(a) A change in the stock of capital in any economy during any particular time period is called capital formation.
The process of capital formation consists of the following steps:
1. Creation of Sayings: It is the first step in the process of capital formation. It is savings which are transformed into capital. If there is no saving, there cannot be any capital formation, even if all other conditions are favourable for capital formation. Savings are done by households and it depends on their income and willingness to save.
2. Mobilization of Savings: If savings are kept in the form of idle cash at home, they will not lead to capital formation. In this case, the rate of investment in the country will be low, even though the rate of saving is high. The savings must be mobilized from the savers. In a modem society, financial and other institutions as well as the capital markets perform this function. People may keep their savings in the banks or other financial institutions. They can also buy shares or bonds issued by companies.
3. Investment of Mobilized Savings: Even mobilization of savings is not sufficient for a high rate of capital formation. The mobilized savings must be actually used by producers for the purpose of investment. For instance, the money kept by the people in the banks must be lent out by the banks to the producers who can use the money.
Capital formation is important for economic growth because:
(i) Capital formation enhances file production, without it production is not possible.
(ii) Capital formation leads to development of human capital like education, health etc. which leads to economic growth.
(b) Supply means the quantity actually offered for sale at a certain price, but Stock means the total quantity which can he offered for sale if the conditions are favourable.
Factors affecting supply are as follows:
1. Price of the commodity: Price is an important factor affecting supply of a commodity. At a higher price the producers would like to supply more and at a lower price the producers would like to supply less.
2. Goals of the firm: The goals of a firm also affect its supply of a commodity. If the goal of a firm is profit maximisation it would supply more at a higher price and vice-versa. However, if the goal of a firm is risk-minimisation the firm would produce and supply less so as to be on the safer side.
3. Input Prices: Input prices play a role in the supply of a commodity by a firm. A firm would like to produce arid supply more if input prices would be low due to the low cost of production and vice-versa.
4. Prices of related commodities: Related commodities refer to substitutes and compliments. If the prices of related goods especially substitutes rises then the producers will shift production to these goods and decrease the production of the existing good. The vice versa will happen when the prices of substitutes will decrease.
