capital output ratio

CAPITAL OUTPUT RATIO COMPLETE DETAILS

1. TOPIC: Topic: CAPITAL OUTPUT RATIO

2. Capital Output Ratio : A capital output ratio which is abbreviated as COR is related to be availability of natural resources in a country. It is used to measure the capital ratio that would be used for the production of some over a certain period of the time. The capital output ratio tends to increase if the capital available in a country is cheaper than the other inputs. Therefore, the countries that are rich in natural resources have a low output ratio. This is because they can easily substitute the capital with natural resources in order to increase the output. When countries use there natural resources instead of capital then COR reduces. We can take the example of Norway. This country does not have much of natural resources therefore its COR is high.

3. The size of COR can be determined when the amount of capital that has been used for the production of output is known. If depreciation capital is assumed as constant, then the COR is calculated by the ratio of GDP invested each year. Other things that determine COR include innovation and technical progression. If a lot of capital is used in order to undertake some projects of technological development, then the COR increase. On the other hand, the countries that are labour incentive i.e, they employ more labour for undertaking a developmental project have a low capital output ratio.

4. Apart from all these factors, another thing that can determine the COR is an investment. The more the rate of investment is,the more will be the COR. Similarly, low ratio of investment means low COR. Countries which can double its capital in ten years than the one which can double in twenty years will have higher capital output ratio.

5. INCREMENTAL CAPITAL OUTPUT RATIO : The incremental capital output ratio (ICOR) Is a metric that assesses the marginal amount of investment capital necessary for an entity to generate the next unit of production. Overall, a higher ICOR value is not prefered because it indicates that the entity’s production is inefficient. The measure is used predominantly in determining a country’s level of production efficiency. ICOR is calculated as : ICOR= Annual investment Annual increase in GDP

6. Example : For example, suppose that a country x has an ICOR of 10. This implies that $10 worth of capital investment is necessary to generate $1 of extra production. Further more, if country X’s ICOR was 12 last year, this implies that country X has become more efficient in its use of capital.

7. So me critics of ICOR have suggested that its uses are restricted as there is a limit to how efficient countries can become as their processes become increasingly advanced. For example, a developing country can theoretically increase its GDP by a greater margin with a set amount of resources than its developed counterpart can. This is because the developed country is already operating with the highest level of technology and infrastructure. Any further improvements would have to come from more costly research and development , whereas the developing country can implement existing technology to improve its situation.

8. Limitations of capital output ratio : It may, however, be pointed out that the concept of capital-output ratio suffers from certain limitations. Its precise calculation presents some formidable difficulties. Hence, the quantities relationship between capital investment and output, which the capital-output ratio suggests, may prove to be misleading. It would, therefore, be hazardous to base the estimates of capital re­quirements of an industry or economy on such ratios. Neither can the capital stock be assumed with any exactitude; nor is the other side of the ratio, i.e., output capable of any precise meas­urement. Besides the index number problems, a clear distinction cannot be often made between capital goods and non-capital goods. Returns to social overheads, in particular, cannot be cal­culated accurately.

9. Further, capital-output ratio is influenced by several variables, e.g., techno­logical improvements, better utilisation of equipment, organisational improvements, labour efficiency, and these factors elude quantitative measurement. Hence, the concept of capital-output ratio has only a limited practical significance, because it cannot indicate the actual contribution of capital alone in a given scheme of investment. Great caution is, therefore, necessary in making use of a particular capital-output ratio in the adoption of actual investment policy.