders, and inventory. It is one of the most important leading economic indicators.
The Census Bureau provides the durable goods report. It surveys companies that ship more than $500 million a year. These companies may be divisions of big diversified corporations. They also include large homogeneous companies as well as single-unit manufacturers in 89 industry categories.
How Capital Goods Drive the Economy
The United States has been a technological innovator in creating capital goods, from the cotton gin to drones. Since 2000, Silicon Valley has become the U.S. innovation center.
Capital goods production creates more manufacturing jobs than do other industries. These are among the most well-paid positions, averaging $70,000 per year. America's success as a provider of capital goods has created a comparative advantage for the country. That helped it to remain the world's largest economy until China attained that spot.
Here are eight examples of how U.S. innovations in capital goods created these advantages:
- In 1789, Samuel Slater improved textile manufacturing, and Eli Whitney invented the cotton gin four years later. These made the United States a leader in clothing manufacturing.
- The invention of Morse code and the telegraph in 1849 and Graham Bell's telephone in 1877 made communication faster.
- Thomas Edison invented a safe incandescent lamp in 1880. That allowed people to work longer and made urban living more attractive.
- Steamboats led to steam locomotives. They allowed private railroad networks to facilitate coast-to-coast commerce and development of the West.
- In 1902, air conditioning allowed migration to formerly hot areas and the ability to work effectively through the summer.
- In 1903, the Wright Brothers' invented the airplane, leading to faster travel.
- In 1908, Ford's assembly line allowed mass production of affordable cars. That increased demand for expanded travel and led to the 1956 Interstate Highway Act. It improved shipping and created a higher suburban standard of living.
- In 1926, Robert Goddard invented the liquid propulsion rocket. That gave the United States an advantage in defense.
Core Capital Goods
Core capital goods are another leading indicator of economic growth. They don't include defense equipment and aircraft. These are large orders that don't appear consistently. Core capital goods orders tell you how much businesses use on an everyday basis.
The Census Department measures both orders and shipments. The latter shows up in that quarter's gross domestic product (GDP) estimate. Orders don't show up until later when the goods are manufactured and shipped. When orders for core capital goods rise, the nation's GDP will increase six months to 12 months later.
Capital Goods vs. Consumer Goods
Unlike capital goods, consumer goods are not used to create other products (although they also may be considered durable goods). Like capital goods, durable consumer goods are heavy-duty and long-lasting. They’re the appliances bought by households, such as cars, refrigerators, and dryers. Shipments of consumer goods are also included in U.S. GDP. As a result, consumer spending drives almost 70% of GDP.
Many items can be both capital goods and consumer goods. The difference is how the items are used.
For example, commercial aircraft are capital goods because they are used by airlines to produce a service: transportation. An airplane used by private pilots for weekend hobbies is a consumer good. That same type of plane used for a sightseeing business is a capital good.
Another example is trucks and cars: businesses use them as capital goods, but families use them as consumer goods. Buildings also double as capital and consumer goods—the former if they're turned into a factory, office, or warehouse, and the latter if they are used for housing.
Computers are capital goods if they are used by a business but not if they are used by a family. The same goes for any ovens, refrigerators, and dishwashers. If they are for commercial use only, they are capital goods.
The Bottom Line
Any man-made durable item used to do business is a capital good. Capital goods, unlike consumer goods, are used for the production of other goods, although they don't go directly into the manufacturing of other goods (those types of goods are called raw materials).
Examples of capital goods are buildings, furniture, and machines (provided they are used for business purposes). All these help drive economic work.
Innovation in capital goods allowed America to get ahead of competition. Manufacturing advantages made the United States one of the top economies in the world.
Core capital goods, which exclude aircraft and defense equipment, are a leading economic indicator. This tells how well U.S. businesses are doing. A rise in capital goods orders means an expectation of higher production numbers and probable higher GDP values.
Federal Reserve Bank of St. Louis. “Factors of Production – The Economic Lowdown Podcast Series, Episode 2." Accessed April 23, 2020.
Inc.com. "Consumer Spending Is Keeping the Economy From Shrinking—But a New Survey of 10,000 Americans Says That Might End in 2020." Accessed April 23, 2020.