Capital Output Ratio

Introduction

• Capital Output Ratio (COR) is the amount of capital required to produce one unit of output.
• It is the relationship between the level of investment made in the economy and the consequent increase in Gross Domestic Product (GDP).
• It also expresses the relationship between the value of capital invested and the value of output.

Example of COR

• For example, investment in an economy is 32% of GDP, and the economic growth corresponding to this level of investment is 8%. Here, it means that an investment of Rs. 32 produces an output of Rs. 8. Therefore, the COR is 32/8 i.e., 4. 
• In other words, to produce one unit of output, 4 units of capital are needed. 

Relevance of COR in Economic Planning

• COR has a crucial role in economic planning. Suppose the government targets an economic growth of 9% for next year (i.e., FY 2023-24). The economic planning authority knows that the COR  in India is 4. Therefore, to realize 9% growth, investment should be increased to 36% (9 x4).
• COR thus explains the relationship between the level of investment and the corresponding economic growth. 
• There is a simple equation in economics that shows the relationship between investment, COR and economic growth.

                                   G= S/V

Here,

G= Economic Growth

S= Saving as a percentage of GDP

V= Capital Output Ratio

Incremental Capital Output Ratio (ICOR)

• It is a variant of the Capital Output Ratio.
• The ICOR indicates an additional unit of capital or investment needed to produce an additional unit of output.
• The utility of ICOR is that with a rise in investment, the capital-output ratio itself may change, and hence the usual capital-output ratio will not be useful.

Lower Capital Output Ratio (LCOR)

• A lower capital-output ratio shows the productivity of capital and technological progress.
• A lower capital-output ratio indicates that a lower level of investment is required to produce a given growth rate in the economy. This is considered to be a desirable situation.
• A lower capital-output ratio also shows that capital is very productive or efficient.

How can the efficiency of capital be achieved?

• It is possible mainly through technological progress. With superior technology, the capital will be efficient to produce more output and the capital-output ratio will be lower.