Despite being a high saving economy, capital formation may not result in significant increase in out

Question

Despite being a high saving economy, capital formation may not result in significant increase in output due to

Accepted Answer

Capital formation means increasing the stock of real capital in a country. In other words, capital formation involves making more capital goods such as machines, tools, factories, transport equipment, materials, electricity, etc., which are all used for future production of goods.For making additions to the stock of capital, savings and investment are essential. Capital output ratio is the amount of capital needed to produce one unit of output. For example, suppose that investment in an economy is 32% (of GDP), and the economic growth corresponding to this level of investment is 8%. Here, a Rs 32 investment produces an output of Rs 8. The capital output ratio is 32/8 or 4. In other words, to produce one unit of output, 4 units of capital are needed.Hence, if the capital-output ratio is high, there will not be a significant increase in output despite high savings and investment.Source: NCERT: Business Studies