Pearson Edexcel International Advanced Level Economics: Fiscal deficits and debt (YEC11) – Practice Questions

These are original questions written for Marlbridge, for revision and practice on this content. They are not reproduced past-paper questions, and they do not replicate the exam’s exact structure, question count or mark tariffs – examination boards hold copyright in their own papers. Use these alongside the official past papers from your board or school.

These questions cover section 4.3.5, item 3 (a to c), fiscal deficits and national debt, in the Pearson Edexcel International Advanced Subsidiary/Advanced Level in Economics (YEC11) specification, Issue 2, June 2018. The content is in Unit 4, International A2 content for the full International Advanced Level only. All countries and figures are invented. Learn the content first in the study guide or the revision notes. See also the course hub, the checklist and the diagnostics.

Questions

1. Country P has revenue of 380, total spending of 412 and GDP of 1,600. Its debt at the start of the year is 700. Next year GDP is 1,650.

(a) Calculate the fiscal balance and express it as a percentage of GDP. [2] (b) Calculate the debt at the end of the year and compare the debt ratio with the starting ratio, to 1 decimal place. [2]

2. Explain why a government running a fiscal surplus can still have a large national debt. [3]

3. Classify each as an automatic stabiliser or discretionary fiscal policy, and state the difference between the two types. [4]

• (i) Unemployment benefit payments rise as firms lay off workers.
• (ii) Parliament votes for a one-year cut in the sales tax rate.
• (iii) Income tax receipts fall as household incomes fall.

4. Country R has potential output of 1,200 and actual output of 1,140. Its fiscal deficit is 54. Each unit of output gap changes the balance by 0.30 through automatic stabilisers.

(a) Work out how far output is below potential, as a percentage of potential output. [2] (b) Calculate the cyclical and structural deficits. [2] (c) Calculate the structural deficit as a percentage of potential output. [1] (d) State what happens to the deficit if output returns to potential with no policy change. [1]

5. Country T owes 900 at an average interest rate of 4%. Its revenue is 300.

(a) Calculate interest payments and their share of revenue. [2] (b) One-third of the debt is refinanced at 7%. Calculate the new interest bill and the rise. [2] (c) Explain one opportunity cost of higher debt servicing. [1]

6. Country U has a debt ratio of 75%, an average interest rate of 5% and nominal GDP growth of 3%. Use the formula d(r - g)/(1 + g).

(a) Calculate the primary surplus, as a percentage of GDP, that keeps the debt ratio stable. [3] (b) Nominal growth rises to 6%. Calculate the new figure and interpret the sign. [2]

7. Explain how a rise in government borrowing could lead to higher interest rates. [4]

8. Explain two factors that could increase the size of a country’s fiscal deficit. [6]

9. Country V borrows 400 at 3% to build a water-treatment network. It brings benefits worth 17 a year to users.

(a) Calculate the annual interest and the annual net benefit to users. [2] (b) Explain why borrowing for current spending raises a concern about intergenerational equity. [3] (c) Explain why borrowing in a deep recession may still be defended on grounds of fairness between generations. [3]

10. Country S is illustrative. Figures are in billions, with debt of 800 at the start of Year 1.

	Year 1	Year 2	Year 3
Revenue	540	560	520
Spending excluding interest	520	560	585
Interest payments	30	34	37
GDP	2,000	2,040	1,980

(a) Find each year’s fiscal deficit relative to GDP, giving percentages to 1 decimal place. [3] (b) Calculate the debt ratio at the end of Year 3. [2] (c) Analyse why the deficit rose sharply in Year 3. [4]

11. Evaluate the view that a national debt of 95% of GDP always requires the government to cut its deficit quickly. [12]

Answers

1. (a) Balance = 380 - 412 = -32 [1]. 32 / 1,600 = 2.0% deficit [1]. [2] (b) Debt = 700 + 32 = 732 [1]. Ratio rises from 700 / 1,600 = 43.8% to 732 / 1,650 = 44.4% [1]. [2] Examiner insight: Show the sign or the word deficit, and divide each debt by the GDP of its own year when comparing ratios.

2. The debt is a stock built up from past deficits [1]. A surplus reduces it only by the size of the surplus [1], so a small surplus against a large accumulated debt leaves most of the debt in place [1]. [3] Examiner insight: Name debt as a stock and the balance as a flow; the contrast is what the question tests.

3. (i) Automatic [1]. (ii) Discretionary [1]. (iii) Automatic [1]. Automatic stabilisers change the balance through existing rules with no new decision, while discretionary policy is a deliberate government choice [1]. [4] Examiner insight: A one-year tax cut is a decision, so it is discretionary even though it also changes the balance; the test is whether anyone had to decide.

4. (a) Gap = 1,200 - 1,140 = 60 [1]. 60 / 1,200 = 5.0% below potential [1]. [2] (b) Cyclical = 0.30 x 60 = 18 [1]. Structural = 54 - 18 = 36 [1]. [2] (c) 36 / 1,200 = 3.0% of potential output [1]. [1] (d) The deficit falls from 54 to 36, not to zero [1]. [1] Examiner insight: Divide the gap by potential output, not actual output, and say the structural part remains after recovery.

5. (a) Interest = 0.04 x 900 = 36 [1]. 36 / 300 = 12% of revenue [1]. [2] (b) New bill = 0.07 x 300 + 0.04 x 600 = 21 + 24 = 45 [1]. Rise = 45 - 36 = 9 [1]. [2] (c) The 9 extra cannot be spent on health or education, or must be financed by higher taxes or more borrowing [1]. [1] Examiner insight: Apply the new rate only to the refinanced part; applying 7% to the whole debt overstates the bill.

6. (a) Formula d(r - g)/(1 + g) [1] = 0.75 x 0.02 / 1.03 [1] = 1.46% of GDP primary surplus [1]. [3] (b) 0.75 x (0.05 - 0.06) / 1.06 = -0.71% [1]. The negative sign means a primary deficit of 0.71% of GDP is consistent with a stable ratio, because growth now exceeds the interest rate [1]. [2] Examiner insight: Interpret the sign; a bare negative number does not say that a primary deficit can be sustained.

7. The government sells bonds to cover the deficit, raising the demand for loanable funds [1]. If the supply of savings is limited, the price of borrowing, the interest rate, rises [1]. Lenders may also demand a risk premium if repayment looks doubtful [1]. Higher rates reduce private investment, so crowding out occurs [1]. [4] Examiner insight: Each link in the chain is separate credit; stopping at “borrowing raises interest rates” leaves out the mechanism.

8. Factor one, for example a recession: identified [1]; revenue falls as incomes and spending fall [1], and benefit spending rises through the stabilisers [1]. Factor two, for example an ageing population: identified [1]; more people draw pensions and use health care while fewer workers pay income tax [1], so spending rises faster than revenue [1]. Accept other valid factors such as higher interest rates or a financial rescue. [6] Examiner insight: Give two different factors and develop each; two versions of the same cause earn little extra.

9. (a) Interest = 0.03 x 400 = 12 a year [1]. Net benefit = 17 - 12 = 5 a year [1]. [2] (b) Future taxpayers must pay the interest and repay the debt [1]. Spending that is consumed now leaves no lasting asset [1], so later generations pay for benefits they never receive [1]. [3] (c) Without borrowing, the government might cut spending or raise taxes in a deep recession, deepening unemployment [1]. Lost output and skills would also harm the same and later generations [1]. Borrowing spreads the cost of an unusual shock and may protect future incomes, so it can be fair [1]. [3] Examiner insight: Part (b) needs the missing asset; “future generations pay” alone does not explain why it is unfair.

10. (a) Spending = 550, 594, 622 [1]. Deficits = 10, 34, 102 [1]. Percentages = 0.5%, 1.7%, 5.2% [1]. [3] (b) Debt = 800 + 10 + 34 + 102 = 946 [1]. 946 / 1,980 = 47.8% [1]. [2] (c) The primary balance swung from +20 to 0 to -65, so higher interest is not the main cause, since interest rose only from 30 to 37 [1]. Revenue fell from 560 to 520 as GDP fell 2.9% [1]. Spending excluding interest rose from 560 to 585, consistent with benefits rising [1]. Much of this is likely cyclical, but potential output is not given, so the structural share cannot be judged [1]. [4] Examiner insight: Use the primary balance to separate interest from other causes, and say what extra information would settle the cyclical-structural split.

11. Debt of 95% of GDP means the stock is almost one year’s output [1]. A large debt means large interest payments, which take revenue from other uses and risk a higher risk premium [1], so lenders may raise yields and crowd out investment [1]. Future taxpayers bear repayment, raising an equity concern [1]. However, the debt ratio depends on r and g: with r = 5% and g = 2%, the primary surplus needed to stabilise it is 0.95 x 0.03 / 1.02 = 2.79% of GDP [1], but if r is below g the ratio can stay stable or fall without cuts [1]. Holders and currency matter: domestic debt in the home currency keeps interest in the economy and cannot force default through the exchange rate [1]. If the deficit is cyclical, rapid cuts in a slump reduce AD and revenue, so the ratio may not improve [1], whereas a structural deficit does need action [1]. The purpose matters: borrowing for investment may raise future output and revenue [1]. Judgement: not always; the urgency depends on the gap between r and g, the share that is structural and who holds the debt [1]; cuts are most justified when the deficit is mainly structural and lenders’ yields are rising [1]. [12] Examiner insight: Use the 95% figure and a calculated condition in the evaluation, and end with a judgement that names what it depends on.

Where marks are usually lost

• Treating the deficit and the national debt as one measure.
• Leaving a deficit in cash terms with no percentage of GDP.
• Dividing an output gap by actual rather than potential output.
• Calling automatic stabilisers a policy decision.
• Applying a new interest rate to all debt rather than the refinanced part.
• Stating crowding out without the link through interest rates.
• Writing “future generations pay” without saying what they receive.
• Giving an evaluation with no figures from the question and no conditional judgement.

Next steps

• Review the revision notes and the study guide.
• Check progress against the Edexcel IAL Economics checklist and the course hub.
• Try all the free 10-minute diagnostics.
• Book a free trial class.

Official syllabus

Pearson Edexcel International Advanced Subsidiary/Advanced Level in Economics (YEC11), Specification, Issue 2, June 2018, first teaching September 2018, published by Pearson Education Limited. Section 4.3.5, item 3 (a to c).