2021 HKDSE Economics Answers & Marking Scheme

Opportunity cost of producing 1 Smartwatch (SW):
- For Country X: \(4 / 2 = 2\) Leather Belts (LB).
- For Country Y: \(9 / 3 = 3\) LB.
Since Country X has a lower opportunity cost in producing SW (\(2 \text{ LB} < 3 \text{ LB}\)), Country X has a comparative advantage in SW.
Since Country Y has a lower opportunity cost in producing LB (\(1/3 \text{ SW} < 1/2 \text{ SW}\)), Country Y has a comparative advantage in LB.
For mutually beneficial trade to occur, the terms of trade for 1 SW must lie between the opportunity costs of the two countries, i.e., \(2 \text{ LB} < 1 \text{ SW} < 3 \text{ LB}\). Therefore, Option C is correct.

Award 1 mark for the correct answer C. Reject other options.

A reduction in personal income tax rates increases consumers' disposable income, which stimulates private consumption expenditure. Aggregate Demand (AD) increases and shifts to the right.
At the same time, an increase in electricity tariffs increases the cost of production for firms. Short-run Aggregate Supply (SRAS) decreases and shifts to the left.
The rightward shift of the AD curve and the leftward shift of the SRAS curve both lead to an increase in the general price level.
However, the effect on real output is uncertain (it depends on whether the increase in AD is larger or smaller than the decrease in SRAS). Therefore, Option A is correct.

Award 1 mark for the correct answer A. Reject other options.

Original required reserve ratio = Reserves / Deposits = \$400M / \$2000M = 20%.
New required reserve ratio = 20% + 5% = 25%.
Since banks do not hold excess reserves and there is no cash leakage, the maximum deposits supported by \$400 million of reserves is:
New Deposits = \$400M / 25% = \$1,600 million.
The change in maximum deposits (and thus money supply) is:
\$1,600 million - \$2,000 million = -\$400 million (decrease of \$400 million). Therefore, Option B is correct.

Award 1 mark for the correct answer B. Reject other options.

Total Revenue (TR) = Price (P) * Quantity demanded (Q).
When price decreases by 15%, total revenue increases by 8%.
This implies that the percentage increase in quantity demanded must be larger than the percentage decrease in price (i.e., % change in Q > 15%).
Therefore, the demand is price elastic, meaning the price elasticity of demand (in absolute terms) is greater than 1. Option A is correct.

Award 1 mark for the correct answer A. Reject other options.

Statement (1) is correct because she moved her job location from Hong Kong to London, demonstrating geographical mobility.
Statement (2) is incorrect because she remains in the same occupation (English teacher), so she did not change her occupation.
Statement (3) is correct because her departure directly reduces the number of available teachers in Hong Kong, shifting the labor supply of the HK education sector to the left (a decrease in labor supply).
Therefore, (1) and (3) only are correct (Option B).

Award 1 mark for the correct answer B. Reject other options.

An effective price ceiling is set below the equilibrium price. When demand increases (shifts right), the market price cannot rise because it is capped by the price ceiling, so the market price remains unchanged at the ceiling price.
The quantity transacted is determined by the quantity supplied at the ceiling price. Since there is no change in the supply curve, the quantity supplied and hence the quantity transacted remains unchanged.
The quantity demanded at the ceiling price increases due to the rightward shift in demand. Thus, the shortage (quantity demanded minus quantity supplied) increases. Option A is correct.

Award 1 mark for the correct answer A. Reject other options.

A Hong Kong investment firm hiring a Japanese resident consultant to perform services in Hong Kong represents domestic production. Since the service is produced within the economic territory of Hong Kong, it is included in Hong Kong's GDP.
However, the consultant is a resident of Japan (a non-resident of Hong Kong), so the payment to the consultant is 'factor income paid to non-residents (outflow)'.
By definition, \(GNI = GDP + \text{Net Factor Income from Abroad (NFIA)}\).
Since GDP increases by the value of the fee, but NFIA decreases by the exact same amount (due to factor income paid to a non-resident), Hong Kong's GNI remains unchanged. Therefore, Option C is correct.

Award 1 mark for the correct answer C. Reject other options.

Under the Linked Exchange Rate System, the Hong Kong dollar exchange rate is pegged to the US dollar. To maintain exchange rate stability, Hong Kong interest rates must track US interest rates.
If the US Fed increases interest rates while Hong Kong's interest rates remain low, capital will flow out of Hong Kong to the US to seek higher returns, putting pressure on the HKD to depreciate.
To defend the peg, the HKMA will buy HKD and sell USD when the weak-side convertibility undertaking is triggered, which contracts the monetary base and pushes Hong Kong interest rates up.
Thus, Hong Kong's interest rates will face upward pressure to maintain exchange rate stability. Option C is correct.

Award 1 mark for the correct answer C. Reject other options.

Marginal product (MP) is the change in total output resulting from employing one additional unit of the variable factor (labor):
- MP of 1st worker = \(20 - 0 = 20\)
- MP of 2nd worker = \(45 - 20 = 25\)
- MP of 3rd worker = \(75 - 45 = 30\)
- MP of 4th worker = \(95 - 75 = 20\)
- MP of 5th worker = \(110 - 95 = 15\)
The marginal product increases for the first 3 workers (from 20 to 25, then to 30) and begins to decrease (diminish) when the 4th worker is employed (dropping to 20). Therefore, the Law of Diminishing Marginal Returns sets in at the 4th worker. Option C is correct.

Award 1 mark for the correct answer C. Reject other options.

An insurance company and a commercial bank operate in related markets but do not have a buyer-seller relationship (vertical) or produce directly competing products (horizontal). Therefore, a merger between them is lateral integration.
A key motive for lateral integration between financial firms is to enjoy economies of scope, such as sharing marketing channels and cross-selling financial products to the same customer base. Thus, Option B is correct.

Award 1 mark for the correct answer B. Reject other options.

When a price ceiling is imposed below the equilibrium price, there is a shortage as the quantity demanded exceeds the quantity supplied at the ceiling price. When the cost of production increases, the supply curve shifts leftwards. At the unchanged ceiling price, the quantity supplied decreases while the quantity demanded remains unchanged. Therefore, the shortage (the difference between quantity demanded and quantity supplied at the ceiling price) will increase.

Award 1 mark for the correct answer A. Award 0 marks for other options.

An import quota restricts the import quantity. When the domestic demand for wine decreases, the demand curve shifts leftwards. This leads to a decrease in the domestic price of wine in Country A. The import quantity may remain at the quota level (if the quota is still binding) or decrease (if the quota becomes non-binding), but in both cases, the domestic price must decrease.

Award 1 mark for the correct answer A. Award 0 marks for other options.

1. Initial state: Required reserve ratio = \( 25\% \). Actual Reserves = \$300 million. Deposits = \$1,200 million. No excess reserves exist.
2. When the public withdraws \$50 million as cash: Reserves drop to \( 300 - 50 = \$250 \text{ million} \). Cash in public hands increases by \$50 million.
3. Under the new required reserve ratio of \( 20\% \), the maximum deposits the banking system can support is \( 250 / 0.20 = \$1,250 \text{ million} \).
4. Change in Deposits: \( 1,250 - 1,200 = +\$50 \text{ million} \).
5. Change in Money Supply (\( \Delta M = \Delta C + \Delta D \)): \( +\$50 \text{ million (cash)} + \$50 \text{ million (deposits)} = +\$100 \text{ million} \).

Award 1 mark for the correct answer B. Award 0 marks for other options.

(1) is included in 2023 GDP because the commission represents payment for current productive services provided by the agency in 2023.
(2) is not included in 2023 GDP. Under the expenditure approach, the increase in exports is offset by the decrease in domestic inventory (investment) because the toys were produced in 2022, not 2023.
(3) is excluded from GDP because government subsidies are transfer payments which do not involve current production.
(4) is included in 2023 GDP because the Japanese chef provided culinary services within the domestic boundary of Hong Kong, contributing to Hong Kong's current production.

Award 1 mark for the correct answer B. Award 0 marks for other options.

1. A severe recession in a major trading partner reduces their demand for the economy's exports. Thus, the country's net exports decrease, causing the Aggregate Demand (AD) curve to shift to the left, which tends to lower both the general price level and real output.
2. A reduction in the import tariff on raw materials lowers the production cost for firms, shifting the Short-run Aggregate Supply (SRAS) curve to the right, which tends to lower the general price level and increase real output.
3. Combining both shifts: the general price level must decrease, while the net effect on real output is uncertain (depending on the relative magnitude of the shifts of AD and SRAS).

Award 1 mark for the correct answer B. Award 0 marks for other options.

According to the economic definition, interest is the price of early availability of resources (or the cost of consuming resources earlier / the reward for waiting/deferred consumption). It exists even in a barter economy without money.

Award 1 mark for the correct answer B. Award 0 marks for other options.

When the required reserve ratio increases, the credit creation ability of commercial banks is reduced, leading to a decrease in money supply. A lower money supply shifts the money supply curve to the left, which increases the nominal interest rate. Higher interest rates increase the cost of borrowing, which discourages investment and consumption, resulting in a decrease in aggregate demand.

Award 1 mark for the correct answer A. Award 0 marks for other options.

A flat tax system reduces the tax burden on high-income individuals relative to low-income individuals compared to a progressive tax system, which reduces the redistribution effect and worsens income equity. However, lowering the marginal tax rate on high-earning individuals increases their incentives to work and invest, reducing the deadweight loss of taxation and thereby improving economic efficiency.

Award 1 mark for the correct answer B. Award 0 marks for other options.

For price discrimination to occur, the firm must be a price searcher (possess market power) to set different prices, and must be able to prevent resale (arbitrage) between the segregated markets. A cost difference is not a necessary condition for price discrimination; in fact, price discrimination is defined as charging different prices for the same product/service when the price difference is NOT caused by cost differences.

Award 1 mark for the correct answer A. Award 0 marks for other options.

According to the Alchian-Allen Effect (or 'shipping the good apples out'), adding or increasing a fixed transportation cost (\( T \)) to both high-quality (\( P_H \)) and low-quality (\( P_L \)) goods, where \( P_H > P_L \), will lower the relative price of the high-quality good (\( (P_H + T)/(P_L + T) < P_H/P_L \)). By the Law of Demand, as the relative price of premium cherries decreases, consumers will substitute towards premium cherries, thereby increasing the proportion of premium cherries imported/consumed.

Award 1 mark for the correct answer A. Award 0 marks for other options.

An effective price ceiling creates a shortage (excess demand) because the quantity demanded exceeds the quantity supplied at the ceiling price. When production cost decreases, the supply curve shifts to the right. At the fixed ceiling price, the quantity supplied increases, which increases the quantity transacted. Since the quantity demanded at the ceiling price remains unchanged while the quantity supplied increases, the excess demand (shortage) must decrease. Producer surplus and consumer surplus will both increase.

1 mark for the correct option A. Correct explanation of supply shift and its impact on excess demand.

The opportunity cost of producing 1 smartphone for Country A is \(200 / 100 = 2\) T-shirts. The opportunity cost of producing 1 smartphone for Country B is \(120 / 80 = 1.5\) T-shirts. For mutually beneficial trade to occur, the terms of trade for 1 smartphone must lie between the opportunity costs of the two countries, i.e., \(1.5 < X < 2\). Among the choices, only 1.8 lies within this range.

1 mark for correct option C. Correct calculation of opportunity costs and determination of terms of trade range.

Occupational mobility of labour refers to the ease with which workers can switch from one occupation to another. Government-funded retraining schemes help workers acquire new skills required by other industries, thereby increasing their occupational mobility. Option A and D enhance geographical mobility.

1 mark for correct option B. Distinguishing occupational mobility from geographical mobility.

High inflation and overemployment indicate an inflationary gap. Contractionary policies are needed. Decreasing public expenditure is a contractionary fiscal policy, and selling government bonds in the open market reduces the monetary base and money supply, which is a contractionary monetary policy. Both act to reduce aggregate demand and stabilize the economy.

1 mark for correct option B. Correct identification of contractionary fiscal and monetary policies.

GDP measures the value of production within the domestic boundary of an economy. Since the flat is located in London, the production of housing services occurs outside Hong Kong and is not included in Hong Kong's GDP. GNI measures the income earned by residents of an economy from both domestic and external economic activities. Since the owner is a Hong Kong resident, the rental income is factor income from abroad, which is included in Hong Kong's GNI.

1 mark for correct option C. Correct application of GDP's geographic concept and GNI's residency concept.

The change in reserves is \(-\$100\). Since banks do not hold excess reserves, the banking system will contract deposits to the maximum extent. The maximum change in total deposits is \(\Delta Deposits = \Delta Reserves \times (1 / R) = -\$100 \times (1 / 0.20) = -\$500\).

1 mark for correct option C. Correct application of the credit contraction multiplier formula.

An increase in government infrastructure expenditure increases investment and government purchases, shifting the aggregate demand (AD) curve to the right, which raises both the price level and real output. A surge in world oil prices increases production costs, shifting the short-run aggregate supply (SRAS) curve to the left, which raises the price level but reduces real output. Combining both: the price level must rise, while the change in real output is unpredictable.

1 mark for correct option B. Correct analysis of AD and SRAS shifts and their combined effect.

When the actual inflation rate is higher than expected, the actual real interest rate (real cost of borrowing) is lower than expected. Debtors repay loans with money that has lower purchasing power than originally anticipated, meaning wealth is redistributed from creditors to debtors.

1 mark for correct option A. Correct explanation of wealth redistribution between debtors and creditors during unexpected inflation.

Price discrimination occurs when different prices are charged for the same good or service, or when price differences do not reflect cost differences. If the price difference is due to cost differences, it is not price discrimination. Therefore, a lower marginal cost for serving one group is not a necessary condition; in fact, the marginal cost is often identical.

1 mark for correct option D. Correct understanding of the concept and conditions of price discrimination.

Both perfect competition and monopolistic competition feature free entry and exit of firms in the long run (no barriers to entry or exit). Perfectly competitive firms face a horizontal demand curve and sell homogeneous products, while monopolistically competitive firms face downward-sloping demand and sell differentiated products. In the long run, both earn zero economic profit.

1 mark for correct option B. Correct comparison of competition models in the DSE syllabus.

Since the import quota restricts the import volume to the exact same level as under the tariff, the domestic price, domestic consumption, and consumer surplus remain unchanged. However, under the tariff, the government collects revenue, whereas under the quota, this revenue is lost (it is captured by quota holders as quota rent). Therefore, government revenue will decrease.

Award 1 mark for the correct option C. Award 0 marks for incorrect options.

Occupational mobility refers to the ability of a labor force to change jobs or occupations. Geographical mobility refers to the ability to change working locations. Since the job changed but the location remained in Hong Kong, this represents high occupational mobility but does not indicate geographical mobility.

Award 1 mark for the correct option A. Award 0 marks for incorrect options.

Under an effective price ceiling, there is excess demand (shortage). Since the market price is legally capped and cannot rise, when supply decreases (supply curve shifts left), the quantity supplied at the ceiling price decreases. The rent remains unchanged at the ceiling, and the quantity transacted (which equals the quantity supplied) decreases.

Award 1 mark for the correct option B. Award 0 marks for incorrect options.

The reduction in corporate profits tax stimulates private investment, shifting the Aggregate Demand (AD) curve to the right. The decrease in import prices of raw materials reduces production costs, shifting the Short-run Aggregate Supply (SRAS) curve to the right. Both shifts increase the real output, so real output will definitely rise. However, the rightward shift of AD increases the price level while the rightward shift of SRAS decreases it, making the net change in the general price level uncertain.

Award 1 mark for the correct option B. Award 0 marks for incorrect options.

An open market purchase of government bonds by the central bank injects liquidity into the banking system, increasing bank reserves and cash in circulation. This increases the money supply. As the money supply curve shifts to the right, the interest rate decreases.

Award 1 mark for the correct option A. Award 0 marks for incorrect options.

(1) is excluded because the production occurs outside Hong Kong's domestic boundary (it is part of HK's GNP but not GDP). (2) is included because the commission represents the value of current productive services provided by the agent within Hong Kong. (3) is excluded because it is a transfer payment with no current production involved. Therefore, only (2) is included.

Award 1 mark for the correct option A. Award 0 marks for incorrect options.

A decrease in supply shifts the supply curve left, leading to a higher equilibrium price and a lower quantity transacted. Since demand is price inelastic, the percentage increase in price is larger than the percentage decrease in quantity. Therefore, the total revenue (price multiplied by quantity) will increase.

Award 1 mark for the correct option B. Award 0 marks for incorrect options.

Country A can produce more Food (20 units) than Country B (15 units) with the same resources, so Country A has an absolute advantage in Food. The opportunity cost of producing 1 unit of Food in Country A is 10/20 = 0.5 units of Clothing, while in Country B it is 15/15 = 1 unit of Clothing. Since 0.5 < 1, Country A has a lower opportunity cost and thus a comparative advantage in Food.

Award 1 mark for the correct option A. Award 0 marks for incorrect options.

When $500,000 cash is deposited into the banking system, cash in public hands decreases by $500,000. Through the credit creation process, bank deposits can increase by a maximum of $500,000 * (1 / 0.20) = $2,500,000. Since Money Supply (M) = Cash in public hands + Bank deposits, the maximum change in money supply is -$500,000 + $2,500,000 = +$2,000,000.

Award 1 mark for the correct option B. Award 0 marks for incorrect options.

Price discrimination is the practice of charging different prices to different consumers for the same good/service (or when the price difference does not reflect cost differences). If the cost of serving adults is higher than that of serving students, the price difference might simply reflect cost differences rather than price discrimination. Thus, a difference in costs is NOT a necessary condition for price discrimination.

Award 1 mark for the correct option C. Award 0 marks for incorrect options.

1. An increase in the corporate profit tax rate reduces post-tax business profits, leading to a decrease in investment expenditure. This shifts the aggregate demand (AD) curve to the left.
2. A decrease in the price of imported raw materials reduces production costs for firms, which shifts the short-run aggregate supply (SRAS) curve to the right.
3. A leftward shift of the AD curve and a rightward shift of the SRAS curve both exert downward pressure on the price level. Therefore, the price level will definitely decrease.
4. However, the leftward shift of AD tends to decrease real output, while the rightward shift of SRAS tends to increase real output. Since the relative magnitudes of these two shifts are unknown, the net effect on the real output level is uncertain.

Choose B: 1 mark. Correct application of AD-AS model with shifts of AD to the left and SRAS to the right.

1. Calculate opportunity costs:
- Country A: Opportunity cost of producing 1C = 10R / 5 = 2R. Opportunity cost of producing 1R = 5C / 10 = 0.5C.
- Country B: Opportunity cost of producing 1C = 6R / 4 = 1.5R. Opportunity cost of producing 1R = 4C / 6 = 2/3C ≈ 0.67C.
2. Determine comparative advantage:
- Country B has a lower opportunity cost in producing Computers (1.5R < 2R), so Country B has a comparative advantage in Computers and will export Computers.
- Country A has a lower opportunity cost in producing Rice (0.5C < 0.67C), so Country A has a comparative advantage in Rice and will export Rice.
3. Analyze mutually beneficial terms of trade:
- For trade to be mutually beneficial, the price of 1C must lie between the opportunity costs of the two countries: 1.5R < 1C < 2R.
- Since the terms of trade is 1C = 1.8R, which lies within this range, both countries will gain from trade. Thus, option B is correct.
4. Analyze option D:
- Total gain from trading 1C = 2R - 1.5R = 0.5R.
- Since the transportation cost of 0.4R is less than the total gain of 0.5R, trade can still be mutually beneficial with a net gain of 0.1R shared between them.

Choose B: 1 mark. Correctly identifying the opportunity costs and verifying that the terms of trade lies between 1.5R and 2R.

1. A decrease in the required reserve ratio increases the maximum banking multiplier, allowing commercial banks to create more loans. This increases the money supply.
2. An increase in the money supply leads to lower interest rates, which stimulates consumption and investment, shifting aggregate demand (AD) to the right.
3. Meanwhile, the increase in salaries tax rates reduces disposable income for households, leading to a decrease in private consumption, which shifts AD to the left.
4. Since one policy shifts AD to the right and the other shifts AD to the left, the net effect on aggregate demand is uncertain and depends on the relative strength of the two policies.

Choose B: 1 mark. Correct application of monetary policy expansion on money supply and opposing effects of monetary and fiscal policies on aggregate demand.

1. An effective price floor is set above the equilibrium price, causing the market price to rise and the quantity traded to fall to the quantity demanded at that price floor.
2. Since consumers pay a higher price and buy a smaller quantity, consumer surplus must decrease. Statement (1) is correct.
3. The effect on producer surplus is uncertain. If demand is highly elastic, the reduction in quantity traded is very large, which can cause producer surplus to decrease. Statement (2) is incorrect.
4. Since the quantity traded is lower than the allocatively efficient quantity (where marginal benefit equals marginal cost), deadweight loss is created. Statement (3) is correct.
5. Because the price floor is above the equilibrium price, quantity supplied exceeds quantity demanded, resulting in a surplus (excess supply), not a shortage. Statement (4) is incorrect.
Therefore, only (1) and (3) are correct.

Choose A: 1 mark. Correct analysis of price floor effects on consumer surplus, producer surplus, efficiency, and market surplus/shortage.

1. Occupational mobility refers to the ability of a labor force to change from one occupation/industry to another. Since Mr. Chan successfully and quickly changed his job from a software engineer to a taxi driver (two completely different occupations), he exhibits high occupational mobility.
2. The fact that his new workplace is near his home does not demonstrate low geographical mobility, as it does not imply he is unable or unwilling to move to another location if needed; it is simply a preference or convenience. Therefore, option A is the correct answer.

Choose A: 1 mark. Correct definition and application of occupational mobility of labour.

1. A technological breakthrough in the manufacturing sector increases productivity, which shifts the short-run aggregate supply (SRAS) curve to the right.\n2. An increase in the profit tax rate reduces post-tax investment returns, leading to a decrease in investment expenditure. This shifts the aggregate demand (AD) curve to the left.\n3. Since both the rightward shift of SRAS and the leftward shift of AD lead to a drop in the general price level, the price level will definitely decrease.\n4. However, the rightward shift of SRAS tends to increase real output, while the leftward shift of AD tends to decrease real output. Therefore, the change in real output is uncertain, depending on the relative magnitudes of the two shifts.

- State that SRAS shifts to the right due to the technological breakthrough (1.5 marks)\n- State that AD shifts to the left due to the increase in profit tax rate (1.5 marks)\n- Conclude that the general price level decreases (1 mark)\n- Conclude that the change in real output is uncertain (0.88 marks)

1. After the tariff is imposed, the domestic price of wheat rises. This leads to a decrease in the quantity demanded of wheat. As a result, consumer surplus decreases.\n2. The tariff leads to a deadweight loss because: (a) domestic production expands, replacing cheaper imports with more expensive domestic production, and (b) domestic consumption contracts, causing consumers to lose transactions where marginal benefit exceeds marginal cost. Therefore, the total social surplus of Country A decreases.

- Explain the decrease in consumer surplus due to the increase in price (2 marks)\n- Explain that total social surplus decreases due to deadweight loss (1 mark)\n- Elaborate on the sources of inefficiency: production inefficiency and consumption inefficiency (1.88 marks)

1. To cool down the economy, the central bank should sell government bonds in the open market to commercial banks and the public. This reduces the reserves of banks, leading to a contraction of the monetary base and the money supply.\n2. The decrease in money supply pushes up interest rates, which increases the cost of borrowing. Consequently, private consumption and investment expenditures decrease, shifting aggregate demand (AD) to the left, which reduces the inflation rate.\n3. One limitation is the time lag, as it takes time for changes in the interest rate to affect investment and consumption behaviors, making the policy less effective in the short run.

- State that the central bank should sell government bonds (1 mark)\n- Explain the chain of effects: bank reserves decrease -> money supply decreases -> interest rates rise -> aggregate demand decreases (2.5 marks)\n- Identify one valid limitation, e.g., time lag or interest-inelastic investment demand (1.38 marks)

(a) When the price ceiling is set below the equilibrium rent, the quantity demanded increases while the quantity supplied decreases. Since transactions require mutual agreement, the quantity transacted is determined by the shorter side of the market (i.e., quantity supplied). Therefore, the quantity transacted decreases to the quantity supplied at the price ceiling.\n(b) At the price ceiling, there is a shortage (excess demand) of rental housing. Because price is legally restricted from rising to the equilibrium level, it can no longer function to allocate the housing to those who are willing to pay the highest prices. Thus, alternative non-price rationing mechanisms (such as queuing or first-come-first-served) must emerge to allocate the scarce rental units.

Part (a):\n- Explain that quantity supplied decreases and becomes the transaction volume (1.5 marks)\n- State that the quantity transacted is lower than the equilibrium level (1 mark)\n\nPart (b):\n- Mention that there is a shortage / excess demand (1 mark)\n- Explain that price cannot adjust to clear the market, requiring non-price criteria for allocation (1.38 marks)

(a) The occupational mobility of labour is low. Occupational mobility refers to the ease with which workers can switch from one occupation to another. In this case, the guide has specialised skills in tourism but lacks the technical programming skills required for the new job, creating a skills mismatch.\n(b) The government can offer professional retraining courses (e.g., through the Employees Retraining Board) or provide subsidies for acquiring new skills (e.g., the Continuing Education Fund) to help workers transition to new industries.

Part (a):\n- Identify occupational mobility of labour (1 mark)\n- Define/explain occupational mobility (1 mark)\n- Apply to the scenario (lack of programming skills / skills mismatch) (0.88 marks)\n\nPart (b):\n- Suggest a valid policy (e.g., retraining courses or skill subsidies) (2 marks)

(a) The maximum change in total bank deposits \n= \text{Excess Reserves} / \text{Required Reserve Ratio} \n= \$50 \text{ million} / 20\% \n= \$250 \text{ million}.\n\n(b) Since there is no cash leakage, all the loans created will be redeposited back into the banking system, and the public's cash holding remains unchanged. Under these conditions, the change in money supply is equal to the change in total bank deposits. Thus, the maximum possible change in money supply is also \$250 \text{ million}.

Part (a):\n- Show formula or working: \$50 million / 0.2 (1.5 marks)\n- Correct answer with unit: \$250 million (1 mark)\n\nPart (b):\n- Explain that change in money supply equals change in deposits when there is no cash leakage (1.38 marks)\n- Correct answer with unit: \$250 million (1 mark)

(a) The purchase price of the second-hand car is NOT included because it does not involve any current production (it was counted in the year it was produced). However, the \$3,000 commission paid to the dealer IS included because it represents a payment for current productive services provided by a local resident producer.\n(b) The \$50,000 service fee IS included. The consulting service is produced by a resident production unit in Hong Kong. Since GDP measures the value of production of resident units within the domestic territory, the location of the buyer (London) does not affect its inclusion.

Part (a):\n- Correctly state that the car price is excluded and the commission is included (1 mark)\n- Explain that the car price represents past production (0.75 marks)\n- Explain that the commission represents current productive service by a resident (0.75 marks)\n\nPart (b):\n- Correctly state that the service fee is included (1 mark)\n- Explain that it is provided by a resident production unit within the domestic territory (1.38 marks)

(a) Price elasticity of demand (\( E_d \)) \n= \| \frac{\% \text{ change in quantity demanded}}{\% \text{ change in price}} \|\n= \| \frac{10\%}{-15\%} \| \approx 0.67 \n(Note: Both negative and positive values are acceptable as long as calculation is correct).\n\n(b) Since the price elasticity of demand is less than 1 (\( E_d < 1 \)), the demand is inelastic. This means that the percentage increase in quantity demanded (10%) is smaller than the percentage decrease in price (15%). Therefore, the gain in revenue from selling more tickets is smaller than the loss in revenue from the lower price, causing the total revenue to decrease.

Part (a):\n- Show working: 10% / -15% (1.5 marks)\n- Correct answer: 0.67 or -0.67 (1 mark)\n\nPart (b):\n- State that demand is inelastic (0.5 marks)\n- Explain that the percentage increase in quantity demanded is smaller than the percentage decrease in price (1 mark)\n- Conclude that total revenue decreases (0.88 marks)

(a) The person holding the fixed-rate mortgage will GAIN from the unanticipated inflation. Inflation reduces the purchasing power of money, which means the real value of the fixed monthly mortgage payments decreases. Therefore, the debtor pays back the loan in money that is worth less in real terms.\n(b) The retired person will LOSE. Since the monthly pension is fixed in nominal terms, the rise in the general price level means the purchasing power of this fixed income declines. The retired person can buy fewer goods and services, leading to a drop in their real income.

Part (a):\n- State that the person will gain (1 mark)\n- Explain that the real value of fixed debt repayments decreases / the debtor pays back in less valuable dollars (1.5 marks)\n\nPart (b):\n- State that the retired person will lose (1 mark)\n- Explain that the fixed nominal income buys less / real income decreases due to the higher price level (1.38 marks)

(a) Under free trade, since Country A is a small open economy, the domestic price is equal to the world price \(P_w\). At \(P_w\), the domestic demand quantity is \(Q_d\), which represents domestic consumption. The domestic supply quantity is \(Q_s\), which represents domestic production. Since consumption exceeds production, the shortage \(Q_d - Q_s\) is satisfied by importing good X.

(b)(i) When an import tariff of \(t\) is imposed, the domestic price increases to \(P_w + t\). Consequently, domestic consumption decreases to \(Q_d'\), domestic production increases to \(Q_s'\), and the import volume shrinks to \(Q_d' - Q_s'\). The tariff revenue collected is represented by the rectangular area: \((Q_d' - Q_s') \times t\).

(b)(ii) The tariff leads to a deadweight loss consisting of two parts:
- Production loss (left triangle): Domestic production increases from \(Q_s\) to \(Q_s'\). Since the marginal cost of domestic production for these extra units is higher than the world price (import cost), resources are misallocated, creating production inefficiency.
- Consumption loss (right triangle): Domestic consumption decreases from \(Q_d'\) to \(Q_d\). Consumers lose consumer surplus on units they value more than the social marginal cost (world price), creating consumption inefficiency.

(c)(i) If the quota licenses are distributed to domestic importers for free, the government will not receive any tariff revenue (government revenue drops to zero). Instead, the holders of the quota licenses will earn a windfall profit known as quota rent, which is equivalent to the previous tariff revenue. The total deadweight loss to society remains unchanged.

(c)(ii) If the quota licenses are sold through a competitive auction, the competitive bidding will drive the license price up to \(t\). The government will collect auction revenue equivalent to the tariff revenue. Thus, the welfare distribution and overall economic effects will be identical to those under the tariff.

(a) Diagram (3 marks):
- Correctly labeled axes, demand (D), supply (S), and world price (\(P_w\)) line below autarky price. (1 mark)
- Correct labeling of domestic consumption (\(Q_d\)) and production (\(Q_s\)). (1 mark)
- Correct labeling of imports (\(Q_d - Q_s\)). (1 mark)
Written explanation (2 marks):
- Explain that domestic price equals world price under free trade. (1 mark)
- Explain that the difference between demand and supply is imported. (1 mark)

(b)(i) Diagram (4 marks):
- Price line shifts up to \(P_w + t\). (1 mark)
- New domestic consumption \(Q_d'\) and production \(Q_s'\) correctly indicated. (1 mark)
- New import volume \(Q_d' - Q_s'\) indicated. (1 mark)
- Tariff revenue area correctly shaded/indicated. (1 mark)

(b)(ii) Explanation (3 marks):
- Explain production loss (inefficiency from producing at higher domestic cost instead of importing). (1.5 marks)
- Explain consumption loss (inefficiency from reduced consumption of highly valued goods). (1.5 marks)

(c)(i) Explanation (2 marks):
- State that government tariff revenue becomes zero. (1 mark)
- State that private importers gain quota rent, so total social deadweight loss remains unchanged. (1 mark)

(c)(ii) Explanation (1 mark):
- State that competitive auction yields government revenue equal to the tariff revenue, making the welfare effect identical to the tariff. (1 mark)

(a) Country B is experiencing a deflationary gap (or recessionary gap / negative output gap).

(b) The AD-AS diagram should feature:
- A downward-sloping AD curve and an upward-sloping SRAS curve intersecting at \((P_1, Y_1)\).
- A vertical LRAS curve positioned to the right of \(Y_1\) at the potential output level \(Y_f\).
- The gap between \(Y_1\) and \(Y_f\) represents the deflationary gap.

(c)(i) Two policy instruments the central bank can use are:
- Lowering the required reserve ratio (which allows commercial banks to lend out more reserves).
- Conducting open market operations by purchasing government bonds (which injects liquidity into the banking system).
(Other acceptable answers: lowering the discount/bank rate, lowering the interest rate on excess reserves.)

(c)(ii) Transmission mechanism:
- The expansionary monetary policy increases the money supply / reserves in the banking system, which leads to a decrease in interest rates.
- Lower interest rates reduce the cost of borrowing for firms and consumers, stimulating private consumption expenditure (\(C\)) and investment expenditure (\(I\)).
- Since \(C\) and \(I\) are components of aggregate demand (\(AD = C + I + G + NX\)), the aggregate demand curve shifts to the right.

(c)(iii) On the diagram, the AD curve shifts to the right from \(AD_1\) to \(AD_2\). The new short-run equilibrium is at the intersection of \(AD_2\) and \(SRAS\), leading to a higher price level \(P_2\) and higher output level \(Y_2\) (where \(Y_1 < Y_2 < Y_f\)).

(d)(i) Policy lags concepts:
- Inside lag: The time delay between when an economic shock occurs and when policymakers recognize it and implement a policy action.
- Outside lag: The time delay between when a policy is implemented and when it actually affects real economic variables like real GDP, employment, and consumption.

(d)(ii) The economist's claim is incorrect. Although monetary policy typically has a shorter inside lag than fiscal policy (as central banks can make decisions quickly without legislative approval), it suffers from a longer and more variable outside lag because it takes considerable time for changes in interest rates to affect investment and consumption behaviors in the real economy.

(a) Deflationary gap / Recessionary gap / Negative output gap (1 mark)

(b) Diagram (4 marks):
- Correct axes labels (Price level and Real GDP/Output). (0.5 mark)
- Downward-sloping AD, upward-sloping SRAS intersecting at \(P_1, Y_1\). (1.5 marks)
- Vertical LRAS curve correctly drawn to the right of \(Y_1\) at \(Y_f\). (1 mark)
- Correct labeling of the initial output gap. (1 mark)

(c)(i) Identify any two correct tools: open market purchase, lowering reserve requirements, lowering discount rate. (1 mark for each, max 2 marks)

(c)(ii) Explanation (3 marks):
- Policy leads to increase in money supply and decrease in interest rate. (1 mark)
- Decrease in interest rate stimulates Consumption (C) and Investment (I). (1 mark)
- Increase in C and I leads to rightward shift in AD. (1 mark)

(c)(iii) Diagram (2 marks):
- Show AD curve shifting to the right. (1 mark)
- Indicate new higher price level \(P_2\) and higher output \(Y_2\), still below \(Y_f\). (1 mark)

(d)(i) Explanation of lags (2 marks):
- Correct definition of inside lag. (1 mark)
- Correct definition of outside lag. (1 mark)

(d)(ii) Evaluation (1 mark):
- Point out that the statement is incorrect because monetary policy still suffers from a long outside lag. (1 mark)

(a)
- Year 1 Real GDP = \( C + I + G + (X - M) \) = \( 500 + 150 + 120 + (180 - 200) = $750 \) billion.
- Year 2 Real GDP = \( 520 + 140 + 130 + (170 - 210) = $750 \) billion.
- No, Country X did not experience economic growth. Economic growth is measured by the percentage change in real GDP. Since the real GDP remained unchanged at $750 billion, the growth rate was 0%.

(b)
- A cut in the personal income tax rate increases disposable income of households.
- This leads to an increase in private consumption expenditure (C).
- Since C is a component of aggregate demand, aggregate demand increases and the AD curve shifts to the right.
- Diagram: Show correct axes (Price Level P, Real Output Y), initial AD1 and SRAS curves, a rightward shift of AD to AD2, and an increase in both price level and real output.

(c)
(i)
- An increase in the cash reserve ratio decreases the maximum banking multiplier.
- Commercial banks are required to hold more reserves, reducing their excess reserves available for loans.
- The credit creation capability of banks decreases, leading to a contraction/decrease in the money supply.
(ii)
- A decrease in money supply increases interest rates, which reduces investment (I) and private consumption (C), causing AD to decrease.
- Since the effect of the cash reserve ratio dominates, the net effect is a leftward shift of the AD curve from AD2 to AD3 (to the left of the original AD1).
- In the diagram, show the final AD3 curve to the left of AD1, with a lower price level and lower real output than the original equilibrium.

(d)
(i)
- Consumer surplus: A tariff increases the domestic price of imported goods. Consumers buy fewer imported goods at a higher price, leading to a decrease in consumer surplus.
- Government revenue: The government collects tariff revenue equal to the tariff per unit multiplied by the volume of imports. Thus, government revenue increases.
(ii)
- Consistencies/Inconsistencies with equity:
- Inconsistent: Tariffs on consumer goods are often regressive. Lower-income groups spend a larger proportion of their income on these protected goods, so they bear a heavier burden relative to their income, worsening income inequality.
- Consistent: A tariff protects the domestic manufacturing industry. This preserves jobs and supports the incomes of low-skilled domestic manufacturing workers, preventing them from falling into poverty, which may improve equity.

(a) [Total: 5 marks]
- Formula and calculation for Year 1: $750 billion [1M for working, 1A for answer]
- Calculation for Year 2: $750 billion [1A]
- State 'No economic growth' [1A]
- Explanation: Economic growth is the percentage change in real GDP. Since real GDP remains unchanged, growth is 0%. [1M]

(b) [Total: 6 marks]
- Income tax cut -> Disposable income increases -> C increases -> AD increases [3M]
- Diagram:
- Correct axes labels and initial equilibrium [1M]
- Rightward shift of AD curve [1M]
- Indication of higher price level and output [1M]

(c) [Total: 8 marks]
(i) [4 marks]
- Max banking multiplier decreases [1M]
- Excess reserves decrease / bank loans decrease [1M]
- Credit creation contracts [1M]
- Money supply decreases [1M]
(ii) [4 marks]
- Explain: Money supply decrease -> Interest rate increase -> I & C decrease -> AD decreases [1M]
- Since reserve ratio effect dominates, AD net shifts left (to the left of AD1) [1M]
- Diagram: Show AD3 to the left of AD1 [1M]
- Show new lower price level and output [1M]

(d) [Total: 11 marks]
(i) [5 marks]
- Consumer surplus decreases: Import price increases, consumers pay more and buy less imports. [2M for explanation, 1M for direction]
- Government revenue increases: Government collects tariff per unit * import quantity. [1M for explanation, 1M for direction]
(ii) [6 marks]
- Arguing tariff is regressive / hurts the poor more (worsens equity) [3M]
- Arguing tariff protects local manufacturing workers' jobs/incomes (improves equity) [3M]