Which ratio measures the percentage increase in capital formation required obtaining a percentage increase in GDP?

Incremental Capital Output Ratio

The correct answer is option 1- Incremental Capital Output Ratio.

Incremental Capital Output Ratio measures the percentage increase in capital formation required obtaining a percentage increase in GDP.

The entrepreneurial decision, in effect, is an investment decision that augments the productive capacity of the economy and hence results in capital formation. In fact, GDP and capital formation are related to each other via Capital Output Ratio (COR); more precisely Incremental Capital Output Ratio (ICOR) that measures the percentage increase in capital formation required obtaining a percentage increase in GDP. So, if a country desires to grow @ 10.0% p.a. and its ICOR is 2.6, then it must ensure capital formation @ 26.0% p.a. Entrepreneurs, by investing their own savings and informally mobilising the savings of their friends and relatives contribute to the process of capital formation. These informal funding supplements the funds made available by the formal means of raising resources from banks, financial institutions and capital markets.

The Incremental Capital Output Ratio (ICOR) measures the amount of capital needed to achieve a certain percentage increase in output (GDP). In other words, it tells you how much additional capital is required to generate an additional unit of GDP.

ICOR= Incremental Capital (Change in Capital)/ Incremental Output (Change in GDP)

A lower ICOR indicates that the economy is more efficient in using capital to generate output, while a higher ICOR suggests that more capital is needed for each unit of GDP growth.

OTHER OPTIONS

• Debt Service Coverage Ratio (DSCR): Measures the ability of an entity (typically a business) to cover its debt obligations with its operating income. It’s not related to capital formation or GDP growth.

• Interest Coverage Ratio: Measures how easily a company can pay its interest expenses on outstanding debt. It is unrelated to capital formation or GDP.

• Capital Ratio: It refers to a financial ratio used in banking or finance to measure the proportion of a bank's capital to its assets. It is not used to measure capital formation in relation to GDP growth.