What Is Physical Capital?
Let me explain physical capital to you directly: it's one of the three main factors of production that economists talk about. It consists of tangible, human-made goods that help in creating a product or service. Think about the machinery, buildings, office supplies, vehicles, and computers that a company owns—these are all part of its physical capital.
Key Takeaways
- In economic theory, physical capital is one of the three factors of production.
- Physical capital consists of tangible, human-made objects that a company buys or invests in and uses to produce goods.
- Physical capital items, such as manufacturing equipment, also fall into the category of fixed capital, meaning they are reusable and not consumed during the production process.
Understanding Physical Capital
In neoclassical economic theory, factors of production are the inputs you need to produce goods or services for profit. Economists generally agree on three main ones, and I'll break them down for you.
First, there's land, natural resources, and real estate. These include the land or property where factories, shipping facilities, and stores are built. Natural resources extracted from the ground, like corn for tortilla chips or iron ore for steel, fit here too.
Second, human capital. This covers labor and other resources humans provide, such as education, experience, or unique skills that contribute to production.
Third, physical capital—sometimes just called 'capital.' This includes human-made items that make manufacturing possible or help it run smoothly. Some are directly involved, like welding equipment on a factory floor fusing car parts. Others are indirect, like computers and printers in headquarters.
Physical Capital and Startups
If you're starting a new company, you'll invest in physical capital early on, often before producing anything or landing your first client. Take a microwave oven manufacturer: they need to build a factory, buy machinery for assembly, and create samples before stores stock their product.
For established firms, the accumulation of physical capital and the required investment can create a big barrier to entry for newcomers, especially in manufacturing-heavy industries. The level of diversification in physical capital shows how diversified an industry is. From this view, starting a law firm is easier than a manufacturing plant— you might just need an office, a desk, a phone, and a computer. That's why there are more law firms than steel manufacturers, as an economist would point out.
Example of Physical Capital
Experts see physical capital as key in valuing a company, but it's tricky to evaluate. There's often disagreement on what counts—economists debate the exact boundaries of the three factors.
Consider Coca-Cola's headquarters in Atlanta: some call the office buildings physical capital as human-made structures; others put them under land or real estate.
Physical capital is often illiquid because it's designed for specific purposes. A machine capping Coca-Cola bottles isn't useful elsewhere, tailored to their unique bottles.
Most physical capital is fixed capital—reusable, not consumed in production, with long-term value that usually declines over time. Manufacturing equipment depreciates and is accounted for over decades. But value can rise if upgraded or if company changes affect it.
What Is an Example of Using Physical Capital?
Here's a straightforward example: a manufacturing company uses machinery to produce goods. For a sneaker company like Nike, machines create layers and press sneakers together—these machines are the physical capital.
What Is the Difference Between Physical Capital and Human Capital?
Physical capital is the tangible assets like machines and equipment used to make goods and services. Human capital is the knowledge, skills, and abilities humans bring to production. A machine might make sneakers, but humans need the know-how to build and operate it.
What Is Natural Capital?
Natural capital is the stock of environmental resources like land, timber, and waterways that you can use in production and protect for ongoing use.
The Bottom Line
Physical capital is the tangible, human-made assets like machinery, buildings, and equipment used in producing goods and services. As one of the three main factors of production, it enables and streamlines manufacturing. It's essential for operations, but hard to value, and it depreciates unless upgraded.
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