The system used in the United States for allocating investment capital has many strengths: flexibility, responsiveness, and high rates of...
GMAT Reading Comprehension : (RC) Questions
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The system used in the United States for allocating investment capital has many strengths: flexibility, responsiveness, and high rates of corporate profitability. It does not, however, direct capital effectively within the economy to those companies that can deploy it most productively, nor within companies to the most productive investment projects. In fact, the external capital market-the system by which outside investors allocate their capital to particular companies-is, if anything, too responsive to immediate stock-market pressures. This is because publicly owned United States companies increasingly rely on institutional investors who invest in a large, diversified portfolio of stocks that they hold for a relatively short time. In contrast, German investors invest for the long term in a few selected companies, and thus are able to gather extensive information about a company's ongoing prospects. United States investors, with small stakes in many companies, are generally unable to do this kind of thorough research. Therefore, when making investment decisions, they simply try to anticipate short-term movements in stock prices by using easily measurable company attributes, such as current profits, to serve as proxies of a company's value. This short-term outlook is often disruptive for companies because their stock prices, which reflect investor interest, can fluctuate dramatically in response to variations in quarterly profits. Moreover, the system as a whole results in overinvestment in rapid-growth sectors of the economy, computer technology for instance, and underinvestment in slow-growth sectors.
The United States internal capital market-the system by which individual companies allocate their own investment capital-can be just as myopic, largely because it uses the same valuation methods that outside investors use. Capital allocation in the United States takes place largely through "by the numbers" exercises that require managers to justify projects quantitatively. Thus, to keep costs low and profits high, many United States companies underinvest in those intangible assets required for long-term competitiveness-research and development, employee training, and organizational development. These areas, where returns are difficult to measure, are usually treated as costs rather than investments during the budgeting process. Thus, a company concerned about its current stock price may decide to sacrifice an employee training program to maintain its current level of profitability.
Ques. 1/4
The primary purpose of the passage is to
Solution
1. Passage Analysis:
Progressive Passage Analysis
| Text from Passage | Analysis |
|---|---|
| "The system used in the United States for allocating investment capital has many strengths: flexibility, responsiveness, and high rates of corporate profitability." | What it says: The US investment capital system has positive qualities - it's flexible, responsive, and makes companies profitable. What it does: Opens with acknowledgment of strengths - sets up balanced tone Source/Type: Author's assessment/opinion Connection to Previous Sentences: This is the opening statement - establishes the topic (US capital allocation system) Visualization: Think of the US system like a responsive sports car: quick to react, adaptable to conditions, and generating strong performance results Reading Strategy Insight: Starting with positives suggests a "but" is coming - author establishing credibility before criticism |
| "It does not, however, direct capital effectively within the economy to those companies that can deploy it most productively, nor within companies to the most productive investment projects." | What it says: BUT the system fails in two ways: 1) doesn't send money to the most productive companies, and 2) doesn't help companies choose their best internal projects What it does: Introduces the main criticism/thesis after the setup Source/Type: Author's critical assessment Connection to Previous Sentences: This directly contrasts with sentence 1's praise. The "however" signals the turn from strengths to weaknesses. This is the author's main argument Visualization: Imagine money flowing like water - instead of going to the most fertile ground (productive companies/projects), it's flowing randomly or to less optimal locations Reading Strategy Insight: The balanced opening (praise + criticism) suggests a nuanced, credible analysis rather than one-sided bashing |
| "In fact, the external capital market-the system by which outside investors allocate their capital to particular companies-is, if anything, too responsive to immediate stock-market pressures." | What it says: The problem with outside investors is they react TOO quickly to stock market changes What it does: Starts explaining WHY the system fails (focuses on external/outside investors first) Source/Type: Author's explanation Connection to Previous Sentences: This builds on sentence 2 by explaining the first failure (money not going to productive companies). Notice how "too responsive" ironically connects to "responsiveness" being listed as a strength in sentence 1 Visualization: Picture outside investors like jumpy drivers who overreact to every small road change, swerving unnecessarily instead of staying steady Reading Strategy Insight: The author is turning a supposed strength (responsiveness) into a weakness (too responsive) - this is sophisticated but logical |
| "This is because publicly owned United States companies increasingly rely on institutional investors who invest in a large, diversified portfolio of stocks that they hold for a relatively short time." | What it says: US companies depend on institutional investors who: 1) own many different stocks, 2) don't hold them for long What it does: Explains the cause of the "too responsive" problem Source/Type: Author's factual explanation Connection to Previous Sentences: This directly explains "This is because..." - building a causal chain. We're getting deeper into WHY the external market fails Visualization: Think of institutional investors like speed-dating participants: they meet many companies (diversified portfolio) but don't stay with any one long enough to really get to know them What We Know So Far: US system has strengths but fails at directing capital productively; external market is too responsive because it relies on short-term, diversified institutional investors What We Don't Know Yet: What the alternative looks like, how this affects internal company decisions |
| "In contrast, German investors invest for the long term in a few selected companies, and thus are able to gather extensive information about a company's ongoing prospects." | What it says: German investors do the opposite: they pick fewer companies, hold for longer, and therefore know much more about each company's future potential What it does: Provides contrasting example to highlight what's wrong with the US approach Source/Type: Author's factual comparison Connection to Previous Sentences: "In contrast" directly compares to sentence 4. This shows what the opposite (better) approach looks like Visualization: German investors are like people in long-term relationships: they invest time to deeply understand fewer partners, versus US investors who are like casual daters meeting many people briefly Reading Strategy Insight: This contrast helps clarify the problem - we now see exactly what the US system lacks |
| "United States investors, with small stakes in many companies, are generally unable to do this kind of thorough research." | What it says: US investors can't do the deep research that Germans do because they have small investments spread across too many companies What it does: Restates and reinforces the US problem using the German contrast Source/Type: Author's logical conclusion Connection to Previous Sentences: This circles back to reinforce the US problem from sentence 4, now made clearer by the German contrast in sentence 5. This is NOT new information - it's clarification! Visualization: Like a teacher with 200 students versus a teacher with 20 students - the first can't give individual attention Reading Strategy Insight: Feel relieved here - this is simplification, not new complexity. The author is helping us understand by restating the problem more clearly |
| "Therefore, when making investment decisions, they simply try to anticipate short-term movements in stock prices by using easily measurable company attributes, such as current profits, to serve as proxies of a company's value." | What it says: Since US investors can't do deep research, they use shortcuts: they guess short-term price changes based on easy-to-measure things like current profits What it does: Explains the logical consequence of the research limitation Source/Type: Author's causal explanation Connection to Previous Sentences: "Therefore" signals this flows directly from sentence 6. We're seeing the result of being unable to do thorough research Visualization: Like judging a student's intelligence only by their last test score instead of observing their learning over time - it's a crude shortcut Reading Strategy Insight: The logical chain is clear: can't do research → use shortcuts → focus on short-term measures |
| "This short-term outlook is often disruptive for companies because their stock prices, which reflect investor interest, can fluctuate dramatically in response to variations in quarterly profits." | What it says: The short-term focus hurts companies because their stock prices swing wildly when quarterly profits change What it does: Shows the negative consequences of the short-term approach Source/Type: Author's assessment of consequences Connection to Previous Sentences: "This short-term outlook" directly refers back to sentence 7. We're seeing the damage caused by the shortcut approach Visualization: Like a company's value being judged by its performance in just the last week of a year-long project - creating unnecessary stress and volatility Reading Strategy Insight: The argument is building systematically: problem identified → cause explained → consequences shown |
| "Moreover, the system as a whole results in overinvestment in rapid-growth sectors of the economy, computer technology for instance, and underinvestment in slow-growth sectors." | What it says: The system also creates broader economic problems: too much money goes to fast-growing areas (like computer technology) and too little to slower-growing areas What it does: Expands from company-level to economy-wide consequences Source/Type: Author's broader analysis with concrete example Connection to Previous Sentences: "Moreover" adds another layer of problems to what we've already established. This broadens our view from individual companies to the whole economy Visualization: Like all the water flowing to already-flooded areas (tech) while drought-stricken areas (slow-growth sectors) get even less Reading Strategy Insight: We're seeing how the same core problem (short-term focus) creates multiple levels of damage |
| "The United States internal capital market-the system by which individual companies allocate their own investment capital-can be just as myopic, largely because it uses the same valuation methods that outside investors use." | What it says: Now shifting to the second problem from sentence 2: companies' internal investment decisions are also short-sighted, and for the same reason (they use the same methods as outside investors) What it does: Transitions to the second part of the main argument (internal capital allocation) Source/Type: Author's analysis Connection to Previous Sentences: This returns to the second failure mentioned in sentence 2 (companies not choosing productive internal projects). The phrase "just as myopic" connects this to all the external market problems we just learned about Visualization: Companies using the same broken measuring tools that outside investors use - like using a broken scale both outside and inside the company Reading Strategy Insight: This feels familiar because it IS familiar - same problem, different location. The author is connecting, not complicating |
| "Capital allocation in the United States takes place largely through "by the numbers" exercises that require managers to justify projects quantitatively." | What it says: US companies make investment decisions by requiring managers to prove projects are good using numbers and data What it does: Explains HOW the internal system works (parallel to how we learned about external system) Source/Type: Author's description of process Connection to Previous Sentences: This elaborates on "same valuation methods" from sentence 10, showing what those methods actually look like in practice Visualization: Like requiring every decision to have a mathematical proof, even for things that are hard to measure Reading Strategy Insight: We're getting the same kind of explanation for internal markets that we got for external markets - the structure is parallel and familiar |
| "Thus, to keep costs low and profits high, many United States companies underinvest in those intangible assets required for long-term competitiveness-research and development, employee training, and organizational development." | What it says: Because of the numbers-focused approach, companies don't invest enough in important long-term things like R&D, training, and organizational development What it does: Shows the consequences of "by the numbers" approach with specific examples Source/Type: Author's analysis with concrete examples Connection to Previous Sentences: "Thus" signals this flows from sentence 11. We're seeing the internal version of the same short-term problem that affected external investment Visualization: Like a person who only buys things they can immediately measure the value of, missing out on education, relationships, and health investments that pay off later Reading Strategy Insight: Same core problem (short-term focus) now showing up internally - this reinforces rather than complicates the argument |
| "These areas, where returns are difficult to measure, are usually treated as costs rather than investments during the budgeting process." | What it says: The things mentioned in sentence 12 (R&D, training, etc.) get treated as expenses to cut rather than investments to make, because their value is hard to measure What it does: Explains WHY companies underinvest in these areas Source/Type: Author's explanation of corporate behavior Connection to Previous Sentences: "These areas" refers directly back to sentence 12's examples. This explains the mechanism behind the underinvestment problem Visualization: Like putting gym memberships and education in the "expense" category instead of "investment" category when making a budget Reading Strategy Insight: This is clarification of the previous sentence, not new complexity - the author is helping us understand the reasoning |
| "Thus, a company concerned about its current stock price may decide to sacrifice an employee training program to maintain its current level of profitability." | What it says: Concrete example: a company worried about stock price cuts employee training to keep profits looking good right now What it does: Provides a specific, concrete example of the whole problem in action Source/Type: Author's illustrative example Connection to Previous Sentences: This brings together the external pressure (stock price concerns) with internal decisions (cutting training) - showing how both parts of the problem connect in real situations Visualization: Company executives saying: "We can't afford training this quarter because investors are watching our profits closely" - sacrificing future capability for current appearance Reading Strategy Insight: This final example ties together everything we've learned - feel confident that you understand how external and internal problems connect! Final Understanding: The passage has shown one core problem (short-term focus) affecting two areas (external and internal capital allocation) with the same root cause (pressure for immediate, measurable returns) |
2. Passage Summary:
Author's Purpose:
To analyze and explain why the US investment capital allocation system fails to direct money effectively to the most productive uses, despite having notable strengths.
Summary of Passage Structure:
The author builds their argument by examining both sides of the capital allocation system and showing how the same core problem affects both:
- First, the author acknowledges the strengths of the US investment system (flexibility, responsiveness, profitability) but immediately introduces the main criticism that it fails to allocate capital effectively.
- Next, the author explains why external investors (those outside companies) make poor allocation decisions by comparing the short-term, diversified approach of US institutional investors to the long-term, focused approach of German investors.
- Then, the author shows the consequences of this short-term focus, including volatile stock prices for individual companies and misallocation of investment across different sectors of the economy.
- Finally, the author demonstrates that companies' internal investment decisions suffer from the same short-term, numbers-focused approach, leading them to underinvest in important long-term assets like research, training, and development.
Main Point:
The US capital allocation system, both external and internal, is too focused on short-term, easily measurable results, which prevents money from flowing to the most productive long-term investments and ultimately hurts both individual companies and the broader economy.
3. Question Analysis:
This question asks us to identify the primary purpose of the passage - essentially, what is the author's main goal in writing this piece? We need to determine what the author is fundamentally trying to accomplish through their discussion of the US capital allocation system.
Connecting to Our Passage Analysis:
From our passage analysis, we can see that:
- The author establishes a balanced tone by acknowledging strengths before introducing criticisms
- The main argument centers on explaining WHY the US system fails to direct capital effectively (sentence 2 presents the core thesis)
- The passage systematically builds a causal chain: short-term focus → poor research → shortcut methods → negative consequences
- The author examines both external and internal capital markets to show how the same core problem affects both areas
- The structure moves from problem identification → cause explanation → consequence demonstration, with concrete examples throughout
Prethinking:
Based on the passage structure and main argument, the author's primary purpose is to analyze and explain the problems with how capital is allocated in the US system. The passage is fundamentally explanatory - it seeks to understand the reasons behind the system's failures and demonstrate the effects of those failures. While comparisons to Germany are made, they serve to illuminate the US problems rather than comprehensively contrast two systems. The focus remains consistently on analyzing the US system's shortcomings and their consequences.
Answer Choices Explained
A
contrast the capital allocation systems used in the United States and Germany, showing the strengths and weaknesses of each
Why It's Wrong:
• The passage mentions Germany only briefly (one sentence) to highlight what the US system lacks
• No comprehensive analysis of German system's strengths and weaknesses is provided
• The German comparison serves as supporting evidence, not a primary focus
• The passage doesn't analyze German weaknesses at all
Common Student Mistakes:
1. Does the presence of a Germany comparison mean the passage is primarily comparative?
→ Look at proportionality - one sentence about Germany versus extensive analysis of the US system shows the true focus
2. Since the author contrasts US and German approaches, isn't this a contrast passage?
→ Distinguish between using contrast as a tool versus making contrast the main purpose
• The passage mentions Germany only briefly (one sentence) to highlight what the US system lacks
• No comprehensive analysis of German system's strengths and weaknesses is provided
• The German comparison serves as supporting evidence, not a primary focus
• The passage doesn't analyze German weaknesses at all
Common Student Mistakes:
1. Does the presence of a Germany comparison mean the passage is primarily comparative?
→ Look at proportionality - one sentence about Germany versus extensive analysis of the US system shows the true focus
2. Since the author contrasts US and German approaches, isn't this a contrast passage?
→ Distinguish between using contrast as a tool versus making contrast the main purpose
B
analyze the reasons for, and the effects of, the way capital is allocated in the United States
Why It's Right:
• Directly matches the passage structure: identifying problems, explaining causes, and demonstrating effects
• Encompasses both external and internal capital market analysis
• Captures the systematic examination of why the system fails (short-term focus, institutional investor behavior, quantitative methods)
• Includes the consequences shown (stock volatility, sector misallocation, underinvestment in intangibles)
Key Evidence: "It does not, however, direct capital effectively within the economy to those companies that can deploy it most productively, nor within companies to the most productive investment projects" - this establishes the core problem that the rest of the passage analyzes.
• Directly matches the passage structure: identifying problems, explaining causes, and demonstrating effects
• Encompasses both external and internal capital market analysis
• Captures the systematic examination of why the system fails (short-term focus, institutional investor behavior, quantitative methods)
• Includes the consequences shown (stock volatility, sector misallocation, underinvestment in intangibles)
Key Evidence: "It does not, however, direct capital effectively within the economy to those companies that can deploy it most productively, nor within companies to the most productive investment projects" - this establishes the core problem that the rest of the passage analyzes.
C
describe the essential differences between the external and internal capital markets in the United States
Why It's Wrong:
• While the passage does discuss both external and internal markets, this misses the analytical purpose
• The passage doesn't just describe differences but explains why both systems fail
• This choice focuses on description rather than the critical analysis that drives the passage
• The essential point isn't the differences but the shared problems
Common Student Mistakes:
1. Since the passage talks about external and internal markets, isn't describing their differences the main purpose?
→ Notice that the passage shows how both markets share the same fundamental problem rather than emphasizing their differences
2. The author does explain both systems, so isn't this descriptive?
→ Look for the analytical elements - the focus on causes, effects, and problems shows this goes beyond mere description
• While the passage does discuss both external and internal markets, this misses the analytical purpose
• The passage doesn't just describe differences but explains why both systems fail
• This choice focuses on description rather than the critical analysis that drives the passage
• The essential point isn't the differences but the shared problems
Common Student Mistakes:
1. Since the passage talks about external and internal markets, isn't describing their differences the main purpose?
→ Notice that the passage shows how both markets share the same fundamental problem rather than emphasizing their differences
2. The author does explain both systems, so isn't this descriptive?
→ Look for the analytical elements - the focus on causes, effects, and problems shows this goes beyond mere description
D
explain why United States companies should invest more in intangible rather than tangible assets
Why It's Wrong:
• The passage analyzes why companies underinvest in intangibles but doesn't advocate for what they should do
• The author's purpose is explanatory, not prescriptive
• The discussion of intangible assets serves as evidence of the system's failures, not as a recommendation
• No explicit argument is made that companies should change their investment patterns
Common Student Mistakes:
1. Since the passage shows problems with underinvestment in R&D and training, isn't the author arguing for more investment in these areas?
→ Distinguish between explaining why something problematic happens versus advocating for a solution
2. The negative tone about underinvestment suggests the author wants more intangible investment, right?
→ Critical analysis of a problem doesn't automatically constitute advocacy for a specific solution
• The passage analyzes why companies underinvest in intangibles but doesn't advocate for what they should do
• The author's purpose is explanatory, not prescriptive
• The discussion of intangible assets serves as evidence of the system's failures, not as a recommendation
• No explicit argument is made that companies should change their investment patterns
Common Student Mistakes:
1. Since the passage shows problems with underinvestment in R&D and training, isn't the author arguing for more investment in these areas?
→ Distinguish between explaining why something problematic happens versus advocating for a solution
2. The negative tone about underinvestment suggests the author wants more intangible investment, right?
→ Critical analysis of a problem doesn't automatically constitute advocacy for a specific solution
E
establish the validity of the connection between a company's current level of profitability and its stock price
Why It's Wrong:
• The passage assumes this connection exists rather than trying to establish its validity
• The focus is on analyzing the consequences of this connection, not proving it exists
• The relationship between profitability and stock price is treated as a given fact that creates problems
• This choice focuses on a minor supporting detail rather than the main analytical purpose
Common Student Mistakes:
1. Since the passage discusses how stock prices reflect profitability, isn't it establishing this connection?
→ The passage uses this connection as a premise to analyze larger problems, not as a conclusion to prove
2. The author explains how quarterly profits affect stock prices - isn't this validating the connection?
→ Explaining how an existing relationship creates problems is different from establishing the validity of that relationship
• The passage assumes this connection exists rather than trying to establish its validity
• The focus is on analyzing the consequences of this connection, not proving it exists
• The relationship between profitability and stock price is treated as a given fact that creates problems
• This choice focuses on a minor supporting detail rather than the main analytical purpose
Common Student Mistakes:
1. Since the passage discusses how stock prices reflect profitability, isn't it establishing this connection?
→ The passage uses this connection as a premise to analyze larger problems, not as a conclusion to prove
2. The author explains how quarterly profits affect stock prices - isn't this validating the connection?
→ Explaining how an existing relationship creates problems is different from establishing the validity of that relationship
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