Factors of Production and the PPC Diagram: Question 10
Syllabus 1.2
Farah says, "My capital is the $8,000 I have saved in my bank account, which I am going to use to start a juice-bar business." She has not yet spent any of this money.
Which of the following best explains how an economist would view Farah's $8,000 of savings, before she spends it on her business?
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Worked solution
Step 1: Recall what “capital” means as a factor of production
In everyday speech, people often use the word “capital” to mean money. For example, “start-up capital.” In economics, however, capital as a factor of production means something more specific: manufactured resources used to help produce other goods or services, such as machinery, tools, equipment and buildings. Money itself is not one of the four factors of production; it is simply a means of acquiring factors of production.
Step 2: Apply this to Farah’s $8,000
Farah’s $8,000 is currently just savings sitting in a bank account. It has not yet been used to buy anything. It only becomes capital once she spends it on manufactured resources that will be used to produce her juice-bar’s output, such as a juicing machine, a fridge, or a counter and stools for the shop.
Step 3: Rule out the other options
- Option A wrongly treats the money itself as capital, rather than recognising that capital is the manufactured resources the money will eventually buy.
- Option C confuses capital with land: Farah’s savings are not a natural resource, so they cannot be land.
- Option D confuses the money with wages: wages are a reward for supplying labour, but Farah’s $8,000 is savings, not a payment she has earned for working in this context.
Final answer
Farah’s $8,000 is money, not capital. It will only become capital once she spends it on manufactured resources, such as a juicing machine or a fridge, that will be used to produce her juice-bar’s output, so the answer is option B.