Illustrating Government Budgets

Question

A government starts off with a total debt of $5.5 billion. In year one, the government runs a deficit of $600 million. In year two, the government runs a deficit of $1.5 billion. In year three, the government runs a surplus of $400 million. 

1. What is the total debt of the government at the end of year three?
2. Assuming the government runs a deficit of $200 million in year three, what is the total debt of the government at the end of year three?
3. If a government runs a budget deficit of $5 billion dollars each year for ten years, then a surplus of $2 billion for five years, and then a balanced budget for another ten years, what is the government debt?

Specify whether expansionary or contractionary fiscal policy would seem to be most appropriate in response to each of the situations below and create a fully labeled diagram using aggregate demand and aggregate supply curves to illustrate your answer for each bullet:

1. An economic boom.
2. A stock market surge that increases consumer and business confidence.
3. Extremely rapid decline of exports.
4. Falling inflation.
5. A fall in the natural rate of unemployment.
6. A fall in oil prices. 

Answer 1

Government debt is just the sum of all prior year budget deficits. A deficit occurs when a government borrows more than it takes in as taxes. Just find the sums to calculate the first part of the question.

1. Contractionary fiscal policy should be used when an economy is overheating and experiencing high inflation. Specifically, this can be done by either raising taxes, cutting spending, or a combination of both. In this case, it should be used to counteract the inflationary effects of a stock market surge that increases consumer and business confidence.