In one financial year, the government of Kestria collected $46 billion in tax revenue. Its total government spending for the same year was $52 billion. (a) Define what is meant by a government budget deficit. [2] (b) Using the figures above, calculate the size of Kestria's budge…

Answer: ((a)) A government budget deficit occurs when, over a given period such as a year, government spending is greater than the tax revenue (and other income) the government collects, so the shortfall has to be financed by borrowing. ((b)) Kestria's budget deficit = $52 billion - $46 billion = $6 billion. ((c)) To finance the $6 billion shortfall, Kestria's government is likely to borrow, and the extra spending this allows adds to total demand in the economy without necessarily adding to what the economy can produce. If the economy is already close to full capacity, this extra demand c…. Part (a): Defining a government budget deficit A government budget is the relationship between what a government plans to spend and the tax revenue it plans to collect over a period, usually a year. A budget deficit exists when government…

IGCSE Economics 0455: Calculating a Government Budget Deficit

Part (a): Defining a government budget deficit

A government budget is the relationship between what a government plans to spend and the tax revenue it plans to collect over a period, usually a year. A budget deficit exists when government spending is greater than the tax revenue collected in that period, meaning the government must borrow money to cover the difference.

Part (b): Calculating the size of the deficit

Subtract tax revenue from total government spending:

$52 - 46 = 6$

So Kestria’s budget deficit for the year is $6 billion.

Part (c): Linking the deficit to the aim of stable prices

A budget deficit of $6 billion means Kestria’s government is spending more than it is taking back out of the economy in tax. To cover the gap, it is likely to borrow, and the money it borrows and then spends flows straight into the economy as extra government demand for goods and services.

If Kestria’s economy is already operating close to its full capacity, firms cannot easily produce much more output to meet this additional demand. With more total spending chasing a similar quantity of output, prices are pulled upward, a demand-pull effect. This makes it harder for the government to hold inflation down and achieve its aim of stable prices, even though the deficit may have been created partly to support other aims, such as economic growth.

Final answers

(a) A budget deficit is when government spending exceeds tax revenue over a period, with the gap financed by borrowing.
(b) Deficit $= 52 - 46 = \boxed{6}$ , i.e. $6 billion.
(c) Borrowing to finance the deficit adds to total demand; if the economy is near full capacity, this pushes prices up, conflicting with the aim of stable prices.