Capital

Topic: Factors of Production, Entrepreneurship and Startups · NCERT: Class 8, Ch 7 "Factors of Production"; Class 9, Ch 8 "Building Blocks in Economics: The Problem of Choice"

Meaning

Capital is any asset used to produce goods and services. It can be physical, like machines, tools and buildings, or financial, like the money used to buy or rent them. Its reward is interest (Class 8, Factors of Production).

• Short form: capital = money + human-made resources used in production.
• Capital matters because it raises how much a worker or a country can produce. The yearly addition to a country's capital (capital formation) is one of the main drivers of economic growth.
• Gross investment = Net investment + Depreciation.

Explanation

Two forms of capital, and how they connect

• Physical capital means the human-made things used to produce other goods and services.
• NCERT examples: machinery, tools, equipment, vehicles, vending carts, computers, shops, factories and office buildings.

• In Ratna's restaurant case (Class 8), her furniture and kitchen equipment are physical capital.

• Financial capital means the money used to buy or rent physical capital.

• It comes from personal savings, family, bank loans or the stock market.

• Ratna's money to lease the site (rent it for a fixed period) and buy equipment was her financial capital.

• The link: financial capital is the means, and physical capital is what it buys.

• Savings or a loan → money in hand → an oven is bought or a shop is rented → production starts.

• Capital is one of the four factors of production:

Factor	Reward
Land	Rent
Labour	Wages / salary
Capital	Interest
Entrepreneurship	Profit

Key features of capital

• It is a produced means of production.
• Land is a gift of nature, and nobody made it.
• Capital is made by people. A tractor was produced in the past so that it can be used to produce more.

• Trap: a natural forest is land. A fishing net made from forest fibre is capital.

• It depreciates. Depreciation is the fall in the value of capital as it wears out through use and age.

• Worked example (straight-line method, where the same amount of value is lost each year): Ratna buys an oven for ₹1,00,000 that lasts 5 years.
• Depreciation per year = ₹1,00,000 ÷ 5 = ₹20,000.

• Book value after 2 years = ₹1,00,000 − ₹40,000 = ₹60,000.

• Gross vs net investment.

• Suppose a firm spends ₹5 lakh on machines in a year, and ₹1 lakh of that only replaces worn-out machines.

• Its net investment (the real addition to its machines) = ₹5 lakh − ₹1 lakh = ₹4 lakh.

• Fixed capital vs working capital (beyond NCERT):

Basis	Fixed capital	Working capital
Life	Lasts over many production cycles	Used up in one cycle
Examples	Ovens, buildings, machines	Raw materials, fuel, cash for daily bills and wages
Depreciation	Yes, slowly	Not applicable; fully used up
Typical funding	Long-term loans, equity	Short-term bank credit, owner's cash

Where financial capital comes from: the ladder (Class 8)

A firm usually climbs these steps as it grows:

1. Personal savings, family and friends. This is the cheapest source, with no formal interest and no paperwork. But it is limited by how much the family has.

2. Bank loans. The borrower repays the principal (the amount borrowed) plus interest (the price paid for using someone else's money for a set time). - Simple interest = Principal × Rate × Time ÷ 100. - Example: ₹2,00,000 at 10% a year for 2 years → 2,00,000 × 10 × 2 ÷ 100 = ₹40,000 interest, so ₹2,40,000 is repaid in total.

3. Stock market. Large companies sell shares (small units of ownership) to the public. Shareholders may receive a dividend, which is a payment made out of profits. - Beyond NCERT, for startups: an angel investor is a wealthy person who puts their own money into a very young startup in exchange for equity (part-ownership). Venture capital (VC) is a professionally managed fund that does the same for high-risk, high-growth startups. An IPO (Initial Public Offering) is a company's first sale of shares to the public.

Choice of technique and capital formation

• "How to produce" is one of the basic economic problems (Class 9, The Problem of Choice).
• Labour-intensive technique: more workers and fewer machines, such as harvesting by hand.
• Capital-intensive technique: more machines and fewer workers, such as using a combine harvester.

• A country with many workers and little capital often prefers labour-intensive methods, because they create jobs.

• Investment is spending on new capital goods. Capital formation is the addition to a country's stock of capital in a year.

• How it builds on itself (Class 12): firms put profits into new machines → production capacity rises → output and income rise → more saving → more investment.

In India

• Measurement: the National Statistical Office (NSO) under MoSPI publishes Gross Fixed Capital Formation (GFCF). This is spending on fixed assets such as buildings, machinery and infrastructure.
• GFCF was ₹98,86,129 crore at current prices in 2024-25 (Provisional Estimates, released 30 May 2025) [6].
• That was 29.9% of GDP in 2024-25, down from 30.4% in 2023-24 and 31.2% in 2022-23 [6].
• Worked example: ₹98,86,129 crore ÷ ₹3,30,68,145 crore × 100 ≈ 29.9% [6].
• Real GFCF (adjusted for inflation) grew 7.1% in 2024-25, and 9.4% in Q4 (January–March 2025) [6].

• Gross Capital Formation (GCF) is a wider measure: GFCF + change in stocks + valuables. It was 31.4% of GDP in 2023-24, against 32.6% in 2022-23 [7].

• Startup capital (SEBI): VC funds are regulated as Category I Alternative Investment Funds (AIFs) under the SEBI (Alternative Investment Funds) Regulations, 2012 [8]. Angel Funds are a sub-category within Category I venture capital funds [8][9].

• Angel Funds raise money only from eligible angel investors and invest only in startups that meet DPIIT (Department for Promotion of Industry and Internal Trade) criteria [9].

• They need the angel investor's approval deal by deal, and may invest only in firms incorporated within the preceding 3 years [9].

• Micro-unit capital (MUDRA): the Pradhan Mantri MUDRA Yojana (PMMY) was launched on 8 April 2015 [4][5]. It gives collateral-free loans (no property has to be pledged) to non-corporate, non-farm, income-generating micro and small enterprises [5].

• Categories: Shishu up to ₹50,000; Kishore ₹50,000 to ₹5 lakh; Tarun ₹5 lakh to ₹10 lakh; Tarun Plus ₹10 lakh to ₹20 lakh, only for borrowers who took and fully repaid a Tarun loan [2][3].
• The overall limit was raised from ₹10 lakh to ₹20 lakh. This was announced in the Union Budget 2024-25 (23 July 2024) and took effect on 24 October 2024 [2][3].
• By April 2026 (the 11-year mark), over 57.79 crore loans had been sanctioned and ₹40.07 lakh crore disbursed [4][5]. About two-thirds went to women and about one-fifth to first-time entrepreneurs [5].
• Shishu had 8.80 crore accounts with ₹2.47 lakh crore sanctioned [5]. Tarun had 55 lakh accounts with ₹4.82 lakh crore sanctioned [4]. So most MUDRA loans are tiny working-capital loans.

Don't confuse with

• Land: a free gift of nature, and its reward is rent. Capital is made by people, and its reward is interest.
• Entrepreneurship / profit: the entrepreneur earns profit for organising production and bearing risk. The reward to capital is interest, not profit.
• Human capital: skills, knowledge and health held inside people. Physical capital loses value with use and can be sold or pledged as security for a loan. Human capital cannot be separated from the person, often grows with use, and usually cannot be pledged.
• Debt vs equity capital: debt earns interest, which is fixed and owed even in a loss year, and the lender is not an owner. Equity earns a dividend, paid only if profits allow, and the shareholder becomes a part-owner. For example, a firm with a ₹10 lakh loan at 12% owes ₹1,20,000 even in a loss year, but can skip the dividend on its ₹10 lakh of equity.

Prelims Hooks

• Capital is a produced means of production, and its reward is interest. A fishing net is capital, but the forest it came from is land.
• Gross investment = Net investment + Depreciation. GCF = GFCF + change in stocks + valuables.
• GFCF was 29.9% of GDP in 2024-25 (current prices), and real GFCF growth was 7.1%. It is published by the NSO, MoSPI [6].
• PMMY was launched on 8 April 2015. It covers only non-farm, non-corporate units, so farm loans are a trap [5]. Tarun Plus (₹10–20 lakh) is open only to borrowers who have repaid a Tarun loan, effective 24 October 2024 [2][3].
• Angel Funds are a sub-category of Category I AIF (venture capital funds) under the SEBI AIF Regulations, 2012. They invest only in firms up to 3 years old [8][9].
• An IPO is a company's first sale of shares to the public. Later share sales by a listed company are not IPOs.

Mains Points

• Capital formation drives growth, but private investment has been slow.
• GFCF fell from 31.2% of GDP in 2022-23 to 29.9% in 2024-25 [6].
• For growth to stay high, private firms must invest more, not only the government.

• Possible policy links: public capex (government spending on long-lasting assets such as roads) that pulls in private investment, stable interest rates, and making it easier to do business (GS-III: investment models).

• How firms raise capital affects how risky they are.

• Too much borrowing → fixed interest owed even in bad years → defaults → bad loans (NPAs) that hurt banks.
• Equity, AIFs and angel funds let startups take risks without fixed interest burdens [8][9].

• MUDRA widens access to credit, with 57.79 crore loans, about two-thirds to women [4][5]. But most loans are small Shishu loans, which raises questions about loan size and repayment (GS-III MSMEs; GS-II welfare for women).

• Physical and human capital must grow together.

• A labour-surplus economy gains from labour-intensive techniques, because they create jobs.
• Skilled workers get more output from every machine they use, so policy on capital and policy on skills (such as vocational training) go hand in hand.

Related concepts

• Financial capital

Read more

• Capital: physical and financial, and where it comes from