What is Capital Output Ratio ?
Capital output ratio is the amount of capital required to produce output worth Rs.1. If Y stands for output (or income) and K stands for stock of capital used to produce that output, then K/Y represents capital output ratio.
Capital output ratio is of two types –
1. Average capital output ratio –
Average capital output ratio is the ratio of total capital to the output (or income) of the economy. Average capital output ratio is denoted by K/Y.
2. Marginal capital output ratio –
Marginal capital output ratio is the ratio of increment in the stock of capital to the increment in output. Marginal capital output ratio is denoted by ∆K/∆Y.
∆K = increment in capital
∆Y = resultant increase in the output (or income)
Marginal capital output ratio is also called incremental capital output ratio (ICOR).
The rate of economic growth of output country depends on the rate of capital formation and capital output ratio.
Capital output ratio determines the rate at which output increases as a result of a given amount of capital investment.
For example, a capital output ratio of 5 means that a capital investment of Rs.5 results in addition of output worth Rs.1. So, if the capital output ratio is small, then a smaller capital investment would be need to produce a given level of output and vice versa.
Factors Determining Capital Output Ratio –
It is very difficult to estimate the capital output ratio of an economy. The productivity of capital (or capital output ratio) depends on various factors such as the degree of technological advancement (development) associated with capital investment, the quality of managerial and organisational skills, the efficiency of handling new types of equipments, the existence and the extend of the utilisation of economic overheads and the pattern and rate of investment.