ECN 104 Study Guide - Capital Expenditure, Quill

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Published on 5 Oct 2011
School
Ryerson University
Department
Economics
Course
ECN 104
Professor
Requirements for increased growth
Capital expenditure
we learned that increasing capital, both human and physical, is the only way to create productivity growth in the long
run. One way to directly increase the amount of capital in an economy, also called the capital stock, is by increasing
the spending on capital.
In order to understand how increasing the spending on capital works, it is necessary to understand how money is
spent on capital. In order for most firms to increase their capital stock, they must purchase additional machinery,
tools, and education for their employees. Because firms do not often have the large sums of cash necessary for these
types of purchases readily available, they must go to banks to get funding for their capital expenditures. Remember
that when banks make loans, they are simply matching up savers and borrowers. Thus, the amount of savings by
individuals directly affects the amount of money available for capital expenditures by firms. In this way, the savings
rate in a country is the single most important determinant of the expenditures made by firms on capital.
How much money should be saved in an economy and how much should be invested in capital? This question is
difficult to answer. Some countries, like Japan, have very high savings rates. Others, like the US, have very low
savings rates. In both cases, the exact effect on the growth of productivity is unclear. In general, the savings rate that
corresponds to the golden rule level of capital is considered optimal. This is defined as the savings rate that maintains
the level of capital associated with the higher per worker consumption rate. In general, a savings rate that is as high
as possible without significantly reducing the standard of living of the population is desirable.
Regardless of the savings rate, expenditures on capital directly affect the growth rate of an economy. They inject the
economy with new tools, machinery, and training. These forms of capital are basic necessities of production. For a
given amount of labor, such an increase in capital will increase possible output.
Technological progress
Of course, spending money to simply increase the amount of capital in an economy is not the only way to increase
productivity. Increases in the quality of capital can also affect growth. The major way the quality of capital is increased
is through technological progress, the fruit of research and development. Technological advances can allow a given
unit of capital to enable a given unit of labor to increase production. This increase is contrasted to the increase
created by simply enlarging capital expenditures. In the latter case, a given unit of labor has more capital to work with
and can thus produce more output; while in the former case a given unit of labor can produce more output with a
given unit of capital.
How does technological progress come about? The major ways are though innovation and invention. Every year,
billions of dollars are spent on research and development by firms and government agencies, like NASA. This money
leads to improvements in existing technology and to the creation of new technologies. While innovation and invention
may not always be immediately profitable, in the long run they can prove very lucrative for the researchers and the
developers--as well as for the economy as a whole, as new, more efficient production technologies become available.
Capital expenditures vs. technological progress
Let's look at a classic example of technological progress. Say that Sam is a scribe. He spends his days hand copying
books and manuscripts. It takes him an average of 1 day to copy a book. Then the printing press is invented. These
new devices allow books to be issued at a rate of 10 per day. The output is the book. In this case, an improvement in
the technology used to produce output (from quill pen to printing press) leads to an increase in the output quantity.
The invention and implementation of the printing press thus qualifies as technological progress.
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Document Summary

Capital expenditure we learned that increasing capital, both human and physical, is the only way to create productivity growth in the long run. One way to directly increase the amount of capital in an economy, also called the capital stock, is by increasing the spending on capital. In order to understand how increasing the spending on capital works, it is necessary to understand how money is spent on capital. In order for most firms to increase their capital stock, they must purchase additional machinery, tools, and education for their employees. Because firms do not often have the large sums of cash necessary for these types of purchases readily available, they must go to banks to get funding for their capital expenditures. Remember that when banks make loans, they are simply matching up savers and borrowers. Thus, the amount of savings by individuals directly affects the amount of money available for capital expenditures by firms.