Let capital formation = CF, Production = P, C = consumption. Then CF =_______

Analyze the question: The question asks for the relationship between capital formation (CF), production (P), and consumption (C) in an economy.

Explain the concept: Capital formation is the process of increasing a country's stock of capital goods, such as machinery, factories, roads, and equipment. Resources used to build capital goods cannot be used to produce consumer goods. So an economy can only invest in capital goods from what is left over after consumption needs are met.

This is the idea of saving: the part of output that is not consumed.

Show the solution:

1. Total output (production) in an economy is either consumed or saved/invested: P = C + CF
2. Rearranging to make CF the subject: CF = P − C
3. Check each option: • A. P − C: matches the derivation. • B. P + C: this would mean capital formation grows as consumption grows, which is wrong. More consumption leaves less for investment. • C. PC: multiplication has no economic meaning here. • D. P/C: this is a ratio, not an amount of capital formed.

Answer: The correct option is A. P − C.

Exam tip: Remember it as "What you don't eat, you plant." Capital formation is what is left of production after consumption. In national income terms, Saving = Income − Consumption, and in a simple economy, Saving = Investment (capital formation).