Capital goods and consumption goods

Overview

Difference between a capital good and a consumption good, durable and non-durable consumption goods and gross and net investment.

What you need to know

Answer each one before you reveal it.

Questions from this subtopic

Each one with the model answer underneath.

1. 1

   What is the difference between a capital good and a consumption good?

   Model answer

   A capital good is bought in order to produce other goods and services, such as a factory, a lathe or a lorry. A consumption good is bought by a household for the direct satisfaction it gives, such as a meal, a jumper or a cinema ticket. The distinction rests on the purpose the good serves, not on the object itself.

2. 2

   The same model of van is bought by a plumber for her business and by a family for weekend trips. Explain how each purchase is classified.

   Model answer

   The plumber's van is a capital good because it is used to deliver a service that is sold, so it contributes to future production. The family's van is a durable consumption good because it yields satisfaction directly to the household. Identical physical objects can fall into different categories, which shows that classification depends on use.

3. 3

   Distinguish between durable and non-durable consumption goods, with an example of each.

   Model answer

   A durable consumption good delivers satisfaction over a long period and is not used up at once, such as a washing machine or a sofa. A non-durable consumption good is consumed quickly, such as bread, petrol or a newspaper. The distinction matters because spending on durables can easily be postponed in a downturn, which makes it far more volatile than spending on non-durables.

4. 4

   Explain the trade-off an economy faces between producing capital goods and producing consumption goods.

   Model answer

   Resources used to build machinery and infrastructure cannot simultaneously be used to make food, clothing and entertainment, so devoting more resources to capital goods means lower consumption today. The compensation is that a larger capital stock raises the economy's productive capacity, so consumption can be higher in future. The choice is therefore about the timing of consumption rather than about giving it up.

5. 5

   Two economies are identical in size, but one devotes a quarter of its output to capital goods and the other a tenth. Analyse how their standards of living will differ now and in twenty years.

   Model answer

   The economy investing a tenth enjoys higher consumption immediately, because more of current output is available to households. The economy investing a quarter has a lower standard of living now but is adding to its stock of machinery, buildings and infrastructure faster, so its productive capacity grows more quickly and its frontier of possible output shifts outward further. After twenty years it will normally be able to sustain a higher level of consumption than the low-investment economy. The high-investment path therefore trades present living standards for future ones, and how attractive that is depends on how much weight society places on the present.

6. 6

   What is depreciation, and why does an economy need some investment simply to stand still?

   Model answer

   Depreciation is the wearing out and obsolescence of existing capital: machines break down, buildings decay and equipment becomes technically out of date. Some new investment must therefore be made each year just to replace what has been lost. If gross investment only matches depreciation the capital stock is unchanged, and productive capacity does not grow.

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