Physical Capital: Definition and Effects on Productivity

What Is Physical Capital?

In any economy, the production of goods and services happens every day. Physical capital is part of the production process, what economists call a factor of production. It includes things like buildings, machinery, equipment and computers. Let's take a closer look at physical capital: what it is, what it isn't and see it in action within our economy.

First, let's take a look at what it is and what it isn't. Physical capital isn't the land or the raw materials that are used and turned into goods and services; those are natural resources. It isn't the people with knowledge or education that help produce things; they're called human capital. Physical capital is the machinery, buildings and computers that helped turn the raw materials into finished products or services. It is all of the equipment and all of the other physical things that a business owner or company invests money into when they want to produce something.

Real-World Examples

To learn more about physical capital, I want you to join me as we take a tour of the Fantastic brand corn chips factory.

Standing outside the factory building, we can see two men unloading bags of corn, salt and a secret flavor recipe from a delivery truck. These raw materials are then carried inside the building, where they are placed in various types of machines. The corn, which is the main ingredient, is placed in a very large pot that cooks it. Once cooked, workers place it into a machine that grinds it down until it becomes fine corn flour. After another machine adds salt, cooking oil and other flavorings to it, this corn flour enters a shaping machine that turns it into small triangles, and then it moves along a conveyor belt towards a large oven.

Sam, who operates this machinery with a computer that monitors the oven's temperature, ensures that every batch of raw chips gets cooked properly. Once this batch is placed in the oven, cooled and placed in bags, this production process has turned it into a crispy, crunchy, corny creation that consumers constantly crave. As a matter of fact, when they eat it, they often say it is 'quite fantastic!'

Tractors are physical capital used in agriculture.

As we just saw in this tour of the corn chips factory, physical capital was used to make the chips, but none of it was included in a bag of Fantastic corn chips. Physical capital is used not just to produce chips, but in the production process across the entire economy to produce other goods and services. In farming, a tractor used in the process of producing crops is an example of physical capital. In the clothing industry, it's a sewing machine. In the auto industry, it's an assembly line that produces cars. Whatever it is that's being produced, these goods and services are then sold at a price that buyers and sellers both agree on in a free market.

Assembly lines are vital physical capital in the automotive industry.

The Importance of Physical Capital

So far, we've talked about what physical capital is and what it isn't. But, why is it important? Physical capital is important because it increases the productivity of goods and services, which helps the economy grow. The machines inside the corn chips factory make it possible for more corn chips to be produced than the amount that the workers could possibly produce otherwise. This increase in productivity occurs everywhere that physical capital is used to produce goods and services.

The total amount of goods and services that are produced within the economy are then counted in the GDP, or gross domestic product. You can watch my lesson on that to learn more about GDP and how to measure economic growth, but when you think about a growing economy, keep in mind that physical capital is one of the main things that helps drive economic growth.

Lesson Summary

Okay, let's review the key points:

Physical capital is part of the production process, what economists call a factor of production. It includes things like buildings, machinery, equipment and computers. It isn't land, labor or entrepreneurship, but it is all of the equipment and all of the other physical things that a business owner or company invests money into when they want to produce something.

In farming, a tractor used in the process of producing crops is an example of physical capital. In the clothing industry, it's a sewing machine. In the auto industry, it's an assembly line that produces cars. Physical capital is important because it increases productivity, which is one of the main things that helps drive economic growth. It is measured by what economists call gross domestic product, or GDP for short.

Learning Outcomes

Following this lesson, you will be able to:

• Define physical capital and explain its importance
• Provide real-life examples of physical capital in different industries