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. • Some 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

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