UPSC Prelims 2014 · Question 41 of 100
UPSC Prelims 2014 question on Interest Rate Cut Investment
- ExamUPSC CSE
- Year2014
- PaperGeneral Studies Paper I
- SubjectIndian Economy
- TopicMoney Market
- DifficultyMedium
- TypeDirect
If the interest rate is decreased in an economy, it will
Show answer
Answer: C. increase the investment expenditure in the economy.
Verdict
The answer is that it will increase investment expenditure in the economy. A lower interest rate cheapens borrowing and makes more projects worth undertaking.
Analysis
The interest rate is the cost of capital, so cutting it lowers the hurdle that a project's expected return must clear, and investment demand rises. The saving option is wrong because a lower return on saving reduces the incentive to save rather than raising it. The consumption option is wrong in direction, since cheaper credit and weaker saving incentives raise consumption expenditure rather than depressing it. The tax collection option is at best a second round effect operating through higher output much later, not a direct consequence.
Source
Uma Kapila and Ramesh Singh.
How to crack it
This is a fundamental applied question, so run the causal chain instead of recalling a sentence. Rate falls, cost of borrowing falls, more projects clear the hurdle, investment rises, and only afterwards do output, employment and revenue move. Ranking options by how many links separate them from the initial change is the reliable filter: the first order effect is the intended answer and the tax option is third order. The same chain, run in reverse, answers rate hike questions.