Econ Question Bank

HKDSE – Macroeconomics 1Chapter 17 Aggregate Demand and Aggregate Supply

Multiple Choice Questions

QUESTION 01

Which of the following is NOT included in the calculation of aggregate demand?

A. households’ demand

B. foreign countries’ demand

C. government’s demand

D. market demand

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D

According to the definition, aggregate demand = households’ demand + firms’ demand + government’s

demand + foreign countries’ demand. Market demand is not included in the calculation of aggregate

demand.

##

QUESTION 02

The aggregate demand curve shows the negative relationship between the _____________ and the

_____________.

A. interest level … real GDP

B. income level … total quantity of output demanded

C. price level … real GDP

D. price level … total quantity of consumer goods demanded

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C

According to the definition, the aggregate demand curve shows the relationship between the price level

and total quantity of output demanded, i.e. real GDP, ceteris paribus. Other factors being constant, a

decrease (an increase) in an economy’s general price level results in an increase (a decrease) in the real

GDP.

##

© Aristo Educational Press Ltd. 17-1


QUESTION 03

Which of the following statements is CORRECT?

A. Aggregate demand in macroeconomics is the same as market demand in microeconomics.

B. The aggregate demand curve shows that the price level and the total quantity of output

demanded are positively related.

C. Aggregate demand refers to the total demand for all goods and services in an economy at

given price levels in a given period of time.

D. The aggregate demand curve can be downward-sloping, upward-sloping or vertical.

##

C

Option A is incorrect. Market demand refers to the quantities of a particular good that all consumers in

the market are willing and able to buy at all given prices over a period of time, ceteris paribus.

Option B is incorrect. The aggregate demand curve shows that the price level and the total quantity of

output demanded are negatively related.

Option D is incorrect. The aggregate demand curve is always downward-sloping.

##

QUESTION 04

Which of the following correctly describe(s) the difference between aggregate demand in

macroeconomics and market demand in microeconomics?

(1) The calculation of aggregate demand should be within a given period of time, while that of

market demand does not have any limit on the period of time.

(2) Aggregate demand includes the demand for all goods and services in an economy, while

market demand only refers to the demand for a particular good in the market.

(3) A change in aggregate demand is caused by a change in the price level, while a change in the

market demand for a particular good is not caused by a change in the price of the good.

A. (1) only

B. (2) only

C. (1) and (2) only

D. (2) and (3) only



##

B

According to the definition, aggregate demand refers to the total demand for all goods and services in

an economy at given price levels in a given period of time. Market demand refers to the quantities of a

good that all consumers in the market are willing and able to buy at all given prices over a period of

time, ceteris paribus.

(1) is incorrect. Both calculations should be within a given period of time.

(3) is incorrect. A change in aggregate demand is not caused by a change in the price level.

##

QUESTION 05

Which of the following descriptions about aggregate demand and total quantity of output demanded is

INCORRECT?

A. Aggregate demand refers to the total demand for all goods and services in an economy at

given price levels in a given period of time.

B. Total quantity of output demanded refers to the total demand for all goods and services in an

economy at a particular price in a given period of time.

C. The relationship between the price level and aggregate demand can be shown by the

aggregate demand curve.

D. A decrease in the price level results in an increase in the total quantity of output demanded.

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C

The aggregate demand curve shows the relationship between the price level and the total quantity of

output demanded (not aggregate demand), ceteris paribus.

##

QUESTION 06

Which of the following can explain why the AD curve is downward-sloping?

A. exchange rate effect

B. law of demand

C. sticky-price theory

D. imperfect information model



##

A

With the exchange rate effect, when the price level decreases, the interest rate of the economy will

decrease. This will lead to capital outflow. Demand for domestic currency will decrease and the price

of domestic currency will decrease. Domestic exports will become relatively cheaper and imported

goods will become relatively more expensive. Volume of exports will increase and volume of imports

will decrease. Net exports will increase and the total quantity demanded for goods and services will

increase.

Option B is incorrect. The law of demand only explains why the demand curve is downward-sloping.

Options C and D are incorrect. They are the models used to explain why the SRAS curve is upward-

sloping.

##

QUESTION 07

With the wealth effect, when the price level increases, _______________________. The total quantity

demanded for goods and services will decrease.

A. people’s nominal value of wealth increases

B. people’s real value of wealth increases

C. people’s nominal value of wealth decreases

D. people’s real value of wealth decreases

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D

When the price level increases, people are able to buy less with the same amount of money. That is, the

real value of wealth held in the form of money decreases.

##

QUESTION 08

When the price level increases, people save less. The interest rate will __________ and __________

will decrease.

A. increase … the aggregate demand

B. decrease … the aggregate demand

C. increase … the total quantity of output demanded

D. decrease … the total quantity of output demanded



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C

When the price level increases, people will hold more money for daily transactions and they will keep

less money in banks. The amount of money available for lending will decrease. The interest rate will

increase.

The higher interest rate will discourage borrowing by firms for investment. Investment expenditure will

increase and the total quantity of output demanded will decrease.

##

QUESTION 09

Suppose the nominal income of people remains unchanged. When the price level decreases,

(1) people’s purchasing power will increase.

(2) private consumption expenditure will increase.

(3) the purchasing power of people will remain unchanged

A. (1) only

B. (3) only

C. (1) and (2) only

D. (1), (2) and (3)

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C

(1) and (2) are correct. Suppose the nominal income of people remains unchanged. When the price

level decreases, people can buy more with the same amount of money, i.e. the purchasing power of

people increases. Consumers will feel that they are richer and thus will increase their spending on

goods and services. Private consumption expenditure will then increase.

##



QUESTION 10

Suppose the price level of an economy increases. Which of the following descriptions about the

economy is/are CORRECT?

(1) People will hold more money for daily transactions.

(2) People will keep more money in banks.

(3) The interest rate will increase.

A. (1) only

B. (2) only

C. (1) and (3) only

D. (2) and (3) only

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C

(1) is correct. When the price level increases, people are able to buy less with the same amount of

money. They will hold more money for daily transactions.

(2) is incorrect. When the price level increases, as people hold more money for daily transactions, they

will keep less money in banks.

(3) is correct. As people keep less money in banks, the amount of money available for lending will

decrease. The interest rate will increase.

##

QUESTION 11

Which of the following is the impact brought by a decrease in the price level?

A. The total quantity demanded for goods and services decreases.

B. Aggregate demand increases.

C. Domestic exports become relatively expensive.

D. Net exports increases if the demand for both exports and imports are elastic.



##

D

When the price level decreases, the interest rate of the economy will decrease. This will lead to capital

outflow. Demand for domestic currency will decrease and the price of domestic currency will decrease.

Domestic exports will become relatively cheaper and imported goods will become relatively more

expensive. When both the demand for exports and imports are elastic, the volume of exports will

increase and the volume of imports will decrease. Net exports will hence increase.

##

QUESTION 12

Suppose that other things are constant; an upward movement along a aggregate demand curve implies

that

A. the disposable income of consumers decreases.

B. the price level increases.

C. the salaries tax rate increases.

D. the aggregate demand decreases.

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B

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QUESTION 13

Which of the following statements is CORRECT?

A. The aggregate demand increases when the salaries tax rate increases.

B. The aggregate demand decreases when the price level increases.

C. The aggregate demand increases when the profits tax rate decreases.

D. The aggregate demand decreases when the interest rate decreases.



##

C

If the profits tax rate decreases, the incentive for firms to invest will increase and their investment

expenditure will increase. Hence, the aggregate demand will increase.

Option A is incorrect. An increase in the salaries tax rate will reduce people’s disposable income.

Private consumption expenditure will decrease and the aggregate demand will decrease.

Option B is incorrect. An increase in the price level will reduce the total quantity of output demanded.

Aggregate demand is not affected.

Option D is incorrect. A decrease in the interest rate will encourage private consumption and

investment. Aggregate demand will increase.

##

QUESTION 14

The AD curve will shift if

A. people have higher education levels.

B. there is an improvement in production technology.

C. the price level increases.

D. the interest rate of borrowing increases.

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D

An increase in the interest rate of borrowing leads to a decrease in private consumption expenditure and

investment expenditure. Hence, the aggregate demand will decrease and the AD curve will shift to the

left.

Options A and B are incorrect. They will not affect aggregate demand.

Option C is incorrect. An increase in the price level results in a decrease in the total quantity of output

demanded instead of a shift the AD curve.

##



QUESTION 15

Which of the following descriptions about disposable income is CORRECT?

A. Disposable income is affected by the private consumption expenditure.

B. Disposable income is the wage left after deducting the Mandatory Provident Fund

contribution.

C. Disposable income is the income available for spending after paying income tax and

receiving government transfers.

D. An increase in disposable income leads to a decrease in investment expenditure.

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C

Option A is incorrect. The private consumption expenditure is affected by the amount of disposable

income, not the opposite.

Option D is incorrect. An increase in disposable income leads to an increase in the private consumption

expenditure, but not a decrease in the investment expenditure.

##

QUESTION 16

Which of the following factors would NOT affect the private consumption expenditure?

A. people’s expectation for future income

B. government’s unemployment benefits

C. the salaries tax rate

D. the profits tax rate

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D

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QUESTION 17

Which of the following will increase the private consumption expenditure?

A. People expect that there will be an economic downturn next year.

B. People expect that the profits tax will decrease.

C. People expect that they will receive a wage increase.

D. People expect that the government will increase the salaries tax rate.



##

C

If people expect that they will receive a wage increase, they tend to spend more at present. The private

consumption expenditure will increase.

Options A, B and D are incorrect. Options A and D will lead to a decrease in the private consumption

expenditure and option B will not affect the private consumption expenditure.

##

QUESTION 18

Suppose the interest rate of an economy decreases. This would encourage

(1) people to buy more goods and services.

(2) borrowing by firms for investment.

(3) people to keep more money in banks.

A. (1) only

B. (3) only

C. (1) and (2) only

D. (2) and (3) only

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C

(1) is correct. When the interest rate decreases, the cost of borrowing will decrease. People will buy

more goods and services.

(2) is correct. A decrease in the interest rate would reduce firms’ cost of borrowing, which would

encourage borrowing by firms for investment.

(3) is incorrect. When the interest rate decreases, people will keep less money in banks.

##

QUESTION 19

All of the following will reduce the investment expenditure EXCEPT

A. firms expect that there will be an economic downturn in the future.

B. firms expect that the risk of business operation will increase.

C. the government lowers the profits tax rate.

D. the interest rate increases.



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C

When the government lowers the profits tax rate, the incentive for firms to invest will increase and

firms will increase their investment expenditure.

##

QUESTION 20

Which of the following government policies will increase aggregate demand?

(1) increasing the tax incentive for firm’s research and development

(2) raising the profits tax rate

(3) increasing the personal allowance of the salaries tax

A. (3) only

B. (1) and (2) only

C. (1) and (3) only

D. (2) and (3) only

##

C

(1) is correct. Increasing the tax incentive for firms’ research and development will increase the

incentive for firms to invest. The firms will increase their investment expenditure and the aggregate

demand will increase.

(3) is correct. Increasing the personal allowance of the salaries tax will increase the amount of

disposable income of consumers. Therefore, the private consumption expenditure will increase and the

aggregate demand will increase.

(2) is incorrect. Raising the profits tax rate will reduce the incentive for firms to invest. Therefore, the

investment expenditure will decrease and the aggregate demand will then decrease.

##



QUESTION 21

Which of the following would most likely lead to an increase in government expenditure?

A. The government revenue from land sales decreases.

B. The government revenue from the salaries tax decreases.

C. The revenue of private enterprises increases.

D. The government intends to boost the economy to recover from the economic crisis.

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D

When the government intends to boost the economy to recover from the economic crisis, extra money

will be used to support the new government policies. Government expenditure will then increase.

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QUESTION 22

When domestic currency appreciates, the imported goods and services will become relatively

____________. Net exports will ____________.

A. more expensive … decrease

B. cheaper … increase

C. more expensive … increase

D. cheaper … decrease

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D

When domestic currency appreciates, the relative prices of imports to domestic goods and services will

decrease and the relative prices of domestic goods and services will increase. Exports will decrease and

imports will increase. As a result, net exports will decrease.

##



QUESTION 23

China and the United States are trading partners. If the Renminbi appreciates while the US dollar

depreciates,

A. the volume of exports of China will increase.

B. the net exports of China may increase or decrease.

C. the United States will decrease the volume of imports from China.

D. the volume of exports of the United States will decrease.

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C

If the Renminbi appreciates and the US dollar depreciates, the products of China will become relatively

more expensive and the products of the United States will become relatively cheaper. Hence, the

United States will decrease the volume of imports from China.

##

QUESTION 24

Which of the following would lead to a decrease in aggregate demand?

A. People’s incentive for saving decreases.

B. The government reduces the salaries of civil servants.

C. The economic condition of trading partners improves.

D. There is a property market boom.

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B

The reduction in the salaries of civil servants will reduce government expenditure. Besides, the private

consumption expenditure will also decrease as the disposable income of the civil servants decreases.

Aggregate demand will decrease.

Option A is incorrect. The decrease in people’s incentive to save will increase the private consumption

expenditure, and aggregate demand will increase.

Option C is incorrect. The improvement of the economic condition of trading partners will increase the

demand for domestic exports. Net exports will increase and thus aggregate demand will increase.

Option D is incorrect. A property market boom will increase people’s wealth. Private consumption

expenditure will increase and thus aggregate demand will increase.

##



QUESTION 25

Which of the following diagrams best describes the effect of an increase in government transfers?

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A

An increase in government transfers would increase people’s disposable income. With a higher

disposable income, consumers can spend more. As a result, private consumption expenditure will

increase and aggregate demand will increase. Hence, the aggregate demand curve would shift to the

right.

##

QUESTION 26

Which of the following will lead to a leftward shift of Hong Kong’s aggregate demand curve?

A. Consumers plan to reduce the amount of monthly saving.

B. The government raises the profits tax rate.

C. The price level increases.

D. The economies of the major trading partners of Hong Kong grow continuously.


A.

Price level

Quantity of output (real GDP)

AD1

AD0

0

C.

Price level


AD

0

P1

P0

Y1Y0

B.

Price level


AD0

AD1

0

D.

Price level


AD

0

P0

P1

Y0Y1


##

B

When the government raises the profits tax rate, the incentive for firms to invest will decrease and

firms will cut their investment expenditure. Therefore, Hong Kong’s aggregate demand will decrease

and the aggregate demand curve will shift to the left.

Option A is incorrect. When consumers plan to reduce the amount of monthly saving, this implies that

they will increase their consumption expenditure. The private consumption expenditure will increase

and the aggregate demand curve will shift to the right.

Option C is incorrect. An increase in the price level results in a decrease in the total quantity of output

demanded, but not the aggregate demand. The aggregate demand curve will not shift.

Option D is incorrect. When the economies of the major trading partners of Hong Kong grow

continuously, demand for Hong Kong’s exports will increase and the net exports will increase. This will

result in an increase in aggregate demand and the aggregate demand curve will shift to the right.

##

QUESTION 27

Other things being constant, when there is a depreciation of the Hong Kong dollar against other

currencies,

(1) the net exports of Hong Kong will decrease.

(2) the aggregate demand curve of Hong Kong will shift to the left.

(3) the relative prices of imported goods will decrease.

A. (1) only

B. (3) only

C. (2) and (3) only

D. None of the above.



##

D

Other things being constant, when there is a depreciation of the Hong Kong dollar against other

currencies, the relative prices of Hong Kong’s goods and services to imports will decrease and the

relative prices of imports will increase. This will increase exports and reduce imports. As a result, Hong

Kong’s net exports will increase and aggregate demand will increase. The aggregate demand curve will

shift to the right.

##

QUESTION 28

If the government lowers the salaries tax rate by 5% and at the same time raises the profits tax rate by

5%, the aggregate demand curve

A. will shift to the left.

B. will shift to the right.

C. will remain unchanged.

D. may remain unchanged, shift to the left or to the right.

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D

Aggregate demand = Households’ demand + Firms’ demand + Government’s demand + Foreign

countries’ demand

Lowering the salaries tax rate will increase households’ demand, while raising the profits tax rate will

decrease firms’ demand. The final change in the aggregate demand depends on the extent of changes

brought by the changes to the tax rates of the two taxes. The change in the aggregate demand curve is

uncertain.

##



QUESTION 29

Aggregate supply refers to

A. the total amount of consumer goods and services produced by firms in an economy at given

price levels in a given period of time.

B. the total amount of producer goods and services produced by firms in an economy at given

price levels in a given period of time.

C. the total amount of goods and services produced by firms in an economy at given price

levels in a given period of time.

D. the total amount of goods and services produced by firms in an economy at a particular price

level in a given period of time.

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C

##

QUESTION 30

Which of the following about the short-run aggregate supply curve is CORRECT?

A. The short-run aggregate supply curve shows the negative relationship between the price

level and the total amount of output produced.

B. The short-run aggregate supply curve shows the positive relationship between the price level

and the total amount of output produced.

C. The short-run aggregate supply curve shows the positive relationship between the interest

rate and the total amount of output produced.

D. The short-run aggregate supply curve shows the positive relationship between the price level

and the total amount of output consumed.

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B

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QUESTION 31

Which of the following CANNOT explain why the short-run aggregate supply curve is upward-

sloping?

A. sticky-wage theory

B. worker-misperception theory

C. interest rate effect

D. imperfect information model

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C

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QUESTION 32

Sticky-wage theory states that _____________ are slow to adjust to economic changes in the

_____________.

A. nominal wages … short run

B. nominal wages … long run

C. real wages … short run

D. real wages … long run

##

A

According to the sticky-wage theory, when firms and workers enter into long-term contracts, they will

use their expectations of future prices to determine nominal wages. Within the contractual period,

nominal wages cannot be adjusted according to economic conditions flexibly. Hence, nominal wages

are slow to adjust to economic changes in the short run.

##

QUESTION 33

According to the sticky-price theory, which of the following is CORRECT in the short run?

A. When the price level decreases, all firms will cut the prices of their output immediately.

B. When the price level increases, consumers will not reduce their consumption immediately.

C. When the price level decreases, sales will drop and stocks will accumulate.

D. When the price level increases, the short-run aggregate supply will decrease.



##

C

According to the sticky-price theory, the prices of some goods and services are sticky and slow to

adjust to economic conditions in the short run. When there is a fall in the price level, some firms will

refuse to cut the prices of their output as costs will be incurred in reducing their prices. Consumers will

find the prices of these goods too high and reduce their consumption. As a result, their sales will drop

and stocks will accumulate.

##

QUESTION 34

Which of the following statements about the sticky-price theory is CORRECT?

A. The prices of all goods and services are sticky in the short run.

B. The prices of some goods and services are not free to adjust to economic conditions in the

short run.

C. Extra cost will not be incurred in changing prices.

D. The prices of some goods and services are slow to adjust to economic conditions in the long

run.

##

B

The sticky-price theory emphasises that the prices of some goods and services are sticky and slow to

adjust to economic conditions in the short run.

##



QUESTION 35

According to the sticky-price theory, which of the following reasons can explain why prices are sticky

in the short run?

(1) Prices of some goods are fixed in long-term contracts.

(2) The nominal wages paid to workers can be adjusted freely.

(3) Suppliers do not want to change the prices of their goods frequently.

A. (1) only

B. (1) and (3) only

C. (2) and (3) only

D. (1), (2) and (3)

##

B

(1) is correct. Prices of some goods are fixed in long-term contracts between suppliers and customers,

and the prices cannot be changed during the contractual period.

(3) is correct. As changing prices of their goods frequently may irritate customers, suppliers do not

want to change the prices of goods frequently.

##

QUESTION 36

According to the _____________________ theory, if there is an increase in the price level, firms will

adjust the nominal wages ___________ to keep real wages unchanged.

A. sticky-wage … upwards

B. worker-misperception … downwards

C. worker-misperception … upwards

D. sticky-wage … downwards

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C

According to the worker-misperception theory, nominal wages are perfectly free to adjust to economic

conditions, and firms have more information about the price level than workers. If there is an increase

in the price level, firms will adjust nominal wages upwards to keep real wages unchanged.

##



QUESTION 37

Paul is the owner of a textile manufacturing factory. When the price level increases, he thinks that the

price of his goods relative to other goods has gone up. According to the imperfect information model, if

many suppliers think in the same way, the __________________ will __________________.

A. quantity supplied of textiles … increase

B. quantity supplied of textiles … decrease

C. total amount of output in the economy … increase

D. total amount of output in the economy … decrease

##

C

According to the imperfect information model, when the price level increases, suppliers mistakenly

believe that this applies to their goods only. They think that the price of their goods relative to other

goods has gone up. Their goods become more popular and hence more profitable. Therefore, they will

produce more. When many suppliers think in the same way, the total amount of output will increase

when the price level increases.

##

QUESTION 38

In the long run, an economy’s total output is affected by

(1) the price level of the economy.

(2) the education level of workers.

(3) the technology level of the economy.

A. (1) only

B. (1) and (3) only

C. (2) and (3) only

D. (1), (2) and (3)



##

C

In the long run, an economy’s total output is determined by its productive capacity, which depends on

the quantity and/or quality of its factors of production. It is independent of the price level. The

education level of workers and the technology level of the economy affect the productive capacity of

the economy, and therefore affect the total output of the economy.

##

QUESTION 39

In the long run, when the price level increases, which of the following statements is/are CORRECT?

(1) The full-employment output level will increase.

(2) The unemployment rate is at its natural rate.

(3) Nominal output prices and factor prices remain unchanged.

A. (1) only

B. (2) only

C. (1) and (3) only

D. (2) and (3) only

##

B

(2) is correct. In the long run, the output level will remain at the full-employment output level, no

matter how the price level changes. At this level, the economy’s resources are fully employed and the

unemployment rate is at its natural rate.

(1) is incorrect. The full-employment output level is independent of the price level.

(3) is incorrect. Nominal output prices and factor prices will increase.

##



QUESTION 40

Which of the following statements is/are CORRECT?

(1) The LRAS curve is vertical.

(2) In the long run, all output prices are flexible.

(3) In the long run, wages are fully flexible.

A. (1) only

B. (1) and (3) only

C. (2) and (3) only

D. (1), (2) and (3)

##

D

(1) is correct. In the long run, the output level of the economy will remain at the full-employment

output level, no matter how the price level changes. Therefore, the LRAS curve is vertical at the full-

employment level of output.

(2) and (3) are correct. In the long run, all prices, including output prices and factor prices, are fully

flexible.

##

QUESTION 41

In the long run, all information is available to the market. Therefore,

A. the unemployment rate is zero in the market.

B. all firms will not change the prices of their products.

C. all prices can fully adjust.

D. real output is different at every price level.



##

C

When there is perfect information, there are no misperceptions about price or wage changes, and all

prices will adjust fully to the changes in the price level.

Option A is incorrect. In the long run, there is still natural rate of unemployment in the market.

Option B is incorrect. Firms will adjust the prices of their products when there are changes in the price

level.

Option D is incorrect. In the long run, the output level will remain at the full-employment output level,

no matter how the price level changes. Hence, the real output is the same at every price level.

##

QUESTION 42

Which of the following descriptions about aggregate supply is INCORRECT?

A. The SRAS curve is upward-sloping, while the LRAS curve is vertical.

B. The SRAS curve shows the positive relationship between the price level and the total

amount of output produced in the short run, while the LRAS curve shows the negative

relationship between the price level and the total amount of output produced in the long run.

C. In the short run, the quantity of goods and services supplied changes with the price level,

while changes in the price level have no effect on the quantity of goods and services supplied

in the long run.

D. Both the SRAS curve and the LRAS curve reflect the relationship between the price level

and the quantity of goods and services produced.

##

B

The SRAS shows the positive relationship between the price level and the total amount of output

produced. However, in the long run, the output level will remain at the full-employment output level,

no matter how the price level changes.

##



QUESTION 43

Refer to the following diagram.

Suppose the price level increases from P0 to P1. Which of the following will change in the long run?

(1) the nominal gross domestic product

(2) the real gross domestic product

(3) the unemployment rate

A. (1) only

B. (2) only

C. (1) and (2) only

D. (1), (2) and (3)

##

A

The output level will remain at the full-employment output level (Yf), no matter how the price level

changes.

As the price level increases while the real GDP remains at Yf, the nominal gross domestic product will

increase.

(2) is incorrect. In the long run, the real GDP remains at Yf.

(3) is incorrect. In the long run, the unemployment rate remains at its natural rate.

##


Price level


0

LRAS

Yf

P0

P1


QUESTION 44

Refer to the following diagram about economy A.

Which of the following is the LEAST likely explanation for the above change in economy A?

A. Due to the exploitation of natural resources over several years, the amount of natural

resources of economy A has dropped sharply.

B. Many students of economy A who studied abroad have chosen to migrate to foreign

countries.

C. The birth rate of economy A has dropped continuously.

D. The government of economy A has reduced its expenditure on subsidising light industries.

##

D

In the long run, an economy’s total output is determined by its productive capacity, which depends on

the quantity and quality of its factors of production. As the reduction in the expenditure on subsidies to

light industries would not have any effect on the quantity and/or quality of resources, the long-run

aggregate supply would not be affected. The reduction in the expenditure on subsidising light industries

would only affect the short-run aggregate supply.

For option A, the amount of natural resources will decrease. For options B and C, the quantity of labour

will decrease. All of them will cause the long-run aggregate supply to decrease.

##


Price level

Quantity of output (real GDP)0

LRAS0

Y0Y1

LRAS1


QUESTION 45

Which of the following will cause short-run and long-run aggregate supply to decrease at the same

time?

A. People postpone their retirement plans as the economic situation becomes worse.

B. The government imposes a sales tax.

C. There is exhaustion of the oil supply.

D. There is a drop in crop yields due to persistent heavy rain.

##

C

An exhaustion in the supply of oil means that the quantity of natural resources decreases and thus the

productive capacity decreases. Both short-run and long-run aggregate supply will decrease.

Option A is incorrect. People postpone their retirement plans will lead to an increase in the quantity of

labour, so both short-run and long-run aggregate supply will increase instead.

Options B and D are incorrect. They will only cause short-run aggregate supply to decrease, but will

not affect long-run aggregate supply.

##

QUESTION 46

In 2008, a magnitude 8 earthquake took place in Sichuan, which damaged a lot of infrastructure in the

area. We can conclude that Sichuan’s

A. aggregate demand and short-run aggregate supply will increase.

B. aggregate demand will increase and short-run aggregate supply will decrease.

C. short-run and long-run aggregate supply will decrease.

D. short-run and long-run aggregate supply will increase.

##

C

The productive capacity of Sichuan will decrease, as the earthquake damaged a lot of infrastructure in

the area. As a result, both the short-run and long-run aggregate supply of Sichuan will decrease.

##



QUESTION 47

Suppose the government increases the expenditure on services for the elderly. As a result,

____________ will increase and ____________ will remain unchanged.

A. aggregate demand and short-run aggregate supply … long-run aggregate supply

B. long-run aggregate supply … aggregate demand and short-run aggregate supply

C. short-run and long-run aggregate supply … aggregate demand

D. aggregate demand … short-run and long-run aggregate supply

##

D

If the government increases its expenditure on services for the elderly, the government expenditure will

increase and therefore aggregate demand will increase.

As the government expenditure will not affect the cost of production or the productive capacity of the

economy, both short-run and long-run aggregate supply will remain unchanged.

##

QUESTION 48

Suppose the government subsidises the firms that are registered to employ university graduates of that

year. Which of the following is the impact of such a policy?

A. Aggregate demand will decrease.

B. Short-run aggregate supply will increase.

C. Long-run aggregate supply will increase.

D. Both short-run and long-run aggregate supply will increase.

##

B

Firms may find it more profitable to produce goods after receiving the subsidies as the cost of

production decreases. Therefore, short-run aggregate supply will increase.

##



QUESTION 49

Suppose the government increases her spending on medical services for workers. Which of the

following are CORRECT?

(1) Aggregate demand will increase.

(2) Short-run aggregate supply will increase.

(3) Long-run aggregate supply will increase.

A. (1) and (2) only

B. (1) and (3) only

C. (2) and (3) only

D. (1), (2) and (3)

##

D

If the government increases her spending on medical services for workers, government expenditure will

increase. Hence, aggregate demand will increase.

Increasing spending on medical services makes the workers healthier and improves the quality of

labour. The productive capacity of the economy will increase and, thus, both short-run and long-run

aggregate supply will increase.

##

QUESTION 50

Which of the following will decrease the long-run aggregate supply of Hong Kong?

A. There is a technological improvement in the animation industry.

B. More and more university graduates migrate to the United States.

C. The Hong Kong Government imports more resources from China.

D. The Hong Kong Government is going to construct the Hong Kong - Zhuhai - Macao Bridge.

##

B

If more and more university graduates migrate to the United States, the quantity of labour in Hong

Kong will decrease. The long-run aggregate supply of Hong Kong will decrease.

##



QUESTION 51

Country A is facing the problem of severe desertification. If an innovative method is invented to

cultivate crops in desert regions, Country A’s

A. short-run aggregate supply will increase and long-run aggregate supply will remain

unchanged.

B. short-run aggregate supply will decrease and long-run aggregate supply will remain

unchanged.

C. short-run and long-run aggregate supply will increase.

D. short-run and long-run aggregate supply will decrease.

##

C

If a new method is innovated to cultivate crops in desert regions, Country A can increase the output in

desert regions and the productive capacity of the country will increase. Country A’s short-run and long-

run aggregate supply will increase.

##

QUESTION 52

Suppose the government of Country X aims to increase aggregate demand and long-run aggregate

supply. Which of the following policies should the government adopt?

A. distribute cash to residents

B. put extra resources into education

C. reduce the sales tax rate

D. control the price level



##

B

Putting extra resources into education will lead to an increase in government expenditure and thus the

aggregate demand will increase. Besides this, putting extra resources into education will increase the

productive capacity of the economy. Long-run aggregate supply will then increase.

Option A is incorrect. Distributing cash to residents will increase the private consumption expenditure.

Aggregate demand will increase. However, since this does not affect the productive capacity of the

economy, long-run aggregate supply will remain unchanged.

Option C is incorrect. Producers will find it more profitable to produce goods after the sales tax rate is

reduced. Short-run aggregate supply will increase. Aggregate demand and long-run aggregate supply

will remain unchanged.

Option D is incorrect. Changes in the price level would not affect aggregate demand or long-run

aggregate supply. Therefore, controlling the price level cannot help the government to achieve its aim.

##

QUESTION 53

Which of the following would result in a decrease in both the short-run and long-run aggregate supply

of an economy?

A. There is an increase in the tariffs on imports.

B. There is an appreciation of the currency of a trading partner.

C. Firms expect the future price level will increase.

D. More entrepreneurs migrate to foreign countries.

##

D

The labour force will decrease if more entrepreneurs migrate to foreign countries. The productive

capacity of the economy will decrease. Short-run and long-run aggregate supply will decrease.

Options A and B are incorrect. An increase in the tariffs on imports and an appreciation of the currency

of the trading partner affect only aggregate demand, but not aggregate supply.

Option C is incorrect. Short-run aggregate supply will decrease when firms expect the future price level

will increase. This does not affect long-run aggregate supply.

##



QUESTION 54

Nowadays, electronic products are developing rapidly due to technological advancement. The products

are much more advanced than before in terms of production technology, product type and quality.

Technological innovation leads to an increase in ______________.

(1) aggregate demand

(2) short-run aggregate supply

(3) long-run aggregate supply

A. (2) only

B. (1) and (2) only

C. (2) and (3) only

D. (1), (2) and (3)

##

C

(2) and (3) are correct. Technological advancement improves the quality of the factors of production,

which increases the productive capacity of the economy. Therefore, short-run and long-run aggregate

supply will increase.

##



QUESTION 55 (NEW)

Refer to the following diagram.

Which of the following will cause the aggregate demand curve to shift from AD0 to AD1?

A. The government raises the basic allowance for the salaries tax.

B. A major trading partner suffers from economic recession.

C. The price level increases.

D. There is a price rise of raw materials.

##

B

When a major trading partner suffers from economic recession, the demand for domestic exports will

decrease and net exports will decrease. This result in a decrease in aggregate demand and the AD curve

will shift to the left.

Option A is incorrect. Raising the basic allowance for the salaries tax will lead to an increase in

people’s disposable income. Private consumption expenditure will increase, and this will lead to an

increase in aggregate demand. The AD curve will shift to the right.

Option C is incorrect. An increase in the price level will lead to an upward movement along the same

AD curve.

Option D is incorrect. An increase in the price of raw materials will lead to a decrease in the short-run

aggregate supply.

##


Price level

Quantity of output(real GDP)

AD0

AD1

0


QUESTION 56 (NEW)

If _________________________, the short-run aggregate supply of an economy will increase.

(1) the government increases the subsidy to enterprises that produce environmental friendly

products

(2) the government builds a new railway line

(3) the government lowers the profits tax rate

A. (1) and (2) only

B. (1) and (3) only

C. (2) and (3) only

D. (1), (2) and (3)

##

A

(1) is correct. When the government increases the subsidy to enterprises that produce environmental

friendly products, the enterprises will find it more profitable to produce the goods. More output will be

produced at every price level. The short-run aggregate supply will thus increase.

(2) is correct. When a new railway line is built, the productive capacity of the economy will increase.

As more output can be produced at every price level in the short run, the short-run aggregate supply

will increase.

(3) is incorrect. When the government lowers the profits tax rate, the incentive for firms to invest will

increase and firms will increase their investment expenditure. Aggregate demand will increase.

However, the short-run aggregate supply of the economy is not affected.

##

QUESTION 57 (NEW)

Which of the following would lead to an increase in both the short-run aggregate supply and the long-

run aggregate supply?

A. The world price of petroleum reaches a new record high.

B. The government lowers the sales tax rate.

C. The education level of the general public rises.

D. The government raises the basic allowance for the salaries tax.



##

C

A rise in the education level of the general public increases the productive capacity of an economy. The

long-run aggregate supply will increase. The short-run aggregate supply will also increase because

more output can be produced at every price level in the short run.

Option A is incorrect. A rise in the world price of petroleum leads to an increase in the cost of

production. The short-run aggregate supply will decrease, but the long-run aggregate supply will

remain unchanged.

Option B is incorrect. When the government lowers the sales tax rate, producers will find it more

profitable to produce the goods. More output will be produced at every price level. The short-run

aggregate supply will increase, but the long-run aggregate supply will remain unchanged.

Option D is incorrect. When the government raises the basic allowance for the salaries tax, people’s

disposable income will increase and private consumption expenditure will increase. Aggregate demand

will increase, while the short-run aggregate supply and the long-run aggregate supply will remain

unchanged.

##



Short Questions

QUESTION 01

According to the interest rate effect, explain how investment expenditure will decrease when the price

level rises. (4 marks)

##

When the price level rises, people will hold more money for daily transactions. People will keep less

money in banks and the amount of money available for lending will decrease. The interest rate will

increase.The higher interest rate will discourage borrowing by firms for investment. Investment

expenditure will decrease. (4 marks)

##

QUESTION 02

Compare the market demand curve of a good and the aggregate demand curve of an economy in terms

of the following:

(a) the variable of the x-axis of the curves (2 marks)

(b) the variable of the y-axis of the curves (2 marks)

(c) relationship between the variables of the x-axis and y-axis of the curves (2 marks)

##

(a) market demand curve: quantity of the good (1 mark)

aggregate demand curve: quantity of output of the economy (real GDP) (1 mark)

(b) market demand curve: unit price of the good (1 mark)

aggregate demand curve: price level of the economy (1 mark)

(c) market demand curve: negatively related (1 mark)

aggregate demand curve: negatively related (1 mark)

##

QUESTION 03

Explain how the following would affect the aggregate demand curve of an economy:

(a) Firms are pessimistic about economic prospects. (3 marks)

(b) The government increases the tariffs on imports. (3 marks)



##

(a) If firms are pessimistic about economic prospects and expect lower future sales and profits, they

will spend less on new plants and equipment. The investment expenditure will decrease.

Aggregate demand will decrease and the aggregate demand curve will shift to the left. (3 marks)

(b) An increase in the tariffs on imports will lead to a decrease in the imports of the economy. The net

exports of the economy will increase. Aggregate demand will increase and the aggregate demand

curve will shift to the right. (3 marks)

##

QUESTION 04

Given that Germany and England are trading partners, with the aid of a diagram, explain how the

aggregate demand of England will be affected when the price level of Germany increases. (6 marks)

##

When the price level of Germany increases, England’s goods become cheaper relative to Germany’s

goods. The Germans would buy more of England’s exports, while the British would import fewer of

Germany’s goods. Therefore, the net exports of England will increase and the aggregate demand will

increase. The aggregate demand curve of England will shift to the right. (3 marks)

(3 marks)

##

QUESTION 05

Jimmy says, “Only changes in the price level would affect the aggregate demand of a country.”

Kelvin says, “Only changes in non-price factors would affect the aggregate demanded of a country.”

Are the above statements correct? Explain. (4 marks)


Price level


AD1

AD0

0


##

Jimmy’s statement is incorrect and Kelvin’s statement is correct. (2 marks)

Aggregate demand changes only when there are changes in factors affecting the expenditure of an

economy other than the price level. (1 mark)

Changes in the price level lead to changes in the total quantity of output demanded at every given price

level. (1 mark)

##

QUESTION 06

Suppose that people expect the future price level will decrease while their future income will increase.

How will the aggregate demand at present change? Explain your answer. (6 marks)

##

People will postpone and decrease their current consumption expenditure if they expect the future price

level will decrease. The private consumption expenditure will decrease and the aggregate demand at

present will decrease. (2 marks)

People will tend to increase their consumption expenditure if they expect their future income will

increase. The private consumption expenditure will increase and the aggregate demand at present will

increase. (2 marks)

Therefore, the change in aggregate demand is uncertain, depending on the extent of the increase and

decrease in aggregate demand brought by the above factors. (2 marks)

##

QUESTION 07

Suppose the nominal wages of people do not change when the price level increases. Based on your

understanding of aggregate demand, explain how the following would change.

(a) private consumption expenditure (3 marks)

(b) aggregate demand (3 marks)



##

(a) If there is no change in nominal wages when the price level increases, the real wages of people

will decrease. People are able to buy fewer goods with the same amount of money. The

purchasing power of their income will decrease. They will feel that they are poorer and will

decrease their spending on goods and services. The private consumption expenditure will

decrease. (3 marks)

(b) Changes in the price level lead to changes in the total quantity of output demanded at every given

price level. The total quantity of output demanded decreases when the price level increases. This

can be represented by a movement up and to the left along the AD curve. Aggregate demand does

not change. (3 marks)

##

QUESTION 08

(a) What is disposable income? (2 marks)

(b) “If the government increases the sales tax rate, the disposable income of people will decrease and

people will spend less.” Do you agree? Explain. (3 marks)

##

(a) Disposable income is the income available for spending after paying income tax and receiving

government transfers. (2 marks)

(b) No. (1 mark)

The disposable income of people would not be affected by the sales tax rate. A higher sales tax

rate would increase the price of goods. People can buy fewer goods with the same amount of

money. However, the amount of income that people can spend (i.e. disposable income) does not

change. (2 marks)

##

QUESTION 09

(a) Explain why the total quantity of output produced by an economy in the long run is not affected

by the change in the price level. (3 marks)

(b) List TWO government policies that can increase the long-run aggregate supply of an economy.

(2 marks)



##

(a) In the long run, an economy’s total output is determined by its productive capacity. It depends on

the quantity and/or quality of its factors of production, which is independent of the price level.

The output level will remain at the full-employment level, no matter how the price level changes.

(3 marks)

(b) - construct more infrastructures

- increase resources put into education

- Any reasonable answer(s)

(Mark the FIRST TWO points only, 1 mark each)

##

QUESTION 10

Explain whether the following statements are correct.

(a) In the long run, the total quantity of output supplied is the same at all price levels. (3 marks)

(b) In the long run, the full-employment output level will never change. (3 marks)

##

(a) Correct. (1 mark)

In the long run, all prices are fully flexible. All information is available to the market and thus

there are no misperceptions about price or wage changes. When prices can fully adjust, the same

level of real output is generated at every price level. (2 marks)

(b) Incorrect. (1 mark)

The determinants of the full-employment output level, and hence the long-run aggregate supply,

are the quantity and quality of resources. When there is a change in the quantity and/or quality of

resources, the productive capacity of the economy will change and therefore the full-employment

output level will change. (2 marks)

##

QUESTION 11

The Admission Scheme for Mainland Talents and Professionals (ASMTP) is a scheme that the Hong

Kong Government has adopted to attract Mainland talents and professionals to work in Hong Kong.

The scheme is aimed at enhancing Hong Kong's competitiveness. Explain how the ASMTP scheme

affects the short-run and long-run aggregate supply of Hong Kong. (4 marks)



##

Both the short-run aggregate supply and long-run aggregate supply of Hong Kong increase. As the

ASMTP scheme brings highly-educated people and professionals to Hong Kong, the quantity and

quality of labour resources and the productive capacity of Hong Kong increase. (4 marks)

##

QUESTION 12

In Country X, the price level and the nominal wages of workers decrease by the same percentage.

Workers think that they earn less and hence reduce their labour supply.

(a) Which theory or model can explain the behaviour of the workers? Explain your answer. (4 marks)

(b) With the aid of a diagram, explain whether the SRAS curve is upward-sloping or downward-

sloping as indicated by the theory or model in (a). (4 marks)

##

(a) Worker-misperception theory. (1 mark)

This theory assumes that nominal wages are perfectly free to adjust to economic conditions, and

firms have more information about the price level than workers. If workers are not aware that the

price level has decreased, they will mistakenly believe that the decrease in the nominal wages lead

to a decrease in their real wages. Hence, they will supply less labour. (3 marks)

(b) As the decrease in the price level causes the labour supply to decrease in (a), the total quantity of

output will decrease. In this case, the SRAS curve is upward-sloping. (2 marks)

(2 marks)

##


Price level

Quantity of output (real GDP)0

SRAS

Y1

P1

P0

Y0


QUESTION 13

Comment on the following statements.

Statement 1: Factors affecting short-run aggregate supply must also affect long-run aggregate supply.

(3 marks)

Statement 2: Factors affecting long-run aggregate supply must also affect short-run aggregate supply.

(3 marks)

##

Statement 1 is incorrect. (1 mark)

Factors affecting short-run aggregate supply may not affect long-run aggregate supply. The

determinants of long-run aggregate supply are the quantity and quality of resources. Since some factors

that affect short-run aggregate supply (e.g. weather condition) may not affect the quantity and/or

quality of resources, long-run aggregate supply will not be affected. (2 marks)

Statement 2 is correct. (1 mark)

Any factors that affect the quantity and quality of resources will change the output produced at every

price level in both short run and long run. (2 marks)

##

QUESTION 14

Suppose the Hong Kong Government increases the amount of subsidy of the Continuing Education

Fund provided for each eligible student. At the same time, the government provides extra subsidies to

institutions for offering more innovative courses.

Explain how this measure affects the aggregate demand, short-run aggregate supply and long-run

aggregate supply of Hong Kong. (6 marks)

##

Increasing the amount of subsidy of the Continuing Education Fund to eligible students encourages

more people to study. Private consumption expenditure will increase and thus the aggregate demand

will increase. (2 marks)

The government’s offering of extra subsidy encourages institutions to provide more innovative courses,

and thus the short-run aggregate supply of Hong Kong will increase. (2 marks)

Better education and training will raise the quality of labour. The productive capacity of Hong Kong

will increase. The long-run aggregate supply of Hong Kong will increase. (2 marks)

##



QUESTION 15

(a) According to the sticky-wage theory, nominal wages are assumed to be slow to adjust to economic

changes in the short run. Explain this assumption. (3 marks)

(b) Suppose all the firms in an economy can freely adjust nominal wages according to economic

changes. When the price level increases, how would the real wages paid to workers and the total

output change? (4 marks)

##

(a) When firms and workers enter into long-term contracts, they will use their expectations of future

prices to determine nominal wages. With the contractual period, nominal wages cannot be

adjusted according to economic conditions flexibly. Therefore, the nominal wages are slow to

adjust to economic changes in the short run. (3 marks)

(b) If all the firms can freely adjust nominal wages according to economic changes, when the price

level increases, the real wages paid to workers will remain unchanged. (2 marks)

Firms will keep their original quantity of output supplied as there is no change in the real wages.

The total output will remain unchanged. (2 marks)

##

QUESTION 16

With the aid of separate diagrams, explain the effects of the following events on short-run aggregate

supply.

(a) There is an increase in the price level. (5 marks)

(b) Firms expect the future price level to increase. (5 marks)



##

(a) In the short run, an increase in the price level tends to increase the quantity of goods and services

produced. An increase in the price level can be shown by an upward movement along the SRAS

curve. Short-run aggregate supply is not affected. (2 marks)

(3 marks)

(b) If firms expect the future price level to increase, firms will decrease their present supply in order

to supply more in the future. Short-run aggregate supply will decrease. The SRAS curve will shift

to the left. (2 marks)

(3 marks)

##

QUESTION 17

Explain how the following would affect the aggregate demand and the short-run aggregate supply of an

economy.

(a) The government refunds part of the salaries tax to taxpayers. (3 marks)

(b) More advanced machinery is imported from foreign countries by producers. (3 marks)


Price level


0

SRAS

Y0

P0

P1

Y1

Price level


SRAS1

0

SRAS0


##

(a) The disposable income of taxpayers will increase if the government refunds part of the salaries tax

to them. Therefore, the private consumption expenditure will increase and the aggregate demand


The short-run aggregate supply will not be affected. (1 mark)

(b) Importing more advanced machinery from foreign countries by producers leads to a decrease in

the cost of production. This will lead to an increase in the short-run aggregate supply. (2 marks)

The aggregate demand will not be affected, as the increase in import will be offset by the increase

in investment. (1 mark)

##

QUESTION 18

(a) Can the change in the price level affect the full-employment output level? (3 marks)

(b) Suppose the government of an economy wants to increase the full-employment output level.

Suggest TWO policies that she may adopt. (4 marks)

##

(a) No. (1 mark)

An economy’s full-employment output level is determined by its productive capacity, which

depends on the quantity and/or quality of its factors of production. It is independent of the price

level. (2 marks)

(b) Any policies that can increase long-run aggregate supply:

- provide better education

- construct more infrastructures

- develop new technologies

- Any reasonable answer(s)

(Mark the FIRST TWO points only, 2 marks each)

##

QUESTION 19

State and explain TWO theories/models that can be used to explain why the SRAS curve is upward-

sloping. (6 marks)



##

The theories/models include:

- Sticky-wage theory: When the price level decreases (to a level lower than expected) but nominal

wages paid to workers remain unchanged, real wages will increase. Higher real wages will cause firms

to employ fewer workers and produce less. Since the price level falls and the quantity of output

decreases, the SRAS curve is upward-sloping.

- Sticky-price theory: When the price level decreases, some firms will refuse to cut the prices of their

output as costs will be incurred in reducing their prices. Consumers will find the prices of these goods

too high and reduce their consumption. As a result, their sales will drop and stocks will accumulate.

These producers will have to reduce output. Therefore, total output will decrease when the price level

decreases and the SRAS curve slopes upwards.

- Worker-misperception theory: If there is a decrease in the price level, firms will adjust nominal wages

downwards to keep real wages unchanged. However, workers are not aware that the price level has

decreased. The workers mistakenly believe that their real wages have decreased and they will supply

less labour. As a result, the total quantity of output will decrease when the price level decreases. The

SRAS curve is thus upward-sloping.

- Imperfect information model: When the price level decreases, suppliers mistakenly believe that this

applies to their goods only. They think that the price of their goods relative to other goods has gone

down. Their goods become less popular and hence less profitable. Therefore, they will produce less.

When many suppliers think in the same way, the total amount of output will decrease when the price

level decreases, and the SRAS curve slopes upwards.

(Mark the FIRST TWO points only, 3 marks each)

##

QUESTION 20 (NEW)

Earlier, the Hong Kong Government proposed to build a third runway for the Hong Kong International

Airport. Explain how Hong Kong’s aggregate demand, short-run aggregate supply and long-run

aggregate supply would be affected if the third runway is to be built. (6 marks)



##

If the third runway is to be built, additional resources will be put on constructing the runway by the

government. Government expenditure will increase and thus the aggregate demand will increase.

(2 marks)

As the third runway can increase the productive capacity of Hong Kong, the long-run aggregate supply


The short-run aggregate supply will also increase because more output can be produced at every price

level in the short run. (2 marks)

##



Long Questions

QUESTION 01

Read the following news report from a newspaper carefully.

(a) How would the short-run and long-run aggregate supply of Germany be affected during the period

of the labour strike? Explain with the aid of separate diagrams. (8 marks)

(b) How would the short-run and long-run aggregate supply of Germany be affected when the labour

strike was over? (4 marks)

##

(a) A labour strike is an unfavourable supply shock that would decrease the short-run aggregate

supply. Therefore, the short-run aggregate supply curve would shift to the left. (2 marks)

(2 marks)

As the labour strike has no effect on the quantity and quality of resources of Germany, the long-

run aggregate supply would remain unchanged at the full-employment output level. (2 marks)

(2 marks)


In Germany, employees of several airline companies were dissatisfied with their wage payment systems and launched a 4-day labour strike to fight for a wage increase and improvements to their benefits. More than half of the employees of the airline companies participated in the strike. The air service in Germany was paralyzed and serious economic losses resulted…

Price level


SRAS1

0

SRAS0

Price level


LRAS

0


(b) When the labour strike was over, the temporary unfavourable supply shocks would disappear and

the short-run aggregate supply would return to its original level. (2 marks)

The long-run aggregate supply would remain unchanged at the full-employment level. (2 marks)

##

QUESTION 02

Hong Kong lacks natural resources. Many important industrial resources are imported from China.

Steel is one example.

(a) In recent years, the Renminbi has appreciated against the Hong Kong Dollar continuously. How

will this affect the short-run and the long-run aggregate supply of Hong Kong? (6 marks)

(b) Suppose Hong Kong found a more efficient material that can substitute for steel. Explain how the

short-run and the long-run aggregate supply of Hong Kong would be affected. (6 marks)

##

(a) The appreciation of the Renminbi will lead to a rise in the import price of steel. When the price of

factors of production increases, the cost of production will increase. As a result, firms will reduce

their output and the short-run aggregate supply will decrease. (3 marks)

The determinants of the full-employment output level and the long-run aggregate supply are the

quantity and quality of resources. As the appreciation of the Renminbi has no effect on the

quantity and quality of resources of Hong Kong, the long-run aggregate supply will remain

unchanged. (3 marks)

(b) The discovery of a more efficient material that can substitute for steel implies that more output

can be produced with the same amount of resources. The cost of production would decrease and

thus the short-run aggregate supply would increase. (3 marks)

As the new material is more efficient, the productive capacity of Hong Kong would increase. The

long-run aggregate supply would increase. (3 marks)

##



QUESTION 03

The coverage of the Individual Visit Scheme has expanded since its implementation. More and more

residents of Mainland cities visit Hong Kong through the scheme. The total amount spent by the

Mainland tourists keeps on rising.

(a) With the aid of a diagram, explain how the aggregate demand of Hong Kong would be affected

after expanding the coverage of the Individual Visit Scheme. (5 marks)

(b) With the aid of the diagram in (a), explain how the aggregate demand of Hong Kong would be

affected when the Renminbi appreciates against the Hong Kong dollar after the expansion of the

Individual Visit Scheme. (5 marks)

(c) Should the amount of spending of Mainland tourists be included in the calculation of the gross

domestic product (GDP) of Hong Kong? Explain your answer. (3 marks)

##

(a) The expansion of the coverage of the Individual Visit Scheme increases the number of tourists

from the Mainland to Hong Kong. As the tourists consume in Hong Kong and they demand Hong

Kong’s goods and services, net exports of Hong Kong will increase. The aggregate demand of

Hong Kong will increase. The aggregate demand curve will shift to the right. (3 marks)

(2 marks)


Price level


AD1

AD0

0


(b) Other things being constant, when the Renminbi appreciates against the Hong Kong dollar, the

relative prices of domestic goods and services in Hong Kong will decrease and the spending of the

visitors from the Mainland in Hong Kong will increase. As a result, net exports will increase and

the aggregate demand of Hong Kong will further increase. (3 marks)

(2 marks)

(c) It is included in Hong Kong’s GDP. (1 mark)

As tourists’ spending is regarded as exports of services, it is included in exports. (2 marks)

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QUESTION 04

Suppose Country A aims to increase aggregate demand and long-run aggregate supply of the economy

at the same time. Explain whether an imposition of the following policies could help Country A achieve

its aims.

(a) families will receive extra tax allowances for giving birth to more than one child (4 marks)

(b) lowering the sales tax rate (4 marks)

(c) restricting the volume on imported goods (4 marks)

##

(a) This policy can help Country A achieve its aims. (1 mark)

This policy can encourage people to give birth and thus results in a rise in population. The total

demand for goods and services will increase when the population increases. The private

consumption expenditure will increase. Aggregate demand will increase. Besides, the babies can

provide a larger labour force for Country A in the future. The productive capacity of Country A

will increase. Therefore, long-run aggregate supply will increase. (3 marks)


Price level


AD1

AD0

0

AD2


(b) This policy cannot help Country A achieve its aim. (1 mark)

Lowering the sales tax rate would not affect the quantity or quality of resources. Long-run

aggregate supply will remain unchanged. Besides, a decrease in the sales tax rate will lead to an

increase in short-run aggregate supply, but aggregate demand will not be affected. (3 marks)

(c) This policy cannot help Country A achieve its aim. (1 mark)

Restricting the volume on imported goods will lead to a drop in the volume of imports. The net

exports of Country A will increase and therefore aggregate demand will increase. However, this

policy will not affect the quantity or quality of resources and thus will not cause any effect on

long-run aggregate supply. (3 marks)

##

QUESTION 05 (NEW)

The Hong Kong Government launches a trial scheme on one-off ad hoc quotas for Guangdong/Hong

Kong cross-boundary private cars (“self-drive tour Scheme”) in Guangdong and Hong Kong in March

2012. Under the Scheme, qualified owners of Hong Kong non-commercial private cars are allowed to

apply for such quotas to enter Guangdong for a short stay not longer than 7 days. Arrangements for

Guangdong private cars to enter Hong Kong fall under the second phase of the Scheme.

(a) Suggest ONE reason to explain why the aggregate demand curve is downward sloping. (3 marks)

(b) With the aid of the diagram below, explain how Guangdong’s aggregate demand would be

affected when Hong Kong’s car owners apply the Scheme. (5 marks)

(c) Would the short-run aggregate supply and the long-run aggregate supply of Guangdong be

affected when Hong Kong’s car owners apply the Scheme? Explain. (4 marks)


Price level

Quantity of output(real GDP)0

AD0


##

(a) Wealth effect (Real balance effect): When the price level decreases, the real value of wealth held

in the form of money increases. Consumers will feel that they are richer and will increase their

spending on goods and services. Consumer expenditure will then go up and the total quantity

demanded for goods and services will increase. (3 marks)

OR

Interest rate effect: When the price level decreases, people will hold less money for daily

transactions. People will keep more money in banks and the amount of money available for

lending will increase. The interest rate will decrease. The lower interest rate will encourage

borrowing by firms for investment. Investment expenditure will increase and the total quantity

demanded for goods and services will increase. (3 marks)

OR

Exchange rate effect: When the price level decreases, the interest rate will decrease. This will lead

to capital outflow. Demand for domestic currency in the foreign exchange market will decrease

and the price of domestic currency will decrease, i.e. the domestic currency will depreciate.

Domestic exports will become relatively cheaper and imported goods will become relatively more

expensive. Volume of exports will increase and volume of imports will decrease. Net exports will

go up and the total quantity demanded for goods and services will increase. (3 marks)

(b) When Hong Kong’s car owners apply the Scheme, spending of tourists from Hong Kong in

Guangdong would increase. Guangdong’s exports of services would increase and net exports

would increase. Its aggregate demand would thus increase and the aggregate demand curve will

shift to the right. (3 marks)

(2 marks)


Price level

Quantity of output(real GDP)

0

AD0

AD1


(c) The short-run aggregate supply of Guangdong would not be affected as the total quantity of goods

and services supplied at all price levels do not change. (2 marks)

The long-run aggregate supply of Guangdong would not be affected as the productive capacity of

Guangdong does not change. (2 marks)

##


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Econ Question Bank