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Economics 12 Notes for Economics Notes

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Capital

Capital

It is durable physical assets used in the production. It includes machines, equipment, plants, tools, and so on. Capital is usable many times in production. It has life period. For its contribution in production it is paid interest, it is passive factor of production, it doesn’t yield anything unless it is used with labor. Its supplies are variable. Its use depends upon marginal physical productivity and interest rate, capital is depreciable every year. Depreciation is called capital consumption allowance or obsolete cost.

Capital formation

It is defines as the addition to capital stock used in the production in a fiscal year. The capital stock means the quantity of durable physical assets used in the production available at the beginning of fiscal year. It is the value of machines, equipment, plants, tools, and so on accumulated to the fiscal year. Capital formation is given by the difference between gross investment and depreciation of fiscal year. Depreciation is called capital consumption allowance or obsolete cost. If gross investment is greater than depreciation then there is positive net investment (capital formation) which gives increase in capital stock. If gross investment is less than depreciation then there is negative net investment (capital formation) which gives decrease in capital stock. If gross investment is equal to depreciation then there is no change in net investment (capital formation).

Mathematically,

Capital formation = Gross investment- depreciation

Capital formation depends upon marginal efficiency of capital and interest rate. Capital formation takes place only if marginal efficiency of capital is greater than or equal to interest rate it is less than interest rate the entrepreneurs don’t make investment rather they withdraw the investment.

Sources of capital formation:

If gross investment is greater than depreciation then there is positive net investment (capital formation) which gives increase in capital stock. For increase in capital stock entrepreneurs must have the sufficient investible fund. The investible fund can be generated from different sources like saving, dishoarding, depreciation fund, saving of non-departmental organization, corporate profit, foreign borrowing etc.

Process of capital formation:

1. Financing investment/ collection of investible fund: The investible fund can be generated from different sources like saving, dishoarding, depreciation fund, saving of non-departmental organization, corporate profit, foreign borrowing etc. Among these sources, the most regular and major type of source is saving. The saving of the people and non-departmental organization are encouraged through increase in interest rate, price subsides and so on.

2. Mobilization of fund: The investible funds are mobilized with the help of banks, finance companies, saving and credit cooperatives and so on. The amounts are collected in the form of deposits and through long term credit instruments like bonds, debentures etc. the money collected is lent to entrepreneurs for investment.

3. Investment: The amount collected by banks, finance companies, saving and credit cooperatives and so on in the form of deposits and through long term credit instruments like bonds, debentures etc. are lent to entrepreneurs for investment. Investment brings capital formation but gross investment must be greater than depreciation.