Question
In: Economics
A recent report on GDP growth rates showed that the GDP of Dorada, a developed economy,...
A recent report on GDP growth rates showed that the GDP of Dorada, a developed economy, has declined by 1.5 percent this year. Emily George and her friend Tabitha Jude, both students of economics, are discussing the possible reasons for the decline in the growth rate. Emily feels that the government deficit has reached an unsustainable level, as a result of which interest rates now are extremely high. This has reduced government expenditure in recent times, leading to a decline in GDP. Tabitha however disagrees. According to her, the fall in GDP must imply a fall in consumer spending as household consumption accounts for the largest share in Dorada's GDP. Which of the following, if true, will strengthen Emily's claim that the high fiscal deficit is affecting the government's ability to spend?
A.
The government of Dorada scaled up its defense expenditure by more than 50 percent in the last two years.
B.
The President's economic advisory council is of the opinion that the fiscal deficit should not exceed 3 percent of the country's GDP.
C.
The central government's grants-in-aid to the local governments increased by 7 percent.
D.
A sizeable portion of the tax revenue generated in Dorada is being used to make interest payments on sovereign debt.
E.
Given that the government of Dorada has never defaulted on sovereign debt, it enjoys very high credit ratings.
Solutions
Expert Solution
Emily has stated that decline in GDP has happened because of reduction in government expenditures in recent times.
When government reduces its expenditure in drastic manner then this impllies that government is able to spend a small portion of its tax revenue for developmental purpose and large portion of its tax revenue is being spent on non-developmental expenditures like interest payments etc.
When government has high level of debt then significant portion of its tax revenue goes in servicing such debt and thus its ability to undertake expenditure for economic development gets greatly reduced.
Similar thing has happened in Dorada as well.
So,
The argument that will strengthen the Emily's claim is that a sizeable portion of the tax revenue generated in Dorada is being used to make interest payments on sovereign debt.
Hence, the correct answer is the option (D).
Rahul Sunny answered 2 years agoRelated Solutions
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