Chapter 28, Problem 11P

To determine

a.

The debt-GDP (Gross Domestic Product) ratio and the budget deficit to GDP (Gross Domestic Product) ratio wherein the budget deficit is $30 over next 10 years and government debt grows by previous year debt.

Introduction: Gross Domestic Product (GDP) refers to the total amount of all the goods as well as serviced produced in an economy in a given period of time.

Budget deficit is the amount of deficit balance in the government budget. It exists whenever government expenses exceed its revenue generation.

Debt is the amount of funds or other assets borrowed by one party from the other party. Debt is a source to carry out various operations by an individual or an organization at the time of low income generation.

Explanation of Solution

The debt every year can be calculated by the formula:

$\text{Debt}\text{in}\text{current}\text{year}=\left(\begin{array}{l}\text{Debt}\text{in}\text{previous}\text{year}\\ +\text{Budget}\text{deficit}\text{in}\text{previous}\text{year}\end{array}\right)$

The formula to calculate debt to GDP ratio is given below:

$\text{Debt}\text{to}{\text{GDP}}_{\text{current}\text{year}}=\frac{{\text{Debt}}_{\text{current}\text{year}}}{{\text{GDP}}_{\text{current}\text{year}}}\times 100$

The formula to calculate Budget deficit to GDP ratio is given below:

$\text{Budget}\text{deficit}\text{to}{\text{GDP}}_{\text{current}\text{year}}=\frac{\text{Budget}{\text{deficit}}_{currentyear}}{{\text{GDP}}_{\text{current}\text{year}}}\times 100$

The government debt to GDP ratio and Budget deficit (BD) to GDP ratio can be calculated for 10 years as given below:

Table (1)

To determine

b.

The debt to GDP ratio and budget deficit to GDP ratio when budget deficit grows by 3% over the 10 years.

Explanation of Solution

The government debt to GDP ratio and budget deficit to GDP ratio when deficit grows 3% every year is calculated as given below:

The debt every year can be calculated by the formula:

$\text{Debt}\text{in}\text{current}\text{year}=\left(\begin{array}{l}\text{Debt}\text{in}\text{previous}\text{year}\\ +\text{Budget}\text{deficit}\text{in}\text{previous}\text{year}\end{array}\right)$

The change in debt of every consecutive year for 10 years can be calculated as given below:

The formula to calculate debt to GDP ratio is given below:

$\text{Debt}\text{to}{\text{GDP}}_{\text{current}\text{year}}=\frac{{\text{Debt}}_{currentyear}}{{\text{GDP}}_{\text{current}\text{year}}}\times 100$

The formula to calculate budget deficit of every successive year is given below:

$\text{Budget}{\text{Deficit}}_{\text{current}\text{year}}=\left(\begin{array}{l}\text{Budget}{\text{deficit}}_{\text{previous}\text{year}}\\ +\left(3\%\times \text{Budget}{\text{deficit}}_{\text{previous}\text{year}}\right)\end{array}\right)$

The formula to calculate Budget deficit to GDP ratio is given below:

$\text{Budget}\text{deficit}\text{to}{\text{GDP}}_{\text{current}\text{year}}=\frac{\text{Budget}{\text{deficit}}_{currentyear}}{{\text{GDP}}_{\text{current}\text{year}}}\times 100$

The government debt to GDP ratio and Budget deficit (BD) to GDP ratio can be calculated for 10 years as given below:

Table (2)

To determine

c.

The debt to GDP ratio and budget deficit to GDP ratio when budget deficit grows by 20% over the 10 years.

Explanation of Solution

The debt to GDP ratio and Budget deficit to GDP ratio when budget deficit grows by 20% over the 10 years.

The debt every year can be calculated by the formula:

$\text{Debt}\text{in}\text{current}\text{year}=\left(\begin{array}{l}\text{Debt}\text{in}\text{previous}\text{year}\\ +\text{Budget}\text{deficit}\text{in}\text{previous}\text{year}\end{array}\right)$

The change in debt of every consecutive year for 10 years can be calculated as given below:

The formula to calculate debt to GDP ratio is given below:

$\text{Debt}\text{to}{\text{GDP}}_{\text{current}\text{year}}=\frac{{\text{Debt}}_{currentyear}}{{\text{GDP}}_{\text{current}\text{year}}}\times 100$

The formula to calculate budget deficit of every successive year is given below:

$\text{Budget}{\text{Deficit}}_{\text{current}\text{year}}=\left(\begin{array}{l}\text{Budget}{\text{deficit}}_{\text{previous}\text{year}}\\ +\left(20\%\times \text{Budget}{\text{deficit}}_{\text{previous}\text{year}}\right)\end{array}\right)$

The formula to calculate Budget deficit to GDP ratio is given below:

$\text{Budget}\text{deficit}\text{to}{\text{GDP}}_{\text{current}\text{year}}=\frac{\text{Budget}{\text{deficit}}_{currentyear}}{{\text{GDP}}_{\text{current}\text{year}}}\times 100$

The government debt to GDP ratio and Budget deficit (BD) to GDP ratio can be calculated for 10 years as given below:

Table (3)

To determine

d.

The effect on the debt-GDP ratio and the ratio of budget deficit to GDP for the economy over time under three different scenarios.

Explanation of Solution

Over the period of 10 years from 2014-2024, Debt to GDP and Budget deficit to GDP ratio changed manifolds. In the above three cases the results were all different. In the first case when budget deficit was constant at $30 for all 10 years, ratio of Budget deficit to GDP decreased at a very lower rate but the Debt to GDP ratio showed an increasing trend.

In the second case, the Budget deficit increased at the rate of 35 every year. This increase resulted in lower lever of Budget deficit o GDP ratio (better than before) but debt to GDP ratio increased more in comparison to the previous case.

Lastly, in the third case budget deficit increases at the rate of 20% every year. The effect is analyzed in the form of increased Budget deficit to GDP ratio as well as the Debt to GDP ratio at an increasing rate over the previous 10 years.

The increased level of budget deficit increases the ratios because more is the deficit in the accounts of government budget, increased fraction of GDP will be consumed in the debt and deficit.