We may define capital as that part of wealth of an individual or community which is used for further production of wealth. In fact, capital is a stock concept which yields a periodical income which is a flow concept. It is necessary to understand the difference between capital and wealth. Whereas wealth refers to all those goods and human qualities which are useful in production and which can be passed on for value, only a part of these goods and services can be characterized as capital because if these resources are lying idle they will constitute wealth but not capital. Capital has been rightly defined as ‘produced means of production’.
Classification of capital
Real capital and human capital: Real capital refers to physical goods such as buildings, plant, machinery etc. As against this human capital refers to human skill and ability. This is called human capital because a good deal of investment has gone into creation of these abilities in humans.
Individual capital and social capital: Individual capital is the personal property owned by an individual or a group of individuals. As against this, social capital is what belongs to the community as a whole in the form of roads, bridges etc.
Fixed and circulating capital: Fixed capital is used in business or industry for producing certain items of use so long as business continues. As against this circulating capital is one which is purchased and sold like stock-in-trade which may create certain obligation like bills receivables and bills payables.
Tangible capital and intangible capital: Tangible capital may be perceived by senses whereas intangible capital is in the form of certain rights and benefits which cannot be perceived by senses as for example, goodwill, patent right, etc.
Role of capital
Capital plays a very vital role in the modern productive system, production without capital is almost impossible. Capital makes it easier for man to extract goods from the nature. With the growth of technology and specialisation, capital has become more sophisticated in nautre and scope. More goods can be produced with the aid of capital. In fact, greater productivity of modern economies like that of U.S.A. is mainly due to the extensive use of capital that is machinery, tools or implements in the productivity process. Capital adds greatly to the productivity of the worker and hence, the economy as a whole.
The productivity of work force depends upon the amount of capital available per worker. The greater the capital per worker, the greater the productivity and the eficiency of the worker.
From the point of view of economic growth, capital formation is important because it makes large-scale production and greater degree specialisation possible. Capital accumulation by enlarging the scale of production and specialisation increases the production and productivity in the economy and thereby promotes economic growth.
Another important role of capital formation is the creation of employment opportunities in the country. Capital formation creates employment at two stages.
1. When the capital is produced.
2. When capital is used for producing the goods.
The fundamental solution to the problem of unemployment and under-employment is to speed up the rate of capital formation so as to generate greater employment opportunities.
Capital formation
Capital formation means a sustained increase in the stock of real capital in a country. In other words, capital formaion involves production of more capital goods like, machines, tools, factories, transport equipment, electricity etc. which are all used for further production of goods. Capital formation is also known as investment. The need for capital formation, or investment is realised not merely for replacement and renovation but for creating additional productive capacity.
In order to accumulate capital goods some current consumption is to be sacrificed and savings of current income are to be made. Savings are also to be channelised into productive investment. The greater the extent that people are willing to abstain from present consumption the greater the extent of savings and investment that society will devote to new capital formation. If society consumes all what it produces and saves nothing, future productive capacity of the economy will fall as the present capital equipment wear out.
Stages of capital formation
There are mainly two stages of capital formation which are as follows:
Savings: The basic factor on which formation of capital depends is the ability to save. The ability to save depends upon the income of an individual. Higher incomes are generally followed by higher savings. This is because with an increase in income the propensity to consume comes down, and the propensity to save increases. This is true not only for an individual but also for the economy as a whole.
Mobilisation of savings: It is not enough that people save money; what is required is that the saved money enters into circulation and facilitates the process by capital formation. There should be a wide spread network of banking and other financial institutions to collect public savings and take them to prospective investors. In this process, the state has a very important and positive role to play both in generating saving through various physical and monetary incentives and channelisation of the savings towards priority needs of the community so that there is not only the capital generation but socially beneficial type of capital formation.
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