Investment and Real Business Cycles

So far we have simplified matters by pretending that labour services were the only variable input to the production process. Now we want to be more realistic by including capital services as well. We shall think primarily of physical capital, such as machines and buildings used by producers. In the national accounts this category is called producer’s durable equipment and structures. But we can broaden this concept of capital to include the goods held as inventories by businesses. We might also add consumer durables, such as homes (called residential structures in the national accounts), automobiles, and appliances. We could go further to include human capital, which measures the effects of education and training on the skills of workers. Although the general economic reasoning applies also to human capital, we shall confine most of the analysis here to physical capital.