25. Sketch a diagram of how a budget deficit causes a trade deficit. (Hint: Begin with what will happen to the
exchange rate when foreigners demand more U.S. government debt.)
26. Sketch a diagram of how sustained budget deficits cause low economic growth.
27. Assume that the newly independent government of Tanzania employed you in 1964. Now free from British
rule, the Tanzanian parliament has decided that it will spend 10 million shillings on schools, roads, and
healthcare for the year. You estimate that the net taxes for the year are eight million shillings. The
government will finance the difference by selling 10-year government bonds at 12% interest per year.
Parliament must add the interest on outstanding bonds to government expenditure each year. Assume
that Parliament places additional taxes to finance this increase in government expenditure so the gap
between government spending is always two million. If the school, road, and healthcare budget are
unchanged, compute the value of the accumulated debt in 10 years.
28. Illustrate the concept of Ricardian equivalence using the demand and supply of financial capital graph.
29. During the most recent recession, some economists argued that the change in the interest rates that
comes about due to deficit spending implied in the demand and supply of financial capital graph would
not occur. A simple reason was that the government was stepping in to invest when private firms were not.
Using a graph, explain how the use by government in investment offsets the deficit demand.