Meaning of Capital Formation

Capital formation means the increase in the stock or real capital in a country. In other Capital Formation involves making of more capital goods such  as machines, tools, factories, transport equipment, materials, electricity, etc., which are all used for further production of goods. For making additions to the stock of capital. saving and investments are essential. Professor Nurse has, therefore, defined Capital Formation as follows.

The meaning of ‘Capital Formation’ is that society does not apply the whole of its current productive activity to the needs and desires of immediate consumption, but directs part of it to the making of Capital Goods: tools and instruments, machines, and transport facilities.plant and equipment -all the various forms of real capital that can  greatly increase the efficacy of productive effort . The essence From the above it is clear that saving is essential for capital formation B in a monetary economy, savings may not direct  automatically result in the production of caps goods. Must be invested in order to ha e . In a modem economy. where savings e fitment are done mainly by two different cl 0 pie, there must be certain means or mechanism hereby savings of the people are obtained and mobilized In order to give them to the businessmen or entrepreneur  to invest in capital goods. Therefore, in a modern free-enterprise economy the process of capital formation consists of the following three stages.

Creation of Savings

Savings are done by individuals or households. They save by not spending all their income on consumer goods. When individuals or households save. ey re ease resources from the production of consumer goods. corkers, natural resources, materials, etc., th re eased are made available for the production of capital.

The level 0 savings in a country depends upon the power to save the to save. The power to save or saving  of an economy mainly depends upon the average level  income and the distribution of national income. The higher the level of income, the greater will be the amount of savings. The countries having higher levels of income are able to save more. That is why the •.ate of savings in the U.S.A. and Western European countries is much higher than that in under-developed am poor countries like India. Further, the greater the inequalities of income, the greater will be the amount of savings in the economy.

Furthermore, savings may be done not only by household but also by business enterprises and government. Business enterprises save when they do not distribute the whole of their profits but retain a part of them in the form of undistributed profits. They then use these undistributed profits for investment in real capital.

The third source of savings is government. The government savings constitute the money collected as taxes and the profits of public undertakings. The greater the amount of taxes collected and profits made, the greater will be the government savings. The savings so made can be used by the government for building up new capital goods like factories, machines, roads, etc., or it can lend.them to private enterprise to invest in capital goods.

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