MEASUREMENT OF CAPITAL

The theory of capital is one of the most difficult and contentious area of economic theory. From Karl Max to the Cambridge, controversies as to what capital are, and how it should be measured has been an ongoing disagreement among economists. Economists have variously defined capital as congeal labour, deferred consumption and the “degree of round- about”, stock of durable commodities or as a flow of factor services. There is also disagreement about whether capital can be aggregated into a single measure and even within the relatively hospitable confines of neoclassical theory, exact aggregate is known to be problematic.

This presents the practical economists with something of a dilemma since many interesting economic problems require a measure of capital. How, for instance, are we to understand the process of economic growth if we cannot agree on how to measure one of the potential, most important factors influencing the process? What can we say about such an important issue? Why productivity is low and why growth rates differ across the Nigerian economy? These issues are too important to be ignored as an estimate of capital, income, and wealth; however, imperfect must somehow be developed in order to get on with the larger task.

In this unit, therefore, applied capital theory, the need for capital measurement and ways of measuring capital are considered.

OBJECTIVES

By the end of this unit, you should be able to:
explain the applied theory of capital
discuss the need for capital measurement
explain the method of measuring capital

Applied Capital Theory

Two aspects of capital (including human capital) differentiate it from a primary input. Unlike labour, capital is a means of production, and capital is durable. The first aspect is the primary source of the Cambridge controversy in pure theory, but the latter (durability) causes much of the difficulty in measuring capital. Durability means that capital is productive for two or more periods, and this in turn implies that the distinction must be made between the value of using or renting in any year and the value of all the capital assets.

This distinction will not necessarily lead to a measurement problem if capital services used in any given period were paid for in that period, that is if all capital were rented. In this case, transactions in the rental market will fix the quantity of capital for each period; much data on the price and quantity of labour services are derived from labour market transactions. Unfortunately, much capital is utilised by its owner and transfer of capital service between owner and user results in an implicit rent typically not observed by the statistician. Market data thus explains inadequacy of the task of directly estimating price and quantity of capital services. This has led to the development of indirect procedures for inferring the quantity of capital like the perpetual inventory method or the acceptance of flawed method for example book value.

SELF-ASSESSMENT EXERCISE 1

1. Identify and discuss the applied theory of capital. 

Need for Capital Measurement

A company that is not making optimum use of its resources is either over capitalised or under-trading. Over capitalisation arises when a company tries to conduct a volume of trade over and above that for which it is financially equipped. On the other hand, under capitalisation occurs when a company manages its capital inefficiently, so that there are excessive stock, debtors and cash and very few creditors, there will be an over investment by company in capital assets.

In view of the above, it becomes necessary to measure the capital required by an organisation due to the following reasons:

• To avoid too much investment in fixed assets above the company’s requirement. 
• To check incidence of high investment in current assets such as stocks and debtors. 
• To avoid reduction in profit margin because of too much discount given to debtors in order to reduce average collection period. 
• To avoid under utilisation of capital employed. 
• To improve the Return on Capital Employed (ROCE) that is the profit attributable to the providers of capital.