5. Suppose that a country has no public debt in year 1 but experiences a budget

Question

5. Suppose that a country has no public debt in year 1 but experiences a budget deficit of $40 billion in year 2, a budget deficit of $20 billion in year 3, a budget surplus of $10 billion in year 3, and a budget deficit of $2 billion in year 4. What is the absolute size of its public debt in year 4? If its year 4? real GDP in year 4 is $104 billion, what is this country's public debt as a percentage of real GDP in 6. Suppose that the investment demand curve in a certain economy is such that investment declines by $100 bilion for every 1 percentage point increase in the real interest rate. Also, suppose that the investment demand curve shifts rightward by $150 billion at each real interest rate for every 1 percentage point increase in the expected rate of return from investment. If stimulus spending (an expansionary fiscal policy) by government increases the real interest rate by 2 percentage points, but also raises the expected rate of return on investment by 1 percent age point, how much investment, If any, will be crowded out?

Explanation / Answer

Answer 5

Debt = Sum of all deficits - sum of all budget surpluses

So,

Debt= ( 40+20+2) - 10

= $52 billion

real GDP = $104 billion in year 4

Now Debt to real GDP ratio of year 4= Debt÷(real GDP of year 4) ;

= 52/104

= 1/2

  

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