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Discussing Government Budget Deficit & Unions

1. What is a government budget deficit? How does a federal budget deficit affect the economy? How does it affect the level of investment and interest rates? How does it affect the individual consumer? Give at least three examples in your response.

2. Are unions good or bad for the economy? How do unions at GM and Ford affect employment levels and wages? How do unions affect other industries in terms of employment and wage levels?

Solution Preview

1. Whenever the government spends more than it takes in through taxation, it runs a deficit. In general, the economy does better when there is a deficit. Avoiding one generally means increasing taxes, which causes a decline in spending and therefore GDP. However, when deficits occur year after year, they accumulate into a debt that can cause problems.

In terms of investment, government debt may "crowd out" private investment. This occurs through higher interest rates. For example, if current interest rates are 5% and the government needs to sell bonds it will offer a higher rate in order to make them appealing. This may drive up interest rates to 5.5%. Private companies may not be able to afford to pay this interest on their debt, so would put off making capital improvements. Thus the government can reduce the level of investment by private firms in this way.

In addition, higher interest rates would attract foreign investment, and cause the domestic currency to increase in value relative to foreign currency. For example, if the exchange rate were $2 to one Euro dollar, and the demand ...