The passage below is accompanied by four questions. Based on the passage, choose the best answer for each question.
Income Inequality and Economic Growth Passage CAT 2025 Slot 1 Verbal Reading Comprehension
Studies showing that income inequality plays a positive role in economic growth are largely based on three arguments. The first argument focuses on investment indivisibilities wherein large sunk costs are required when implementing new fundamental innovations. Without stock markets and financial institutions to mobilize large sums of money, a high concentration of wealth is needed for individuals to undertake new industrial activities accompanied by high sunk costs . . . [One study] shows the relation between economic growth and income inequality for 45 countries during 1966-1995. [It was found] that the increase in income inequality has a significant positive relationship with economic growth in the short and medium term. Using system GMM, [another study estimated] the relation between income inequality and economic growth for 106 countries during 1965–2005 period. The results show that income inequality has a positive impact on economic growth in the short run, but the two are negatively correlated in the long run. The second argument is related to moral hazard and incentives . . . Because economic performance is determined by the unobservable level of effort that agents make, paying compensations without taking into account the economic performance achieved by individual agents will fail to elicit optimum effort from the agents. Thus, certain income inequalities contribute to growth by enhancing worker motivation . . . and by giving motivation to innovators and entrepreneurs . . . Finally, [another study] point[s] out that the concentration of wealth or stock ownership in relation to corporate governance contributes to growth. If stock ownership is distributed and owned by a large number of shareholders, it is not easy to make quick decisions due to the conflicting interests among shareholders, and this may also cause a free-rider problem in terms of monitoring and supervising managers and workers. . . .
Various studies have examined the relationships between income inequality and economic growth, and most of these assert that a negative correlation exists between the two. . . . Analyzing 159 countries for 1980–2012, they conclude that there exists a negative relation between income inequality and economic growth; when the income share of the richest 20% of population increases by 1%, the GDP decreases by 0.08%, whereas when the income share of the poorest 20% of population increases by 1%, the GDP increases by 0.38%. Some studies find that inequality has a negative impact on growth due to poor human capital accumulation and low fertility rates . . . while [others] point out that inequality creates political instability, resulting in lower investment. . . . [Some economists] argue that widening income inequality has a negative impact on economic growth because it negatively affects social consensus or social capital formation. One important research topic is the correlation between democratization and income redistribution. [Some scholars] explain that social pressure for income redistribution rises as income inequality increases in a democratic society. In other words, when democratization extends suffrage to a wider class of people, the increased political power of low- and middle-income voters results in broader support for income redistribution and social welfare expansion. However . . . if the rich have more political influence than the poor, the democratic system actually worsens income inequality rather than improving it.
The passage refers to “democratization”. Choose the one option below that comes closest to the opposite of this process. MEDIUM
1. The coalition imposed term limits and strengthened judicial review in order to further entrench autocratic rule.
2. After the emergency decree, the regime shifted toward authoritarianism as suffrage narrowed and opposition parties were deregistered.
3. Municipalities adopted participatory budgeting and recall elections which a press release called totalitarianism.
4. Corporate donations were capped and parties received public funding which was portrayed as establishing an oligarchy.
Solution
Correct Option: 2
Rationale:
The passage explicitly defines “democratization” as a process that “extends suffrage to a wider class of people,” thereby increasing the political power of low- and middle-income voters. The opposite of this process would involve reducing the number of people who can vote (narrowing suffrage) and concentrating power rather than distributing it.
Option 2 describes a scenario where “suffrage narrowed” and the regime shifted toward “authoritarianism.” This directly contradicts the passage’s description of democratization (extending suffrage and empowering the broader population). Therefore, it represents the closest conceptual opposite.
Wrong Options:
Option 1 is incorrect because imposing term limits and strengthening judicial review are typically mechanisms used to prevent autocracy, not entrench it. While the sentence claims the goal is autocratic, the actions described are generally democratic checks and balances, making the scenario logically inconsistent as a clear opposite to democratization.
Option 3 is incorrect because participatory budgeting and recall elections are examples of direct democracy (increasing people’s power). Even though the sentence says they were called “totalitarianism,” the actual process described is an increase in democratization, not its opposite.
Option 4 is incorrect because capping corporate donations and providing public funding are measures usually taken to reduce the influence of wealth in politics, which aligns with democratic principles of fairness. The label “oligarchy” is applied in the sentence, but the action itself promotes democratic equality, so it is not the opposite of the process described in the text.
Difficulty: Medium
According to the incentive or moral hazard argument, which one of the designs below is most consistent with the claim that some inequality can raise growth? EASY
1. Pay rewards on verifiable performance for highly productive workers.
2. A regime that concentrates stock ownership in relation to corporate governance.
3. Wages are determined by tenure rather than output to ensure equity.
4. Rents protected by market power that enlarge top incomes without linking pay to results.
Solution
Correct Option: 1
Rationale:
The question specifically asks about the “incentive or moral hazard argument” found in the middle of the first paragraph. The passage states that because effort is often unobservable, “paying compensations without taking into account the economic performance achieved by individual agents will fail to elicit optimum effort.” Therefore, inequality contributes to growth when it is a result of rewarding effort and motivation. Option 1, which proposes paying rewards based on verifiable performance, directly aligns with this logic: it creates inequality based on productivity, thereby incentivizing agents to work harder and driving growth.
Wrong Options:
Option 2 refers to the third argument mentioned in the passage regarding “corporate governance” and the “free-rider problem,” not the moral hazard/incentive argument.
Option 3 advocates for equity and tenure over output, which is the exact opposite of the incentive argument. The passage argues that ignoring performance leads to suboptimal effort.
Option 4 describes inequality resulting from “rents” and “market power” without linking pay to results. The incentive argument explicitly relies on the link between compensation and performance/effort; unearned income does not provide the motivation described in the text.
Difficulty: Easy
Which one of the options below best summarises the passage? MEDUIM
1. The passage argues that income inequality accelerates economic growth while also emphasising the significance of concerns regarding human capital accumulation, fertility rates, and political instability.
2. The passage outlines investment, incentive, and governance channels through which income inequality may support economic growth and reports short-term gains while noting long-term drawbacks.
3. The passage claims that evaluating the effect of income inequality on economic growth without considering both short- and long-term consequences is misguided.
4. The passage confines its discussion to financing gaps and corporate control while undercutting cross country evidence and overlooking the significance of concerns regarding human capital accumulation, fertility rates, and income redistribution under democratisation.
Solution
Correct Option: 2
Rationale:
The passage is structured around explaining the relationship between income inequality and economic growth. The first paragraph explicitly details three specific arguments (channels) why inequality might support growth: 1) Investment indivisibilities (financing), 2) Moral hazard/incentives, and 3) Corporate governance. It also cites a study noting positive impacts in the short run but negative correlations in the long run. The second paragraph expands on the negative correlations and drawbacks (human capital, political instability). Option 2 accurately captures this structure by listing the three specific channels (“investment, incentive, and governance”) and summarizing the empirical findings (“short-term gains while noting long-term drawbacks”).
Wrong Options:
Option 1 is incorrect because it claims the passage “argues that income inequality accelerates economic growth.” The passage does not take this stance; it objectively reports on studies that make this claim while also reporting on studies that assert the opposite (negative correlation).
Option 3 is incorrect because it frames the summary as a prescriptive lesson (“evaluating… is misguided”) rather than a descriptive summary of the text’s content.
Option 4 is incorrect because it states the passage “overlooking the significance of concerns regarding human capital accumulation.” The second paragraph explicitly discusses human capital accumulation, making this option factually false.
Difficulty: Medium
The primary function of the three-part case for a positive income inequality–economic growth link in the first half of the passage is to show that: MEDIUM
1. inequality boosts growth in every period and type of economy, regardless of finance or governance conditions.
2. dispersed ownership speeds corporate decision-making and removes free rider problems.
3. mature stock markets make wealth concentration unnecessary, yet they might still be harmful to investment.
4. inequality can aid short-term growth in settings with high sunk costs, incentive alignment, and concentrated ownership.
Solution
Correct Option: 4
Rationale:
The first half of the passage presents three specific arguments to explain why income inequality might positively affect economic growth:
- High Sunk Costs: Inequality helps mobilize funds for large sunk costs when financial markets are absent.
- Incentive Alignment: Inequality solves moral hazard issues by aligning incentives and rewarding effort.
- Concentrated Ownership: Concentrated wealth aids corporate governance by facilitating quick decisions, whereas dispersed ownership slows this down.
Additionally, the studies cited in this section specifically highlight that this positive relationship is observed in the short and medium term or short run, contrasting it with the long run. Option 4 accurately synthesizes these three specific mechanisms and the temporal context provided in the text.
Wrong Options:
Option 1 is incorrect because the passage explicitly states that inequality and growth are negatively correlated in the long run, contradicting the claim that it boosts growth in every period.
Option 2 is incorrect because it states the exact opposite of the passage. The text argues that distributed ownership makes it difficult to make quick decisions and causes free-rider problems.
Option 3 is incorrect because it misrepresents the argument. The primary function of the section is not to critique stock markets, but to explain why inequality is useful in specific contexts.
Difficulty: Medium
