Day-398 | Daily MCQs | UPSC Prelims | ECONOMY

Answer: B
Explanation:
● Statement 1 is correct: It refers to increase in public sector spending and can eliminate private sector spending.
● Statement 2 is correct: A high magnitude of the crowding out effect may lead to lesser income in the economy as it affects private investment decisions which can further slowdown economy.
● Statement 3 is incorrect: Lower interest rate led to less crowding out effect. It is higher interest which leads to more crowding out effect as with higher interest rates, the cost for funds to be invested increases and affects their accessibility to debt financing mechanisms. This leads to lesser investment ultimately and crowds out the funds.
Additional information: Crowding out effect is a concept of public finance which means an increase in the government expenditure which has an effect of reducing the private sector expenditure. Crowding in is more likely to occur in a recession when the private sector has unused savings. Crowding in may prove to be a temporary effect. Crowding out will occur when the economy is close to full capacity and limited spare savings. Some believe that government spending does not always lead to a crowding out of private investment in the economy. It is argued that government demand for funds can compensate for the lack of private demand for funds during economic depressions, thus helping to prop up aggregate demand.

Answer: C
Explanation:
The most important exclusion from GFCF is land sales and land purchases. The most significant exception from Gross fixed capital formation is the trade and acquisition of real estate.
Gross Fixed Capital Formation is essentially net investment. It is a component of the Expenditure method of calculating GDP. The total dividends are denoted by Gross fixed capital formation. It is calculated as the sum of a producer’s purchases, minus the value of fixed assets disposed of during the income statement, plus specific adjustments to the value of quasi asset
What it includes?
● Land improvements (fences, ditches, drains, and so on); plant, machinery, and equipment purchases; the construction of roads, railways, private residential dwellings, and commercial and industrial buildings.
● Disposal of fixed assets is taken away from the total.
What it excludes?
• Land Purchases
• Effects of depreciation (referred to as consumption of capital)
Gross fixed capital formation (GFCF) determines the economy that is included in a country’s official statistics, such as those maintained by the UN System.

Answer: A
Explanation:
Given below is correctly matched pairs:
Economic Curves – Explanations
1. Phillips Curve – Inverse relationship between inflation and unemployment
2. Laffer Curve – Relationship between tax rates and tax revenue collected
3. Lorenz Curve – Graphical representation of income inequality or wealth inequality
4. Kuznets Curve – Relationship between economic growth and inequality

Answer: B
Explanation:
● Statement 1 is incorrect: It is an economic theory that compares different countries’ currency through a market basket of goods only. It does not account for services.
● Statement 2 is correct: Purchasing power parity (PPP) allows for economists to compare both economic productivity and standards of living between countries.
● Statement 3 is incorrect: India is the third largest economy in the world in terms of purchasing power parity (PPP) terms, with a share of 7 percent of global GDP.
Additional information: Purchasing power parities are the rates of currency conversion that try to equalise the purchasing power of different currencies, by eliminating the differences in price levels between countries. According to this concept, two currencies are in equilibrium or at par when a market basket of goods (taking into account the exchange rate) is priced the same in both countries. Purchasing power parity (PPP) is a popular metric used by macroeconomic analysts that compares different countries’ currencies through a “basket of goods” approach. Some countries adjust their gross domestic product (GDP) figures to reflect PPP. An economist will use the PPP to compare the economic output of different nations against one another. It might be used to determine which country has the world’s largest economy. Using PPP exchange rates in addition to a country’s gross domestic product (GDP) may help to provide a more detailed picture of a country’s economic health. It enables analysts to compare productive capacity and life quality across nations.

Answer: A
Explanation:
● Statement 1 is correct: Fiscal drag basically means a slowdown of economic growth due to lack of spending which is caused due to increased taxation which reduces demand for goods and services.
● Statement 2 is incorrect: It happens due to decreased consumer spending due to increased taxation which eventually reduces demand of consumer. Also note that fiscal drag means greater tax burden for people which lead to less consumer spending.
● Statement 3 is incorrect: Fiscal drag is a result of decreased consumer spending as a result of increased taxation that eventually reduces aggregate demand, which leads to deflationary pressures.
Additional information:
FISCAL DRAG = negative effect of the progressive taxation that economies feel on their expansion – fall in the aggregate demand of the economy due to people moving from lower to higher tax brackets.
Fiscal drag happens when the government’s net fiscal position fails to cover the net savings desires of the private economy, also called the private economy’s spending gap. It is common to view fiscal drag as a natural economic stabilizer as it tends to keep demand stable and the economy from overheating. This is generally viewed as a mild deflationary policy and a positive aspect to fiscal drag.