These are original Marlbridge practice questions, not past exam questions. All questions use Valdoria, a fictional country whose currency is the valda (VD); all figures are fictional and in VD billion. The rubrics are a suggested Marlbridge rubric to help you check your work; they are not an official scoring guideline. Assumptions: deficits are financed entirely by borrowing; surpluses are used to repay debt; a four-function calculator is enough.
Question 1 (multiple choice · foundation)
In one year Valdoria’s government collects VD 640 billion in taxes. It spends VD 500 billion on goods and services, VD 150 billion on transfer payments and VD 30 billion in interest on its debt. What is its budget balance?
- (A) A surplus of VD 140 billion
- (B) A deficit of VD 10 billion
- (C) A deficit of VD 40 billion
- (D) A surplus of VD 40 billion
Answer and explanation
Answer: (C). Spending = 500 + 150 + 30 = 680. Balance = 640 − 680 = −40, a deficit of VD 40 billion.
- (A) counts only government purchases (640 − 500). Transfers and interest are also spending in the budget.
- (B) leaves out interest (640 − 650). Interest is not in G, but it is still budget spending.
- (D) has the right size but the wrong sign. Spending is greater than revenue, so it is a deficit.
Question 2 (multiple choice · core)
Valdoria’s budget deficit falls from VD 60 billion last year to VD 25 billion this year. Assuming the deficit is financed by borrowing, what happens to the national debt this year?
- (A) It falls by VD 35 billion.
- (B) It rises by VD 25 billion.
- (C) It rises by VD 35 billion.
- (D) It does not change, because the deficit fell.
Answer and explanation
Answer: (B). This year’s deficit of VD 25 billion must be borrowed, so the debt rises by VD 25 billion. A smaller deficit slows the growth of the debt; it does not reverse it.
- (A) treats the fall in the deficit as a repayment. Only a surplus reduces the debt.
- (C) uses the change in the deficit (60 − 25) instead of this year’s deficit.
- (D) confuses a falling deficit with a balanced budget.
Question 3 (multiple choice · core)
At the start of Year 1, Valdoria’s national debt is VD 900 billion. In Year 1 the government runs a surplus of VD 20 billion. In Year 2 it runs a deficit of VD 50 billion. What is the debt at the end of Year 2?
- (A) VD 830 billion
- (B) VD 870 billion
- (C) VD 970 billion
- (D) VD 930 billion
Answer and explanation
Answer: (D). End of Year 1: 900 − 20 = 880. End of Year 2: 880 + 50 = 930.
- (A) subtracts both the surplus and the deficit (900 − 20 − 50). A deficit adds to the debt.
- (B) reverses both signs (900 + 20 − 50). A surplus reduces the debt and a deficit increases it.
- (C) adds both (900 + 20 + 50). A surplus is used to repay debt, not to add to it.
Question 4 (multiple choice · core)
Which statement best explains why interest payments on a large national debt are a burden?
- (A) Interest payments use funds that the government could otherwise spend on public services or return to households as tax cuts.
- (B) Interest payments are part of government purchases, so they directly raise aggregate demand and cause inflation.
- (C) The government must repay the whole national debt every year, together with the interest.
- (D) Interest must be paid only in years when the budget is in deficit, which makes recessions longer.
Answer and explanation
Answer: (A). Interest is an opportunity cost: money spent on past borrowing cannot be used for schools, roads or lower taxes.
- (B) misclassifies interest. It buys no good or service, so it is not part of G.
- (C) is false. Debt is repaid as bonds mature, not all at once each year; interest is paid every year on the amount still owed.
- (D) is false. Interest is owed every year on the outstanding debt, whatever the budget balance.
Question 5 (calculation · core)
At the start of Year 1, Valdoria’s debt is VD 1,200 billion. The table shows its budget for three years.
| Year | Tax revenue | Government purchases | Transfer payments | Interest |
|---|---|---|---|---|
| 1 | 420 | 330 | 95 | 48 |
| 2 | 440 | 340 | 98 | 50 |
| 3 | 470 | 345 | 100 | 52 |
(a) Calculate the budget balance in each year. (b) Calculate the national debt at the end of each year. (c) Calculate interest as a percentage of tax revenue in Year 1. (d) A minister says: “We cut the deficit by about half between Year 1 and Year 3, so our debt is falling.” Evaluate this claim.
Worked solution and suggested Marlbridge rubric
(a) Year 1: 420 − (330 + 95 + 48) = 420 − 473 = −53 (deficit). Year 2: 440 − (340 + 98 + 50) = 440 − 488 = −48 (deficit). Year 3: 470 − (345 + 100 + 52) = 470 − 497 = −27 (deficit).
(b) Year 1: 1,200 + 53 = 1,253. Year 2: 1,253 + 48 = 1,301. Year 3: 1,301 + 27 = 1,328.
(c) 48 ÷ 420 × 100 = 11.43%.
(d) The first part is roughly right: the deficit fell from VD 53 billion to VD 27 billion. The conclusion is wrong. Every year was still a deficit, so the government borrowed every year and the debt rose from VD 1,200 billion to VD 1,328 billion. The debt would fall only with a surplus.
| Point | What earns it |
|---|---|
| 1 | All three balances correct, including interest and transfers |
| 1 | Debt correct at the end of each year |
| 1 | Interest share of 11.43% |
| 1 | Recognises the deficit fell but every year is still a deficit |
| 1 | Concludes that the debt rose, because only a surplus reduces it |
Accept values carried forward from an error in (a).
Question 6 (constructed response · core)
Valdoria’s national debt is VD 800 billion. The average interest rate on the debt is 4%.
(a) Calculate the yearly interest bill. (b) The interest rate on the debt rises to 6%. Calculate the new interest bill and the increase. (c) Suppose the government’s budget is balanced except for interest, and it borrows to pay all of its interest at 6%. Calculate the debt after one year and after two years, and the interest paid in the second year. (d) Explain why the government’s interest payments are larger in the second year than in the first, even though its other spending did not change. (e) Identify one way, other than borrowing, that the government could pay the extra interest, and state one cost of that choice.
Model answer and suggested Marlbridge rubric
(a) 800 × 0.04 = VD 32 billion.
(b) 800 × 0.06 = VD 48 billion, an increase of VD 16 billion.
(c) After one year: 800 + 48 = VD 848 billion. Interest in year 2: 848 × 0.06 = VD 50.88 billion. After two years: 848 + 50.88 = VD 898.88 billion.
(d) The borrowed interest from year 1 was added to the debt. In year 2 the government pays interest on a larger debt, including interest on the interest it borrowed. So the debt grows faster each year.
(e) Any one, with a matching cost:
- Raise taxes: households have less disposable income, so consumption falls.
- Cut government purchases or transfers: fewer public services or lower support for people who rely on transfers. The money spent on interest has an opportunity cost.
| Point | What earns it |
|---|---|
| 1 | VD 32 billion, then VD 48 billion and an increase of VD 16 billion |
| 1 | VD 848 billion and VD 898.88 billion |
| 1 | Second-year interest of VD 50.88 billion |
| 1 | Explains that borrowed interest raises the debt, so interest is paid on a larger debt |
| 1 | A valid alternative with a matching cost |
Question 7 (constructed response · stretch)
In one year Valdoria’s government collects VD 500 billion in taxes. It spends VD 380 billion on goods and services and VD 90 billion on transfer payments. Its debt at the start of the year is VD 1,000 billion, and the interest rate on the debt is 4.5%.
(a) Calculate the budget balance before interest is counted, and the overall budget balance after interest. (b) Calculate the debt at the end of the year. (c) Explain how a government whose tax revenue is greater than its purchases plus transfers can still add to its debt. (d) If the interest rate on the debt had been 3% instead, what would the overall balance have been, and what would have happened to the debt? (e) Government borrowing to finance deficits can have a long-run cost beyond interest. Identify it and explain it briefly.
Model answer and suggested Marlbridge rubric
(a) Before interest: 500 − (380 + 90) = +30 (a surplus of VD 30 billion). Interest = 1,000 × 0.045 = 45. Overall: 30 − 45 = −15, a deficit of VD 15 billion.
(b) 1,000 + 15 = VD 1,015 billion.
(c) Interest on past debt is also spending. Here it is larger than the surplus on the rest of the budget, so total spending is greater than tax revenue. The gap must be borrowed, which adds to the debt. The burden of past borrowing keeps the debt rising.
(d) Interest = 1,000 × 0.03 = 30. Overall balance = 30 − 30 = 0, a balanced budget, so the debt stays at VD 1,000 billion.
(e) Crowding out. Government borrowing raises the demand for loanable funds, which can push up the real interest rate. Higher real interest rates reduce private investment, so less physical capital is built and long-run growth may be slower. (Topic 5.5 covers this.)
| Point | What earns it |
|---|---|
| 1 | +30 before interest and −15 overall |
| 1 | End-of-year debt of VD 1,015 billion |
| 1 | Explains that interest is spending large enough to turn the surplus into a deficit, which must be borrowed |
| 1 | Balanced budget at 3% and the debt unchanged |
| 1 | Crowding out explained through borrowing, a higher real interest rate and lower private investment |
In (e), “higher future taxes” with a clear explanation is also acceptable.
How did you do?
- Q1 or Q5(a) wrong: re-read “The government budget” in the study guide and check you counted transfers and interest.
- Q2, Q3, Q5(b) or Q5(d) wrong: revisit “Deficit and debt: flow and stock” and Worked example 1.
- Q4, Q6 or Q5(c) wrong: revisit “The burden of the national debt” and Worked example 2.
- Q7 wrong: work through Worked example 1’s note on interest, then preview crowding out in “The burden of the national debt”.
Then tick off the topic checklist.