2024 HKDSE Economics Answers & Marking Scheme

A sharp increase in global crude oil prices increases the cost of production, shifting the short-run aggregate supply (SRAS) curve to the left. A reduction in the profits tax rate increases after-tax profits, encouraging investment and shifting the aggregate demand (AD) curve to the right. A leftward shift in SRAS and a rightward shift in AD will both cause the price level to rise. However, the effect on real output is indeterminate because the leftward shift in SRAS decreases output while the rightward shift in AD increases output.

Award 1 mark for the correct option. No partial marks.

The tax burden shared between buyers and sellers depends on the relative price elasticities of demand (\(E_d\)) and supply (\(E_s\)). The ratio of buyers' tax burden to sellers' tax burden is equal to \(E_s / |E_d|\). Therefore, the tax burden is shared equally if and only if the price elasticity of demand is equal to the price elasticity of supply in absolute terms (i.e., \(|E_d| = E_s\)).

Award 1 mark for the correct option. No partial marks.

Purchasing government bonds increases the money supply, which lowers the interest rate. If private investment is highly sensitive to interest rate changes, the lower interest rate will induce a large increase in investment, shifting the aggregate demand (AD) curve significantly to the right, which is more effective in increasing real GDP. If cash demand is highly sensitive to interest rates, the interest rate will barely fall. If the marginal propensity to import is high, the multiplier is smaller. If the AS curve is vertical, real GDP will not change.

Award 1 mark for the correct option. No partial marks.

An import tariff raises the domestic price to \(P_w + t\). This reduces consumer surplus. Part of the lost consumer surplus is transferred to domestic producers (producer surplus) and the government (tariff revenue). The remaining part becomes deadweight loss. The deadweight loss is caused by two distortions: (1) overproduction by inefficient domestic producers who have higher marginal costs than the world price, and (2) underconsumption by domestic consumers who value the good at more than the world price but less than the tariff-inclusive price.

Award 1 mark for the correct option. No partial marks.

Since total revenue increases when the price is reduced, the percentage increase in quantity demanded must be larger than the percentage decrease in price (i.e., percentage change in quantity demanded is \(+20\%\), calculated as \(1.08 / 0.9 - 1 = 0.2\) or \(20\%\), which is larger than the \(10\%\) price cut). Therefore, the demand is price elastic (\(|E_d| = 2 > 1\)).

Award 1 mark for the correct option. No partial marks.

GDP measures the value of production within the domestic territory of Hong Kong. Providing consulting services in Hong Kong is domestic production, so it increases GDP by HK\(\\$50,000\). Renting out a flat in London is production taking place outside Hong Kong, so it is not included in Hong Kong's GDP. GNI measures the income earned by resident economic units of Hong Kong. Since both the consultant salary (HK\(\\$50,000\)) and the London rental income (£10,000) are earned by a Hong Kong resident, both are included in Hong Kong's GNI. Therefore, GDP increases by HK\(\\$50,000\), and GNI increases by HK\(\\$50,000\) + the equivalent of £10,000.

Award 1 mark for the correct option. No partial marks.

A negative externality in production means marginal social cost (MSC) exceeds marginal private cost (MPC) by the marginal external cost (MEC). In an unregulated market, the equilibrium output is determined where marginal private benefit (MPB) equals MPC. Assuming no consumption externality, MSB = MPB. At this equilibrium, MSC > MPC = MPB = MSB, so MSB < MSC (marginal social benefit is less than marginal social cost). This leads to overproduction and inefficiency.

Award 1 mark for the correct option. No partial marks.

When the public deposits \(\\$100\) million of cash into the banks, the reserves of the banking system increase by \(\\$100\) million. With a required reserve ratio of 20%, the maximum increase in deposits is \(\Delta D = \Delta R / 20\% = \\$100 \text{ million} / 0.2 = +\\$500 \text{ million}\). Since the public's cash holdings decrease by \(\\$100\) million (\(\Delta C_p = -\\$100 \text{ million}\)), the maximum change in the money supply is \(\Delta M_s = \Delta C_p + \Delta D = -\\$100 \text{ million} + \\$500 \text{ million} = +\\$400 \text{ million}\).

Award 1 mark for the correct option. No partial marks.

We calculate the average tax rate (ATR) for each individual:\n- For X: \(\text{ATR} = \\$500 / \\$10,000 = 5\%\)\n- For Y: \(\text{ATR} = \\$2,100 / \\$30,000 = 7\%\)\n- For Z: \(\text{ATR} = \\$4,500 / \\$50,000 = 9\%\)\nSince the average tax rate increases as income increases, this tax system is progressive.

Award 1 mark for the correct option. No partial marks.

Money acts as a unit of account when it is used to measure and compare the values of goods and services. Here, expressing the prices of both the smartphone and the laptop in Hong Kong dollars allows the person to easily compare their relative values.

Award 1 mark for the correct option. No partial marks.

An increase in international oil prices raises production costs, leading to a decrease in short-run aggregate supply (SRAS shifts to the left). At the same time, a reduction in personal income tax rates increases consumers' disposable income, which boosts consumption expenditure and increases aggregate demand (AD shifts to the right). A decrease in SRAS combined with an increase in AD will definitely lead to an increase in the price level, while the change in real output is indeterminate, depending on the relative magnitudes of the two shifts.

Award 1 mark for the correct answer (B). No marks are awarded for incorrect options.

An effective price ceiling is set below the equilibrium price. It causes a shortage because the quantity demanded exceeds the quantity supplied. The quantity transacted drops to the quantity supplied, which is lower than the equilibrium quantity (1 is correct). Producers receive a lower price and sell a smaller quantity, so producer surplus must decrease (2 is correct). Total social surplus decreases because of the deadweight loss created by underproduction (4 is correct). However, consumer surplus may increase or decrease, depending on the price elasticity of demand and how the shortage is allocated among buyers (3 is incorrect).

Award 1 mark for the correct answer (C). No marks are awarded for incorrect options.

A lower required reserve ratio creates excess reserves for commercial banks. If banks hold zero voluntary excess reserves, they will lend out all these excess reserves, maximizing the money creation effect and money supply growth. If investment demand is interest-elastic, a drop in interest rates (caused by the increase in money supply) will lead to a substantial increase in investment expenditure, making the expansionary monetary policy highly effective in boosting aggregate demand.

Award 1 mark for the correct answer (B). No marks are awarded for incorrect options.

Imposing a tariff increases the domestic price of the imported good. This leads to a loss in domestic consumer surplus. However, some of this lost consumer surplus is transferred to domestic producers (gain in producer surplus) and some is captured by the government as tariff revenue. The remaining portion of the lost consumer surplus represents the deadweight loss (due to consumption and production inefficiencies). Therefore, the loss in consumer surplus is strictly greater than the sum of the gain in producer surplus and the government's tariff revenue.

Award 1 mark for the correct answer (B). No marks are awarded for incorrect options.

Total Revenue (\(TR\)) is equal to Price (\(P\)) multiplied by Quantity Demanded (\(Q\)). An increase in price (\(P \uparrow\)) accompanied by a decrease in total revenue (\(TR \downarrow\)) means that the percentage decrease in quantity demanded must be larger than the percentage increase in price in absolute terms. This indicates that the price elasticity of demand is greater than 1 (demand is price-elastic). Price elasticity of supply cannot be determined from this demand-side revenue change.

Award 1 mark for the correct answer (A). No marks are awarded for incorrect options.

(1) is included because a Hong Kong-based airline is a resident producing unit of Hong Kong. Production (the flight service) is considered to take place within Hong Kong's economic territory regardless of the pilot's nationality. (2) is included because the building was produced in the current year; unsold units are counted as an increase in inventories (a component of investment/gross domestic capital formation). (3) is excluded because it is a transfer payment, which does not involve any production of goods or services.

Award 1 mark for the correct answer (A). No marks are awarded for incorrect options.

External benefits in consumption mean that Marginal Social Benefit (\(MSB\)) is greater than Marginal Private Benefit (\(MPB\)). In a free market, equilibrium occurs where \(MPB = MPC\) (where \(MPC\) is equal to \(MSC\) in the absence of external costs). Because \(MSB > MPB\), at this market equilibrium, \(MSB > MSC\). This divergence means that society values additional units of the good more than the cost to produce them, leading to underproduction and inefficiency (deadweight loss). To correct this, a subsidy (not a tax) is required.

Award 1 mark for the correct answer (C). No marks are awarded for incorrect options.

First, find the required reserve ratio (\(RRR\)): \(RRR = \frac{\text{Reserves}}{\text{Deposits}} = \frac{250}{1000} = 25\%\).
When \$50 million of cash is withdrawn, bank reserves decrease by \$50 million, leaving reserves at \$200 million. The maximum deposits that the banking system can support now is: \(\text{New Deposits} = \frac{\text{New Reserves}}{RRR} = \frac{200}{0.25} = 800\) million.
Thus, the change in deposits (\(\Delta D\)) is \(800 - 1000 = -200\) million.
The change in cash held by the public (\(\Delta C_p\)) is \(+50\) million.
The maximum change in money supply (\(\Delta M\)) is: \(\Delta M = \Delta C_p + \Delta D = +50 + (-200) = -150\) million (i.e., a decrease of \$150 million).

Award 1 mark for the correct answer (B). No marks are awarded for incorrect options.

Since the fee is a fixed amount (\$1,200), it takes up a larger percentage of income for low-income households than for high-income households. Thus, the tax rate (tax paid as a percentage of income) decreases as income increases, making it a regressive fee. It violates vertical equity, which states that people with a greater ability to pay (higher income) should pay more tax.

Award 1 mark for the correct answer (B). No marks are awarded for incorrect options.

An oligopolistic market consists of a few dominant firms. Due to the small number of competitors, firms are mutually interdependent, meaning each firm must anticipate and take into account the potential reactions of its rivals when making pricing and output decisions. In contrast, in a monopolistically competitive market, there are many small firms, and each firm acts independently without fearing reactions from individual rivals.

Award 1 mark for the correct answer (C). No marks are awarded for incorrect options.

To find the mutually beneficial terms of trade, we first calculate the opportunity cost of producing 1 smartphone for each country.
- Opportunity cost of 1 smartphone in Country A = \(10 / 5 = 2\) smart watches.
- Opportunity cost of 1 smartphone in Country B = \(8 / 2 = 4\) smart watches.

For trade to be mutually beneficial, the terms of trade for 1 smartphone must lie between the opportunity costs of the two countries, i.e., \(2\text{ smart watches} < 1\text{ smartphone} < 4\text{ smart watches}\).
- Option A (1.5 smart watches) is below the cost of Country A, so Country A would not agree.
- Option B (3 smart watches) lies between 2 and 4, which is mutually beneficial.
- Option C (4.5 smart watches) is above the cost of Country B, so Country B would not agree.
- Option D (1 smart watch = 2 smartphones, which means 1 smartphone = 0.5 smart watches) is also outside the range.

Correct answer: B (1 mark). Award 1 mark for the correct answer. No marks are awarded for incorrect options.

Under an effective price ceiling, the transaction price is capped at the ceiling price, and there is a shortage because quantity demanded (Qd) exceeds quantity supplied (Qs). The actual quantity transacted is limited by the quantity supplied (Qs).
When the supply of the good increases, the supply curve shifts to the right:
1. The quantity supplied at the ceiling price increases, which causes the actual quantity transacted to increase.
2. Since Qd remains unchanged and Qs increases, the shortage (Qd - Qs) must decrease.
3. Note that if supply increases sufficiently, the ceiling may become ineffective (market price falls below the ceiling), in which case the shortage becomes zero (decreased) and the quantity transacted is the new equilibrium quantity (increased). Thus, in all scenarios, the shortage decreases and the quantity transacted increases.

Correct answer: B (1 mark). Award 1 mark for the correct answer.

When the central bank purchases $100 million of government bonds from the public, the public receives $100 million and deposits all of it into the banking system. This increases the total reserves of the banking system by $100 million (\(\Delta R = \$100\text{ million}\)).
Using the banking multiplier:
\(\text{Maximum Deposit Creation } (\Delta D) = \Delta R / \text{Required Reserve Ratio} = \$100\text{ million} / 0.10 = \$1,000\text{ million}\).
Since the public does not hold any cash (all cash is deposited in banks), the money supply (M) consists entirely of bank deposits. Therefore, the maximum change in the money supply is equal to the change in deposits, which is an increase of $1,000 million.

Correct answer: C (1 mark). Award 1 mark for the correct answer.

Total revenue is given by \(TR = P \times Q\).
Let \(P_1 = 1.1P_0\) and \(TR_1 = 1.06TR_0\).
Thus, \(1.1P_0 \times Q_1 = 1.06 P_0 Q_0 \implies Q_1 / Q_0 = 1.06 / 1.1 \approx 0.9636\).
This implies the quantity demanded decreases by approximately 3.64% (\(1 - 0.9636 = 3.64\%\)).
- Since the percentage decrease in quantity demanded (3.64%) is less than the percentage increase in price (10%), the demand for Good X is inelastic (elasticity < 1). This rules out Option A and Option D.
- Option B is correct because the quantity demanded decreases by 3.64%, which is indeed less than 10%.
- Option C is incorrect because the percentage change in quantity demanded (3.64%) is less than the percentage change in price (10%).

Correct answer: B (1 mark). Award 1 mark for the correct answer.

GDP measures the market value of all final goods and services produced by resident producing units in a specified period.
- Option A: Capital gains from selling shares are financial transactions and do not represent any production of new goods or services, so they are excluded.
- Option B: The commission earned by a resident stockbroker is a payment for productive financial services provided in the current period, so it is included.
- Option C: The value of a second-hand car imported from Japan is excluded from Hong Kong's GDP because the car was produced in Japan in a past period.
- Option D: Cash subsidies from the government are transfer payments and are excluded because they are not payments for any production of goods or services.

Correct answer: B (1 mark). Award 1 mark for the correct answer.

We analyze the shifts in aggregate supply and aggregate demand:
1. A major technological breakthrough increases productivity, which shifts the Short-run Aggregate Supply (SRAS) curve to the right. This shift tends to decrease the price level and increase real output.
2. An increase in the profits tax rate reduces the after-tax profitability of investment, causing investment expenditure to fall. This shifts the Aggregate Demand (AD) curve to the left. This shift tends to decrease the price level and decrease real output.

Combining both effects:
- Price level: Both shifts (SRAS right, AD left) work to decrease the price level. Thus, the price level will definitely decrease.
- Real output: The SRAS shift increases real output, while the AD shift decreases real output. Since the relative magnitudes of the shifts are unknown, the change in real output is indeterminate.
Therefore, Option B is correct.

Correct answer: B (1 mark). Award 1 mark for the correct answer.

A positive externality in consumption means that the consumption of the vaccine benefits third parties, implying Marginal Social Benefit (MSB) > Marginal Private Benefit (MPB).
- In a free market without intervention, the competitive equilibrium is determined by \(MPB = MPC\) (where MPC is Marginal Private Cost). Assuming no production externalities, \(MPC = MSC\).
- At the market equilibrium output: \(MSB > MPB = MPC = MSC\), meaning \(MSB > MSC\). Thus, some units of output where MSB exceeds MSC are not produced, leading to underproduction (market output is lower than the efficient level) and a deadweight loss. This makes Option C correct and Options A and B incorrect.
- Option D is incorrect because a tax on producers would shift supply to the left, reducing output further and increasing the deadweight loss. To correct underproduction, the government should subsidize consumers or producers.

Correct answer: C (1 mark). Award 1 mark for the correct answer.

A progressive tax system reduces income inequality by taxing higher income earners at higher rates. Replaced by a proportional tax (where everyone pays the same tax rate), the tax system becomes less redistributive.
- As a result, post-tax income distribution becomes more unequal.
- The Gini coefficient, which measures income inequality (ranging from 0 for perfect equality to 1 for perfect inequality), will increase.
- Therefore, post-tax income distribution becomes more unequal, making Option A correct.

Correct answer: A (1 mark). Award 1 mark for the correct answer.

A deflationary (recessionary) gap exists when actual output is below the potential/full-employment output level. To close the gap, expansionary policies are needed to increase Aggregate Demand (AD).
- Decreasing personal income tax rates is an expansionary fiscal policy. It increases consumers' disposable income, which stimulates private consumption (C) and shifts the AD curve to the right.
- Purchasing government bonds in the open market is an expansionary monetary policy. When the central bank buys bonds from the public, bank reserves and the money supply increase, which lowers interest rates and stimulates investment (I), shifting the AD curve further to the right.
- In contrast, selling government bonds (Option A), increasing the required reserve ratio (Option B), and decreasing government expenditure (Option D) are contractionary policies, which would worsen the deflationary gap. Therefore, Option C is correct.

Correct answer: C (1 mark). Award 1 mark for the correct answer.

Opportunity cost is defined as the highest-valued option forgone when making a decision.
Kelvin's options tonight are:
1. Attend the music festival.
2. Work a freelance shift (yields $1,200).
3. Stay home and study (valued at $900).

If Kelvin chooses to attend the music festival, he must give up the other options. The highest-valued alternative among the forgone options is working the freelance shift, which is valued at $1,200. The non-refundable free ticket has no market value or resale value, so it does not add any cost. Thus, his opportunity cost of attending the festival is $1,200.

Correct answer: B (1 mark). Award 1 mark for the correct answer.

1. A reduction in the personal income tax rate increases disposable income, leading to an increase in private consumption expenditure. This shifts the Aggregate Demand (AD) curve to the right.
2. A significant increase in the price of imported raw materials raises production costs, shifting the Short-run Aggregate Supply (SRAS) curve to the left.
3. The rightward shift of the AD curve increases both the price level and real output.
4. The leftward shift of the SRAS curve increases the price level but decreases real output.
5. Combining both effects, the price level definitely increases, while the effect on real output is uncertain.

Award 1 mark for the correct option B. Reject all other options.

An effective price ceiling is set below the equilibrium price. This leads to: (1) Quantity demanded exceeding quantity supplied, causing a shortage. (2) Landlords reducing maintenance quality because rent is capped (non-price adjustment). (3) Non-price rationing since price cannot clear the market. (4) Quantity traded being lower than the efficient level, creating a deadweight loss. Therefore, all statements are correct.

Award 1 mark for the correct option D. Reject all other options.

To tackle high unemployment during an economic downturn, expansionary fiscal policy and expansionary monetary policy should be used. Increasing government expenditure on infrastructure (expansionary fiscal policy) increases AD. Buying government bonds from the public by the central bank (expansionary monetary policy) increases money supply, lowers interest rates, and boosts consumption and investment, shifting AD further to the right, which increases output and employment.

Award 1 mark for the correct option A. Reject all other options.

1. Opportunity cost of producing 1 unit of clothes in Country A = 40/20 = 2 units of toys.
2. Opportunity cost of producing 1 unit of clothes in Country B = 30/10 = 3 units of toys.
3. Since Country A has a lower opportunity cost in producing clothes (2 < 3), Country A has a comparative advantage in clothes and will export clothes.
4. For mutually beneficial trade to occur, the terms of trade (T) for clothes must lie between the opportunity costs of the two countries: 2 toys < T < 3 toys. If 1 unit of clothes is exchanged for 2.5 units of toys, both countries gain, and Country A exports clothes.

Award 1 mark for the correct option C. Reject all other options.

1. According to the Law of Demand, an increase in price leads to a decrease in the quantity demanded. Hence, quantity demanded decreases.
2. Since the demand is price-inelastic (elasticity < 1), the percentage decrease in quantity demanded is less than the percentage increase in price. Therefore, the total revenue (Price * Quantity) of the operator will increase.

Award 1 mark for the correct option B. Reject all other options.

Option A is a transaction of a second-hand asset, which does not involve current production, so its value is excluded.
Option B involves income earned by a Hong Kong resident abroad (in London), which is part of GNP/GNI but not GDP.
Option C is a commission representing a productive service provided by a local agent within Hong Kong in 2023, so it is included in GDP.
Option D is a transfer payment which does not involve any productive contribution, so it is excluded.

Award 1 mark for the correct option C. Reject all other options.

An effective price floor is set above the equilibrium price, reducing the quantity traded. This results in underproduction (where the quantity traded is less than the efficient quantity). Since some mutually beneficial transactions cannot occur, a deadweight loss is created. At the new transaction quantity, marginal social benefit is actually greater than marginal social cost.

Award 1 mark for the correct option C. Reject all other options.

When a customer deposits cash into the bank, the reserves of the banking system increase by the full deposit amount of $20,000.
Using the deposit multiplier: \( \text{Maximum change in total deposits} = \frac{\text{Change in Reserves}}{\text{Legal Reserve Ratio}} = \frac{\$20,000}{0.25} = \$80,000 \).

Award 1 mark for the correct option C. Reject all other options.

Option A illustrates the function of unit of account.
Option B illustrates the function of medium of exchange.
Option C illustrates standard of deferred payment, as the buyer agrees to pay a specified money amount in the future to settle a current debt/agreement.
Option D illustrates the store of value function.

Award 1 mark for the correct option C. Reject all other options.

Increasing the progressive personal income tax rates for top income brackets takes a higher proportion of income from high-income earners. This redistributes income, reducing income inequality and lowering the Gini coefficient. However, the higher marginal tax rates may discourage high-income individuals from working or investing more (reducing work incentives).

Award 1 mark for the correct option C. Reject all other options.

The share of subsidy received by consumers is larger than that of producers if and only if supply is more elastic than demand (i.e., \(E_s > E_d\)).
- Under Statement I, supply is perfectly elastic (\(E_s = \infty\)), so consumers enjoy all the subsidy benefit. This is correct.
- Under Statement II, demand is perfectly inelastic (\(E_d = 0\)), so consumers enjoy all the subsidy benefit. This is correct.
- Under Statement III, demand is more elastic than supply (\(E_d > E_s\)), so producers enjoy a larger share. This is incorrect.
- Under Statement IV, supply is more elastic than demand (\(E_s > E_d\)), so consumers enjoy a larger share. This is correct.
Therefore, I, II and IV are correct.

Award 1 mark for the correct answer C. No marks for other options.

Initially, the required reserves are \$2,000 \times 15\% = \$300. Since actual reserves are \$400, the banking system has excess reserves of \$100 (\$400 - \$300). When the public withdraws \$100 of cash, actual reserves fall to \$300. These \$300 of reserves are exactly enough to back the initial \$2,000 of deposits (since \$300 / 0.15 = \$2,000). Therefore, the banking system does not need to contract deposits. Deposits remain at \$2,000, while cash in the hands of the public increases by \$100. The money supply (Deposits + Cash held by the public) increases by \$100.

Award 1 mark for the correct answer C. No marks for other options.

Let's calculate the opportunity cost of production:
- For Country A:
- Opportunity cost of 1 Computer = \(10/5 = 2\) units of Clothing.
- Opportunity cost of 1 Clothing = \(5/10 = 0.5\) units of Computer.
- For Country B:
- Opportunity cost of 1 Computer = \(8/2 = 4\) units of Clothing.
- Opportunity cost of 1 Clothing = \(2/8 = 0.25\) units of Computer.

Analysis of statements:
- A is incorrect: Country A's opportunity cost of producing computers (2 Clothing) is lower than Country B's (4 Clothing). Thus, Country A has a comparative advantage in computers, and Country B has a comparative advantage in clothing.
- B is incorrect: Country B requires fewer resources to produce computers (8 < 10), so Country B has an absolute advantage in producing computers.
- C is incorrect: The mutually beneficial terms of trade for 1 Computer must lie between the opportunity costs: \(2 \text{ Clothing} < 1 \text{ Computer} < 4 \text{ Clothing}\). 1.5 Clothing is outside this range, so it is not mutually beneficial.
- D is correct: At the terms of trade of 1 Computer = 3 Clothing (which is mutually beneficial), Country B (which has comparative advantage in clothing) will specialize in producing clothing, export clothing, and import computers.

Award 1 mark for the correct answer D. No marks for other options.

Option A is correct: The commission paid to a real estate agent is a payment for current productive services and is included in the current GDP, even though the second-hand apartment itself was built 10 years ago and is excluded.
Option B is incorrect: Cash handouts from the government are transfer payments, which do not involve current production and are excluded from GDP.
Option C is incorrect: Buying raw materials from Japan increases investment (inventories, \(I\)) but also increases imports (\(M\)) by the same amount. The net effect on GDP (\(C+I+G+X-M\)) is zero.
Option D is incorrect: Mark Six lottery winnings are financial transfers and non-productive transactions, which are excluded from GDP.

Award 1 mark for the correct answer A. No marks for other options.

An increase in profits tax rate on corporations has two effects:
1. It lowers the expected after-tax return on investment, which discourages private investment expenditure. As investment (\(I\)) decreases, aggregate demand shifts to the left (AD decreases).
2. It increases the business tax burden and lowers the incentive to produce, which is equivalent to an increase in production costs, shifting the short-run aggregate supply to the left (SRAS decreases).
When both AD and SRAS shift to the left, real output (\(Y\)) must decrease. However, the price level (\(P\)) will decrease due to the AD shift but increase due to the SRAS shift, making the final change in price level uncertain (depending on the relative magnitude of the shifts).

Award 1 mark for the correct answer D. No marks for other options.

Diagram: Draw a diagram showing a demand curve shifting to the right from \(D_1\) to \(D_2\). Show that the original price floor \(P_f\) is above the original equilibrium price \(P_1\) (binding). Show that the new equilibrium price \(P_2\) is higher than the price floor \(P_f\). Explanation: An increase in market demand shifts the demand curve to the right, which drives up the equilibrium price. When the new equilibrium price \(P_2\) is higher than the price floor \(P_f\), the price floor is no longer binding and becomes ineffective. The market price will rise to the new equilibrium price \(P_2\), and the market will clear with no excess supply.

Diagram (2.5 marks): - Correct rightward shift of the demand curve [0.5 mark] - Labeled binding price floor \(P_f\) above \(P_1\) [0.5 mark] - Show new equilibrium price \(P_2\) above \(P_f\) [0.5 mark] - Correct axes (P, Q) and curves (D, S) [1 mark] Explanation (3 marks): - Explain that the increase in demand shifts the demand curve to the right and pushes up the equilibrium price [1 mark]. - Explain that when the new equilibrium price exceeds the price floor, the price floor becomes ineffective / non-binding [1 mark]. - Conclude that the price will rise to the new equilibrium level and market clears [1 mark].

(a) Country A's opportunity cost of producing 1 unit of Clothing is \(100 / 50 = 2\) units of Rice. Country B's opportunity cost of producing 1 unit of Clothing is \(80 / 20 = 4\) units of Rice. Since Country A's opportunity cost of producing Clothing is lower than Country B's, Country A has the comparative advantage in producing Clothing. (b) Yes, both countries will gain from trade. The terms of trade (1 Clothing = 3 Rice) lies between the opportunity costs of the two countries (\(2 < 3 < 4\)). Country A (exporter of Clothing) gains because it gets 3 Rice for 1 Clothing, which is more than its cost (2 Rice). Country B (importer of Clothing) gains because it pays 3 Rice for 1 Clothing, which is less than its domestic cost (4 Rice).

(a) [3.5 marks] - Calculate Country A's opportunity cost of 1 Clothing = 2 Rice [1 mark] - Calculate Country B's opportunity cost of 1 Clothing = 4 Rice [1 mark] - State that Country A has a lower opportunity cost in producing Clothing [1 mark] - Conclude Country A has the comparative advantage in Clothing [0.5 mark] (b) [2 marks] - Explain that both countries gain because the terms of trade (1 Clothing = 3 Rice) lies between their respective opportunity costs (2 Rice and 4 Rice) [1 mark]. - Explain why the exporter (A) and importer (B) both benefit compared to their domestic opportunity costs [1 mark].

Diagram: Draw AD shifting right from \(AD_1\) to \(AD_2\). Draw SRAS shifting left from \(SRAS_1\) to \(SRAS_2\). Show that the price level definitely rises from \(P_1\) to \(P_2\), while the change in real output from \(Y_1\) to \(Y_2\) is uncertain. Explanation: Currency depreciation makes exports cheaper in foreign currencies and imports more expensive in local currency, which increases net exports and shifts the AD curve to the right. Meanwhile, it increases the import costs of raw materials and intermediate inputs, raising production costs and shifting the SRAS curve to the left. Consequently, the price level definitely rises, while the net effect on real output is uncertain.

Diagram (2.5 marks): - Shift AD curve to the right [0.5 mark] - Shift SRAS curve to the left [0.5 mark] - Labeled price level rising [0.5 mark] - Labeled uncertain change in output [0.5 mark] - Correct axes (P, Y) and curves [0.5 mark] Explanation (3 marks): - Explain that currency depreciation increases net exports, shifting AD to the right [1 mark]. - Explain that currency depreciation increases the cost of imported raw materials, shifting SRAS to the left [1 mark]. - Conclude that price level rises, but the effect on output is uncertain [1 mark].

First, the purchase of the aircraft from Boeing: Since the aircraft is a capital good, investment (I) increases by $100 million. However, since it is imported from the US, imports of goods (M) also increase by $100 million. Under the expenditure approach, these two effects offset each other, so the net effect on GDP is zero. Second, the passenger services: Services sold to HK residents ($40 million) are private consumption expenditure (C), which increases by $40 million. Services sold to non-residents ($80 million) are exports of services (X), which increases by $80 million. Therefore, the net increase in Hong Kong's GDP is $40 million + $80 million = $120 million.

- Explain that investment (I) increases by $100 million [1 mark]. - Explain that imports (M) increase by $100 million [1 mark]. - Conclude that the net effect of the aircraft purchase on GDP is zero [0.5 mark]. - Explain that service sales to residents increase Private Consumption Expenditure (C) by $40 million [1 mark]. - Explain that service sales to non-residents increase Exports of Services (X) by $80 million [1 mark]. - Calculate the final net effect on GDP as an increase of $120 million [1 mark].

(a) Required reserves = Deposits \(\times\) Required reserve ratio = \(1000 \times 20\% = 200\). Excess reserves = Actual reserves - Required reserves = \(300 - 200 = 100\). (b) When the public withdraws $100 of deposits, the reserves of the banking system fall to \(300 - 100 = 200\). Since banks do not hold excess reserves in the end, the maximum deposits (D') the banking system can support with $200 of reserves is: \(D' = 200 / 20\% = 1000\). Since the original deposits were $1000, the change in deposits is \(\Delta D = 1000 - 1000 = 0\). The change in cash held by the public is \(\Delta Cp = +100\). The maximum change in money supply is \(\Delta M = \Delta Cp + \Delta D = +100 + 0 = +100\).

(a) [1.5 marks] - Calculate required reserves = $200 [0.5 mark] - Calculate excess reserves = $100 [1 mark] (b) [4 marks] - Explain that reserves in the banking system decrease to $200 [1 mark]. - Calculate maximum deposits the system can support: \(200 / 0.2 = 1000\) [1 mark]. - State that change in deposits is 0 [1 mark]. - Calculate maximum change in money supply: \(\Delta M = \Delta Cp + \Delta D = +100 + 0 = +100\) [1 mark].

(a) Diagram: Draw MPC and MSC curves, with MSC higher than MPC. Draw MSB curve. Mark the market output \(Q_m\) (where MPC = MSB) and efficient output \(Q_e\) (where MSC = MSB), showing \(Q_m > Q_e\). Shade the deadweight loss area. Explanation: Due to negative externality, the marginal social cost (MSC) exceeds the marginal private cost (MPC). At the market equilibrium output \(Q_m\), MSC is greater than the marginal social benefit (MSB). This leads to overproduction, creating a deadweight loss and making the market output inefficient. (b) Policy: Imposing a per-unit tax equal to the marginal external cost on producers. How it works: The tax increases the marginal private cost of producers, shifting the MPC curve upward to coincide with the MSC curve. The new market equilibrium will move to \(Q_e\), achieving allocative efficiency.

(a) [3.5 marks] Diagram (1.5 marks): - Correct MSC curve above MPC [0.5 mark] - Show \(Q_m\), \(Q_e\) and deadweight loss [0.5 mark] - Labeled axes and curves [0.5 mark] Explanation (2 marks): - Explain that negative externality makes MSC > MPC [0.5 mark]. - Explain that at \(Q_m\), MSC > MSB, leading to overproduction and deadweight loss [1.5 marks]. (b) [2 marks] - Suggest a per-unit tax on producers equal to marginal external cost [1 mark]. - Explain that the tax shifts MPC upward to align with MSC, reducing output to the efficient level \(Q_e\) [1 mark].

(a) Equalizing opportunities means ensuring individuals have an equal starting point or equal access to life chances regardless of family background. Free education ensures children from low-income families have equal access to quality education, which helps reduce the intergenerational transmission of poverty and gives them a fair chance to compete in the job market. (b) The policy is a progressive measure. The value of free education received is the same for all children, but it constitutes a larger percentage of income for low-income families than for high-income families. Funded by a flat tax (which takes the same percentage of income from everyone), the net benefit as a percentage of income is higher for low-income groups, narrowing the income gap and redistributing income from the rich to the poor.

(a) [2.5 marks] - Define equalizing opportunities as giving everyone an equal starting point / equal access to life chances [1 mark]. - Explain that free education allows children from poor families to access educational resources, reducing intergenerational poverty and enabling fair competition [1.5 marks]. (b) [3 marks] - State that it is a progressive measure / reduces income inequality [1 mark]. - Explain that the education benefit is relatively larger as a percentage of income for low-income families [1 mark]. - Explain that with a flat tax funding, net benefits as a percentage of income are higher for low-income groups, equalizing the income distribution [1 mark].

(a) Price elasticity of demand (\(E_d\)) = % change in quantity demanded / % change in price = \(15\% / 20\% = 0.75\) (or \(-0.75\)). (b) Since the price elasticity of demand is 0.75, which is less than 1, demand is inelastic. This means that the percentage increase in quantity demanded (15%) is smaller than the percentage decrease in price (20%). The gain in revenue from the increase in sales volume is less than the loss in revenue from the lower price. Therefore, the total revenue of the cinema chain will decrease.

(a) [1.5 marks] - Show formula and calculation of price elasticity of demand = 0.75 (accept -0.75) [1.5 marks] (b) [4 marks] - State that demand is inelastic because \(E_d < 1\) [1 mark]. - Explain that the percentage increase in quantity demanded is smaller than the percentage decrease in price [1.5 marks]. - Show that the gain in revenue from selling more is smaller than the loss from lower price [1 mark]. - Conclude that total revenue will decrease [0.5 mark].

(a) Raising the required reserve ratio reduces the excess reserves of commercial banks, which decreases their capability to extend loans and create credit. This leads to a contraction in the money supply and pushes up nominal interest rates. Higher interest rates discourage private consumption and investment expenditures, shifting the Aggregate Demand (AD) curve to the left. Consequently, the aggregate price level falls, which helps curb inflation. (b) One major limitation of monetary policy is the existence of time lags (e.g., inside and outside lags). It takes time for banks to adjust interest rates, and even longer for households and firms to respond by cutting consumption and investment. By the time the policy takes effect, the economic conditions may have changed.

(a) [3.5 marks] - Explain that raising the required reserve ratio reduces bank reserves and credit-creating ability [1 mark]. - Explain that money supply contracts, pushing up interest rates [1 mark]. - Explain that higher interest rates reduce consumption and investment, shifting AD to the left [1 mark]. - Conclude that price level falls, curbing inflation [0.5 mark]. (b) [2 marks] - Suggest one valid limitation: e.g., existence of time lags [1 mark] and explain why it limits the policy's effectiveness [1 mark]. (Alternative: Banks holding high excess reserves; cannot solve cost-push inflation effectively; public confidence remains unchanged.)

(a) (i) The general price level increases from \( P_1 \) to \( P_2 \). (ii) The level of output decreases from \( Y_f \) to \( Y_2 \). (iii) The unemployment rate increases because output falls below the full-employment level. Diagram: Draw a downward-sloping AD curve, an upward-sloping SRAS curve, and a vertical LRAS curve intersecting at initial equilibrium \( (P_1, Y_f) \). Shift the SRAS curve leftward to \( \text{SRAS}_2 \). Show the new short-run equilibrium at \( (P_2, Y_2) \), where \( P_2 > P_1 \) and \( Y_2 < Y_f \). (b) (i) Both policies shift the aggregate demand (AD) curve to the right. Increasing transfer payments to low-income households increases their disposable income, which stimulates private consumption expenditure (C). Reducing profit tax rates increases firms' expected after-tax rate of return, stimulating private investment expenditure (I). (ii) Condition: The increase in aggregate demand (AD) must be of a sufficient magnitude to shift the AD curve rightward to exactly intersect the new \( \text{SRAS}_2 \) at the full-employment output level \( Y_f \). Diagram: Show the AD curve shifting rightward from \( \text{AD}_1 \) to \( \text{AD}_2 \) such that the intersection of \( \text{AD}_2 \) and \( \text{SRAS}_2 \) lies on the vertical \( \text{LRAS} \) curve.

Part (a) [Total: 8 marks] - Diagram (3 marks): Correctly labelled axes, AD, SRAS, and LRAS curves (1 mark); Leftward shift of SRAS curve (1 mark); Correctly indicated new equilibrium price level \( P_2 \) and output \( Y_2 \) (1 mark). - Explanation (5 marks): Oil is a major production input, so an increase in oil prices leads to higher production costs, shifting SRAS leftwards (2 marks); Price level increases (1 mark); Output level decreases (1 mark); Unemployment rate increases as production contracts and fewer workers are hired (1 mark). Part (b)(i) [Total: 4.5 marks] - Both policies shift AD to the right (0.5 mark). - Transfer payments increase disposable income, leading to an increase in private consumption expenditure (C) (2 marks). - Reducing profit tax rates increases after-tax profits, leading to an increase in investment expenditure (I) (2 marks). Part (b)(ii) [Total: 5 marks] - Condition (2 marks): The expansion of aggregate demand must be of a sufficient magnitude to shift the AD curve rightward so that it intersects the new SRAS curve at the full-employment output level (2 marks). - Diagram (2 marks): Show a rightward shift of AD curve to intersect the new SRAS curve on the LRAS curve (2 marks). - Price level (1 mark): State that the general price level will rise further (1 mark).

(a) Condition: The price ceiling \( P_c \) must be set below the market equilibrium price \( P_0 \). Diagram: Draw a standard downward-sloping demand curve (D) and upward-sloping supply curve (S). Mark the equilibrium price \( P_0 \) and quantity \( Q_0 \). Draw a horizontal line representing the price ceiling \( P_c \) below \( P_0 \). Indicate the quantity demanded \( Q_d \) and quantity supplied \( Q_s \), showing a shortage \( Q_d - Q_s \). (b) (i) Diagram: Shade the triangular area between the demand and supply curves from the quantity transacted \( Q_s \) to the equilibrium quantity \( Q_0 \). This represents the deadweight loss (DWL). (ii) Producer surplus: Decreases because landlords receive a lower price \( P_c \) and the quantity transacted decreases to \( Q_s \). Consumer surplus: The change is uncertain. Consumers who successfully rent housing benefit from the lower price \( P_c \), gaining surplus. However, those who are priced out or unable to find housing due to the shortage lose surplus. Social surplus: Decreases because the quantity transacted \( Q_s \) is below the allocatively efficient level \( Q_0 \). (c) Diagram: Draw supply curve shifting downwards by \( s \) to \( S' \). Show the price paid by consumers falling to \( P_1 \) and quantity transacted rising to \( Q_1 \). Shade the area of consumer surplus before and after to show the increase. Explain: Consumer surplus increases because the price paid by consumers decreases and the quantity transacted increases. Yes, it results in deadweight loss because at the new quantity \( Q_1 \), the marginal cost of producing housing (on curve S) is greater than the marginal benefit to consumers (on curve D), leading to overproduction and allocative inefficiency.

Part (a) [Total: 4.5 marks] - Condition (1.5 marks): The price ceiling must be set below the market equilibrium price (1.5 marks). - Diagram (3 marks): Correct demand and supply curves with equilibrium (1 mark); Price ceiling line \( P_c \) below equilibrium price (1 mark); Correctly indicated shortage (1 mark). Part (b)(i) [Total: 2 marks] - Diagram (2 marks): Correctly shaded triangular area of deadweight loss (2 marks). Part (b)(ii) [Total: 6 marks] - Producer surplus decreases with explanation of lower price and lower quantity transacted (2 marks). - Consumer surplus change is uncertain, with explanation of gain from lower price versus loss from lower quantity (2 marks). - Social surplus decreases because underproduction leads to allocative inefficiency (2 marks). Part (c) [Total: 5 marks] - Diagram (2 marks): Supply curve shifting downwards/rightwards by \( s \) (1 mark); showing lower price and higher quantity (1 mark). - Consumer surplus (1.5 marks): Increases because consumers pay a lower price and consume more (1.5 marks). - Deadweight loss (1.5 marks): Yes, a deadweight loss is created because marginal cost exceeds marginal benefit at the new quantity, resulting in overproduction (1.5 marks).

(a) Diagram: Draw money demand (Md) and money supply (Ms) curves. Show initial interest rate \( r_1 \). Shift Ms rightward to \( \text{Ms}_2 \), showing interest rate falling to \( r_2 \). Explanation: When the central bank purchases bonds from the public, it injects cash/reserves into the banking system, shifting the money supply curve to the right. At the original interest rate, there is an excess supply of money. To reduce holdings of excess money, people purchase financial assets, bidding up asset prices and lowering the equilibrium interest rate to \( r_2 \). (b) Money expansion: When the central bank buys bonds, the public deposits the cash proceeds into commercial banks. This increases initial deposits and excess reserves in the banking system. Banks will lend out these excess reserves. Borrowers spend the loans, and the recipients deposit the funds back into banks, initiating a chain of credit creation. The total money supply expands by a multiple of the initial deposit. Assumptions: (1) Commercial banks keep zero excess reserves (i.e., they lend out all excess reserves). (2) The public does not hold cash drains (i.e., all money is deposited back into banks). (c) Effect: A lower interest rate reduces the cost of borrowing. This stimulates private consumption expenditure (C) and investment expenditure (I). Since C and I are components of AD, the AD curve shifts to the right. Consequently, real GDP increases and firms hire more labor, leading to an increase in employment in the short run. (d) If the public holds more cash (cash drain increases), the actual money multiplier decreases. The banking system will create less credit and money supply. Therefore, the expansion of the money supply will be smaller, the interest rate will not drop as much, and the monetary policy will be less effective in stimulating aggregate demand and output.

Part (a) [Total: 5.5 marks] - Diagram (3 marks): Labelled axes, Md and Ms curves (1 mark); Rightward shift of Ms curve (1 mark); Correctly indicated interest rate fall (1 mark). - Explanation (2.5 marks): Central bank bond purchase increases banking reserves/money supply (1 mark); Excess supply of money leads to buying of assets, bidding up prices and lowering interest rate (1.5 marks). Part (b) [Total: 5 marks] - Explanation (3 marks): Cash deposited in banks increases reserves (1 mark); banks lend out excess reserves, starting a chain of deposit creation, resulting in multiple expansion of deposits/money supply (2 marks). - Assumptions (2 marks): Correctly list two assumptions: No excess reserves held by banks (1 mark); No cash drain held by the public (1 mark). Part (c) [Total: 4 marks] - Lower interest rate reduces borrowing cost (1 mark). - Private consumption (C) and investment (I) increase, shifting AD to the right (1 mark). - Real GDP increases (1 mark). - Employment increases / unemployment falls (1 mark). Part (d) [Total: 3 marks] - Cash holding reduces the actual money multiplier (1 mark). - The expansion of money supply is smaller, leading to a smaller drop in interest rate (1 mark). - Policy effectiveness in stimulating AD and GDP decreases (1 mark).

(a) Opportunity cost of producing 1 Smartphone (S) in Country A = \( 10 / 20 = 0.5 \) units of Clothing (C). Opportunity cost of producing 1 Smartphone (S) in Country B = \( 16 / 8 = 2 \) units of Clothing (C). Since Country A's opportunity cost of producing Smartphones is lower than Country B's (\( 0.5 < 2 \)), Country A has a comparative advantage in producing Smartphones. (b) For mutually beneficial trade, the terms of trade of 1 unit of Smartphone must lie between the opportunity costs of the two countries: \( 0.5 \text{ units of Clothing} < 1 \text{ unit of Smartphone} < 2 \text{ units of Clothing} \). (c) (i) For Country A, the opportunity cost of producing 1 Smartphone domestically is 0.5 units of Clothing. Under trade, Country A can export 1 Smartphone to get 1.2 units of Clothing. Since \( 1.2 > 0.5 \), Country A gets more Clothing per Smartphone through trade than through domestic production, allowing it to consume beyond its PPF. (ii) Since Country A specializes in Smartphones, it produces \( 100 \times 20 = 2000 \) units of Smartphones and 0 units of Clothing. If it exports 400 Smartphones, it receives \( 400 \times 1.2 = 480 \) units of Clothing from Country B. Thus, Country A's total consumption of Clothing is 480 units. (d) (i) The tariff increases the price of imported Smartphones in Country B. This reduces the quantity demanded of imported Smartphones by Country B's consumers and encourages domestic production of Smartphones in Country B. Consequently, imports from Country A decrease, reducing the volume of trade. (ii) This tariff will decrease the economic welfare of Country B as a whole. It creates a deadweight loss due to consumption distortion (consumers buy less of their preferred good) and production distortion (inefficient domestic producers produce more), outweighing any government tariff revenue.

Part (a) [Total: 4 marks] - Opportunity cost in Country A: 0.5 C (1.5 marks). - Opportunity cost in Country B: 2 C (1.5 marks). - Correct country and explanation: Country A, as it has a lower opportunity cost (1 mark). Part (b) [Total: 2.5 marks] - Mutually beneficial range must lie between the opportunity costs (1 mark). - Correct range: \( 0.5 \text{ C} < 1 \text{ S} < 2 \text{ C} \) (1.5 marks). Part (c)(i) [Total: 3 marks] - Identify that Country A exports Smartphones (1 mark). - Explain that the price received in trade (1.2 C) is higher than the domestic opportunity cost of producing it (0.5 C) (1 mark). - Conclude that Country A can consume more than without trade / beyond PPF (1 mark). Part (c)(ii) [Total: 3 marks] - Country A produces 2000 S and 0 C under specialization (1 mark). - Country A trades 400 S for \( 400 \times 1.2 = 480 \) C (1 mark). - Final consumption of Clothing is 480 units (1 mark). Part (d)(i) [Total: 3 marks] - Tariff increases domestic price of imported Smartphones in Country B (1 mark). - Quantity demanded of imports decreases, domestic production in Country B increases (1 mark). - The volume of trade (imports of S by Country B) decreases (1 mark). Part (d)(ii) [Total: 2 marks] - Welfare decreases / loss of economic efficiency (1 mark). - Explanation of consumption and production distortion / deadweight loss (1 mark).