What is capital and interest
capital and interest, in economics, a stock of resources that may be employed in the production of goods and services and the price paid for the use of credit or money, respectively.
Capital in economics is a word of many meanings. They all imply that capital is a “stock” by contrast with income, which is a “flow.” In its broadest possible sense, capital includes the human population; nonmaterial elements such as skills, abilities, and education; land, buildings, machines, equipment of all kinds; and all stocks of goods—finished or unfinished—in the hands of both firms and households.
In the business world the word capital usually refers to an item in the balance sheet representing that part of the net worth of an enterprise that has not been produced through the operations of the enterprise. In economics the word capital is generally confined to “real” as opposed to merely “financial” assets.
Different as the two concepts may seem, they are not unrelated. If all balance sheets were consolidated in a closed economic system, all debts would be cancelled out because every debt is an asset in one balance sheet and a liability in another. What is left in the consolidated balance sheet, therefore, is a value of all the real assets of a society on one side and its total net worth on the other. This is the economist’s concept of capital.
A distinction may be made between goods in the hands of firms and goods in the hands of households, and attempts have been made to confine the term capital structure to the former.
There is also a distinction between goods that have been produced and goods that are gifts of nature; attempts have been made to confine the term capital to the former, though the distinction is hard to maintain in practice. Another important distinction is between the stock of human beings (and their abilities) and the stock of nonhuman elements. In a slave society human beings are counted as capital in the same way as livestock or machines. In a free society each man is his own slave—the value of his body and mind is not, therefore, an article of commerce and does not get into the accounting system. In strict logic persons should continue to be regarded as part of the capital of a society; but in practice the distinction between the part of the total stock that enters into the accounting system, and the part that does not, is so important that it is not surprising that many writers have excluded persons from the capital stock.
Another distinction that has some historical importance is that between circulating and fixed capital. Fixed capital is usually defined as that which does not change its form in the course of the process of production, such as land, buildings, and machines. Circulating capital consists of goods in process, raw materials, and stocks of finished goods waiting to be sold; these goods must either be transformed, as when wheat is ground into flour, or they must change ownership, as when a stock of goods is sold. This distinction, like many others, is not always easy to maintain. Nevertheless, it represents a rough approach to an important problem of the relative structure of capital; that is, of the proportions in which goods of various kinds are found. The stock of real capital exhibits strong complementarities. A machine is of no use without a skilled operator and without raw materials for it to work on.
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