MEANING OF CAPITAL FORMATION - STAGES OF CAPITAL FORMATION 

Process of Capital Formation picture
Process of Capital Formation (non-copyright form healthymarketing.com)

Meaning of Capital


Capital formation is defined as the process of increasing the stock of real capital in the country. In other words, capital formation involves making more and more capital goods. It is defined in both narrow and wider sense. In the narrow sense, it refers to the expenditure on fixed capitals such as machines, tools, etc over a period of time. In this sense, capital formation denotes investment in physical or material capital only, which leads to an increase in material capital goods. However, in a wider sense, it includes investment in human capital along with material capital. Capital formation is also known as capital accumulation the economic development of a country significantly depends upon the availability of capital stock with it. The higher rate of capital formation enables the economy to produces a larger volume of goods and services, which in turn, increases the national income or output. Thus, capital formation leads to industrialization, economic welfare, reduction in the cost of production, and so on.

PROCESS OF CAPITAL FORMATION

Three distinct processes of Capital formation stages are


1. Creation of saving:


Saving is the first stage of the process of capital formation. Saving is that part of income that is not consumed. As the rate of income increases in an economy, the rate of saving increases, which in turn increases the rate of capital formation and economic development. The part of income that is saved by the people is used for the creation of capital goods. However, an increase in saving depends upon many factors such as power and willingness to save, distribution of income, the imposition of taxes, rate of interest, etc.

2. Mobilization of saving:


Merely saving is not sufficient, if it is not mobilized. The mobilization or canalization of saving is essential since the people who save are different from the people who invest. The mobilization of savings is done through the various financial and non-financial institutions in a country. The banks, insurance companies, capital markets, etc: are the institutions that act for the mobilization of savings. These institutions accept the saving from the people or give loans to the investor. However, mobilization of saving in an economy depends upon many factors, such as the development of banking or financial system, the banking habit
of the people, etc.

3. Investment of saving:


Investment in saving is the third and the last stage of the process of capital formation. There are certain classes of people in a country who invest in the production of goods and services both in the agricultural as well as industrial sectors. The part of the investment that goes to capital goods creation leads to capital formation. However, there are many factors upon which the investment of saving depends. Some of them are availability o good entrepreneurs, rate of interest, expected rate of profit, government policy, level of economic development, etc.

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