Capital formation is a macroeconomic term referring to additions to the capital stock in a given period, allowing economists to understand a country’s economic expansion and production. It includes fixed capital investment, inventory value increase, and net value of assets lent to other countries. Variations include gross fixed capital formation and human capital formation. While some economists question its value, supporters argue it can be used in conjunction with other formulas to present a broader picture of the economy.
A term commonly used in the study of macroeconomics, capital formation has to do with additions to the capital stock in a given accounting period. Developed by Simon Kuznets during the 1930s and 1940s, the approach is heralded by some financial analysts as an essential way to assess a country’s true financial picture. Understanding the current rate can help economists understand the state of a national economy, as the number helps identify the rate of economic expansion and the incidence of increased production by the country in question.
In many cases, this figure is considered equal to the sum of several factors. Capital formation has to do with the investment of fixed capital within a country, as well as the increase in the value of the various inventories of assets held and the net value of assets lent to other countries during the period considered. This may include transferring savings to finance loans or some other aspect of the economy. Depending on the exact application, the number may allow for depreciation or exclude any amortization for deductions related to depreciation.
Among the variations of capital formation, there are a couple of focused applications that are worth noting. A gross fixed capital formation will exclude any assets that cannot be properly designated as a fixed capital asset. Human capital formation is a more recent variation that focuses on the inclusion of human labor, talents, skills, and the resources that are used to train new workers to replace retirees.
While many economists consider this approach an important method for understanding the state of the national economy, others question the value of the process. Issues such as price inflation, consumption of fixed assets, and the fact that a domestic entity’s sales also happen to be another entity’s investment are often mentioned as important factors that are not involved in calculating the figure. However, supporters argue that these and other elements can be explained by subjecting capital formation to other formulas to present a broader picture of the economy.
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