One of the most important aspects of economic theory known today is that of the capital definition. The capital stock refers to the value of something, i.e., the worth of an individual's personal assets, whether real or personal, such as one's house or his/her car. This definition is important because it tells us what the ownership of things is and also the allocation of resources. It also gives us the theory of economies of scale which shows that the more common a resource is, the more there will be a demand for it and the same applies to the more valuable assets.
By the standard definition, the wealth of an economy is that total income plus capital stock. However, in economics, unlike elsewhere, it is the value of something that should be taken into account. Now, before you make the conclusion that capital stock is equated with wealth, it should be said that the two are not necessarily identical. For instance, a bank can own a great deal of property, but it would not be considered wealth unless and until it makes interest on its own money. On the other hand, wealth is equated only with income.
The question then is: how do you determine the value of something? The classical economists distinguished value from wages or profit, which they said were merely the results of production. By comparing production to the demand for what is produced, they arrived at a definition of what is considered value. The modern economists, however, have extended this concept to include the value of productive assets such as capital and land as well as the means of producing them, which they call capital.
The capital stock is therefore the measure of wealth in an economy. But why is the value of the capital stock decided? Well, it all boils down to supply and demand. As to supply, the supply of capital stock itself decides the value because the supply always exceeds demand, i.e., if there are more investors buying up the stock, its value rises. On the other hand, if the supply exceeds the demand, then the value of the stock declines.
However, just because the value of the capital stock changes does not necessarily mean that the rate of capitalization increases or decreases. For example, during the 1970s the rate of capitalization per dollar of invested was rather low. As time went by, capital gains increased and the capital stock itself became worth much more. The same thing happened in the housing market, when houses started appreciating and their value appreciated.
So the wealth of the society is the value of the capital stock, minus the rate of inflation. If the rate of inflation increases, then the value of the stock will also increase. On the other hand, if the rate of inflation decreases, then the value of the stock will decrease.
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