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Chapter 21. Question 16

Question 16
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Suppose an economy has a GDP of $40 billion and a national debt of $20 billion, and the average interest rate on this debt is currently 3%.

A. How much are the annual interest payments on the debt? $ million. What percentage of this economy’s GDP is spent on interest payments on its debt? (Round to the nearest tenth of a percent.) %
Correct! Interest payments are calculated by multiplying the interest rate by the dollar value of the debt. In this case, 3% times $20 billion = 0.03 x $20,000 million = $600 million.
To find the percentage this is of the GDP, divide the annual interest payment by the GDP. In this example, $600 million divided by $40 billion is 0.015, or 1.5%.
Incorrect! Interest payments are calculated by multiplying the interest rate by the dollar value of the debt. In this case, 3% times $20 billion = 0.03 x $20,000 million = $600 million.
To find the percentage this is of the GDP, divide the annual interest payment by the GDP. In this example, $600 million divided by $40 billion is 0.015, or 1.5%.

B. Suppose that next year one of two events occurs: (1) GDP and interest rates stay the same, but the economy adds $4 billion to its national debt; or (2) GDP and the national debt stay the same, but interest rates increase to 4%. Which of these two events would result in a larger portion of the economy’s GDP going toward interest payments on the national debt? Event #
Correct! Under event (1), interest payments would be $720 million (3% x $24 billion). This is equal to 1.8% of the economy’s GDP ($720 million divided by $40 billion). Under event (2), interest payments would be $800 million (4% x $20 billion). This is equal to 2% of its GDP ($800 million divided by $40 billion).
Thus, the interest rate increase described as event (2) causes a greater interest payment burden, both in terms of dollars and as a percentage of the GDP.
Incorrect! Under event (1), interest payments would be $720 million (3% x $24 billion). This is equal to 1.8% of the economy’s GDP ($720 million divided by $40 billion). Under event (2), interest payments would be $800 million (4% x $20 billion). This is equal to 2% of its GDP ($800 million divided by $40 billion).
Thus, the interest rate increase described as event (2) causes a greater interest payment burden, both in terms of dollars and as a percentage of the GDP.