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Principles of Economics 2e

2nd Edition
Steven A. Greenlaw; David Shapiro
ISBN: 9781947172364

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BuyFindarrow_forward

Principles of Economics 2e

2nd Edition
Steven A. Greenlaw; David Shapiro
ISBN: 9781947172364
Textbook Problem

Assume that the newly independent government of Tanzania employed you in 1964. Now free from British rule, the Tanzanian parliament has decided that it will spend 10 million shillings on schools, roads, and healthcare for the year. You estimate that the net taxes for the year are eight million shillings. The government will finance the difference by selling 10-year government bonds at 12% interest per year. Parliament must add the interest on outstanding bonds to government expenditure each year. Assume that Parliament places additional taxes to finance this increase in government expenditure so the gap between government spending is always two million. If the school, road, and healthcare budget are unchanged, compute the value of the accumulated debt in 10 years.

To determine

To calculate: The value of accumulated debt for 10 years.

Explanation

In the year 1, the government spends more on education and health sectors and it is given that proposed expenditure incurred on roads, schools is $10 million and estimated net taxes are $8 million. So, the budget deficit is calculated as done below:

  Budget deficit = $10 million$8 million=$2 million

Now, to calculate the interest to be paid per year is calculated below:

  Interest to be paid per year = rate of interest × principal amount on debt=12%×$2 million= $0.24 million

It should be kept in mind that the budget deficit was $2 million which implies the government has to pay back this amount in the future. So, the amount of debt accumulated in 10 years will be calculated as done below:

For simplicity, let the budget deficit is x and interest paid is y.

  The amount of debt accumulated in 10 years = (budget deficit +  1 10i×interest paid)=(x+10×

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