2019 - 2020
1. a) “The prime objective of private finance is wealth maximization
whereas for public finance it is welfare maximization.” do you think
so? Justify your answer.
Yes, the statement is generally true and reflects a key difference between private finance and public
finance. Let’s break it down in a way that everyone can understand.
Private Finance: Focus on Wealth Maximization
Private finance deals with the financial decisions of individuals, households, and businesses. The
main goal here is to maximize profit or wealth. For example:
• A company wants to earn as much profit as possible.
• A person invests money to get the highest possible return.
So, the focus is on personal or business gain.
Public Finance: Focus on Welfare Maximization
Public finance is about how the government collects and spends money. Its main goal is to improve
the well-being of society, not to make a profit. For example:
• The government builds hospitals or schools to help people.
• Taxes are collected to provide public services like roads, police, or clean water.
The aim is to make life better for everyone, especially the poor and vulnerable.
Simple Example:
Imagine a company and a government both have $1 million:
• The company might invest in a business project to earn more money.
• The government might use it to build a health clinic in a poor village.
The company wants profit; the government wants public good.
Conclusion:
So yes, the statement is true.
Private finance = Wealth for self or business.
Public finance = Welfare for society.
b) What is pareto efficient allocation? Explain it with hypothetical
graph.
Definition of Pareto Efficient Allocation
Pareto efficient allocation is an allocation of resources such tat no person can be made better off
without making another person worse off.
Hypothetical Graph
Figure 3.3 – Making Adam better off without Eve
becoming worse off
Moving from point g to pint h to point p leaves Eve’s utility
unchanged but improves Adam’s utility. At point p, it is
impossible to make one of them better off without hurting the
other. Therefore, point p represents a Pareto efficient allocation.
Figure 3.4 – Making Eve better off without Adam
becoming worse off
Moving from point g to point p1 leaves Adam’s utility unchanged
but improves Eve’s utility. At point p1 it is impossible to make
one of them better off without hurting the other. Therefore, point
p1 is a pareto efficient allocation.
Figure 3.5 – Making both Adam and Eve better off
Moving from point g to point p2 makes both Adam and Eve better
off. At point p2 it is impossible to make one of them better off
without hurting the other. Therefore, point p2 is a Pareto efficient
allocation.
c) Discuss the second fundamental theorem of welfare economics
The second fundamental theorem of welfare economics stales that any efficient allocation of
resources can be achieved through a competitive market, as long as the government properly
redistributes wealth first.
The past theorem tells us that free market allocates resources efficiently but do not generate
fairness. On the other hand, the second theorem says that fairness and efficiency can go ahead in
hand, if we are government fast, we distribute wealth properly.
Condition for second theorem to work:
1. Market must be competitive.
2. no market failures
3. proper wealth redistribution by government
4. people must respond rationally
If this condition hold market can move freely and the efficient distribution of resources will
become certain.
Understanding with an example:
Imagine a village with 10 people and there is a limited amount of food. The market works
efficiently to distribute food to those who can afford it however if some villagers are too poor, they
make it very little or no food.
• The first theorem says: the market will distribute food efficiently, but it does not care if
some people starve.
• The second theorem says: if the government redistribute money (e.g. Through text on the
reach and direct aid to the poor) then the market can still work efficiently while ensuring a
fairer outcome.
This means the government can intervene the wealth distribution (before the market operates) but
they do not need to interfere with actual market prices.
2. a) What are the main characteristics should have a good to be
pure public goods? Describe few common aspects of the
definition of public good.
Pure public goods is a commodity that is non-rival and non-excludable in consumption.
Characteristics of pure public goods
1. Non-rivalry: One person consumption of the goods does not reduce its availability for
others. For example, enjoying a lighthouse signal does not prevent others from using it.
2. Non-excludability: no one can be Effectively excluded from using the good even if they
do not pay for it. For example, national defense Protects on citizens regardless of whether
they contribute to its funding.
Few common aspects of the definition of public good
I. Even through everyone consumes the same quantity of the good, it need not be valued
equally by all.
II. Classifications as a public good is not an absolute. It depends on market conditions and
the state of technology.
III. A commodity can satisfy one part of the definition of a public good and not the other
IV. Something that are not conventionally thought of as commodities have public good
characteristics
V. Private goods are not necessarily provided exclusively by the private sector.
VI. Public provision of a good does not necessarily mean that it is also produced by the
public sector.
Different values, same amount: Everyone gets the same amount of a public good (like national
defense or clean air), but people may value it differently. For example, someone living near a
military base might feel more protected than someone far away.
Not always a clear category: Whether something is a public good can change over time. New
technology or changes in markets can turn something from a private good into a public one, or
vice versa.
Partial fit: A product can meet only part of the public good definition. For instance, it might be
non-rival (one person's use doesn't reduce others' use) but still be excludable (some people can
be kept from using it).
Not just physical products: Things like knowledge, street art, or social norms can also act like
public goods because many people benefit and no one is easily excluded.
Private goods, public help: Even goods we think of as “private” (like food or housing) are
sometimes provided or supported by the government or non-profits to help people in need.
Public service, private production: Just because the government provides something doesn't
mean they make it themselves. For example, public schools may buy textbooks from private
companies.
b) Prove whether the following goods and services are public or
not. Explain responses for each:
1. Access to clean drinking water.
2. The healthcare facilities in Bangladesh
3. The Padma Bridge.
4. Signal light on road.
5. The railway transportation in Bangladesh
1. Access to clean drinking water
Not a pure public good.
• Why? Water can be limited (rival) and people can be charged for it (excludable).
• Simple view: If too many people use water, it can run out. Also, it’s often sold, so not
everyone gets it for free.
2. Healthcare facilities in Bangladesh
Not a pure public good.
• Why? Healthcare services are rival (limited doctors, beds) and usually not free
(excludable).
• Simple view: If one person uses a hospital bed, another can’t use it at the same time. And
treatment usually costs money.
3. The Padma Bridge
Not a pure public good.
• Why? It can be crowded (rival during traffic), and there’s a toll to cross (excludable).
• Simple view: Everyone can’t use it freely all the time, and there’s a fee to use it.
4. Signal light on road
Yes, a public good.
• Why? One person using it doesn’t reduce others' use (non-rival), and people can’t be kept
from seeing it (non-excludable).
• Simple view: Everyone benefits from traffic signals, and you can't stop someone from
seeing them.
5. Railway transportation in Bangladesh
Not a pure public good.
• Why? Seats are limited (rival), and tickets are required (excludable).
• Simple view: You need to buy a ticket, and if all seats are taken, others can’t ride.
c) Explain the efficient provision of public goods with hypothetical
graph
Efficient provision of public goods means providing the right amount of a public good so that
society benefits the most without wasting resources.
Here’s a simple explanation:
• For private goods, efficiency happens when each person pays for what they use.
• For public goods, it’s different because they are non-rival (everyone can enjoy them
without reducing others’ benefit) and non-excludable (people can’t easily be stopped
from using them).
Key idea for efficiency:
A public good is provided efficiently when the sum of everyone's willingness to pay equals the
cost of providing one more unit.
This is called the Samuelson condition, which says:
Total marginal benefit = Marginal cost
Example:
Imagine a streetlight in a neighborhood:
• Person A is willing to pay $3 for one more light.
• Person B is willing to pay $2.
• Person C is willing to pay $5.
Total benefit = $3 + $2 + $5 = $10
If the cost of one streetlight is $10, then it's efficient to install it. If the cost were $12, it wouldn’t
be worth it.
Why it’s tricky:
• People might hide their true value to avoid paying (free-rider problem).
• That makes it hard for markets to supply public goods efficiently on their own.
• That’s why governments often step in to provide them.
3. a) Define Externality. Discuss the following characteristics of it
with example.
a. Externalities are reciprocal in nature.
b. externalities can be positive
Definition of Externalities
Externalities is a cost or benefits that occurs when the activity of one entity directly affects the
welfare of another in a way that is outside the market mechanism.
Characteristics of Externalities
1. Reciprocal in Nature – Externalities affect both parties; one’s actions can benefit or harm
others, creating interdependent effects. Externalities affect both sides — the person causing
it and the person affected.
• Example: If a factory pollutes a river, it harms nearby fishermen. But stopping the factory
might hurt workers or reduce goods for consumers. So, both sides are connected — it's not
just one causing harm, the solution affects both.
2. Can Be Positive – Some externalities create benefits, like education improving workforce
skills or vaccination reducing disease spread. Externalities aren’t always bad — sometimes
they benefit others.
• Example: A person plants flowers in their yard. Neighbors also enjoy the beauty and bees
pollinate their gardens. The person didn’t plant the flowers for the neighbors, but they still
benefit.
b) “An efficient solution to an externality problem is achieved as
long as someone is assigned property rights.” do you support it?
Why or why not?
Statement:
“An efficient solution to an externality problem is achieved
as long as someone is assigned property rights.”
Do I support it?
Partly yes, but with important conditions.
Why?
Yes, in theory:
• If people can bargain without cost and property rights
are clear, they can negotiate and solve the problem fairly.
• Example: If a factory pollutes a farmer’s land, and the
farmer has the right to clean air, the factory might pay the
farmer or reduce pollution.
But in real life, it’s not so easy:
• High bargaining costs: It’s hard to gather all people
affected (e.g., air pollution in a big city).
• Unequal power: One side might be much stronger or
richer.
• Hard to define rights: Who “owns” clean air or quiet?
Simple answer:
Assigning property rights helps, but it only works well if people can bargain fairly, cheaply, and
clearly. In many real-life cases, government rules or taxes may work better.
c) Explain graphically the public responses to the government
intervention to attain an efficient solution of externality problem
by levying Texas and subsidies.
1. Taxes (for negative externalities)
• Purpose: To reduce harmful activities like pollution or smoking.
• Public response:
o Support: People who care about the environment or public health often support it.
o Opposition: Businesses or consumers may complain about higher costs (e.g., gas
or plastic taxes). Some may feel it’s unfair or
hurts the poor more.
Analysis of a Pigouvian Tax
The Pigouvian tax shifts up Bart’s private marginal cost curve
by an amount equal to the marginal external damage at the
efficient output, cd, Bart now maximizes profit at the efficient
output Q*.
2. Subsidies (for positive externalities)
• Purpose: To encourage good actions like education, vaccinations, or clean energy.
• Public response:
o Support: People usually welcome subsidies if they benefit directly (like cheaper
solar panels or free vaccines).
o Skepticism: Some may worry about government waste or unfair advantages to
certain groups or companies.
Analysis of a Pigouvian subsidy
A Pigouvian subsidy for each unit Bart does not produce shifts
up his private marginal cost curve by the amount of the per-unit
subsidy, cd, and induces him to produce at the efficient level of
output.
Simple summary:
People usually support policies they benefit from or agree with, and resist those that raise their
costs or seem unfair. Clear communication and fairness help improve public acceptance.
4. a) What are the basic principles should follow in case of public
expenditure decisions?
Principles of Public Expenditure
1. Principle of Maximum Social Benefit: This is the most important principle. The main aim of
public expenditure is to bring the greatest possible benefit to society. The government should spend
money in a way that improves the well-being of the majority of people. Every rupee spent should
create more social good than its cost. For example, spending on education or healthcare benefits
many people and builds a stronger society.
2. Canon of Economy: This principle means avoiding waste. The government should use public
money wisely, spend only what is necessary, and try to get the best results at the lowest cost. For
example, if a road project can be completed for less without reducing quality, the government
should choose that option. Overspending or mismanagement of funds should be avoided.
3. Canon of Sanction: No public money should be spent without proper approval. This ensures
transparency and accountability. Every spending decision must go through legal and official
processes, such as being passed by parliament or the proper authority. This prevents misuse,
corruption, and ensures that funds are used for approved and justified purposes.
4. Canon of Elasticity: Public expenditure should be flexible to meet changing needs. In times of
crisis (like war, natural disasters, or economic recession), the government should be able to
increase its spending. During stable times, it can reduce spending. This adaptability ensures that
public expenditure can respond to both urgent and long-term needs.
5. No Adverse Influence on Production or Distribution: Government spending should support,
not harm, the economy. It should encourage production (business, farming, industry) and ensure
fair distribution of income and wealth. For example, public expenditure should not discourage
people from working hard or investing in business. It should not widen the gap between the rich
and poor but should reduce inequality.
6. Principle of Surplus: In normal times, the government should aim to collect more money than
it spends. This creates a budget surplus. The extra funds can be saved and used during emergencies,
like an economic crisis or natural disaster. This principle promotes financial discipline and reduces
the risk of heavy borrowing or debt in the future.
7. Promotion of Economic Growth and Stability: Government spending should contribute to the
long-term development and stability of the economy. Investment in infrastructure (like roads,
power, and transport), education, health, and technology helps create jobs, boosts productivity, and
supports overall economic growth. At the same time, careful spending can prevent sudden ups and
downs (inflation or recession) in the economy.
b) Discuss the possible effects of public expenditure on production
and distribution.
1. Effects on Production
Public expenditure plays a major role in increasing the productive capacity of an economy. Here’s
how:
a) Power to Work and Save
When the government invests in health care, education, housing, and transportation, people
become stronger, healthier, and more skilled. This increases their ability to work hard and earn
more, which helps them save for the future.
b) Will to Work and Save
Government support (like job security, pensions, or unemployment benefits) gives people
confidence about the future. When people feel secure, they’re more willing to work and plan
ahead, which encourages savings and long-term investments.
c) Diversion of Resources Between Jobs and Areas
The government can guide where resources (like money, labor, and materials) should go. For
example, it might spend more in rural areas or poor regions to bring balanced development. It
can also promote specific industries (like green energy or farming) by funding them.
d) Total Volume of Employment and Income
When the government builds roads, schools, or hospitals, it creates many jobs directly
(construction workers, teachers, nurses). These workers earn money and spend it, which supports
other businesses. This increases total employment and income across the country.
2. Effects on Distribution
Public expenditure helps make income distribution fairer. Rich people naturally earn more, but
government spending on public goods (like free schooling or health care) helps poor and middle-
income groups improve their lives. Also, direct support like pensions, food programs, or
scholarships reduces the gap between rich and poor.
c) Graphically explain the multiplier effect of increase in
government expenditure on national income and employment.
Multiplier effect of increase in
government expenditure on national
Income
1. What You See in the Graph
• The X-axis shows National Income.
• The Y-axis shows Aggregate Demand /
Expenditure.
• The 45° line (from point O) represents
Aggregate Supply (AS)
where income equals expenditure.
2. Initial Situation (Before Government Spending)
• The line C + I is the initial aggregate demand made up of:
▪ C = Consumption
▪ I = Investment
• This line intersects the AS line at point E, where national income is Y₁.
3. Government Increases Spending
• The government adds spending (G), so the new demand line becomes C + I + G.
• This new line is above the previous one and meets the AS line at point F.
• This shifts the economy to a new income level Y₂, which is higher than Y₁.
4. Multiplier Effect in the Graph
• The vertical gap (GH) shows the initial increase in government spending (G).
• But the increase in national income is from Y₁ to Y₂, which is a much bigger change.
• This larger change happens because of the multiplier effect:
• Government spends money → people receive it as income → they spend part of it others
earn and spend more → and so on.
• This cycle increases total national income much more than the original government
spending.
5. Easy Example
Imagine the government spends $100 million to build roads:
• Workers earn money and spend it.
• Shopkeepers and suppliers earn from that spending and spend more.
• This keeps repeating.
• Eventually, the total income generated is much more than $100 million.
6. Conclusion (What This Graph Tells Us)
• Government spending (GH) leads to a bigger rise in national income (Y₁ to Y₂).
• That is the multiplier effect — a small push creates a big impact on the economy.
5. a) Distinguish among impact, incidence and effect of tax.
Here is a simple table distinguishing impact, incidence, and effect of tax:
Term Meaning Who It Applies To Example
The initial burden of the tax The person or business A shopkeeper pays VAT
Impact of
— the person who pays the legally responsible for to the government when
Tax
tax to the government. paying the tax. selling goods.
The final burden of the tax The person who The customer who buys
Incidence — the person who actually ultimately pays the tax the product and pays a
of Tax bears the cost. out of their own higher price due to VAT.
pocket.
The overall economic Affects the whole VAT may reduce demand
Effect of
impact of the tax on prices, economy or market for goods, affecting sales
Tax
consumption, savings, etc. behavior. and production.
b) 'Direct tax imposes lesser burden compared to the indirect tax'-
Do you support it? If so, explain with a pictorial representation.
DIRECT TAX IMPOSES LESSER BURDEN COMPARE TO THE INDIRECT TAX
Direct tax is considered to impose a lesser burden
compared to indirect tax because of how they are
applied. Direct taxes, like income tax, are paid
directly by individuals or businesses based on their
earnings or property. This means the burden is
directly tied to an individual's ability to pay, so those
who earn more pay more, and it’s easier to
understand how much you owe.
On the other hand, indirect taxes, like sales tax, are
added to the prices of goods and services. These taxes
are paid by consumers when they buy things,
regardless of their income. This means even people
with lower incomes have to pay the same tax on
everyday purchases, making the burden heavier for them compared to higher earners. Essentially,
indirect taxes affect everyone the same way, while direct taxes are more flexible and based on what
someone can afford.
c) "A Part of tax is borne by seller and a part by buyer. But the
amount of tax depends on the ratio of elasticity of demand and
supply of a certain product"- Explain graphically.
Incidence of Commodity Tax
The incidence of commodity tax refers to who
ultimately bears the burden of a tax that is imposed on
a specific good or service.
• Impact on Consumers: If the seller raises the
price of the good or service to cover the tax, the
consumer may bear most or all of the burden.
• Impact on Producers: If the seller decides not
to raise the price, the producer may absorb part
of the tax, affecting their profits.
In simple terms, the incidence of commodity tax is about
who pays the tax—whether it’s passed on to the
consumer in the form of higher prices or absorbed by the
producer through lower profits.
Elasticity of Demand:
It refers to how much the quantity demanded of a good or
service changes when its price changes.
• If demand is elastic: A small change in price leads
to a large change in the quantity demanded. For
example, luxury items like smartphones may have
elastic demand.
• If demand is inelastic: A change in price leads to
little or no change in the quantity demanded.
Necessities like medicine tend to have inelastic
demand.
Elasticity of Supply:
It refers to how much the quantity supplied of a good or
service changes when its price changes.
• If supply is elastic: A small change in price leads
to a large change in the quantity supplied. For
example, products that are easy to produce may
have elastic supply.
• If supply is inelastic: A change in price leads to
little or no change in the quantity supplied. For
example, goods with limited production capacity
or long production times may have inelastic
supply.
In simple terms:
• Elasticity of Demand: Measures how much demand changes when prices change.
• Elasticity of Supply: Measures how much supply changes when prices change.
6. Write short notes on the following:
a. Classification of taxes
b. Short particulars of Government Budget 2022-2023
c. The main sources of government revenue
d. Importance of deficit financing
e. Difficulties of public borrowing in under-developed countries
(a)
CLASSIFICATION OF TAXES
Based on Tax rate
➢ Proportional Tax: Everyone pays the same percentage of their income as tax. Example:
If the tax rate is 10%, both a person earning $1,000 and another earning $10,000 pay 10%
of their income.
➢ Progressive Tax: The tax rate increases as
income increases. Rich people pay a higher
percentage than poor people. Example:
Income tax with different tax brackets.
➢ Regressive Tax: A regressive tax is a tax
where lower-income people pay a higher
percentage of their income than higher-
income people. The tax burden is heavier
on the poor than the rich. Example: Sales
tax, where both rich and poor pay the same
amount for an item, but it affects the poor
more.
➢ Degressive Tax: A degressive tax is a type of tax where the tax rate decreases as income
or wealth increases. Rich people pay more but not in the same proportion. Example: A tax
rate of 10% on incomes up to $50,000, then a fixed amount of $5,000 for higher incomes.
Based on Taxation
➢ Direct Tax: A direct tax is paid directly to the government by the person or organization
on whom it is imposed. Example: Income tax, where you pay tax directly on your earnings.
➢ Indirect Tax: An indirect tax is a tax that is collected by someone else. Example: Sales
tax, where businesses collect tax from customers.
Based on value
➢ Specific Tax: The tax is based on quantity or product, not price. Example: A tax of $1 per
liter of petrol, no matter the price.
➢ Ad Valorem Tax: The tax is based on the value of an item. Example: 10% tax on a car’s
price.
(b)
Here’s a brief overview of the Bangladesh National Budget for FY 2022–2023, presented by
Finance Minister AHM Mustafa Kamal on June 9, 2022:
Key Figures
• Total Budget Size: Tk 6,78,064 crore
• Revenue Target: Tk 4,33,000 crore
o NBR Tax Revenue: Tk 3,70,000 crore
• Budget Deficit: Tk 2,45,064 crore (5.5% of GDP)
• GDP Growth Target: 7.5%
• Average Inflation Target: 5.6%
Major Sector Allocations
• Operating Expenditure: Tk 4,32,000 crore
• Annual Development Programme (ADP): Tk 2,46,066 crore
• Top Sectors:
o Public Services: 21% increase from previous year
o Education & Technology: 14% increase
o Transport & Communication: 24% increase
o Agriculture: Tk 24,224 crore (6.2% of total budget)
o Health: Tk 36,864 crore (5.4% of total budget)
Revenue Sources
• Tax Revenue: Tk 3,70,000 crore (54.6% of total revenue)
o Value Added Tax (VAT): 38%
o Income Tax: 33%
o Import Duty: 12%
o Supplementary Duty: 16%
• Domestic Borrowing: Tk 1,46,000 crore (21.6% of total financing)
o Banking Sector: 72.7% of domestic borrowing
Key Initiatives and Projects
• Infrastructure:
o Inauguration of the 6.15 km Padma Bridge on June 26, 2022
o Launch of the first metro rail segment (Uttara North to Agargaon) on December 28,
2022
o Completion of the 3.32 km Bangabandhu Sheikh Mujibur Rahman Tunnel under
the Karnaphuli River
• Agriculture:
o Increased subsidies and incentives, including tax concessions on agricultural
machinery
o Allocation of Tk 16,000 crore for agricultural subsidies
• Social Welfare:
o Allocation of 5.5% of the total budget to social security and welfare programs
Contextual Factors
• Global Challenges:
o Inflationary pressures due to the Russia-Ukraine conflict
o Supply chain disruptions impacting commodity prices
• Economic Recovery:
o Focus on supporting local businesses and export-oriented industries
o Efforts to contain inflation and provide relief to the populace
(c)
The major sources of revenue are Taxes and Prices. The minor sources are Fees, Special
Assessment, Fines, Forfeitures and Escheats, Tributes and Indemnities, Gifts and Grants.
Major Sources of Revenue:
1. Taxes:
o What it is: Money the government collects from individuals and businesses based
on their income, property, goods, and services.
o Example: Income tax (tax on what you earn), sales tax (tax on the goods you buy),
or property tax (tax on your house or land).
2. Prices:
o What it is: The government can charge for goods and services it provides.
o Example: If you pay for a passport or a parking ticket, that money goes to the
government.
Minor Sources of Revenue:
1. Fees:
o What it is: Payments for specific government services.
o Example: A fee for a driver’s license or a fee to enter a public park.
2. Special Assessment:
o What it is: A charge for specific local improvements that benefit the property.
o Example: A fee for road repairs or sewage system upgrades that directly affect
nearby properties.
3. Fines:
o What it is: Money collected when people break the law or rules.
o Example: Fines for speeding or littering.
4. Forfeitures and Escheats:
o What it is: Property that the government takes when someone doesn’t claim it or
when it is abandoned.
o Example: If someone dies without a will and no relatives claim their property, it
goes to the government.
5. Tributes and Indemnities:
o What it is: Payments from other countries as a form of compensation or a peace
agreement.
o Example: If a country is paying money to another country as part of a peace treaty.
6. Gifts and Grants:
o What it is: Money or property given to the government as a donation or aid.
o Example: Charitable donations to support public health or education.
(d)
Uses of deficit financing
1. For Prosecuting a War
During war, governments often need a lot of money quickly to pay for weapons, soldiers, and
other war-related expenses. Deficit financing helps the government borrow money or print more
money to fund the war when it doesn't have enough in its budget.
2. For Fighting Depressions
In times of economic depression (when businesses are failing, unemployment is high, and the
economy is shrinking), the government needs to stimulate the economy. By using deficit
financing, the government can increase spending on public projects (like building roads or
schools) to create jobs and boost demand for goods and services.
3. For Financing Economic Development
Governments borrow or print money to fund big development projects like infrastructure (roads,
bridges, power plants, etc.) that help the country grow. Even if the government doesn’t have
enough money from taxes, deficit financing allows it to invest in long-term growth and
development.
(e)
Difficulties of public borrowing in under developed countries
Here’s a simple explanation of the difficulties of public borrowing in underdeveloped countries:
1. High Interest Rates
Underdeveloped countries often have higher interest rates on loans because they are seen as risky
by lenders. This means they have to pay back more money than they borrowed, making it harder
to manage debt.
2. Low Creditworthiness
Many underdeveloped countries have poor credit histories or unstable economies, so lenders are
hesitant to lend money. This makes borrowing more difficult and expensive for them.
3. Dependency on Foreign Lenders
When borrowing from foreign countries or institutions, the underdeveloped country becomes
dependent on external sources. If they cannot repay loans, they may face pressure or conditions
(like changing their policies) from foreign lenders.
4. Currency Risk
Underdeveloped countries often borrow in foreign currencies (like dollars or euros). If the local
currency loses value compared to the foreign currency, repaying the debt becomes more
expensive.
5. Limited Capacity to Repay
Since many underdeveloped countries have weak economies, they may not earn enough money
from taxes or exports to easily repay their debts. This can lead to a cycle of borrowing just to pay
interest on old debts, making it harder to invest in development.
6. Negative Impact on Development
Borrowing to pay for things like infrastructure projects can be helpful, but in the long run, the
money spent on repaying debt might limit the government’s ability to spend on essential services
like healthcare, education, and poverty reduction.
7. Risk of Debt Default
If a country is unable to repay its debt on time, it might face a default (failure to pay back). This
can harm the country’s reputation, making it even harder and more expensive to borrow in the
future.
