UPSC Static Quiz – Economy : 31 December 2024

Solution: d)

In January 2014, an expert committee of the RBI submitted its report on the ways to revise and strengthen the monetary policy framework in India, it chose to target retail inflation.

Here’s why.

• Firstly, the committee pointed out that wholesale inflation “does not capture price movements in non-commodity producing sectors like services, which constitute close to two-thirds of economic activity in India”.
• Secondly, it pointed out that wholesale inflation “does not generally reflect price movements in all wholesale markets”. This happens because price quotations for some important commodities such as milk, LPG etc. are taken from retail markets.
• Thirdly, movements in WPI often reflect large external shocks and as such, the wholesale inflation rate is often subject to large revisions.

Solution: c)

• Engel’s Law is a principle in economics named after the 19th-century German statistician Ernst Engel. It states that as household income increases, the proportion of income spent on food decreases, even though the absolute expenditure on food may rise. This relationship highlights the diminishing marginal utility of food consumption as basic needs are met.
• For example, a low-income household might allocate a significant portion of its income to food due to necessity, whereas a wealthier household will spend a smaller percentage, diverting surplus income toward other goods like housing, education, and leisure.
• This law is crucial for understanding consumer behavior, economic development, and poverty. It also helps policymakers and businesses anticipate changes in consumption patterns as income levels grow, focusing on sectors that cater to discretionary spending.

Solution: c)

A credit line, also known as a line of credit, is a financial arrangement between a borrower and a lender that provides a preset borrowing limit.

Statement 1 is correct as it allows individuals or businesses to access funds up to the limit as needed, rather than borrowing a fixed amount at once.

Unlike a lump-sum loan, where the entire loan amount is disbursed upfront and interest is charged on the full sum, a credit line functions as a flexible loan. Borrowers can withdraw only the amount they need and pay interest only on the borrowed amount, not on the total limit. This flexibility makes it suitable for managing cash flow or unexpected expenses, making Statement 2 also correct.

Solution: c)

Curbing imports of non-essential goods and promoting exports would help control imports and thus the depreciation of the rupee by increasing the growth with promoting exports.

Encouraging Indian borrowers to issue rupee-denominated Masala Bonds is a measure of the RBI/government to stop the slide of Indian rupee as it does not put pressure on our currency through borrowing dollars as the bond issue would be rupee denominated.

Following an expansionary monetary policy may lead to lower interest rates thereby increasing the inflation with higher imports through higher spending of the government and therefore the slide of rupee takes place.

Easing conditions relating to external commercial borrowing will lead to higher borrowing abroad and would temporarily reduce the deficit of forex in India preventing the slide of rupee.

Solution: a)

Statement 2 is incorrect.

Statement 1 is Correct. The cost of capital is the weighted average of the cost of equity and the cost of debt. It represents the minimum return a company needs to generate to satisfy its investors and lenders.

Statement 2 is Incorrect. When bond yields rise, it typically indicates higher interest rates or inflation. This increases the cost of debt and the overall cost of capital. Higher cost of capital leads to lower valuation of future cash flows, as higher discount rates reduce present values.

Statement 3 is Correct. The valuation of equities is commonly done by discounting future cash flows (DCF method). The present value of future cash flows is calculated using the discount rate, which is influenced by the cost of capital.