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Q61 (IAS/2014) Economy › Money, Banking & Inflation › Interest rate concepts Official Key

If the interest rate is decreased in an economy, it will

Result
Your answer: —  Âˇ  Correct: C
Explanation

The correct answer is option C because interest rate is the cost of investible funds, and at higher interest rates, firms tend to lower investment[1]. Conversely, when interest rates decrease, the cost of borrowing falls, making investment more attractive. All else equal, when the interest rate rises, the cost of investing—the interest the business will pay—rises, resulting in less investment overall[2]. Therefore, a decrease in interest rates will have the opposite effect, increasing investment expenditure.

Option A is incorrect because growth in household consumption expenditure generally follows the same trend as growth in disposable income[3], and lower interest rates typically encourage rather than decrease consumption. Option B is incorrect as there is no direct automatic relationship between interest rate decreases and increased tax collection. Option D is incorrect because supply of savings results in lower interest rates, and a lower supply of savings results in higher interest rates[4], indicating that lower interest rates generally discourage rather than increase savings.

Sources
  1. [1] Macroeconomics (NCERT class XII 2025 ed.) > Chapter 4: Determination of Income and Employment > 4.3.2 Effect of an Autonomous Change in Aggregate Demand on Income and Output > p. 60
  2. [2] https://www.congress.gov/crs-product/IF11020
  3. [4] https://www.congress.gov/crs-product/IF11020
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Don’t just practise – reverse-engineer the question. This panel shows where this PYQ came from (books / web), how the examiner broke it into hidden statements, and which nearby micro-concepts you were supposed to learn from it. Treat it like an autopsy of the question: what might have triggered it, which exact lines in the book matter, and what linked ideas you should carry forward to future questions.
Q. If the interest rate is decreased in an economy, it will [A] decrease the consumption expenditure in the economy [B] increase the tax c…
At a glance
Origin: Books + Current Affairs Fairness: Low / Borderline fairness Books / CA: 2.5/10 ¡ 5/10
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This is a classic 'Sitter' derived directly from NCERT Macroeconomics. It tests the fundamental Investment Function (I = f(r)). While real-world economics is messy, UPSC Prelims demands the primary theoretical relationship: Interest Rate is the cost of capital; when it falls, Investment rises. Ignore secondary effects like tax buoyancy.

How this question is built

This question can be broken into the following sub-statements. Tap a statement sentence to jump into its detailed analysis.

Statement 1
Does a decrease in interest rates in an economy decrease household consumption expenditure?
Origin: Weak / unclear Fairness: Borderline / guessy
Indirect textbook clues
Indian Economy, Nitin Singhania .(ed 2nd 2021-22) > Chapter 4: Inflation > a) Demand-Pull Inflation > p. 63
Strength: 5/5
“(a) Demand-Pull Inflation • It is caused by an increase in aggregate demand and consumption due to 'n (i) increased private and government spending, (ii) lower rate of savings by households, (iii) depreciation in local exchange rate, (iv) reduction in taxes and (v) increase in money supply and bank credit. • This leads to increased disposable income in the hands of households, thereby resulting a. in increase in the aggregate demand with no change in aggregate supply”
Why relevant

Explains that increased money supply and bank credit lead to higher disposable income and increased consumption (demand‑pull inflation driver).

How to extend

A student can infer that lower interest rates tend to raise bank credit/money supply, which would likely raise household consumption rather than decrease it.

Indian Economy, Nitin Singhania .(ed 2nd 2021-22) > Chapter 4: Inflation > CHAPTER SUMMARY > p. 77
Strength: 5/5
“• Demand-Pull inflation caused by increased private and government spending, lower rate of savings by households, depreciation in local exchange rate, reduction in taxes and increase in money supply and bank credit - increased disposable income - increase in the aggregate demand. • Cost-Push inflation (supply shock) inflation caused by growing cost of factors of production of goods and services, increase in indirect taxes, increase in import prices, higher cost of capital, interest rates, etc. EXAMPLE Previous Years' Preliminary Examination Questions EXAMPLE Previous Press”
Why relevant

Summarises that increases in money supply and bank credit increase disposable income and aggregate demand via higher private spending.

How to extend

Combine this with the fact that lower interest rates usually boost credit and money creation to judge that consumption would rise, not fall.

Indian Economy, Nitin Singhania .(ed 2nd 2021-22) > Chapter 4: Inflation > Deflation > p. 74
Strength: 4/5
“It is a decrease in general price levels of goods and services throughout an economy. If there is a higher supply of goods and services but not enough money supply to combat the situation, deflation can occur. Deflation is mainly caused by shifts in supply and demand. Deflation is usually associated with significant unemployment. However, deflation increases the value of money. When inflation becomes negative, it leads to deflation. It is invariably associated with recession, i.e. negative growth in the economy. To check deflation, the following measures can be taken to increase money supply: • Increase Government spending ٥• Lower bank rate and repo rates• Print more currency e• Decrease taxes to boost demand ۰”
Why relevant

Recommends lowering bank/repo rates as a policy to increase money supply and boost demand when fighting deflation.

How to extend

Use the policy link (lower rates → more money supply → higher demand) to infer effects on household consumption.

Macroeconomics (NCERT class XII 2025 ed.) > Chapter 4: Determination of Income and Employment > Paradox of Thrift > p. 63
Strength: 4/5
“This may happen due to a new information regarding an imminent war or some other impending disaster, which makes people more circumspect and conservative about their expenditures. Hence the mps of the economy increases, or, alternatively, the mpc decreases from 0.8 to 0.5. At the initial income level of AD* 1 = Y * 1 = 250, this sudden decline in mpc will imply a decrease in aggregate consumption spending and hence in aggregate demand, AD = A + cY , by an amount equal to (0.8 – 0.5) 250 = 75. This can be regarded as an autonomous reduction in consumption expenditure, to the extent that the change in mpc is occurring from some exogenous cause and is not a consequence of changes in the variables of the model.”
Why relevant

Shows how changes in the marginal propensity to consume (mpc) change aggregate consumption for a given income level.

How to extend

A student could combine the mpc mechanism with lower rates' effect on disposable income or borrowing to assess net consumption change.

Indian Economy, Vivek Singh (7th ed. 2023-24) > Chapter 2: Money and Banking- Part I > 2.31 Previous Years Questions > p. 116
Strength: 3/5
“If the interest rate is decreased in an economy, it will [2014] • (a) Decrease the consumption expenditure in the economy• (b) Increase the tax collection of the Government• (c) Increase the investment expenditure in the economy• (d) Increase the total savings in the economy• 17. With reference to Indian economy, consider the following: [2015] • (i) Bank rate• (ii) Open market operations• (iii) Public debt• (iv) Public Revenue”
Why relevant

Contains a past-question framing that links a fall in interest rates to possible changes in consumption, investment and savings—highlighting common textbook comparisons.

How to extend

Use this as a checklist: compare whether lower rates more strongly affect borrowing/consumption or investment in the relevant economy to judge the statement.

Statement analysis

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Statement analysis

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Statement analysis

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