Mod 10: Capital Formation & the Capital–Output Ratio
Concept
10.1 Capital formation: saving, mobilisation, investment
🏫 School level · NCERT Class 9–12 (the base for UPSC, BPSC, SSC and Bank exams)
Investment is the essential step
Capital formation is the addition to a country’s stock of real capital (machines, buildings, roads, inventories) during a year. It has three steps: saving, the mobilisation of saving through banks and financial markets, and investment in new assets. Investment is the essential step: saving that sits idle does not create capital.
| Measure | Meaning | Latest figure |
|---|---|---|
| Gross capital formation (GCF) | GFCF + change in stocks + valuables | 34.3% of GDP in 2024-25 (₹109.25 lakh crore), MoSPI Feb 2026 |
| Gross fixed capital formation (GFCF) | New fixed assets: machinery, construction, intellectual property | 31.9% of GDP in FY 2025-26; real growth 8.2% (NSO June 2026) |
| Net capital formation | GCF − depreciation | — |
For the whole economy, saving − investment = current account balance. When India invests more than it saves, the gap is financed from abroad and shows up as a current account deficit. So capital formation can exceed domestic saving only by borrowing foreign saving.
- Capital formation = saving → mobilisation → investment.
- GCF ≈ 34.3% of GDP (2024-25); GFCF 31.9% (2025-26).
- S − I = current account balance.
- Is saving without investment capital formation? Answer: No
- GCF minus GFCF mainly equals? Answer: Change in stocks (and valuables)
MCQs
Answer this question, then use Next.
Saving rises but banks do not lend and firms buy no assets. Capital formation:
If gross investment equals depreciation, NCERT Class 12 implies that:
[Current affairs] According to MoSPI’s new series (February 2026), India’s gross capital formation rate in 2024-25 was about:
[School] The three stages of capital formation are:
[UPSC level] For an economy, if gross investment exceeds gross domestic saving, the difference is reflected in:
[Bank PO pattern] Gross fixed capital formation (GFCF) does NOT include:
[School] Spending on education, health and training of people is called:
[Current affairs] India’s gross fixed capital formation in FY 2025-26 was about what share of GDP (NSO, June 2026)?
One-liners
Write your answer, then submit to see the correct answer.
Is saving without investment capital formation?
NoGCF minus GFCF mainly equals?
Change in stocks (and valuables)Concept
10.2 Capital–output ratio, Harrod–Domar and slow per capita growth (NCERT Class 12)
🏫 School level · NCERT Class 9–12 (the base for UPSC, BPSC, SSC and Bank exams)
Same saving, higher ICOR → slower growth
The capital–output ratio (COR) is the amount of capital needed to produce one unit of output; the incremental COR (ICOR) is the extra capital needed for one more unit of output. A high ICOR means capital is used inefficiently: idle capacity, delayed projects, poor technology or waste.
Two economies both invest 32% of GDP. A has ICOR 4, B has ICOR 6. Population grows 1% in both. Find GDP growth and per capita growth.
- A: g = 32 ÷ 4 = 8%; per capita ≈ 8 − 1 = 7%.
- B: g = 32 ÷ 6 ≈ 5.3%; per capita ≈ 4.3%.
- Same saving, slower growth in B because capital is less productive.
- High capital–output ratio (capital-intensive heavy industry, project delays).
- Rapid population growth diluting GDP gains.
- Slow growth of agriculture and industry; inflation eroding real incomes.
- Rural incomes lower than urban: little scientific farming, low prices of primary products, low investment in agriculture.
- Not causes: a high rate of capital formation (it raises growth).
- ICOR = ΔK ÷ ΔY; g = s ÷ ICOR.
- High ICOR + fast population growth → slow per capita growth.
- Rural incomes lag: low productivity, low farm prices, low farm investment.
- Saving 32%, ICOR 4: growth? Answer: 8%
MCQs
Answer this question, then use Next.
Two economies save 24 percent of income. The one with the higher capital-output ratio will, on the simple sketch, have:
Which pair slows the growth of per capita income on the 1993 item?
[Numerical] The investment rate is 32% of GDP and the ICOR is 4. By the Harrod–Domar relation, GDP growth is:
Question 87: Assertion (A): Though India's National Income has gone up several fold since 1947, there has been no marked improvement in the Per Capita Income level.
Reason (R): Sizeable proportion of the population of India is still living below the poverty line. [I.A.S. (Pre) 1996]
Question 88: In India, rural incomes are generally lower than urban incomes. Which of the following reasons account for this?
1. Farmers know little about scientific agriculture
2. Prices of primary products are lower than manufactured products
3. Investment in agriculture has been low compared to industry
Select the correct answer: [I.A.S. (Pre) 1996]
Question 92: Which of the following are the main causes of slow rate of growth of Per Capita Income in India:
1. High capital-output ratio
2. High rate of growth of population
3. High rate of capital formation
4. High level of fiscal deficits
Select the correct answer: [I.A.S. (Pre) 1993]
Question 96: Which of the following reasons are mainly responsible for slow growth of Real Per Capita Income in India:
1. Rapid increase in population
2. High increase in prices
3. Slow growth in agriculture and industrial sectors
4. Unavailability of foreign exchange
Find the correct answer: [U.P.P.C.S. (Pre) 2001]
One-liners
Write your answer, then submit to see the correct answer.
Saving 32%, ICOR 4: growth?
8%Concept
🎯 Competitive Level (UPSC Pre · BPSC Pre · State PSC · SSC · Bank PO · RBI Grade B): Capital formation in past papers
| Exam | What it asks from this module |
|---|---|
| UPSC Prelims | high COR despite high saving (1995, 2018); capital formation and growth (2013); causes of slow per capita growth (1993); rural–urban gap (1996) |
| BPSC / State PSC | meaning of capital formation (UPPSC 2021); stalled projects (RAS 2013) |
| SSC / Railways | GFCF, net investment |
| Bank PO / RBI Grade B | ICOR numericals, saving–investment gap and CAD |
The main reason for low growth rate in India, in spite of high rate of savings and capital formation is: (a) high birth rate (b) low level of foreign aid (c) low capital-output ratio (d) high capital-output ratio
- Growth = investment rate ÷ ICOR.
- With high investment, low growth can only mean a high ICOR: each unit of output needs a lot of capital.
- A low COR (c) would give faster growth. The same idea was asked again in UPSC 2018.
- UPSC 1995 and 2018: high saving, low growth → high COR.
- UPSC 2013: capital formation in X makes growth in X necessary.
- Investment is the essential factor of what? Answer: Capital formation
MCQs
Answer this question, then use Next.
Question 89: With reference to 'Capital formation' which of the statements is/are correct?
1. Process of capital formation depends on savings and effectiveness of financial institutions.
2. Investment is the essential factor of capital formation.
Select the correct answer: [U.P.P.C.S. (Pre) 2021]
Question 94: Economic growth in country X will necessarily have to occur if: [I.A.S. (Pre) 2013]
Question 95: Which factor can be highly supportive in achieving economic growth rate of 8% or more in the near future in India? [R.A.S./R.T.S. (Pre) (Re. Exam.) 2013]
Question 90: The main reason for low growth rate in India, inspite of high rate of savings and capital formation is: [I.A.S. (Pre) 1995]
Question 91: Despite being a high saving economy, capital formation may not result in significant increase in output due to: [I.A.S. (Pre) 2018]
One-liners
Write your answer, then submit to see the correct answer.
Investment is the essential factor of what?
Capital formation