Essential economic activities
Resource maintenance means tending to, preserving, or improving the stocks of resources that form the basis for the preservation and quality of life. A capital stock is a quantity of any resource that is valued for its potential economic contributions. Capital stocks are also often referred to as “capital assets.”
We can identify four types of capital that contribute to an economy’s productivity. Natural capital refers to physical assets provided by nature, such as land that is suitable for agriculture or other human uses, fresh water sources, and stocks of minerals and crude oil that are still in the ground. Manufactured capital means physical assets that are generated by applying human productive activities to natural capital. These include such things as buildings, machinery, stocks of refined oil, transportation infrastructure, and inventories of produced goods that are waiting to be sold or to be used in further production. Human capital refers to individual people’s capacity for labor, particularly the knowledge and skills each can personally bring to his or her work. Social capital means the stock of trust, mutual understanding, shared values, and socially held knowledge that facilitates the social coordination of economic activity.
Lastly, there is a fifth sort of resource, financial capital, which is a fund of purchasing power available to an economic actor. While financial capital doesn’t directly help to produce anything, it indirectly contributes to production by making it possible for people to produce goods and services in advance of getting paid for them. It also facilitates the activities of distribution and consumption. Key examples of financial capital would be a bank checking account, filled with funds that have been either saved up by the economic agent who owns it or loaned to the agent by a bank.
Notice that economists’ description of “capital” is different from what you might hear in everyday use. In common usage, sometimes people take “capital” to mean only financial capital. We hear this in everyday references to “capital markets,” “undercapitalized businesses,” “venture capital,” etc. Economists take a broader view.
Capital stocks may increase or decrease as a consequence of natural forces, as in the case of a natural forest; or they may be deliberately managed by humans, in order to provide needed inputs for the production of desired goods and services. When the quantity or quality of a non-financial resource is increased now in order to make benefits possible in the future, this is what economists mean by investment. The activity of “resource maintenance” is about making sure that investments are sufficient to provide an economy with good asset base for future years and future generations. You, right now, are investing in your “human capital” by studying economics.
The second of the four basic economic activities is production. Production is the conversion of resources into usable products, which may be either goods or services. Goods are tangible objects, like bread or books, whereas services are intangibles, like TV broadcasting, teaching, or haircuts. Manufactured assets, such as machines and buildings, are also the result of human productive activity—that is, some items are produced for investment purposes. Popular bands producing music, recording companies producing CDs, local governments building roads, and individuals producing cooked meals are all engaged in the economic activity of production.
The economic activity of production converts some resources, which we call inputs, into new goods and services, which we refer to as outputs, as a flow over some period of time. The way in which this production occurs depends on available technologies. Production processes can also lead to undesirable outputs, such as waste products. We consider only useful outputs to be economic goods and services.
Inputs include materials that become part of the produced good, supplies that are used up in the production process, and labor time. For example, were we to ask a chef how to prepare one of his specialties, say ginger chicken, we would be given an answer in terms of ingredients (chicken, ginger, oil, etc.) and a method for combining them. The food ingredients become part of the produced good. Other inputs that will be used up in the process probably include the natural gas or electricity that provides heat and other supplies such as paper towels. The chef’s labor time is necessary for the dish to be prepared, and is used up by the process.
But the recipe, the chef’s skills, and the stove and cooking implements that will be used neither become part of the produced good nor are “used up,” although they are crucial for the production process. We can best think of these as flows of services arising out of capital stocks. The production process draws on services from social capital, in the form of the social knowledge embodied in a recipe; services of the chef’s human capital in the form of the chef’s acquired knowledge; and services of manufactured capital in the form of the stove and implements. But unlike materials and supplies, these capital stocks are not themselves transformed or used up in production.
In the case of commercial production, the services of another form of capital—financial capital—are also vitally important. This is because the production process takes time. Imagine that the chef and her husband, for example, are also entrepreneurs. They need to be able to buy the ingredients, buy or rent kitchen space, and get to work well before they can prepare the meal and sell it. They therefore need to have financial capital available at the start of the process—either financial assets of their own, or loans they can use to pay the bills until their revenues start coming in. If at the end of the process, they can sell the meal, cover all their expenses, and make a profit, they will end up with more financial capital than before.
This is illustrated in Figure 1. The reliance of commercial production on manufactured and financial capital is very important for macroeconomics. Production by noncommercial organizations such as households, nonprofit organizations, and governments, also begins with resources—including financial resources, if any of the inputs are going to be bought on markets. Generally, however, such production is intended for purposes other than making a financial profit.
Distribution is the sharing of products and resources among people. In contemporary economies, distribution activities take two main forms: exchange and transfer.
When you hand over money in return for goods and services produced by other people, or when you receive a wage for the work you have provided to an employer, you are engaging in exchange. Markets are social institutions that facilitate exchange relations. People are generally much better off if they specialize in the production of some limited range of goods and services, and meet at least some of their other needs through exchange, than if they to produce everything they need themselves.
Distribution also takes place through transfer. Transfers are payments given with nothing specific expected in return. For example, wealth is transferred from one generation to the next by inheritance. Social Security payments from the federal government to the elderly, to give another example, are transfers.
Distribution also takes place through transfers of goods, services, or assets as well as transfers of money. Local public school boards, for example, distribute education services to child and teenage students in their districts, tuition-free. Parents in households transfer food and care to children. These sorts of nonmonetary transfers are called in-kind transfers.
Consumption refers to the process by which goods and services are, at last, put to final use by people. In some cases, such as eating a meal or burning gasoline in a car, goods are literally “consumed” in the sense that they are used up and are no longer available for other uses. In other cases, such as enjoying art in a museum, the experience may be "consumed" without excluding others or using up material resources.
The activity of consumption is frequently contrasted, in macroeconomics, to the resource maintenance activity of investment. The two activities are linked by the activity of saving, or refraining from consumption today in order to gain benefits in the future.
For example, suppose a subsistence farmer grows a crop of corn. To the extent the farmer eats some of the corn, the farmer consumes—the corn is used up in the process of eating, and is not available for future use. To the extent that the farmer sets some of this year’s corn crop aside for planting next season, the farmer saves. The farmer also invests—that is, creates a resource that will aid production in the future. Having an inventory of seeds is what makes growing a crop in the next season possible.
In a modern, financially sophisticated economy, the situation is more complex, but the basic idea is the same. Modern households can save by spending less money on consumption than their income would allow. Governments can save by spending less on government consumption goods than their budgets would allow. Businesses save by retaining some of their earnings, instead of paying out to their shareholders (as dividends) all of what they make beyond their (non-investment) expenses. These flows of savings add to the stock of available financial assets. Financial intermediaries such as banks and bond markets allow savers to loan out the use of their financial capital to others who want to borrow. Some of the borrowers will use the funds to pay for the creation of new investment goods, such as buildings, factories, or a college education.
- Global Development And Environment Institute, Tufts University
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