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Monday, 27 August 2018

Stages of capital formation

Stages of Capital Creation

Creation of Saving

The level of saving in an economy depends on power to save and the will to save. It depends on average level of income and distribution of national income. Higher the level of income, the greater will be amount of savings.

People save for future emergencies; some for old age and some for other contingencies. Further saving me either voluntarily or forced. Voluntarily savings means saving by people of their free will. It depends on power to save. Due to taxes imposed by government , people are forced to save. This is called forced saving.

Saving may be done by:

1. Households
2. Business Firms
3. Government

Businessman retain their profit in the form of undistributed profits. They use this amount to invest in real assets.

Government saving represent tax collected and profit earned by public undertakings. This saving can be used by the government for building new capital goods e.g plant and machinery , factories, roads, dams etc. or it can lend this money.
Stages of capital formation

Mobilization of saving

Mobilization means movement of saving from household to entrepreneurs for production purpose. Producers require funds for making investment which is very essential for the economy. In the capital market funds are supplied by individual , firms, banks, financial institutions etc. Development of capital market is very important because it is a platform where producers are able to arrange funds for investment.

Investment of savings in real assets

For capital formation, savings must be invested. A country should have honest and risk taking entrepreneurs for this purpose. Entrepreneurs invest when there is requirement to invest. It means there is prospective profit but there is risk also. Prospective profit is more important than risk inherent in an opportunity. If an entrepreneur fluctuates investment level, it means there is change in prospective profit. It is the size and nature of market which determines the level of profit.

Foreign Capital 

Foreign capital plays an important role also in capital formation. A country can obtain foreign capital from following sources:

1. Private investment by foreigners
2. Loans received by foreign governments
3. Loans from World Bank, IMF etc.

Foreign capital is very essential for the development of less developed countries. It is divided into two categories; Foreign Direct Investment ( FDI ) and Foreign Institutional Investment ( FII ).

Foreign Direct Investment

FDI is very important source of investment in an economy. Foreigners are allowed to establish directly factories, mills, stores etc. Apart from it foreign investors can also join their hands with corporate and government in the investing country. Due to FDI , Investment level increase, technology updates and more employment opportunities generates in the economy.

Foreign Institutional Investment

When foreign investors invest in portfolio investment in the economy, it is termed as FII's. In other words when foreign investors purchase securities of a company in investing country is known as FII's. It may be beneficial or harmful for the economy due to its speculative nature. Due to liberalization and globalization FII's are increasing their investment in developing countries.

Deficit Financing 

Another source of capital formation in a developing country is deficit financing. A risk inherent in deficit financing is inflationary pressure. Deficit financing should be used on under-employed labour so the increase in supply can take place. This will eliminate the effect of inflationary pressure.

Disguised unemployment

This is also a source of capital formation by using the unproductive labour in productive purpose without decreasing the level of output. The workers working on field who are nothing useful to work there should be used in other capital creating projects e.g roads, dams etc. Hence with the same level of output in agriculture, unproductive workers working on fields may be used for capital creation projects.

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