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CHAPTER 18
Deficits, Surpluses, and the Public Debt
A. Short-Answer, Essays, and Problems
1. Differentiate between the Federal deficit and the Federal debt.
2. The following table shows government spending and tax revenue for a hypothetical
economy over a five-year period. All figures are in billions.
Year
1
2
3
4
5
Government Spending
$ 800
850
900
950
1,000
Tax Revenues
$825
850
875
900
925
(a) In what years were there budget deficits and what were the amounts?
(b) In what year was there a budget surplus and what was the amount?
(c) What is the public debt in this economy over the five years?
3. Compare and contrast the three budget philosophies: annually balanced budget,
cyclically balanced budget, and functional finance.
4. What is the problem with a cyclically balanced budget?
New 5. Why is an annually balanced budget not compatible with government fiscal activity
viewed as a countercyclical, stabilizing force in the economy?
New 6. What is the cyclically balanced budget? What is its major problem?
New 7. Briefly explain functional finance.
8. State three causes of the public debt.
9. What information would be important for assessing the size of the public debt beside the
absolute amount of the public debt?
10. In 2000 the public debt was $5.6 trillion. Put this number in perspective by relating the
debt to GDP, to other countries’ debt, to the amount of interest payments on the debt,
and to ownership of the debt.
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New 11. What is the relationship between social security and the public debt?
12. Can the large public debt cause the nation to go bankrupt? Explain.
13. Adam Smith once wrote: “What is prudence in the conduct of every private family can
scarce be folly in that of a great kingdom.” Evaluate in terms of the national debt.
14. If we as individuals would continue to spend more than we made, we would sooner or
later have to pay up or go bankrupt. Our government is in the same position or will be
unless we get serious about our liabilities and reduce expenditures enough to reduce the
deficits or increase revenues enough to pay our bills and have some left over to pay the
old bills. Evaluate this statement.
15. Why is the ownership of the public debt an important issue?
16. Is the public debt a burden on future generations? Explain.
17. Is it possible to impose a burden on future generations by increasing the public debt?
18. What are four real and potential problems with the public debt?
19. If the public debt is a debt that we owe to ourselves, then there are obviously no
problems connected with such a debt. Critically evaluate.
20. Crowding out and international effects can weaken the effect of an expansionary fiscal
deficit. Explain.
21. The table below gives data on interest rates and investment demand in a hypothetical
economy. Figures are in billions.
Interest rate
7%
6
5
4
3
Id1
$500
600
700
800
900
Id2
$ 600
700
800
900
1,000
(a) Use the Id1 schedule. Assume that the government needs to finance a budget deficit
and this public borrowing increases the interest rate from 5% to 6%. How much
crowding-out of private investment will occur?
(b) Now assume that the deficit is used to improve the performance of the economy,
and that as a consequence the investment-demand schedule changes from Id1 to Id2. At
the same time, the interest rate rises from 5% to 6% as the government borrows money
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to finance the deficit. How much crowding-out of private investment will occur in this
case?
(c) Graph the two investment-demand schedules on the graph below and show the
difference between the two events. Put the interest rate on the vertical axis and the
quantity of investment demanded on the horizontal axis.
New 22. What two factors could reduce the net economic burden that might be shifted to future
generations from the public debt?
23. Changes in the size of the public debt have a much greater impact on the economy than
does the mere existence of a large debt. Evaluate.
New 24. Describe the actions taken by government to reduce the budget deficits of the 1990s.
New 25. Discuss the pros and cons of paying down the public debt with the projected surpluses.
New 26. Evaluate the advantages and disadvantages of tax cuts for the disposing of budget
surpluses.
New 27. How can the surplus be used to bolster social security?
New 28. (Last Word) How can paying down the public debt potentially reduce the U.S. trade
deficit?
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