Question

Explain what condition must occur for each of the following to occur: (1) the capital stock to increase; (2) the capital stock to decrease; and (3) the capital stock to remain constant

Answer 1

Answer )

Before delving straight into the factors that lead to the increase, decrease or same capital amount, we first discuss the factors that lead to the change in the capital which are as follows:

(i) Saving or investment:

Saving (or investment) is the percent of income that is invested in the new machinery , land etc in order to increase the production capacity in a factory.As the saving rate increases, the capital stock in the economy also increases.For example, let "y" be the output produced in the economy and "s" be the saving rate in the economy.So, "sy" is the total amount invested in the purchase of new capital.

(ii) Depreciation:

Depreciation is the wear and tear of capital due to the continuous use in the production process.As the depreciation increases, the capital (say,machines) in the economy starts decreasing and thus less capital is available for the production of goods.For example, if the machines producing the cars start breaking down, then the production of cars would decrease as less number of machines would be available for the production.Let "d" be the rate of depreciation.So, "dy" is the amount of capital depreciated in an economy during a given period of time.

Increase in Capital:

The overall capital in an economy increases when the savings is greater than the depreciation.In other words, it means that more capital is being replaced than the amount which is getting depreciated.

Mathematically, increase in capital occurs when,

sy > dy

So, we can conclude that as the saving rate in an economy increases, the capital also increases.  

Decrease in Capital:

The capital starts decreasing when the depreciation is greater than the savings in an economy.In other words, more capital is worne out of the production than the amount being replaced back.

Mathematically, decrease in capital occurs when,

sy < dy

So, we can conclude that as the saving rate in an economy decreases, the capital also decreases as the depreciation outweighs the savings.

Constant Capital:

The capital remains constant in the economy when the savings is equal to the depreciation.In other words, the amount of capital that is getting worne out or outdated is exactly equal to the amount that is being saved.

Mathematically, constant capital occurs when,

sy = dy