UPSC Prelims 2002 Q50: Indian Economy – Economic Development
Despite being a high saving economy, capital formation may not result in significant
increase in output due to
- (a) weak administrative machinery
- (b) illiteracy
- (c) high population density
- (d) high capital - output ratio
Answer: (d) high capital - output ratio
Explanation
Why capital formation may not raise output in a high-saving economy
| Factor | Effect on output |
|---|---|
| High capital-output ratio | Yes — each unit of output needs a large amount of capital, so extra capital adds little output |
| Weak administrative machinery | Slows implementation but is not the direct link |
| Illiteracy | Lowers productivity indirectly |
| High population density | Dilutes per capita income but is not the direct link |
Output rises by capital invested divided by the capital-output ratio. If the capital-output ratio is high, a large capital formation yields only a small increase in output, even for a high-saving economy.
Answer: (d) high capital-output ratio.
Why each option is right or wrong
- (a) Incorrect. Weak administration is a general problem, not the direct arithmetic reason.
- (b) Incorrect. Illiteracy lowers productivity but is not the direct reason.
- (c) Incorrect. High density affects per capita figures, not the output per unit of capital.
- (d) CORRECT. A high capital-output ratio means more capital per unit of output.
Key point
Harrod-Domar: growth rate = saving rate ÷ capital-output ratio (ICOR).
Remember
Growth = savings rate ÷ capital-output ratio.
Common mistakes
- Choosing weak administrative machinery as a broad cause.
- Blaming population density for the weak output response of capital.
- Overlooking that ICOR links capital to output directly.
Exam tip
Only the ICOR connects capital formation to output in a formula.
Sources
- Ramesh Singh — Indian Economy
- NCERT Class XII — Introductory Macroeconomics