Short on time? This page is the recap. For explanations, the debt chart and worked examples, use the full study guide.
Recap
- Budget surplus: tax revenue is greater than government purchases plus transfer payments in a year. Deficit: it is smaller. Balanced budget: they are equal.
- Interest on the debt is not part of G (it buys nothing), but it is government spending in the budget.
- A deficit is financed by borrowing: the government sells bonds.
- The national debt is the total the government owes: past deficits minus past surpluses.
- Any deficit adds to the debt. Only a surplus reduces it.
- Burden of the debt: interest must be paid every year; it uses funds that could go to other uses (opportunity cost); borrowed interest makes the debt grow faster; future taxpayers bear the cost; government borrowing may crowd out private investment (Topic 5.5).
Key relationships
| Relationship | Formula | Use it to |
|---|---|---|
| Budget balance | T − (G + transfers + interest) | find a surplus (+) or deficit (−) |
| Debt after a deficit | start debt + deficit | update the debt |
| Debt after a surplus | start debt − surplus | update the debt |
| Interest bill | debt × interest rate | find the yearly cost of the debt |
| Interest share of revenue | interest ÷ tax revenue × 100 | measure the burden on the budget |
| Debt when all interest is borrowed | start debt × (1 + interest rate) | see the debt grow by itself |
Assumptions behind the numbers
- Figures are for one government over one year (the budget) or at one date (the debt).
- Unless the question says otherwise, the deficit is financed entirely by borrowing, and a surplus is used to repay debt.
- If a question gives total “government spending” as one figure, it already includes everything on the spending side.
Mistakes to avoid
- Mixing up deficit and debt (flow v. stock).
- Saying a falling deficit lowers the debt. The debt still rises.
- Leaving out transfers or interest from the spending side.
- Wrong sign: revenue minus spending, so negative = deficit.
- Thinking a surplus wipes out the debt. It reduces it only by the size of the surplus.
- Treating borrowed interest as costless. It adds to the debt and to next year’s interest.
Quick self-check
VD is the valda, the currency of the fictional country Valdoria used in the study guide.
- T = 250, G = 200, transfers = 60, interest = 15 (VD billion). What is the balance? (Deficit of VD 25 billion)
- The debt is VD 400 billion and the government runs a deficit of VD 30 billion. What is the new debt? (VD 430 billion)
- The deficit falls from VD 50 billion to VD 20 billion. What happens to the debt? (It still rises, by VD 20 billion)
- Debt of VD 300 billion at 4% interest, all borrowed. Debt one year later? (VD 312 billion)
Next: practice questions.