UPSC STATIC QUIZ – Economy : 12 April 2024

Solution: b)

Statement 3 is incorrect.

Recovery

An economy tries to come out of the low production phase to survive. The low production phase might be depression, recession or slowdown with the former being the worst and rare, governments take many new fiscal and monetary measures to boost demand and production and ultimately a recovery in an economy is managed. The business cycle of recovery may show the following major economy traits:

(i) an upturn in aggregate (total) demand which has to be accompanied by increase in the level of production;

(ii) production process expands and new investments become attractive;

(iii) as demand goes upward, inflation also moves upward making borrowing cheaper for investors;

(iv) with an upturn in production, new employment avenues are created and unemployment rate starts declining; etc.

Solution: b)

Statement 2 is incorrect.

What is the Federal Funds Rate (FFR) and how does the US Fed tweak it?

The FFR is the interest rate at which commercial banks in the US borrow from each other overnight. Arguably, if banks borrow at higher rates from each other, they will also lend the money to consumers at a higher rate.

Now, unlike in India, where the RBI decides what the repo rate (or the interest rate at which RBI lends money to banks) will be, in the US, the Fed can’t directly specify the FFR. Instead, it tries to “target” the FFR by controlling the money supply. So when the Fed wants to raise the prevailing interest rates in the US economy, it reduces the money supply. This forces every bank in the economy to charge higher interest rates. The process starts with commercial banks charging higher interest rates to lend to each other for overnight loans.

Solution: c)

The Z-shaped recovery is the most-optimistic scenario in which the economy quickly rises like a phoenix after a crash. It more than makes up for lost ground (think revenge-buying after the lockdowns are lifted) before settling back to the normal trend-line, thus forming a Z-shaped chart.

V-shaped recovery in which the economy quickly recoups lost ground and gets back to the normal growth trend-line.

A U-shaped recovery — resembling a bathtub — is a scenario in which the economy, after falling, struggles and muddles around a low growth rate for some time, before rising gradually to usual levels.

A W-shaped recovery is a dangerous creature — growth falls and rises, but falls again before recovering yet again, thus forming a W-like chart.

The L-shaped recovery is the worst-case scenario, in which growth after falling, stagnates at low levels and does not recover for a long, long time.

Then, there is the J-shaped recovery, a somewhat unrealistic scenario, in which growth rises sharply from the lows much higher than the trend-line and stays there.

Solution: b)

Statement 3 is incorrect.

Factor income is the flow of income that is derived from the factors of production—the general inputs required to produce goods and services.

Factor income on the use of land is called rent, income generated from labor is called wages, and income generated from capital is called profit.

The factor income of all normal residents of a country is referred to as the national income, while factor income and current transfers together are referred to as private income.

Factor income is most commonly used in macroeconomic analysis, helping governments to determine the difference between gross domestic product (GDP) and gross national product (GNP).

It can also be used to expose disparities in income distribution.

Solution: b)

Money illusion is an economic theory positing that people have a tendency to view their wealth and income in nominal dollar terms, rather than in real terms. In other words, it is assumed that people do not take into account the level of inflation in an economy, wrongly believing that a dollar is worth the same as it was the prior year.

Money illusion is sometimes also referred to as price illusion.