CAPITAL EXPENDITURE

Subject: Economics

Context : The Centre must mount an aggressive programme of capital expenditure to the tune of about 2 per cent of GDP to pull the economy, top economist and public policy thinker C. Rangarajan, said.

Concept :

Capital expenditures

• Capital expenditures are the ones that create some liability/asset for the government. These include loans to public enterprises, loans to States, Union Territories and foreign governments and acquisition of valuables.
• They are long-term investments of huge amount of money for acquiring long-term assets like manufacturing equipment. Such assets acquired provide income-generating value over a period of years.
• Hence, the cost of such assets is recovered through year-by-year depreciation over the productive life of the asset. In essence, the expenditure which is done for initiating current, as well as the future economic benefit, is actually capital expenditure.

Examples of capital expenditures

• Purchase of factory and building.
• Purchase of machine, furniture, motor vehicle, office equipment etc.
• Cost of goodwill, trademarks, patents, copy right, patterns and designs.
• Expenditure on installation of plant and machinery and other office equipment.
• Additions or extension of existing fixed assets.
• Structural improvement or alterations as to fixed assets which increase their life or earning capacity. For example: Conversion of handloom to powerloom.
• Development expenses in case of mines and plantations.

Money Multiplier Effect :

• Money multiplier is a term in monetary Economics that is a phenomenon of creating money in the economy in the form of credit creation, based on the fractional reserve banking system.
• Money multiplier is also known as the monetary multiplier. It is the maximum limit to which money supply can be affected by bringing about changes in the amount of money deposits.
• Money multiplier effect is seen in commercial banks as they accept deposits and after keeping a certain amount as a reserve, distribute the money as loans for injecting liquidity in the economy.
• The amount of money that should be kept by commercial banks in their reserve for withdrawal purposes by the customers is referred to as the reserve ratio or required reserve ratio or cash reserve ratio.
• Mathematically, money multiplier formula can be represented as

                Money Multiplier = 1/ r

                Where r = Required reserve ratio or cash reserve ratio

• It means that if the reserve ratio is higher, then the money multiplier will be lower and the banks need to keep more reserves. As a result, they will not be able to lend more money to individuals and businesses.
• Similarly, a lower reserve ratio results in a higher money multiplier which allows a lesser amount of money to be kept as a reserve and more lending opportunities to the public.