Let’s talk about debt (baby)

Lets talk about debts.

There has been a lot of talk in the media about debt. Whether it’s Greece’s spiraling debt, Iceland’s refusal to pay its debt, Dubai having its debt bailed out, Football clubs fighting to stay afloat in sea of debt, student loans and student debt, or the spiraling levels of consumer debt, debt is in the news a lot at the moment. The UK is currently at a record level of national debt, and so is the United States.

But what is debt, and what does economics have to say about it? Debt is borrowing something; an asset, and then paying it back over time.  This immediately leads to some issues; how do you know the person you’re lending to can pay you back? Why would you lend your money to someone? And how do you make money out of lending your money to other people?

One way this is dealt with is via the interest rate. This is a percentage that is paid on top of the amount borrowed, for example a 10% rate on a 100-pound loan results in £110 to be paid back (10/100*100=10). This economic revelation results in all 3 criteria being fulfilled, money being made, money being lent to those who can pay it back (via a method known as self-selection) and therefore an incentive to lend.

Economics teaches us a wide variety of ways to calculate the interest rate. This seemingly asinine thing is fascinating the more you study it. You see the interest rate affects all sorts of things. If the rate of interest falls, then the charges on a loan to buy larger items like cars, furniture, electrical equipment and so on is also likely to fall. Therefore total sales of these goods are likely to increase. Holidays are likely to become more likely and more houses will be sold. You will likely see more tourists as the exchange rate falls (and pounds become cheaper) One of the key things you will learn from economics is that changes to things like the interest rate have knock-on effects (also called externalities). This principle applies to a whole variety of things from signage to coffee prices. Your question this week is what implications could there be to Iceland not paying off their debt?

Answers on a postcard please.

One Response to “Let’s talk about debt (baby)”

  1. Rx Help Says:

    What amazes me about the United States is that you have a country that is so over their head in debt and yet they just keep piling it up! A billion US dollars to them is pocket change. They continue to finance a way of life that they can not afford and it will eventually come back to haunt them.

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