Capital formation - One of the four basic economic activities

The four basic economic activities of any economy are interlinked and each activity leads to the other next activity.

• Production of goods and services leads to and results in distribution of the goods so produced to their consumption points..
• Distribution of goods to all corners of economy results in consumption of those goods and services in an effective way.
• Consumption can be refrained at some point of satiety and then, the extra consumption capacity can be got diverted into investment for future stocks and capital formation.

So, you are able to see how one activity leads to the other activity.and how they can be interlinked.

Now, coming to capital formation, It can be defined as creation of capital- either working capital or fixed capital- by way of purchasing new stocks or plant and machinery or through increasing the present levels of capital. It can be treated as new investments in business or the yearly increases in present stocks or working capital.

The creation of capital or capital formation refers to the net worth of assets after meeting out liabilities. It is the balance value of additions to capital by way of deducting all liabilities from assets.

Decrease in the expenses and in present consumption leads to excess of income and excess of stocks of produced goods and services. So, whenever there is more production and lesser consumption, it leads to capital formation. So, the restraint from present consumption and generation of savings are the major sources of capital formation. The overall production is either consumed or used for creating capital.


Understanding capital formation process

• Whenever you refrain from present consumption and save your money, it gets deposited into banks generally.
• The banks in turn lend that money to producers or invests the money in shares and equity funds. 
• This investment again is used by the producers and businessmen to purchase machinery and equipments and in starting new ventures or to increase the present production levels. Increased production is possible because of this extra income or savings utilised positively by producers. 
• This will again boost the economy and can increase both income of workers and also the consumption levels. 
• Increased consumption is a sign of elevated standard of living and symbolises a developed economy.

Increased consumption should not mean that whatever you are producing is consumed entirely. When the production of goods and services are much more than requirements, and since you are having more money to spend in developed economies, it is possible that you can consume more things at relatively affordable prices and still save sufficient money. So these savings again create capital formation.


Capital formation takes place when these savings are deposited into banks and used for investments in shares or for financing the producers. If the savings are kept idle at home, then no capital formation can occur. So it is important that idle funds are utilised for producing more goods and services to be considered as contributing to capital formation process.

Consumption of Goods and Services and its effects on economy

Consumption is the 3rd basic economic activity of any economy that follows after Production and Distribution of goods. In some cases, consumption may not necessarily require to go through the intermediary process of distribution, as in the case of a roadside eatery, where food is produced and consumed immediately with no intermediary.

Consumption is the act of using up something. Economically, it is the usage or utilisation of goods and services that are being produced. Whatever goods and services get produced, we use them up for satisfying our needs - let it be our immediate need or some future need. Either way, it is the act of consumption. So, whenever we are eating at some eatery or restaurant, or purchasing some provisions, clothes or other household and electronic goods, all these are counted to be acts of consumption. Similarly, consulting a Doctor, availing hospital services, legal services or salon services - all these acts are also adding to the concept of consumption function.


Types of consumption
Every consumption does not lead to immediate satisfaction of needs.

• Some portion of the consumption adds to storage and future utilisation of those goods. For example purchasing a bag of rice and other monthly or weekly purchases. These items are consumed throughout the month or week.
• Some items of consumption are used for longer durations of life like electronic goods, furniture and other equipments which are utilised for years.
• Many items of goods and resources are procured for using them in manufacturing other end products. This consumption can be termed as industrial consumption. Industrial consumption leads to production of many goods and products that are again utilised by end users or intermediaries. So, it is a chain of consumption.

Limitations of Consumption

There can be some limitations to consumption as it is dependent on other circumstances that are inter linked with it. 

• An individual's income determines his consumption. As the income is limited in nature for any one person, he can spend only a certain amount of money to purchase things or services. So, his consumption is limited according to his income.
• Availability of goods also determines or affects consumption function. You may be wanting to buy something, but it is not available in your region or presently not there in stock. So, you are unable to buy it and should look at other options or go without it.
• Ignorance of knowledge also affects consumption, as you are unaware of some goods in market and so do not think of purchasing them.

Bad effects of Consumption
Consumption, if uncontrolled, can lead to many worst situations of economy.

• Consumption makes goods and services out of stock sometimes.
• Consumption can dry up the resources of economy thereby depriving the future generations of their resources.
• Consumption can make governments depend upon other countries for goods and resources thereby tilting the balance of payments position negatively.

From the above facts, we are able to see that our needs and wants require to be controlled and balanced by curtailing unnecessary consumptions of goods and resources. Then only can our economy prosper.

Distribution of Goods and Services as one of the basic economics activities of man

Distribution also is considered as one major economic activity in addition to the three basic economic activities. It is the activity that comes after production and its job is to distribute the goods and services that have been produced during the period to their points of consumption. Goods produced does not get consumed in the local market of your region itself when productions are on large scales. So, the goods need to be transported to all corners of the market depending upon their requirements. First of all, you may need to create awareness in the market about your produce so that people come to know of it and demand it for their requirements. This involves publicity and advertisement. Then, you need the transporting facilities and storage facilities also for the goods till they get consumed.

So, distribution of goods and services involve these following major activities.

Publicity
To get requirement or demand for your goods, the public should be aware that you are producing so and so goods and/ or services. This can be achieved through advertisements in all leading newspapers or broadcasts on Radio and TV. Further, awareness about your products as to their quality and functions also need to be publicised through distribution of pamphlets and TV advertisements. This will make interested people to demand for your products.

Transportation
When you receive requirement for goods, you need to transport them to the required places. This can be done either with your own fleet of vehicles or through public transportation facilities available like carriers, couriers, railway freight services, cargo services, etc.

Storage
Distribution of goods may require storage space and facilities also for storing the goods at destination points or even at intermediary points till actual consumption takes place to protect them from heat and rain. You can't ship each and every requirement separately, since it will be not economical and may delay the supply also. So, storage occupies an important role in the distribution of goods.

So, from above analysis, you can see that distribution of goods is a very complex economic activity involving publicity, transportation and storage of goods also and it needs to be considered as the second major economic activity after production.

There can be exceptions, in which case there may not be the need of this distribution activity taking place. For example, food consumed directly at small roadside eateries, a hair-cut in the saloon, etc. where there is no involvement of distributing activities. It is a case of direct production and consumption.