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All man made goods which can be used for further production is known as capital. For example, plant and machinery, dams and canals, equipments, etc. are all known as capital. Capital has been defined as “produced means of production”. This is because, unlike land and labour which are primary factors of production, capital is produced by man to help in the production of further goods. Money is regarded as capital because it can be used to buy raw materials, tools, implements and machinery for production. The terms capital and wealth are not synonymous. Capital is that part of wealth which is used for further production of wealth. Thus, all wealth is not capital, but all capital is wealth.

Capital formation

Capital formation means creating more and more of capital assets and adding that to the existing stock of capital. Hence, it can be termed as a form of investment. In order to accumulate capital goods, some current consumption has to be sacrificed. This is because, if all that is produced is used for current consumption and nothing is stored for the future, then the future productive capacity will decline. It is not only required for creating additional productive capacity, but also for replacement and renovation of existing machinery and equipments.

Accumulation of capital / Capital formation

We can say that capital can be accumulated through savings. But savings alone is not responsible for capital formation because, if the savings of individuals lie idle, no capital formation takes place. Thus, the savings of all the individuals are accumulated and invested in a profitable venture to fetch returns which would result in capital accumulation. Thus, capital is accumulated in three stages:
  • ƒ Creation of savings: Savings are very essential for capital formation. However, the ability to save depends on various factors like:
    • Income of the individuals: Generally, higher the income, higher would be the ability to save.
    • Willingness to save: An individual may have surplus income which he can save. But he must have the willingness to create savings. Willingness to save depends upon the interest of an individual to have a secure future.
Savings are done by the individuals or households, and Government saves by way of tax collections and profits of PSU’s. It has been noticed that individuals of an underdeveloped country use their income for current consumption rather than for future consumption. Thus, the savings of an underdeveloped country is far lesser than those of developed countries. This is why the developed countries become richer quickly when compared to underdeveloped countries.
  • ƒMobilisation of savings: If the savings of the individuals lie idle, they are of no use to the economy. Thus, financial institutions like banks must collect deposits of all the small investors and make them available to the prospective investors to invest the money and create capital.
  • ƒUtilisation of savings or investment: The savings must be made available to the entrepreneurial class who are prepared to bear the risk of the business and invest them in profitable ventures which would create new capital assets.

Types of capital

  • ƒFixed capital: It refers to durable capital goods which are used in production again and again till they wear out.
    Example: Machinery, tools, etc.
  • ƒCirculating capital: It is capital used for the purchase of raw material. It is also known as working capital. It is meant for single use.
  • ƒFloating capital: Capital goods which have some alternative uses are floating capital.
    Example: Electricity.
  • ƒReal capital: It is referred to capital goods other than money such as machinery, land, etc.
  • ƒHuman capital: Skills, knowledge and abilities possessed by an individual is called human capital.
  • ƒSocial capital: It is referred to non commercial assets owned by the society as a whole.
    Example: Parks, hospitals, etc.
  • ƒIntangible capital: It refers to some benefits and rights, which cannot be perceived by senses.
    Example: Copy right, patent, etc.

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