Gross Domestic Capital Formation
Production requires services of fixed assets such as machinery, equipment and structures as well as working capital i.e. stocks of raw materials, work in process, finished goods, etc. The act of replacing worn out assets and creating new assets is capital formation. Gross domestic capital formation (GDCF) consists of
i. Making good the depreciation on existing fixed assets
ii. Adding to the stock of fixed assets
iii. Adding to inventories
Sometimes the first two of these together are called gross fixed investment while the third is called inventory investment. The word investment can be misleading. When you buy a corporate share on the secondary market (i.e. an existing share) you are making an 'investment' in the popular sense of the word. However, this may not lead to any capital formation at all; the person who sells the shares might spend the entire proceeds on current consumption. All that has happened is ownership of a part of existing assets has changed hands. We are concerned with replacement and new additions to physical assets not merely financial assets nor transfer of ownership of existing assets.
Bulk of domestic capital formation is financed from gross domestic savings (GDS). However, GDS need not equal GDCF. Domestic savings may be loaned to foreigners and contribute to capital formation abroad; conversely, foreigners may loan their savings to us for capital formation here. In the former case GDS will exceed GDCF, in the latter case GDCF will exceed GDS.
Treatment of a class of goods called consumer durables is problematic. When you buy a refrigerator, are you spending on current consumption or investing in a physical asset? Strictly speaking, it is the latter because you consume refrigeration service yielded by the refrigerator not the refrigerator itself, and the refrigerator will continue to yield such services over a number of years, just as a machine tool yields services over a number of years. However, it is the practice in many countries to regard expenditure by households on many consumer durables as consumption expenditure. The same refrigerator if it were bought by the research laboratory of a pharmaceutical company would have become 'capital formation'.If depreciation is subtracted from GDCF we get another aggregate called net capital formation.
It just indicates net additions to the stock of fixed assets.