Day-579 | Daily MCQs | UPSC Prelims | ECONOMICS

Answer: B
Explanation
Statement 1 is incorrect: Income elasticity measures the percentage change in quantity demanded with respect to percentage change in income of a consumer.
Formula= Percentage change in quantity demanded/ percentage change in income
Income elasticity can be greater than one, less than one or equal to one.
Luxury goods are those goods whose demand increases more than proportionately with increase in its income. Thus, they have positive income elasticity of demand, which is greater than one. For example, high-end automobiles.
On the other hand, Inferior goods are those commodities, which have a negative relationship with income. It means their demand reduces with increase in income and vice versa. For example, Parle-G biscuit.
Statement 2 is correct: Giffen goods are those goods, which are an exception to law of demand and have an upward sloping demand curve. The law of demand states that, other factors being constant (cetris peribus), price and quantity demand of any good and service are inversely related, ie, the demand increases with fall in price and vice versa.
Contrary to this this, Giffen goods’ demand increases as price increases and vice-versa. Examples include potato and other staple goods. These goods have low substitutes and form a high percentage of a household’s budget. This phenomenon is witnessed in low-income households as the increase in their prices leaves less money for other goods. Hence, households buy more of these goods to compensate for other goods.

Answer: B
Explanation
Statement 1 is incorrect: High oil-prices negatively impacts the current account of an economy and not capital account. The balance of payment of the country consists of current account and capital account. Current account records all the transactions of trade in goods and services, in addition to private remittances, foreign aid, etc. A high current account deficit is not healthy for the economy.
Capital account, on the other hand, records the net flow of all transactions of the country with the rest of the world that includes buying and selling of non- financial assets such as fixed assets, land, properties, etc and the financial components like FDI, FPI, external commercial borrowings, etc. India maintains a current account deficit on account of import of oil, electronic goods, etc.
Statement 2 is correct: High exchange rate with respect to domestic currency also refers to the depreciation of a currency, which is the loss in its value. This makes the exports of a country cheaper in the foreign market, ie, increases its trade competitiveness. Thus, it results in the improvement of the trade balance.
Statement 3 is correct: Low exchange rate is also known as appreciation of a currency. This results in increase in its value via-a-vis foreign currency. Thus, imports of a country become cheaper as the same value of a domestic currency can buy more goods.
Additional information: Usually the BoP account doesn’t balance, so for this net errors and omissions account is maintained as not all the transactions can be recorded with the rest of the world.

Answer: A
Explanation
• Statement 1 is correct: Recently, the interest rate differential between the US and India has narrowed down due to the hike in policy rate by the Fed. Thus, effectively, yield spread between the US government bonds and Indian bonds has reduced. Due to this, investors may find the risk-reward ratio unfavourable due to high risk involved in the emerging markets, while they consider the US market to be a safe bet. This may result in a capital outflows from emerging markets, here India.
• Statement 2 is incorrect: A depreciation of rupee represents high demand for foreign currency and low demand for Indian currency. To arrest the sharp depreciation of rupee, RBI may intervene by selling dollars and buying rupee, thus propping up the value of rupee. However, this would also result in decline in forex of the country. RBI became a net seller of dollar in FY23 to curb the fall in the value of rupee following Ukraine- Russia war.
• Statement 3 is incorrect: Selling of Indian stocks by the foreign institutional investors represents capital outflows. This results in less demand for the Indian currency and high demand for foreign currency ( dollar) and would result in depreciation of rupee and not appreciation as there is low confidence on the Indian markets.

Answer: A
Explanation
• Statement 1 is incorrect: A contractionary/tight monetary policy is undertaken by the central bank, the Reserve Bank of India, in order reduce the inflationary situation in the economy. The banks will raise interest rates to make lending more expensive, thus discouraging the consumption activity in the economy.
• Statement 2 is incorrect: A contractionary monetary policy by the central bank raises interest rate, which makes the borrowings costlier. This negatively impacts the investment cycle as the capital costs go up.
• Statement 3 is correct: A contractionary monetary policy negatively impacts the growth rate in the medium term. Interest rates are raised to cool down the overheated economy. Prolonged high interest discourages the businesses, corporates to undertake capital expenditure, which reduces the gross fixed capital formation in the economy, thus reducing the economic growth.

Answer: C
Explanation:
Statement C is correct: Gross Domestic Product (GDP) measures the aggregate value of final goods and services produced within the domestic economy during a year. On the other hand, Gross National Product (GNP) is the total value of all the final goods and services produced by the normal residents of a country.
GDP can be calculated with three different approaches— expenditure side, income side and output side— with each arriving at the same value. This principle is based on the concept that someone’s expenditure is other person’s income.
According to expenditure approach:
GDP= consumption + investment + government spending+ exports- imports
Relationship between GDP and GNP
GNP= GDP+net factor income from abroad
Where net factor income from abroad is the difference between the factor income received from the rest of the world and the factor income paid to the rest of the world.
Gross Value Added (GVA) or GDP at market prices is the difference between value of output and intermediate consumption of all primary sector, secondary sector and tertiary sector. While GVA at basic prices includes production taxes and exclude production subsidies, GVA at factor cost includes no taxes and excludes no subsidies.
GVA/GDP at basic prices = GVA at factor cost + production taxes- production subsidies.
GVA/GDP at market prices= GDP at basic prices+ product taxes- product subsidies.
It is to be noted that production taxes and subsidies are not dependent on the volume of production, while product taxes and product subsidies are paid or received based on per unit of a product.