Flash-Cards-for-IAS-Prelims-2018-Economy-Day-33
70 Days WAR Plan

Day#33 Static Flash Cards Economic & Social Development [70 Days WAR Plan]

GDP Deflator; 14th Finance Commission; Fiscal deficit; Special Economic Zone (SEZ); Crowding out effect; ‘Round Tripping’; ‘Indicative Planning’; Demographic Dividend; Primary sector of the economy;
By IT's Core Team
April 23, 2019

 

 

 

Which sectors constitute the primary sector of the economy?

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Answer & Enrich Your Learning:

Primary sector of the economy:

  • The primary sector is concerned with the extraction of raw materials. It includes fishing, farming and mining.
  • It extracts or harvests products from the earth, such as raw materials and basic foods.
  • Activities associated with primary economic activity include agriculture (both subsistence and commercial), mining, forestry, grazing, hunting and gathering, fishing, and quarrying.
  • The packaging and processing of raw materials are also considered to be part of this sector.

Significance of the sector:

  • Primary sector provides the base for the other sectors of the economy.
  • It fulfils the demand of raw material needed by secondary sector for their operations.
  • It is responsible for the maintenance of good food supply in the economy.
  • In India primary sector is providing employment to large no of labour force.
  • Major source of livelihood in rural areas where labour force is largely unskilled.
  • It is significant contributor in the GDP, nearly 20%.
  • Increase in exports will increase Indian economic growth.
  • It helps in increasing GDP and employment in India.

 

 

 

Which is the ratio of money held by the public in currency to that they hold in bank deposits?

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Answer:

  • Currency Deposit Ratio

Enrich Your Learning:

  • Currency Deposit Ratio (CDR) is the ratio of currency held by public to their holdings of bank deposits.
  • It shows the amount of currency that people hold as a proportion of aggregate deposits.
  • An increase in cash deposit ratio leads to a decrease in money multiplier. An increase in deposit rates will induce depositors to deposit more, thereby leading to a decrease in Cash to Aggregate Deposit ratio. This will in turn lead to a rise in Money Multiplier.
  • Money multiplier (m) is the ratio of total money supply (M) to stock of High Powered Money (H) in the economy.
  • During economic slowdowns, when the currency-deposit ratio tends to rise, the RBI encourages lending by lowering the federal funds rate.

 

 

 

‘Demographic Dividend’ has the economic growth potential that can result from increased fertility and decreased Mortality rates. Right OR Wrong?

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Answer:

Right Statement:

  • ‘Demographic Dividend’ is typically brought on by a decline in fertility and mortality rates.

Enrich Your Learning:

Demographic Dividend:

  • As per United Nations Population Fund (UNFP), ‘Demographic Dividend’ is the economic growth potential that can result from shifts in a population’s age structure, mainly when the share of the working-age population (15 to 64) is larger than the non-working-age share of the population (14 and younger, and 65 and older).
  • It occurs when the proportion of working population out of the total population is high as it indicates that more people have the potential to be productive and contribute to growth of the economy.
  • It refers to the growth in an economy that is the resultant effect of a change in the age structure of a country’s population, that is typically brought on by a decline in fertility and mortality rates.
  • A country is expected to reap the demographic dividend when the share of its working population is larger than the share of its non-working population.
  • It can increase economic growth through; the swelling of the labour force, as more people reach working age, the increased fiscal space, the rise in women’s workforce that results in declining fertility, the increase in savings rate, the additional boost to savings that occurs as the incentive and a massive shift towards a middle-class society.
  • The benefit of a demographic dividend depends on whether the bulge in working population can be trained, and enough jobs created.
  • Growth, education, home ownership, better economic security, and a desire for more durable goods are the cause and consequence of young demographics.
  • Dependency ratio will remain high due to factors like; Ageing population, Low birth rate, High Life expectancy, Low death rate.
  • To reap the benefits of the demographic dividend, a country must take some special measures that are aimed at economic development and better living standards and need to invest to get the maximum benefits of demographic dividend in; health and security, education, employment generation and social security.
  • A UNESCAP survey warns there are no guarantees the “dividend” will automatically translate to economic growth. Countries need to put in place the appropriate “social and economic policies and institutions” to absorb the rapidly growing labour force.

 

 

 

What is the meaning of ‘Indicative Planning’?

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Answer:

  • Indicative planning is a form of economic planning implemented by a state in an effort to solve the problem of imperfect information in market and mixed economies in order to increase economic performance.

Enrich Your Learning:

  • ‘Indicative Planning’ is found in capitalist countries as well as in mixed economies. Indicative planning was attempted first in France.
  • It recognises not only consumers’ sovereignty but also producer’s freedom so that the targets and priorities of the plans are achieved.
  • Indicative planning takes only endogenous market uncertainty and plans the economy accordingly and does not look into exogenous uncertainty like technology, foreign trade, etc.
  • It involves a middle path of planning mechanism and market mechanism, a kind of coordination between private and public activities.
  • Under indicative planning those industries and sectors are identified, where future growth is to be encouraged which will develop the core sector through allocation and optimal utilisation of funds.
  • The plan must provide the broad blueprint for achieving the essential social and economic objectives and indicate the direction in which the entire economy as well as its various sectors and sub- sectors should be moving.
  • Identifying such areas and channelling the resources to those areas are an integral part of planning.
  • The indicative planning does not intend to reduce the importance of the role of the state.
  • The state has the primary responsibility for the development of both physical infrastructures and social infrastructures. Besides, central plans are linked up with the state plans since both the partners have responsibilities in all the areas.
  • This type of planning in India is since the 8th Five-Year Plan.

 

 

 

GDP deflator is the ratio of the value of goods and services, while Wholesale Price Index (WPI) is the measure of average change in the prices of commodities. Right OR Wrong?

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Answer:

Enrich Your Learning:

GDP Deflator:

  • GDP deflator is the ratio of the value of goods and services an economy produces in a particular year at current prices to that of prices that prevailed during the base year.
  • The GDP deflator is also called implicit price deflator. It is a measure of inflation.
  • It is calculated by dividing nominal GDP by real GDP and then multiplying by 100. Nominal GDP is the market value of goods and services produced in an economy, unadjusted for inflation (It is the GDP measured at current prices). Real GDP is nominal GDP, adjusted for inflation to reflect changes in real output (It is the GDP measured at constant prices).
  • It helps show the extent to which the increase in gross domestic product has happened because of higher prices rather than increase in output.
  • It covers the entire range of goods and services produced in the economy, as against the limited commodity baskets for the wholesale or consumer price indices
  • GDP deflator is available only on a quarterly basis along with GDP estimates, whereas CPI and WPI data are released every month.
  • Ministry of Statistics and Programme Implementation (MOSPI) comes out with GDP deflator in National Accounts Statistics as price indices.

Wholesale Price Index (WPI):

  • Wholesale Price Index (WPI) measures the average change in the prices of commodities for bulk sale at the level of early stage of transactions.
  • It is an index that measures and tracks the changes in the price of goods in the stages before the retail level.
  • It is the price of a representative basket of wholesale goods.
  • WPI shows the average price change of goods included in the index and is often expressed as a ratio or percentage, and the change is one indicator of a country’s level of inflation.
  • The WPI is published by the Economic Adviser in the Ministry of Commerce and Industry.
  • The index basket of the WPI covers commodities falling under the three Major Groups namely Primary Articles, Fuel and Power and Manufactured products.
  • The prices tracked are ex- factory price for manufactured products, agri-market (mandi) price for agricultural commodities and ex-mines prices for minerals.
  • Weights given to each commodity covered in the WPI basket is based on the value of production adjusted for net imports.
  • WPI basket does not cover services.
  • It influences stock and fixed price markets.
  • On account of the structural changes over time in the economy, products and their specification are changing even faster, thus base year is changed at regular intervals and simultaneously index basket weights and source agencies are also updated to keep the index series representative.
  • So far, six revisions have taken place introducing the new base year, viz. 1952-53, 1961-62, 1970-71, 1981-82, 1993-94 and 2004-05.
  • The year 2011-12 was the seventh revised base year that improved the concept, coverage and methodology in the WPI series and increased the number of items in the basket from 676 to 697.
  • The Wholesale Price Index focuses on the price of goods traded between corporations, rather than goods bought by consumers, which is measured by the Consumer Price Index.
  • The purpose of the WPI is to monitor price movements that reflect supply and demand in industry, manufacturing and construction. This helps in analysing both macroeconomic and microeconomic conditions.

 

 

 

What is ‘Round Tripping’ in economy?

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Answer:

  • Round-tripping is a money laundering and tax evasion technique.

Enrich Your Learning:

  • Round-tripping is a method used to show an increase in volume in a thinly traded stock.
  • It is also known as round-trip transactions or ‘Lazy Susans’ and is a characteristic of the New Economy companies.
  • It is a market-manipulation practice used to misrepresent the number of transactions occurring on any given day.
  • Companies used round-tripping to distort the market by establishing false revenue benchmarks, aiming to meet or beat the numbers.
  • Round-trip trading artificially inflates volume and revenues, but in reality, it adds no profit.
  • It is a form of barter that involves a company selling “an unused asset to another company, while at the same time agreeing to buy back the same or similar assets at about the same price.
  • This process is sometimes used as a means of increasing the apparent amount of sales and revenue generated by the seller during a specific financial period.
  • While a relatively common process, not everyone in the financial community considers this a proper method of doing business.
  • In the context of black money, it leaves the country through various channels such as inflated invoices, payments to shell companies overseas, the hawala route and so on. After cooling its heels overseas for a while, this money returns in a freshly laundered form; thus, completing a round-trip.
  • Round trip stock trading is one method that companies use to deceptively increase income. It is also a method used to show an increase in volume in a thinly traded stock. Most of the time, round trips occur when the person is a day trader.

 

 

 

What is Crowding out effect in economy?

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Answer:

  • Crowding out is a situation where personal consumption of goods and services and investments by business are reduced because of increases in government spending and deficit financing sucking up available financial resources and raising interest rates.

Enrich Your Learning:

  • Crowding out effect can be caused by an expansionary fiscal policy financed by increased taxes, borrowing, or both.
  • Crowding out effect in economy is a situation when increased interest rates lead to a reduction in private investment spending such that it dampens the initial increase of total investment spending.
  • The most common forms of crowding out takes place when a large government increases its borrowing. The increased interest rates have the effect of absorbing the economy’s lending capacity and of discouraging businesses from making capital investments.
  • Sometimes, government adopts an expansionary fiscal policy stance and increases its spending to boost the economic activity which leads to an increase in interest rates, that affect private investment decisions.
  • A high magnitude of the crowding out effect may even lead to lesser income in the economy.
  • With higher interest rates, the cost for funds to be invested increases and affects their accessibility to debt financing mechanisms that leads to lesser investment which ultimately crowds out the impact of the initial rise in the total investment spending.
  • Usually the initial increase in government spending is funded using higher taxes or borrowing on part of the government.

Answer & Enrich Your Learning:

  • A special economic zone is an area in a country that is subject to unique economic regulations that differ from other areas in the same country.
  • SEZs are located within a country’s national borders, and their aims include: increased trade, increased investment, job creation and effective administration.
  • The SEZ regulations tend to be conducive to foreign direct investment. Here, the business and trade laws are different from the rest of the country.
  • Conducting business in an SEZ typically implies that the company will receive tax incentives and the opportunity to pay lower tariffs.
  • It facilitates rapid economic growth by leveraging tax incentives to attract foreign dollars and technological advancement.
  • The benefits of operating within a SEZ include tax breaks for business owners and independence.
  • SEZ increase export levels for the implementing country and other countries that supply it with intermediate products, but there is a risk that countries may abuse the system and use it to retain protectionist barriers in the form of taxes and fees.
  • SEZs also create excessive bureaucracy that funnels money away from the system.
  • For encouraging the businesses to set up in the zone, financial policies are introduced regarding investing, taxation, trading, quotas, customs and labour regulations.
  • Companies may be offered tax holidays, where upon establishing in a zone they are granted a period of lower taxation.
  • The benefits a company gains by being in a special economic zone may mean that it can produce and trade goods at a lower price, aimed at being globally competitive. But in some countries the zones have been criticized for being little more than labour camps, with workers denied fundamental labour rights.

Types of SEZ:

  • Free trade zones (FTZ)
  • Export processing zones (EPZ)
  • Free zones/ Free economic zones (FZ/ FEZ)
  • Industrial parks/ industrial estates (IE)
  • Free ports
  • Bonded logistics parks (BLP)
  • Urban enterprise zones

SEZ in India:

  • India was one of the first in Asia to recognize the effectiveness of the Export Processing Zone (EPZ) model in promoting exports, with Asia’s first EPZ set up in Kandla in 1965.
  • With a view to overcome the shortcomings experienced because of the multiplicity of controls and clearances; absence of world-class infrastructure, and an unstable fiscal regime and with a view to attract larger foreign investments in India, the Special Economic Zones (SEZs) Policy was announced in April 2000 for the first time in India.
  • It aimed to enhance foreign investment and provide an internationally competitive and hassle-free environment for exports.
  • The idea was to promote exports from the country and realising the need that level playing field must be made available to the domestic enterprises and manufacturers to be competitive globally.
  • The Special Economic Zones Act, 2005, was passed by Parliament in May 2005 which received Presidential assent on the 23rd of June 2005.
  • SEZ Rules, came into effect on 10th February 2006, providing for drastic simplification of procedures and for single window clearance on matters relating to central as well as state governments.
  • Any private/public/joint sector or state government or its agencies can set up an SEZ, even a foreign agency can set up SEZs in India.
  • In all SEZs the statutory functions are controlled by the government. Government also controls the operation and maintenance function in the seven central government controlled SEZs. The rest of the operations and maintenance are privatised.

The main objectives of the SEZ Act are:

  • Generation of additional economic activity
  • Promotion of exports of goods and services
  • Promotion of investment from domestic and foreign sources
  • Creation of employment opportunities
  • Development of infrastructure facilities
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Fiscal deficit occurs when a government’s total expenditures exceed the revenue that it generates, including money from borrowings. Right OR Wrong?

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Answer:

Right Statement:

  • A fiscal deficit occurs when a government’s total expenditures exceed the revenue that it generates, excluding money from borrowings.

Enrich Your Learning:

  • Fiscal deficit leads to excessive Government borrowing from the market which causes rise in market interest rate that in turn reduce private investment, and it reduces the resources available for private sector investment.
  • The large fiscal deficit is financed by borrowing from the Reserve Bank of India which issues new currency (which is called reserve money or high-powered money) for the government. This causes greater expansion in money supply and generates inflationary situation in the economy.
  • Thus, to check the rate of inflation, fiscal deficit must be reduced through both raising revenue of the government and reducing government expenditure. Other measures also include borrowing from domestic sources, borrowing from external sources and deficit financing (printing of new currency notes).
  • The reduction in fiscal deficit will prevent the emergence of excess demand in the economy and thereby help in controlling inflation and achieving price stability.
  • Fiscal deficit is advantageous to an economy if it creates new capital assets which increase productive capacity and generate future income stream. On the contrary, it is detrimental for the economy if it is used just to cover revenue deficit.

Measures to reduce the fiscal deficit:

These measures can be studied under two heads, they are:

By reducing government expenditure:

  • A drastic reduction in expenditure on major subsidies such as food, fertilisers, exports, electricity to curtail public expenditure.
  • Reducing the huge amount of money that is spent by the government on LTC (Leave Travelling Concessions), bonus, leave encashment etc.
  • The government has to reduce interest payments on past debt.
  • Funds raised through disinvestment in the public sector should be used to retire a part of old public debt rather than financing current expenditure, which will quickly reduce burden of interest payments in future.
  • Budgetary support to public sector enterprises other than infrastructure projects should be substantially reduced, and they should be asked to raise funds from the market and banks.
  • Curtail unnecessary expenditure in all government departments.

By raising revenue of the government:

  • Mobilising resources to increase public revenue.
  • Policy of moderate taxes with simplified taxation structure should be followed.
  • High marginal rates of taxes should be avoided as they serve as disincentives to work more, save more and invest more and cause evasion of taxes.
  • The tax base should be broadened for both direct and indirect taxes. This can be achieved by withdrawing exemptions and deductions provided in the income and wealth taxes, taxing agricultural incomes and incomes derived from unorganised industrial and services sectors, etc.
  • Steps should be taken to curtail black money, tax evasion and corruption and prevented them by strict enforcement of the tax laws.
  • Mobilise more resources through indirect taxes, more commodities should be brought within the tax net.
  • Various tax concessions should be withdrawn to collect more revenue from taxes and the social objectives should be served by adopting more effective policy instruments.
  • Public sector enterprises should be restructured so that they should make some surpluses at least for their own development so that their dependence on government’s budgetary resources should be dispensed with.

 

 

14th Finance Commission has ignored the Plan and Non-Plan distinction. Right OR Wrong?

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Answer:

Enrich Your Learning:

About the Fourteenth Finance Commission (FFC):

  • The 14th Finance Commission (FFC) was constituted by the orders of President on 2nd January 2013 and submitted its report on 15th December 2014.
  • The Finance Commission is required to recommend the distribution of the net proceeds of taxes of the Union between the Union and the States (commonly referred to as vertical devolution); and the allocation between the States of the respective shares of such proceeds (commonly known as horizontal devolution).

Recommendations of 14th FC:

  • The States’ share in the net proceeds of the Union tax revenues be 42%, which is a huge jump from the 32% recommended by the 13th Finance Commission. 
  • A majority of the resources should flow in the form of tax devolution.
  • An overwhelming majority of States have suggested reducing the number of centrally sponsored scheme as well as outlays on them.
  • Tax devolution should be primary route of transfer of resources to States.
  • It has ignored the Plan and Non-Plan distinction and sees the enhanced devolution of the divisible pool of taxes as a “compositional shift in transfers from grants to tax devolution”.
  • Central assistance to State Plans as a whole, to reduce and be replaced by greater devolution of taxes.
  • As service tax is not levied in J&K, the share of the States, in percentage terms has been calculated separately by FFC.
  • It also recommended the measures needed to augment the Consolidated Fund of a State to supplement the resources of the Panchayats and Municipalities in the State on the basis of the recommendations made by the Finance Commission of the State.
  • It recommended distribution of grants to States for local bodies using 2011 population data with weight of 90% and area with weight of 10%.
  • It recommended grants in two parts; a basic grant, and a performance grant, for duly constituted Gram Panchayats and municipalities. The ratio of basic to performance grant is 90:10 with respect to Panchayats and 80:20 with respect to Municipalities.
  • It also made certain recommendations on cooperative federalism, Goods & Services Tax, Fiscal Consolidation Roadmap, Pricing of Public Utilities and Public Sector Enterprises.
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