Sources Of Capital Formation

							                             Sources of Capital Formation (Domestic Source)

1. Individual savings: It is that part of income of individual which is not consumed on consumers good.
The saving is a directly proportional function of income .i.e. S = f(Y). The level of savings in a country
depends upon the power to save and the will to save. The higher the level of income, the greater will be
the amount of savings.

2. Business savings: Business enterprises save when they do not distribute whole of their profits but
retain a part of them in the form of undistributed profits which are used for investment in real capital.

3. Government savings: The government savings constitute the money collected as taxes and the
profits of public sector. The greater the amount of taxes collected and profits made, the greater will be
the government savings. These can be used by the government for holding up new capital goods like
factories, machines, roads etc. or it can lend them to private enterprise to invest in capital goods.



4. Public Borrowing: It is an important source of capital formation. It acts as an anti-inflationary
measure by mobilizing surplus resources to productive channel.



5. Deficit Financing: It is newly created money and is an important source of capital formation in a
developing country. It is the method on which the government can fall back to obtain funds but it may
lead to inflationary pressures in the economy.



6. Disguised unemployment: The surplus agricultural workers can be transferred from the agricultural
sector to the non-agricultural sectors without diminishing agricultural output. These un-productive
workers can be employed in various capital creating projects such as roads, buildings, canals, health
centers etc.



Savings are the major determinant of capital formation savings are of two types. Personal savings refer
to the amount saved by households, while business savings are the undistributed profits of the
businesses. Personal savings form the major part of the total savings in a country. Capital market
consists of stock exchanges, financial institutions, and investment agencies etc. efficient capital market
induces more investment and it is vital for capital formation. Investment, especially in capital good
industries, is essential for increasing the capital stock in a country. For more investment in a country
government should provide proper facilities and incentives to investors.
Stock of capital in a country can also be increased through government borrowing. Govt. of a country
can mobilize unutilized savings by selling securities and bonds of various denominations. The funds so
generated can be invested to increase the stock of capital in a country. Many countries firms and multi-
national companies make investment in countries. Usually they invest in heavy industries such as
fertilizers and chemicals, automobile industries etc. there are different specialized international financial
institutions that provide loans to members’ countries.