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TITAN 2025
Indian Economy – Mains Question 05

1. Incremental Capital Output Ratio (ICOR) is a crucial economic indicator. Discuss the factors
influencing ICOR and its significance in the context of economic efficiency and growth.
(150 Words, 10 Marks)

Approach:
❖ Introduction: Highlights ICOR's role in assessing capital efficiency and economic growth dynamics.
❖ Body: Write the answer in two parts: The first part explains the factors affecting ICOR (industry
nature, time and cost overruns, technology influence, higher capacity utilisation). And second part
mentions its significance.
❖ Conclusion: Give the significance of understanding ICOR and its factors, which play a pivotal role in
making informed economic decisions.
Answer:
Incremental Capital Output Ratio (ICOR) is a pivotal economic metric representing the quantity of capital
necessary to produce one extra unit of output. Its calculation involves dividing the increase in capital
investment by the corresponding increase in output.
Factors influence ICOR:
❖ Nature of Industry:
➢ Heavy industries like cement and steel, which are capital-intensive, generally exhibit higher ICOR
due to substantial capital requirements in their production processes.
❖ Time and Cost Overruns:
➢ Projects experiencing delays and cost overruns contribute to an escalation in ICOR. A recent report
by the Ministry of Statistics and Programme Implementation highlighted an extra expenditure of INR
4.3 lakh crores on delayed projects, emphasising the impact on ICOR.
❖ Technology:
➢ The adoption of efficient and contemporary technology tends to reduce ICOR, signifying enhanced
productivity. Conversely, outdated or inefficient technology raises ICOR, indicating a less efficient
use of capital.
❖ Capacity Utilisation:
➢ Higher capacity utilisation generally results in a more favourable ICOR, as it implies that existing
capital is being utilised efficiently to meet demand, leading to increased output without
proportionately higher capital investment.
❖ Harrod-Domar Model:
➢ According to the Harrod-Domar model, the growth rate is inversely proportional to ICOR. A higher
ICOR implies a lower growth rate, emphasising the importance of efficient capital use for economic
expansion.
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Significance of ICOR in Economic Efficiency and Growth:

❖ Resource Allocation Efficiency: A lower ICOR implies that the economy is using its resources more
efficiently, as it produces more output with less additional capital.
❖ Productivity Growth: A declining ICOR suggests that the economy is becoming more efficient, which
can contribute to sustained economic growth.
❖ Investment Planning: A higher ICOR may indicate diminishing returns to capital, potentially influencing
investment decisions.
❖ Policy Evaluation: Policies that lead to a reduction in ICOR may be considered successful in promoting
economic efficiency.
❖ Sustainability: Lower ICOR values are often associated with more sustainable growth, as they suggest
that economic expansion is not solely reliant on ever-increasing levels of capital investment.
Understanding ICOR and its determinants is crucial for policymakers and economists, providing insights into
the efficiency of capital allocation and its implications for economic growth. A lower ICOR is generally
desirable as it indicates that the economy is achieving more output with less additional capital, contributing
to sustainable and efficient economic development.
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