Factors of Production – Capital

For any business to start and function the first requirement is money. This is the capital of the firm. It forms the basis of the company and all other factors of production are bought with the capital. Capital consists of all types of wealth, even the free gifts of nature. Let us learn more about capital and capital formation.

Browse more Topics under Theory Of Production And Cost

• Meaning of Production
• Factors of Production – Land
• Factors of Production – Labour
• Factors of Production – Entrepreneur
• Production Function
• The Law of Diminishing Returns
• Returns to Scale (Production Function)
• Production Optimisation

Capital as a Factor of Production

We can define capital as the productive part of a firm’s wealth. Wealth is the sum of all money, goods, human values, etc that can be useful in the production of further wealth. But capital is the part of this wealth that is currently in productive use. Resources lying idle are wealth but not capital.

So capital is known as the man-made means of production. Hence capital will include every man-made goods that are used in the production process. This differentiates both land and labour from capital since both of these are not man-made. So machinery, tools, plant, instruments, factories, transport vehicles, etc are all forms of capital itself.

Features of Capital

• Capital is a passive factor of production. It needs labour to be productive.
• Capital is variable in nature. It increases and decreases according to the needs of the firm
• Among all the other factors of production, capital is the most mobile. Transportation of capital is an easy activity
• Also capital is destructible in nature. It’s not permanent like land. For example, a machine will wear and tear and may even completely break down with time.

Capital Formation

Capital formation essentially means investment. It involves an increase in the production of capital goods in a country. These goods include machines, factories, power supply units, railways, roadways, etc. The need for capital formation arises not only out of replacement or renovation but also to increase the production capacity of an economy. Let us take a look at the stages of capital formation.

1] Increase in Real Savings

With an increase in income, there is an increase in savings. So higher income generally means higher savings. This is true for individuals as well as an economy as a whole. A richer country has more capacity to save and increase its wealth than a relatively poorer country.

But only the ability to save is not enough. There should be a willingness to save. A person with one eye on the future will save more and create wealth. The government also encourages savings for its citizens. They provide tax benefits and exemptions on saving schemes. For an economy both individual savings and government savings are important.

2] Mobilization of Savings

Only saving does not lead to capital formation. These savings have to be mobilized. The banks, financial institution, etc collect these savings and offer them to prospective investors. So such institutions and financial products should be available to the public. And they should also be attractive in terms of returns. The state will play an important role in the mobilization of savings as well.

3] Investment

The final step of capital formation. Here the real savings get converted to actual investment. The entrepreneurs will properly utilize these savings to generate more income and more wealth and the cycle will continue.

Solved Example for You

Q: Capital is generated from labour. True or False?

Ans: This statement is true. It can be said that capital is a stored form of labour in a way. Labour earns a person wealth. This wealth is saved and turned into capital. So indirectly capital is a saved form of labour.