Public sector finances

Question 1

Which of the following does government spending not include?

Answer 1

Public expenditure includes current expenditure, capital expenditure and transfer payments. The government spending part of the aggregate demand formula is similar but it doesn’t include transfer payments.
Transfer payments are not included in ‘G’ because they don’t actually involve spending on goods and services. For example, benefits are just a transfer of money from the government to low-income families. The money spent on benefits usually appears in AD under consumption because most of it is spent by the individuals receiving it.

Question 2

What is the business cycle based on?

Answer 2

The business cycle is based on the simple observation that virtually all economies are in a cycle where they move from negative economic growth, known as a bust, to positive economic growth, known as a boom.

Question 3

Which of the following describes what is meant by the business cycle ?

Answer 3

Which of the following describes what is meant by the business cycle ?

Question 4

What impact will high unemployment have on a country’s budget ?

Answer 4

High unemployment worsens a budget in two main ways. First, fewer people are in work, so income tax revenue will decrease. Second, government spending on unemployment related benefits will increase. An increase in spending and a decrease in tax revenue will worsen the budget.

Question 5

Which of the combinations above shows the impact of an increase in real GDP on the budget ?

Answer 5

An increase in real GDP will increase derived demand for labour. More are in work and so income tax revenue will increase. Also, government spending on unemployment related benefits will decrease. An increase in tax revenue and a decrease in government spending will improve the budget.

Question 6

What is a cyclical deficit ?

Answer 6

A cyclical deficit occurs when public expenditure increases and tax revenue decreases during a recession. For example, an increase in unemployment during a recession means spending on benefits will increase and income tax revenue will decrease.

Question 7

Which of the following is the best definition for a budget deficit?

Answer 7

D When public expenditure is greater than tax revenue

Public expenditure includes current expenditure, capital expenditure and transfer payments.
Transfer payments are not included in ‘G’ because they don’t actually involve spending on goods and services. For example, benefits are just a transfer of money from the government to low-income families. The money spent on benefits usually appears in AD under consumption as most of it is spent by the individuals receiving it.

Question 8

Which of the following is the best definition for a structural budget deficit?

Answer 8

A structural budget deficit is the budget deficit that remains at any point of the business cycle. It occurs when public expenditure is greater than tax revenue.

Question 9

Which of the following is the best definition for a cyclical budget deficit?

Answer 9

A cyclical deficit occurs when public expenditure increases and tax revenue decreases during a recession (two consecutive quarters of negative economic growth).

Question 10

Which of the following is most likely to cause a structural budget deficit?

Answer 10

D A decision by the government to reduce corporation tax in order to attract Foreign Direct Investment

Question 11

Which of the following is most likely to cause a cyclical budget deficit?

Answer 11

B A decrease in corporation tax revenue as a result of lower sales

Question 12

1. Budget Deficit

Answer 12

When public expenditure is greater than tax revenue.

Question 13

2. Cyclical Deficit

Answer 13

A cyclical deficit occurs during a recession when public expenditure is high and tax revenues are low.

Question 14

3. Structural Deficit

Answer 14

A structural deficit is the budget deficit that remains at any point of the business cycle.

Question 15

1 in 3 people in Botswana are under the age of 15. How is this population structure likely to impact a government’s budget ?

Answer 15

As a result of a young population, governments will increasingly need to prioritise education spending. In addition, they will receive less income tax as there are fewer people working.
So, a young population will require an increase in public expenditure and a decrease in tax revenue. This will increase the size of the budget deficit.

Question 16

Why is a structural deficit much worse than a cyclical deficit?

Answer 16

Structural deficits are the budget deficits that persist throughout the business cycle i.e. during booms, recessions, slumps and recoveries! A cyclical deficit only occurs during a recession.

Question 17

National Debt

Answer 17

National debt is the total debt built up by government borrowing over time.

Question 18

What will happen to the price of borrowed money if the demand for borrowed money increases ?

Answer 18

The demand for borrowed money will increase, as the government is borrowing so much. This will then increase the price of borrowed money.

Question 19

What will happen to the interest rate if it costs more to borrow money ?

Answer 19

The demand for borrowed money will increase, as the government is borrowing so much. This will then increase the price of borrowed money. This will then increase the interest rate.

Question 20

What will happen to private sector investing if budget deficits lead to higher interest rates??

Answer 20

Decrease:
If a country has a budget deficit, the government will need to borrow money in order to fund its public expenditure. An increase in government borrowing will increase the demand for money. This will then increase the price of borrowed money, which is known as the interest rate. This will increase the cost of borrowing for private sector firms, which means they will decrease their investment and this is called financial crowding out.

Question 21

Which of the combinations above shows the impact of a budget deficit?

Answer 21

If a country has a budget deficit, the government will need to borrow money in order to fund its public expenditure. An increase in government borrowing will increase the demand for money. This will then increase the price of borrowed money, which is known as the interest rate. This will increase the cost of borrowing for private sector firms, which means they will decrease their investment. This is called financial crowding out.

Question 22

Which of the combinations above shows an impact of a decrease in the size of a country’s budget deficit ?

Answer 22

If a country has a smaller budget deficit, the government will need to borrow less money in order to fund its public expenditure. A decrease in government borrowing will decrease the demand for money. This will then decrease the price of borrowed money, which is known as the interest rate. This will decrease the cost of borrowing for private sector firms, which means they will increase their investment. In other words, there is less financial crowding out.

Question 23

Which of the following explains why a large national debt be a problem ?

Answer 23

A large national debt can be a problem for several reasons, for example:

1. There is an opportunity cost for interest payments (for example, the money could have been spent on schools).
2. It may lead to financial crowding out of private sector firms (by increasing the demand for borrowed money, increasing the interest rate and therefore decreasing investment).
3. A decrease in consumer and business confidence as they expect taxes will rise or public expenditure will fall in the future in order to pay back the debt.

Question 24

Why might a national debt not be a problem ?

Answer 24

A large national debt is less of a problem if:

1. The government is able to continue to borrow at a low interest rate (as this means that there will be a lower opportunity cost).
2. The national debt is a small percentage of GDP - this means that is is less significant and easier to pay back.
3. The money borrowed was used to pay for capital expenditure as these will encourage future economic growth - for example, money borrowed for a new school will increase human capital.

Question 25

Financial crowding out

Answer 25

If a country has a budget deficit, the government will need to borrow money in order to fund its public expenditure. An increase in government borrowing will increase the demand for money. This will then increase the price of borrowed money, which is known as the interest rate. This will decrease private sector investment. This is known as financial crowding out .

Question 26

What is the likely impact of a high national debt on future generations?

Answer 26

As the government borrows more and more money to fund a budget deficit, the national debt will increase. The government will also have to pay more or high interest.
A high national debt will need to be paid back at some point. In order to do this, the government will either need to increase taxes or decrease public expenditure - or a combination of both.