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Ludwig Von Mises

Definition

If we are going to talk about something, it would be a good idea to define it first. Capital is one of those things that are very specific but very difficult to define and as such there is a large tendency to mis-define and re-define it. And so, we are not going to define it just yet. What we are going to do is to outline its origins which will then naturally lead to its definition.

Savings

As we have seen before, humans act in order to diminish uneasiness. We have also seen that humans act to diminish their more pressing uneasiness first. But acting takes time. One thing is to produce in the Praxeological sense (i.e. to create a way for create something out of nothing) and a completely different one is to put this idea into practice (i.e. to manufacture - to make something in the physical sense through combination or transformation).

This process would seem like a good idea because the outcome of our production and manufacturing is something that will diminish our more pressing need far better than what we can without it. However there is a problem. We cannot do two things at the same time. While we are producing and manufacturing we are not fulfilling other needs. In order to do so, we need to save before we embark in manufacturing. Let's decrease this situation to its most basic level to make it more understandable.

John lives in an island. There are wild pigs in that island. John survives by hunting (and eating) those pigs. But the process of hunting them is time consuming. John must track them, chase them, kill them, bring them back to his camp and so on. And so John has an idea. If he could somehow capture those pigs keeping them in a fenced place near his camp, then hunting would be trivial. All John would have to do is to go to the fenced location, select a pig and that would be it. Obviously this situation is far more preferable to the constant difficulties involved in hunting. And so John devises a plan (i.e. John produces a plan) to create a fenced location, to capture pigs alive and to transport them to this location. Now John must put his plan in motion (i.e. to manufacture). But there is another problem. Manufacturing takes time and if John spends the time manufacturing the fence and tools necessary to capture and transport pigs, he won't have the time to hunt and thus John would die of starvation. Not the sought scenario.

Therefore John comes up with an idea. John will continue to hunt but instead of eating the entire pig, he would eat only a portion. The remaining of the meat will be dried out for future consumption. Although this would imply that John may be a little bit hungry every day, it would also imply that once John has enough dried meat, he could stop hunting altogether and spend his time creating the fence and other tools needed to capture pigs and maintain them in captivity. He can now do so because the dry meat will sustain him while he works on the project. These dry meats are his savings.

Without savings there can be no manufacturing and therefore no further satisfaction of our needs through production and manufacturing.

Capital goods

We can now define what capital goods are:

Capital goods are savings which are either goods ready for consumption (allowing people to satisfy needs while manufacturing) or goods intermediate in the manufacturing process.

We can also understand capital goods in terms of their use. Capital goods allow us to store (or save) time for later use (during manufacturing). As such capital goods can be understood as saved (stored) time.

Capital

Now that we understand what capital goods are, we can define what Capital itself is. Capital is:

The total sum of all capital goods.

Remember, goods can be defined as consumption or acquisition goods. Consumption goods are those destined to satisfy our needs immediately. Acquisition goods are those destined to satisfy our needs at a later time during manufacturing and are also called capital goods. Therefore, capital can also be defined as:

The total sum of all goods destined to satisfy our needs while we manufacture.

But considering this total sum in terms of goods is impractical. For example, what is the sum total of 3 apples and two nails? In order for this sum total to be able to be counted (or accounted) what we sum is its evaluation in terms of money. What we do is to add the price of 3 apples and the price of two nails. This we can add. Therefore the final definition of capital is:

The total sum of all goods destined to satisfy our needs while we manufacture evaluated in terms of money.

Economic calculation

This definition of capital allows for the beginning of all economic calculations. By being able to calculate capital in terms of money, we are able to perform any other economic calculation. This, as we shall see in future lessons, is of critical importance for the existence of free markets.

Income, capital and consumption

The end of the process of acquiring (i.e. producing and manufacturing) goods and services is to increase (or at least preserve) capital. As we acquire goods and services over the initial value of the invested capital, we can consume them because we only need the original quantity of capital to keep acquiring. Once John has his pig farm, he and eat as many pigs as he wants as long as the amount of dried meat is above the original quantity he saved. This is so because should any problem arise, he will be able to reconstruct the farm from the saved meat.

Income is the amount of capital generated through acquisition over and above the original capital.

If we consume more than the original capital, we are consuming our capital. Therefore:

Capital consumption is the amount of capital consumed exceeding the amount of available income.

But if we are careful, we may consume less than the excess of capital which was produced through acquisition over the original capital. Thus we can now re-define savings as:

Savings are leftovers between income and consumption.

These three definitions are critical because one of the most important tasks of any economic calculation is to determine the magnitudes of income, savings and capital consumption.

Note: please see the Glossary if you are unfamiliar with certain words.

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