2022 HKDSE Economics Answers & Marking Scheme

To close an inflationary gap, contractionary policies are required. Reducing government transfer payments is a contractionary fiscal policy, which reduces aggregate demand (AD). Selling government bonds in the open market is a contractionary monetary policy, which reduces the money supply and increases interest rates, thereby reducing consumption and investment demand (AD). Option A and Option B contain expansionary policies. Option D contains an expansionary monetary policy (lowering the discount rate). Therefore, Option C is the correct answer.

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

In Country A, the opportunity cost of producing 1 unit of W is \(2 / 4 = 0.5\) units of T. In Country B, the opportunity cost of producing 1 unit of W is \(2 / 2 = 1\) unit of T. Since Country A has a lower opportunity cost in producing W, it will specialize in and export W. Country B will import W. For trade to be mutually beneficial, the price of 1 unit of W must lie between the opportunity costs of the two countries, which is: \(0.5 \text{ units of Toys} < 1 \text{ unit of Smart watch} < 1 \text{ unit of Toy}\). Thus, Option A is correct.

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

The scientific study increases the preferences for coffee, causing the demand for coffee beans to increase (demand curve shifts to the right). The severe drought in major producing countries reduces the harvest, causing the supply of coffee beans to decrease (supply curve shifts to the left). An increase in demand and a decrease in supply will definitely cause the equilibrium price to rise. However, the change in equilibrium quantity is uncertain as it depends on the relative magnitudes of the shifts in demand and supply. Therefore, Option A is correct.

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

A rise in international oil prices increases the production costs for firms in an oil-importing economy. This causes the short-run aggregate supply (SRAS) to decrease (the SRAS curve shifts to the left). As a result, the short-run macroeconomic equilibrium shifts along the aggregate demand (AD) curve, leading to a higher price level (inflation) and a lower level of real output (recession). Therefore, Option B is correct.

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

The maximum deposit creation multiplier is \(1 / R = 1 / 0.20 = 5\). The maximum total deposits that can be supported by the \$100,000 cash deposit is \(\$100,000 \times 5 = \$500,000\). Total credit (loans) created by the entire banking system is equal to the change in total deposits minus the change in reserves (which equals the initial cash deposit), i.e., \(\$500,000 - \$100,000 = \$400,000\). Therefore, Option B is correct.

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

(1) is included because the commission represents a service produced within Hong Kong's domestic boundary during the current period. (2) is included because it is an export of services produced by a resident production unit in Hong Kong. (3) is a transfer payment, which does not involve any current production, so it is excluded. (4) is a financial transaction (transfer of ownership of existing assets/claims), which does not involve any production of new goods or services, so it is excluded. Thus, only (1) and (2) are included. Option A is correct.

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

Since the HKD is pegged to the USD, any change in the exchange rate of the USD against other currencies is mirrored by the HKD. (1) Since the USD depreciates against the EUR, the HKD will also depreciate against the EUR. This statement is correct. (2) As the HKD depreciates against the EUR, Hong Kong goods become cheaper in terms of EUR, making HK exports to Europe more price competitive. This statement is correct. (3) A depreciated HKD means it takes more HKD to buy EUR, so travelling to Europe becomes more expensive, not less. This statement is incorrect. (4) Since the EUR appreciates against the HKD, imports from Europe will become more expensive in HKD terms. This statement is incorrect. Therefore, Option A is correct.

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

The price elasticity of demand is 1.5, which is greater than 1, indicating that demand is elastic. When demand is elastic, the percentage decrease in quantity demanded is greater than the percentage increase in price. Specifically, a 10% increase in price leads to a \(10\% \times 1.5 = 15\%\) decrease in quantity demanded. Since the percentage decrease in quantity demanded (15%) is greater than the percentage increase in price (10%), the total revenue (Price \(\times\) Quantity) will decrease. Thus, Option B is correct.

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

Opportunity cost is the value of the highest-valued alternative forgone. If Susan chooses Option X, her forgone alternatives are Option Y and Option Z. The net value of Option Y is the wage of \$150. The net value of Option Z is its valuation minus the cost, which is \(\$180 - \$80 = \$100\). Comparing the forgone alternatives, Option Y has the highest net value (\$150 > \$100). Therefore, the opportunity cost of choosing Option X is the value of Option Y, which is \$150. Option A is correct.

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

A price floor is a government-imposed minimum price above which the market price is allowed to be. If the price floor is set below the equilibrium price, it is non-binding (ineffective). The market forces of demand and supply will keep the price at the equilibrium level. Therefore, there will be no change in either the market price or the quantity traded of the good. Thus, Option C is correct.

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

Let's calculate the opportunity cost of producing 1 unit of clothing (C) in both countries:
- For Country A: opportunity cost of 1C = \( 10 / 5 = 2 \) units of food (F).
- For Country B: opportunity cost of 1C = \( 8 / 2 = 4 \) units of food (F).
Since Country A has a lower opportunity cost in producing clothing (2F < 4F), it has a comparative advantage in clothing. Country B has a comparative advantage in food.
For trade to be mutually beneficial, the terms of trade for 1 unit of clothing must lie between the two countries' opportunity costs: \( 2F < 1C < 4F \).
Option C suggests 1C is traded for 3F, which lies within this range (between 2F and 4F). Thus, both countries will benefit.

Award 1 mark for selecting the correct option C.

The actual money multiplier is determined by the total reserves (required + excess) and cash leakage. An increase in the required reserve ratio decreases the maximum money multiplier. At the same time, when commercial banks hold more excess reserves, they lend out less, which directly reduces the actual money multiplier. Therefore, both actions will lead to a decrease in the actual money multiplier.

Award 1 mark for selecting the correct option A.

Relaxing the import quota increases the market supply of Japanese beef (supply curve shifts right), which tends to lower the equilibrium price and increase the equilibrium quantity.
The scientific report on health risks decreases the consumer demand for Japanese beef (demand curve shifts left), which tends to lower both the equilibrium price and equilibrium quantity.
Combining both shifts: the equilibrium price will definitely decrease, while the effect on equilibrium quantity is uncertain as it depends on the relative magnitude of the shifts.

Award 1 mark for selecting the correct option A.

An increase in the price of imported raw materials increases the cost of production, which shifts the Short-run Aggregate Supply (SRAS) curve to the left. This causes the price level to rise and real GDP to fall.
An increase in government spending on infrastructure increases aggregate demand, shifting the Aggregate Demand (AD) curve to the right. This causes both the price level and real GDP to rise.
When SRAS shifts left and AD shifts right: the aggregate price level will definitely increase, while the change in real GDP is uncertain.

Award 1 mark for selecting the correct option A.

GDP is measured based on the location of production. Since the property is located in London, the housing service is produced within the economic territory of the UK, so it is included in the UK's GDP.
GNI (GNP) is measured based on the residency of the factor owner. Since the owner is a Hong Kong resident, the rental income (which is property income from abroad) is included in Hong Kong's GNI. It is not included in Hong Kong's GDP because the production did not take place in Hong Kong.

Award 1 mark for selecting the correct option B.

Let \( C_0 \) be the initial cash held by the public.
Initial maximum money supply = \( C_0 + \text{Max Deposits}_0 = C_0 + \frac{400}{0.25} = C_0 + 1,600 \) million.
After the public withdraws \$100 million:
- Cash held by the public becomes \( C_0 + 100 \) million.
- Reserves in the banking system decrease to \( 400 - 100 = 300 \) million.
New maximum deposits that can be created with \$300 million of reserves = \( \frac{300}{0.25} = 1,200 \) million.
New maximum money supply = \( (C_0 + 100) + 1,200 = C_0 + 1,300 \) million.
Change in maximum money supply = \( (C_0 + 1,300) - (C_0 + 1,600) = -300 \) million.
Therefore, the maximum possible money supply will decrease by \$300 million.

Award 1 mark for selecting the correct option A.

The price elasticity of demand is 1.5, which is greater than 1 (elastic demand).
When demand is price-elastic, the percentage change in quantity demanded is greater than the percentage change in price.
Thus, if price decreases, the percentage increase in quantity demanded will be greater than the percentage decrease in price, leading to an increase in total revenue.

Award 1 mark for selecting the correct option A.

Let's calculate the marginal product (MP) of each additional worker:
- 1st worker: \( 10 \) units
- 2nd worker: \( 24 - 10 = 14 \) units
- 3rd worker: \( 42 - 24 = 18 \) units
- 4th worker: \( 56 - 42 = 14 \) units
- 5th worker: \( 65 - 56 = 9 \) units
- 6th worker: \( 70 - 65 = 5 \) units
The marginal product increases up to the 3rd worker (from 10 to 14, then to 18) and starts to decrease with the employment of the 4th worker (falling to 14). Therefore, the Law of Diminishing Marginal Returns starts to operate with the employment of the 4th worker.

Award 1 mark for selecting the correct option C.

Since the HKD is pegged to the USD, when the USD depreciates against the Euro, the HKD will also depreciate against the Euro.
As a result, Hong Kong goods become cheaper in terms of Euros. Thus, the price of Hong Kong exports in terms of Euros will decrease.
This makes Hong Kong's exports more competitive in European markets. European goods imported to Hong Kong will become more expensive in terms of HKD.

Award 1 mark for selecting the correct option B.

An effective price ceiling is set below the equilibrium price. This creates excess demand (a shortage) of rental housing.
Since landlords cannot raise rent legally to clear the market, they have no incentive to maintain the quality of the flats or compete for tenants. Instead, they may let the quality of rental housing deteriorate (reducing repair/maintenance costs) or engage in non-price discrimination.

Award 1 mark for selecting the correct option C.

To find the comparative advantage, we calculate the opportunity cost of producing 1 unit of food in terms of clothing:\n- Country X: \(40 \text{ clothing} / 20 \text{ food} = 2 \text{ clothing}\).\n- Country Y: \(30 \text{ clothing} / 10 \text{ food} = 3 \text{ clothing}\).\nSince Country X has a lower opportunity cost in producing food, it has a comparative advantage in food. Conversely, Country Y has a comparative advantage in clothing.\nThe terms of trade must lie between the opportunity costs of the two countries for mutually beneficial trade: \(2 \text{ clothing} < 1 \text{ food} < 3 \text{ clothing}\).\nSince \(2.5 \text{ clothing}\) lies within this range, both countries will gain from trade.

Award 1 mark for selecting correct option C. Incorrect options award 0 marks.

A government subsidy to buyers of electric vehicles (EVs) will increase the demand for EVs, shifting the demand curve to the right. Concurrently, a reduction in the cost of lithium batteries (an input) will decrease the production cost, shifting the supply curve of EVs to the right. When both demand and supply shift to the right, the equilibrium quantity will definitely increase, while the equilibrium price may increase, decrease, or remain unchanged, depending on the relative magnitude of the shifts in demand and supply.

Award 1 mark for selecting correct option B. Incorrect options award 0 marks.

An increase in the prices of imported oil and raw materials raises the cost of production for domestic firms. This causes the short-run aggregate supply (SRAS) curve to shift to the left (upward). As a result, the equilibrium real GDP decreases, and the price level increases, a phenomenon known as stagflation.

Award 1 mark for selecting correct option B. Incorrect options award 0 marks.

A reduction in the required reserve ratio increases the excess reserves of commercial banks, allowing them to create more credit and increase the money supply. However, if commercial banks hold large excess reserves and are reluctant to lend (e.g., due to pessimistic economic outlook or high credit risks), the credit creation process will be disrupted, making the expansionary monetary policy less effective.

Award 1 mark for selecting correct option A. Incorrect options award 0 marks.

If an import quota and a tariff achieve the same level of domestic production, they must result in the same domestic price and import quantity. Thus, consumer surplus and domestic production surplus are identical under both policies. However, under a tariff, the government receives tariff revenue. Under a quota where licenses are allocated to domestic importers for free, the government receives zero revenue (the quota rent goes to domestic importers). Therefore, government revenue is lower under the quota.

Award 1 mark for selecting correct option B. Incorrect options award 0 marks.

During an economic recovery, real output and national income rise. This leads to an increase in corporate profits and individual incomes, thereby raising tax revenues from profits tax and salaries tax automatically. At the same time, unemployment falls, reducing government spending on unemployment benefits. These automatic stabilizers work together to narrow the budget deficit.

Award 1 mark for selecting correct option B. Incorrect options award 0 marks.

According to the relationship between price elasticity of demand and total revenue, if demand is elastic (elasticity > 1), a percentage decrease in price leads to a larger percentage increase in quantity demanded, causing total revenue to increase. In this case, price drops by 10% and total revenue increases by 5%, which indicates that the demand is elastic.

Award 1 mark for selecting correct option C. Incorrect options award 0 marks.

An increase in government spending on infrastructure shifts the aggregate demand (AD) curve to the right. In the short run, real output and price level both rise. In the long run, as input prices and wages adjust upwards, the short-run aggregate supply (SRAS) curve shifts to the left until the economy returns to its full-employment level of output (vertical LRAS). Therefore, in the long run, the real output remains unchanged at the full-employment level, while the price level increases permanently.

Award 1 mark for selecting correct option A. Incorrect options award 0 marks.

When the government sets a price floor above the equilibrium price and purchases all the surplus, the price received by producers rises to the floor price, and the quantity they sell increases to the quantity supplied at that price. Thus, producer surplus increases significantly. Consumer surplus decreases because consumers pay a higher price and buy a smaller quantity.

Award 1 mark for selecting correct option B. Incorrect options award 0 marks.

1. Rental income received by a Hong Kong resident from a London property is factor income earned by a Hong Kong resident from abroad. It is included in Hong Kong's GNI, but not in GDP, as the production (housing service) took place outside Hong Kong.\n2. The salary earned by a Japanese consultant working in Hong Kong for two weeks is factor income earned by a non-resident within the domestic territory of Hong Kong. It is included in Hong Kong's GDP (since the economic activity took place in Hong Kong) but excluded from Hong Kong's GNI.

Award 1 mark for selecting correct option B. Incorrect options award 0 marks.

First, calculate the opportunity cost of producing 1W for each country:\n- For Country A: \( 1\text{W} = 20 / 40 = 0.5\text{G} \)\n- For Country B: \( 1\text{W} = 30 / 30 = 1\text{G} \)\n\nCountry A has a comparative advantage in producing Smart Watches (W) because its opportunity cost is lower (\( 0.5\text{G} < 1\text{G} \)). Therefore, Country A will export W and Country B will import W.\n\nFor Country A (the exporter) to gain from trade, the price of 1W must cover both its domestic opportunity cost and the transportation cost:\n\( \text{Minimum price} = 0.5\text{G} + 0.1\text{G} = 0.6\text{G} \).\n\nFor Country B (the importer) to gain from trade, the price of 1W must be lower than its domestic opportunity cost of producing W:\n\( \text{Maximum price} = 1\text{G} \).\n\nThus, the mutually beneficial terms of trade must satisfy:\n\( 0.6\text{G} < 1\text{W} < 1\text{G} \).\nOnly Option C (\( 1\text{W} = 0.8\text{G} \)) falls within this range.

Correct option is C (1 mark).

An increase in the required reserve ratio reduces the bank multiplier and the lending capacity of commercial banks, which decreases the money supply. Simultaneously, selling government bonds to the public decreases the monetary base as the public pays the central bank, which also decreases the money supply. As the money supply decreases, ceteris paribus, the equilibrium nominal interest rate will increase in the money market.

Correct option is B (1 mark).

The technological breakthrough reduces production costs, which increases the supply of EVs (supply curve shifts right). The tax increase on petrol vehicles makes petrol vehicles more expensive to own, which increases the demand for their substitute, EVs (demand curve shifts right). When both demand and supply increase, the equilibrium quantity of EVs will definitely increase. However, the effect on the equilibrium price depends on the relative magnitudes of the shifts. Thus, the change in equilibrium price is uncertain.

Correct option is C (1 mark).

Increased planned investment shifts the Aggregate Demand (AD) curve to the right. A surge in crude oil prices increases the cost of production across industries, which shifts the Short-run Aggregate Supply (SRAS) curve to the left. The rightward shift of AD increases both real GDP and the price level. The leftward shift of SRAS increases the price level but decreases real GDP. Combined, the general price level will definitely rise. The net change in real GDP is uncertain and depends on which shift is larger.

Correct option is B (1 mark).

Under both trade barriers, the import quantity is restricted to the exact same level. Because the domestic demand and domestic supply curves remain unchanged, the equilibrium price that clears the domestic market must be identical under both the tariff and the quota. Consequently, the domestic quantity supplied (domestic production) is the same under both. Government revenue under the tariff is positive, whereas under a quota with free distribution of licenses, government revenue is zero, making Option B incorrect.

Correct option is C (1 mark).

Since coffee and sugar are complements in consumption, an increase in the price of sugar (due to a decrease in its supply) will lead to a decrease in the demand for coffee (the demand curve for coffee shifts to the left). This shift to the left causes both the equilibrium price and equilibrium quantity of coffee to decrease, which explains why the total revenue of coffee shops decreases. Thus, the demand for coffee must have decreased.

Correct option is C (1 mark).

To stimulate aggregate demand (expansionary fiscal policy), the government can decrease taxes (which increases disposable income and thus consumption/investment) and increase government expenditure (which directly increases aggregate demand). Option B combines both a tax cut and an expenditure increase, making it highly effective.

Correct option is B (1 mark).

In a closed economy with no government, the multiplier is given by:\n\( \text{Multiplier} = \frac{1}{\text{MPS}} = \frac{1}{0.25} = 4 \).\n\nThe change in equilibrium national income (\( \Delta Y \)) is:\n\( \Delta Y = \text{Multiplier} \times \Delta I = 4 \times \$50 \text{ million} = \$200 \text{ million} \) (increase).

Correct option is D (1 mark).

When the government provides an export subsidy of \( \$s \), exporters can receive the world price plus \( \$s \) for every unit they sell abroad. To be willing to sell domestically, domestic consumers must pay this higher price. Thus, the domestic price rises to \( P_{\text{world}} + s \). At this higher price, domestic quantity demanded (consumption) decreases, domestic quantity supplied increases, and the volume of exports increases. Consumer surplus decreases and producer surplus increases.

Correct option is B (1 mark).

A price ceiling below the equilibrium level leads to a shortage of residential rentals. Since landlords cannot charge higher rental prices to clear the market, they may resort to non-price adjustments, such as reducing the quality of housing maintenance, to lower their costs and increase effective returns. The quantity traded decreases to the quantity supplied at the ceiling price (which is lower than equilibrium), and total revenue (Price x Quantity) decreases.

Correct option is C (1 mark).

(1) is a possible outcome: The tax cut shifts Aggregate Demand (AD) to the right, while the bond sale shifts AD to the left. Since the net effect on AD is uncertain, AD could remain unchanged, leading to an unchanged general price level.
(2) is a possible outcome: The tax cut increases transaction demand for money, and the bond sale reduces the money supply. Both effects push up the interest rate, so the real interest rate increases.
(3) is a possible outcome: Private consumption increases due to the tax cut but decreases due to a higher interest rate. If the latter effect dominates, private consumption will decrease.
Therefore, all three outcomes are possible.

Award 1 mark for the correct option D.
Reject options A, B, and C as they omit one or more possible outcomes.

Opportunity cost of 1 unit of Watch:
- Country X: \(200 / 100 = 2\) Smartphones.
- Country Y: \(120 / 80 = 1.5\) Smartphones.
Since Country Y has a lower opportunity cost in producing Watches, Country Y will export Watches and Country X will import Watches.
Let \(T\) be the price of 1 Watch in terms of Smartphones.
- For Country Y (exporter) to gain: \(T > 1.5\) Smartphones.
- For Country X (importer) to gain: The total cost including transport cost must be less than its domestic opportunity cost, i.e., \(T + 0.2 < 2 \implies T < 1.8\) Smartphones.
Thus, the mutually beneficial terms of trade must lie between 1.5 and 1.8 Smartphones. Both (2) and (3) fall within this range.

Award 1 mark for the correct option B.
Reject other options because only statements (2) and (3) lie in the range \(1.5 \text{ Smartphones} < T < 1.8 \text{ Smartphones}\).

1. Pest damages tea plantations -> Supply of tea decreases -> Price of tea rises. Since coffee and tea are substitutes, consumers switch to coffee, shifting the demand for coffee to the right.
2. The decrease in the price of coffee beans reduces the production cost of coffee, shifting the supply of coffee to the right.
3. When both demand and supply of coffee shift to the right, the equilibrium quantity must increase, while the effect on the equilibrium price is uncertain.

Award 1 mark for the correct option C.
Reject other options as they incorrectly state the changes in equilibrium price or quantity.

1. Technological advancement increases productivity, shifting the short-run aggregate supply (SRAS) curve to the right. This exerts a downward pressure on the price level and an upward pressure on real output.
2. An increase in the corporate profit tax rate reduces after-tax profits of firms, discouraging investment expenditure. This shifts the aggregate demand (AD) curve to the left. This exerts a downward pressure on both the price level and real output.
3. Combining both effects: the price level will definitely decrease, while the change in real output is uncertain.

Award 1 mark for the correct option B.
Reject other options because the change in price level is certain (decrease) and the change in real output is uncertain.

1. Let the initial cash held by the public be \(C\). Initial money supply \(M_1 = C + \text{Deposits} = C + 1200\).
2. After withdrawing $50 million, cash held by the public increases to \(C + 50\).
3. Reserves in the banking system decrease to \(240 - 50 = 190\) million.
4. Since banks hold no excess reserves, final deposits \(D_2 = \text{New Reserves} / \text{Required Reserve Ratio} = 190 / 0.2 = 950\) million.
5. Final money supply \(M_2 = (C + 50) + 950 = C + 1000\) million.
6. Change in money supply = \(M_2 - M_1 = (C + 1000) - (C + 1200) = -200\) million (i.e., decreases by $200 million).

Award 1 mark for the correct option B.
Reject other options because they do not correctly account for both the cash expansion effect and the deposit contraction effect.

(a) An increase in the profits tax rate reduces the after-tax profits of firms. This reduces their incentive to invest, leading to a decrease in private investment expenditure (\(I\)). Since investment expenditure is a component of aggregate demand (\(AD = C + I + G + NX\)), aggregate demand will decrease in the short run. (3 marks)
(b) This is a contractionary fiscal policy. (1 mark) In the short run, the increase in the tax rate increases tax revenue, which helps improve the government budget balance (i.e., reduces budget deficit or increases budget surplus). (1.5 marks)

(a)
- Identify that after-tax profits of firms decrease, reducing private investment expenditure (\(I\)). [2 marks]
- Explain that aggregate demand (\(AD\)) decreases. [1 mark]
(b)
- Identify it as a contractionary fiscal policy. [1 mark]
- Explain that tax revenue increases, leading to an improvement in the government budget balance (reducing deficit/increasing surplus). [1.5 marks]

(a) After the tariff is imposed, the domestic price of wheat increases from \(P_W\) to \(P_W + t\). At this higher price, domestic producers are willing and able to produce more wheat, so domestic production increases from \(Q_{S1}\) to \(Q_{S2}\). On the other hand, consumers are less willing and able to buy wheat, so domestic consumption decreases from \(Q_{C1}\) to \(Q_{C2\). (3.5 marks)
(b) Since the domestic price rises from \(P_W\) to \(P_W + t\) and domestic consumption decreases, the consumer surplus decreases. The reduction in consumer surplus is represented by the area between \(P_W + t\) and \(P_W\) bounded by the demand curve. (2 marks)

(a)
- Explanation that price increase leads to an increase in domestic production. [1.5 marks]
- Explanation that price increase leads to a decrease in domestic consumption. [2 marks]
(b)
- Correctly state that consumer surplus decreases. [1 mark]
- Explain that this is due to a higher price paid and lower quantity consumed. [1 mark]

(a) A technological breakthrough that lowers the production cost of e-books will increase the supply of e-books, causing the price of e-books to fall. Since e-books and printed books are substitutes, a drop in the price of e-books will lead to a decrease in the demand for printed books. As a result, both the equilibrium price and quantity of printed books will fall. (3.5 marks)
(b) Other factors include: a change in consumer preferences (e.g., people prefer digital media over paper), a decrease in the price of e-readers (which are complements to e-books), or a decrease in consumer income (if printed books are normal goods). (2 marks for any one valid factor)

(a)
- Explain that the technological breakthrough increases the supply of e-books, lowering their price. [1.5 marks]
- Explain that because they are substitutes, a lower price of e-books leads to a decrease in the demand for printed books. [1 mark]
- State that both equilibrium price and quantity of printed books will decrease. [1 mark]
(b)
- Identify one valid factor (e.g., preference shift, decrease in income for normal goods, decrease in price of complements) with brief explanation. [2 marks]

(a) International oil is a crucial production input for many industries. A significant increase in oil prices raises the production cost of firms. This leads to a decrease in short-run aggregate supply (\(SRAS\)), shifting the \(SRAS\) curve to the left. As a result, the price level rises and the real output (real GDP) decreases. (3.5 marks)
(b) This situation, characterized by a rising price level (inflation) and falling real output (stagnant growth/recession), represents "stagflation". (2 marks)

(a)
- Explain that rising oil prices increase production costs, leading to a decrease in \(SRAS\) (leftward shift of \(SRAS\)). [1.5 marks]
- Explain that the price level increases. [1 mark]
- Explain that the real output (real GDP) decreases. [1 mark]
(b)
- Correctly identify the term "stagflation". [2 marks]

(a) When the required reserve ratio is lowered, commercial banks have more excess reserves. They are able to expand credit by granting more loans, which increases the maximum banking multiplier (\(1 / \text{required reserve ratio}\)). As a result of credit creation, the money supply increases. (3.5 marks)
(b) The increase in money supply shifts the money supply curve to the right. Given the money demand, the equilibrium nominal interest rate will decrease. (2 marks)

(a)
- Explain that a lower required reserve ratio increases excess reserves and increases the maximum banking multiplier. [2 marks]
- Explain that banks can grant more loans, leading to an increase in money supply through credit creation. [1.5 marks]
(b)
- Correctly state that the nominal interest rate decreases. [1 mark]
- Briefly explain with reference to money demand and money supply. [1 mark]

(a) An import quota restricts the quantity of imports, which creates a shortage of shoes at the original price. This causes the price of imported shoes in Country X to rise. Since the domestic demand for imported shoes is price inelastic, the percentage increase in price is greater than the percentage decrease in the quantity of imports. Therefore, the total revenue of foreign exporters (who can sell at the higher price) will increase. (3.5 marks)
(b) The holders of import licenses (quota holders) gain by buying at the world price and selling at the higher domestic price (earning quota rents). (2 marks)

(a)
- Explain that the import quota reduces import quantity and raises the price. [1 mark]
- Define/apply price inelastic demand: percentage increase in price is larger than percentage decrease in quantity. [1.5 marks]
- Conclude that total revenue of foreign exporters increases. [1 mark]
(b)
- Correctly identify quota license holders / importers who obtain the licenses as beneficiaries. [2 marks]

(a) When a price ceiling is set below the equilibrium rent, the quantity demanded of rental housing increases, while the quantity supplied by landlords decreases. The transaction quantity will be determined by the short side of the market, which is the quantity supplied. Therefore, the transacted quantity decreases. Since the quantity demanded exceeds the quantity supplied at the price ceiling, a shortage of rental housing occurs. (3.5 marks)
(b) Since price can no longer clear the market, non-price rationing methods will emerge. For example, landlords may use "first-come, first-served" (queuing) or personal relationship (favoritism) to allocate flats, or they may bundle tenancy with mandatory fees (key money) to circumvent the control. (2 marks)

(a)
- Explain that quantity demanded increases and quantity supplied decreases at the price ceiling. [1.5 marks]
- State that transacted quantity decreases (determined by quantity supplied). [1 mark]
- State that a shortage occurs. [1 mark]
(b)
- Identify and briefly explain one valid non-price rationing method (e.g., queuing, favoritism, tie-in sales/black market). [2 marks]

(a) In the diagram, the vertical \(LRAS\) is plotted at the full-employment output level \(Y_f\). The short-run equilibrium output \(Y_1\) (where the downward-sloping \(AD\) intersects the upward-sloping \(SRAS\)) is to the left of \(LRAS\) (i.e., \(Y_1 < Y_f\)). The distance between \(Y_1\) and \(Y_f\) represents the recessionary gap. (3.5 marks)
(b) In the long run, due to the recession and high unemployment, workers are willing to accept lower nominal wages, and other input prices will fall. This reduces production costs for firms, causing the short-run aggregate supply (\(SRAS\)) to increase (the \(SRAS\) curve shifts to the right) until real GDP returns to the full-employment level \(Y_f\). (2 marks)

(a)
- Correctly draw the downward-sloping \(AD\), upward-sloping \(SRAS\), and vertical \(LRAS\) at \(Y_f\). [1.5 marks]
- Show the short-run equilibrium output \(Y_1\) is less than \(Y_f\), identifying the recessionary gap. [2 marks]
(b)
- Explain that wages and input prices fall in the long run due to high unemployment. [1 mark]
- Explain that \(SRAS\) increases (shifts rightwards) to restore full employment. [1 mark]

a(i) The opportunity cost of producing 1 unit of Food in Country A is \( 50/100 = 0.5 \) units of Clothing. The opportunity cost of producing 1 unit of Food in Country B is \( 80/80 = 1 \) unit of Clothing. Since Country A has a lower opportunity cost in producing Food than Country B (\( 0.5\text{C} < 1\text{C} \)), Country A has a comparative advantage in producing Food. a(ii) For Country B, the opportunity cost of 1 unit of Clothing is 1 unit of Food. For Country A, the opportunity cost of 1 unit of Clothing is \( 100/50 = 2 \) units of Food. For trade to be mutually beneficial, the terms of trade for 1 unit of Clothing must lie between the opportunity costs of the two countries: \( 1\text{ unit of Food} < 1\text{ unit of Clothing} < 2\text{ units of Food} \). b(i) An import tariff increases the domestic price of Clothing. As price rises, consumer surplus of Country A's consumers decreases. Since the tariff is levied on each imported unit, the government collects tariff revenue, so government revenue increases. b(ii) Both policies restrict imports to the same level, resulting in the exact same price, domestic production, and consumption. Hence, consumer surplus and producer surplus changes are identical. However, under a tariff, the government earns tariff revenue. Under a quota, this revenue (quota rent) is typically captured by foreign exporters holding import licenses. Therefore, Country A's national welfare is lower under a quota than under a tariff, representing a larger deadweight loss for the domestic economy. c The infant industry argument states that temporary protection allows young firms to gain experience and achieve economies of scale. However, it is critically evaluated because: 1. Lack of competition reduces incentives to improve productivity, leading to permanent dependency and inefficiency. 2. The government lacks perfect information to correctly identify which industries will become competitive, leading to resource misallocation. 3. Even if temporary, protectionism causes deadweight loss and reduces economic efficiency in the short run.

a(i) Opportunity cost of Food in Country A (0.5C) (1 mark). Opportunity cost of Food in Country B (1C) (1 mark). Correct comparison and conclusion (1 mark). a(ii) Opportunity cost of Clothing in Country A (2F) (1 mark). Opportunity cost of Clothing in Country B (1F) (1 mark). Correct range of terms of trade (1 mark). b(i) Explain decrease in consumer surplus (2 marks). Explain increase in government revenue (2 marks). b(ii) State identical effects on price, consumer surplus, and producer surplus (2 marks). Explain why quota leads to lower welfare for Country A due to quota rents captured by foreign exporters instead of government tariff revenue (2 marks). c Define/explain infant industry argument (2 marks). Critique 1: Lack of efficiency incentives/complacency (2 marks). Critique 2: Government lack of information/resource misallocation (2 marks). Max 6 marks for part c.

a(i) When the central bank purchases bonds from the public, it injects new reserves into the banking system as the public deposits the sales proceeds into commercial banks. Commercial banks now hold excess reserves and will make new loans to borrowers. The borrowers will spend the loans, and the recipients will deposit the money back into banks, leading to a chain of credit creation. Total deposits expand by a multiple of the initial deposit (multiplied by the reciprocal of the required reserve ratio), which ultimately increases the money supply of the economy. a(ii) An increase in the money supply shifts the money supply curve to the right, causing the interest rate to fall. A lower interest rate reduces the borrowing costs for firms, prompting them to increase investment expenditure (I). Since investment is a key component of Aggregate Demand (\( \text{AD} = \text{C} + \text{I} + \text{G} + \text{NX} \)), the aggregate demand curve shifts to the right. b(i) Government infrastructure spending (G) is a component of Aggregate Demand. An increase in G directly shifts the AD curve to the right. Since the short-run aggregate supply (SRAS) curve is upward-sloping, this rightward shift in the AD curve leads to a shortage at the original price level. As the price level rises, firms increase production, resulting in a higher short-run equilibrium real output and a higher general price level. b(ii) Under a 'liquidity trap', the demand for money is horizontal (highly elastic) at a very low interest rate. The monetary expansion fails to lower interest rates further or stimulate investment, making monetary policy completely ineffective. Fiscal policy is highly effective here as it directly stimulates AD. Under a strong 'crowding-out effect', the government's borrowing to finance infrastructure spending increases the demand for loanable funds, pushing up interest rates. This higher interest rate discourages private investment and consumption, which offsets a large portion of the expansionary effect of government spending, rendering fiscal policy less effective.

a(i) Injecting reserves/initial deposit (1 mark). Banks loan out excess reserves (1 mark). Deposit expansion process (1 mark). Formula or concept of money multiplier (1 mark). Conclusion on increased money supply (1 mark). a(ii) Shift in money supply / drop in interest rate (2 marks). Rise in investment (1 mark). Shift of AD to the right (1 mark). b(i) Mentioning G is a component of AD (1 mark). Direct rightward shift of AD curve (2 marks). Explanation of the upward-sloping SRAS leading to higher equilibrium output and price level (2 marks). b(ii) Liquidity trap: explain why monetary policy is ineffective due to unresponsive interest rates (2 marks); fiscal policy is effective (1 mark). Crowding-out effect: explain government borrowing raising interest rates (1 mark); crowding out private investment/C (1 mark); conclusion on reduced fiscal policy effectiveness (1 mark).

a The breakthrough in AI technology increases the productivity of both labor and capital. This increases the total productive capacity of the economy, shifting the Long-run Aggregate Supply (LRAS) curve to the right. Simultaneously, the automation of production processes reduces production costs per unit of output, shifting the Short-run Aggregate Supply (SRAS) curve to the right. b A reduction in the corporate profit tax rate increases the post-tax profits of firms, raising their expected rate of return. This encourages firms to increase investment expenditure (I), shifting the Aggregate Demand (AD) curve to the right. At the same time, the tax cut lowers the cost of doing business, which encourages business expansion and entry of new firms, shifting the SRAS curve to the right. c In the AD-AS diagram, the AD curve shifts to the right (due to increased investment from the tax cut), and the SRAS curve shifts to the right (due to both the AI technology breakthrough and the tax cut). Because both curves shift to the right, the equilibrium output definitely increases. However, the effect on the equilibrium price level is indeterminate (uncertain), as a rightward shift in AD tends to push prices up, while a rightward shift in SRAS tends to push prices down. The final direction of the price level depends on the relative magnitude of these shifts. d Supply-side policies (such as promoting tech R&D and tax cuts) are designed to expand the productive capacity of the economy, shifting LRAS and SRAS to the right. In the long run, this allows the economy to achieve economic growth while putting downward pressure on prices, thereby securing growth with price stability. However, these policies suffer from long time lags and are costly to implement. Demand-management policies (such as transfer payments), on the other hand, shift AD to the right. While they can quickly lift an economy out of a recession, they do not expand long-run productive capacity. Continuous demand stimulus will eventually cause inflation in the long run without changing the real potential output. Therefore, supply-side policies are superior for achieving long-term economic growth and price stability, whereas demand-management policies are more appropriate for short-run stabilization. (Quality of Communication: Arguments are structured logically with clear transitions, correct use of economic terminology, and structured comparison.)

a Explain shift of LRAS to the right due to productivity increase (2 marks). Explain shift of SRAS to the right due to cost reduction (2 marks). b Explain why tax cut increases investment and shifts AD to the right (3 marks). Explain why tax cut reduces business costs and shifts SRAS to the right (2 marks). c Rightward shift in AD and SRAS correctly shown or described (2 marks). Conclude that equilibrium output definitely increases (2 marks). Conclude that equilibrium price level is indeterminate/uncertain (1 mark). d Evaluate supply-side policies: explain growth with price stability, and note the time-lag limitation (2 marks). Evaluate demand-management policies: explain short-term effectiveness but long-term inflationary risks (2 marks). Make a clear comparison and conclusion (1 mark). Quality of Communication: awarded for clear, coherent, and logical presentation of arguments with proper economic terms (1 mark).