For simplicity consider a village where the villagers only grow and consume potatoes. Each year they plant the potatoes they set aside for this purpose to grow more potatoes. The remainder they consume. In the following diagram, the villagers consume two thirds of their potatoes each year and save one third to plant the next year. Year after year, production remains essentially constant.
But one year the villagers decide to set aside two thirds of their harvest for planting and consume only one third. This is represented in the next diagram. While the first year, they must consume less, by the next year they are back to consuming the original amount again. And the year following that, they consume twice as much as they did originally. The year following that would be twice again, and so on.
You can see the evidence of the power of capital accumulation in the following diagram from the June 20 2012 issue of The Atlantic. Up until the time of the industrial revolution, the world looked much like our first diagram above. There was no meaningful change in the standard of living for millennia. But the start of the industrial revolution in the west led to rapid economic growth.
But specifically, how does capital create value? In short, capital provides leverage. Leverage is simply the utilization of a tool or resource to amplify the impact of some given resources. The villagers in our example increased the impact of their planting by using more seed potatoes. Just as tools increase the productivity of a carpenter, a computer the productivity of a writer, and so on. So, leverage allows us to generate more marketable value using potentially fewer resources overall.
This advantage of capital though is also its weakness. Leverage increases profit potential by allowing revenue to grow disproportionate to cost. But it can as easily leverage losses when revenues fail to materialize but costs are largely fixed. If one gym is profitable, then five gyms might be five times as profitable (in aggregate). But if the market can’t support five gyms, then revenue will not scale up with fixed cost potentially leading to a business failure.
As a final cautionary note, physical capital is subject to diminishing marginal impact. Buy a carpenter a power saw, you increase their productivity immensely. Buy them a second one, there’s hardly any impact. The same goes for investment in human capital. A course in effective sells can have a substantial impact. A second or third course, not so much.