How Entrepreneur Contribution to Capital Formation?

How Entrepreneur Contribution to Capital Formation?

Entrepreneur Contribution to Capital Formation

The entrepreneurial decision, in effect, is an investment decision that augments the productive capacity of the economy and hence results in capital formation. Capital formation is a phrase used to explain the net capital growth during an accounting period for a exacting country, and the phrase refers to additions of capital stock, such as equipment, tools, transportation assets and electricity.

In a modern economy, where saving and investment are done mainly by two different classes of people, there must be certain means or mechanism whereby the savings of the people are obtained and mobilized in order to give them to the businessmen or entrepreneurs to invest in capital. In fact, GDP and capital formation are related to each other via Capital Output Ratio (COR); more precisely Incremental Capital Output Ratio (ICOR) that measures the percentage increase in capital formation required obtaining a percentage increase in GDP. So, if a country desires to grow @ 10.0 % p.a. and its ICOR is 2.6, then it must ensure capital formation @ 26.0% p.a.

Entrepreneurs, by investing their own savings and informally mobilizing the savings of their friends and relatives contribute to the process of capital formation. They employ their own as well as borrowed resources for setting up their enterprises. Such type of entrepreneurial activities leads to value addition and creation of wealth, which is very essential for the industrial and economic development of the country. These informal funding supplements the funds made available by the formal means of raising resources from banks, financial institutions and capital markets.