Previous Year Question

Economic growth means a sustained increase in an economy’s real production of goods and services and its productive capacity over time.

Capital formation is the process through which an economy devotes part of its current output to the creation of machinery, factories, equipment, transport, irrigation, energy and other productive assets instead of using the entire output for immediate consumption.

In simplified terms:

Capital Formation = Gross Domestic Saving + Net Foreign Capital Inflow

In national accounting, Gross Capital Formation broadly includes:

• Gross Fixed Capital Formation—investment in fixed assets such as buildings, machinery, equipment and infrastructure.

• Change in Stocks—changes in inventories of raw materials, work-in-progress and finished goods.

• Valuables—acquisition of valuable items held primarily as stores of value.

Option (c) is correct.

Capital formation enlarges the economy’s capital stock and productive capacity. Additional and improved machinery, energy, transportation and infrastructure can increase output per worker and labour productivity, enabling the economy to produce more goods and services in the future.

Here, Y is output, K is capital, L is labour and A represents technological efficiency. Other things remaining unchanged, an increase in K raises the economy’s productive capacity.

Examination of the options:

• Option (a): Technical progress in the world economy does not necessarily benefit country X if it lacks access to the technology or the capacity and institutions required to adopt it.

• Option (b): Population growth alone does not guarantee growth in output or per capita income. Without adequate capital and jobs, it may increase unemployment and the dependency burden.

• Option (c): Capital formation directly increases the domestic productive capacity of country X and is the most definite basis for growth among the given options.

• Option (d): Growth in world trade does not necessarily produce growth in country X if the country does not participate effectively or lacks export competitiveness.

Qualification: In practice, capital formation alone may not be sufficient. Productive utilisation of investment, technology, skilled labour, institutional quality and demand also matter. However, among the given alternatives, only capital formation is directly linked to an expansion of country X’s productive capacity.