Question

'Savings is essential for capital formation.' Explain.

Answer 1

1. Creation of Savings: Saving is the first stage in the process of capital formation. Savings in a country are made by different individuals. These depend upon several factors like (a) ability to save (b) desire to save and (c) opportunities to save. Ability to save directly depends upon the level of income. Higher the income of people, more will be their ability to save. Besides income, taxation policy of the government also affect the ability to save. When the rates of income tax and sales tax are high, people will be able to save only less amount than before. Opportunity to save refers to the conditions of peace and security in the country and favourable attitude of the government to motivate people to save.
2. Mobilisation of Savings: Capital formation cannot occur unless savings made by people are mobilised for investment purposes. Savings are done by millions of households and firms. It is very important that these savings are mobilised and used for productive and investment purposes. This requires a network of banks and other financial intermediaries who collect these savings and make them available to the producers or investors. Without banks and other financial intermediaries, these savings would remain idle and might not be utilised for productive and investment purposes.
3. Investment of Savings: The third and last stage of capital formation is the investment of mobilised savings. Unless mobilised savings are utilised or invested, there cannot be any capital formation. It is, therefore, necessary that the economy should have an entrepreneurial class which is prepared to bear the risk of business and invest savings in productive channels. The enterpreneurs will however get motivated only when (a) rate of interest is not very high and (b) there are good expectations of profit.