Question

Define capital formation. Explain the three important stages of capital formation.

Answer 1

Capital formation is the creation of capital. A change in the stock of any capital during a particular period of time is called capital formation.

The stages are:

1. Creation of savings : Capital formation depends on savings. Saving is that part of national income which is not spent on consumption goods.

2. Conversion of savings into investment : To accelerate the rate of capital formation it is absolutely essential to convert savings into investible resources. Thus, the second stage of capital formation is concerned with channelizing the savings of the household sector and convert these into loanable funds.

3. The actual production of capital goods : This stage involves the con­version of money-savings into the making of capital goods, or what is known as investment. The latter, in turn, hinges on the existing technical facilities available in the country, existing capital equipment, entrepreneurial skill and venture, rate of return on investment, rate of interest, govern­ment policy, etc.