ECF Saint Too Canaan College 2010 2011 2nd Term Examination S.

.5 Economics Paper 2 SUGGESTED ANSWERS Section A Question 1

The function of money as a medium of exchange is decreased as the purchasing power of money decreases, it means general acceptability decreases. The function of money as a store of value will decreases as people will be less willing to use money as to accumulating the purchasing power. Other point: a unit of account (as it becomes less convenient to measure the value of goods when the price rises very high) a standard of deferred payment (as it is less generally accepted with a lower purchasing power of the same amount of payment) (Any Two, @2, 4 marks)

Short Questions

(46 marks)

Question 2
(a) Deflation is defined as a persistent decrease in the general price level. Disinflation is defined as a decreasing rate of inflation. (b) (i) (1 mark) (1 mark)

Lose. During deflation, the purchasing power of the mortgage payment increases. The amount the person pays has a higher real value. (2 marks) Gain. During deflation, the purchasing power of the cash coupon increases, provided that the department store adjusts the prices of its goods according to the change in the price level. The person can buy more goods with that coupon. (2 marks)

(ii)

Question 3
(a) The minimum required reserves ratio is $2,000 $10,000 = 0.2 After the withdrawal by the banks clients, the required reserves = $9,000 0.2 = $1,800 The banking system is short of reserves by $800 (= $1,800$1,000). (b) The maximum decrease in loans = = $4,000
$800 0.2

(1 mark)

(1 mark) (1 mark) (1 mark) (1 mark)

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Question 4
(a) The amount of the sales tax charged on a certain good or service is the same regardless of consumers income. For a higher-income person, the proportion of tax payment to his/her income is smaller than that for a lower-income person. (2 marks) Therefore, the distribution of income will become more uneven. A lump-sum sales tax imposed on general goods and services is a regressive tax. (1 mark) (1 mark)

(b) Those people paying the standard tax rate belong to the high-income group.
As the high-income group needs to pay more tax, while the tax paid by low-income group remains unchanged, (2 marks) the distribution of income will become more even. Salaries tax calculated by the standard tax rate is a proportional tax. (1 mark) (1 mark)

Question 5 Any two reasons as follows: differences in human capital: e.g. well educated may earn a higher income discrimination: people certain gender / race may earn a lower income because of gender / racial discrimination differences in labour qulity differences in working conditions monopoly power and political power any other possible answers (2@, 4 marks)

Question 6 The law states that when variable factors are added continuously to fixed factors, holding technological constant, the marginal product will eventually decrease. (3 marks) Labour Marginal Product (units) OR Marginal product of labour falls from 600 units to 300 units when labour increases from 3 units to 4 units. (3 marks) 3 600 4 300 5 200

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*** Question 7

( ok ,Ca t r3p7 5 Bo 5 hp , . 4 7) e (2 marks)

(a) (i) Nominal interest rate = real interest rate + expected inflation rate NOTE: Nominal interest rate = rate of change of nominal value of asset Real interest rate = rate of change of real value of asset

(ii) The nominal interest rate would be lower than the real interest rate if the expected inflation rate is negative. (2 marks)

(b) The nominal interest rate is the return to holding interest bearing assets.
Holding money forgoes the option of holding interest bearing assets, and the cost of doing so is the nominal interest rate. (3 marks)

Question 8 (a) Any two reasons as follows:

wealth effect: Price level decreases wealth increases ( in real term) consumption expenditure increases income increases

interest rate effect: Price level decreases real interest rate decreases investment expenditure increases income increases exchange rate effect: Price level decreaes exports become relatively cheaper and imports becomes relatively more expensive net exports increases income increases (3@, 6

marks)

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Section B Question 9
(a)

Structure Questions

(54 marks)

(i) Written explanation If the demand for the movie ticket was inelastic, (1 mark) the percentage decrease in quantity would have been smaller than the percentage increase in price. (1 mark) Therefore, the total revenue (box office) increases. (1 mark) Diagram The area of increase in revenue is larger than the area of decrease in revenue. (2 marks)

Box office for Kings Speech in Cinema X (ii) No. Land refers to all the natural resources, i.e., no human effort is involved. Price Since cinema is built by people, production (building) cost is involved; it is capital instead of land. (3 marks)

(c)

Possible reasons:

Decrease in revenue

P2

The movie was not filmed domestically. Only the value of output of Hong Kong resident Increase in revenue producing units should be included, e.g., services provided by domestic cinemas. Some tickets were sold in 2010, which should be excluded from the computation of Hong Kongs GDP in 2009. Intermediate consumption, including electricity charges, should be excluded.

P1

D Any other relevant points 0 Q2 above, each 2 marks) Q1 (Any two of the

Quantity

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Question 10 (a)

(0.5 @, 1 mark) (b) Supply will increase, resulting in a lower price, a larger quantity transacted, larger consumer surplus and uncertain producer surplus. (2 marks) (*The result of larger producer surplus holds when the supply curve shifts in a parallel manner.) (1 mark) (c) (i) It is a variable cost because it varies with output. (ii) 600 (iii) 600 (2 marks) (1 mark) (1 mark)

(d) (i) Private limited company (1 mark) (ii) No, because his liability is limited only to the amount that he invested or he promised to invest. (2 marks) Question 11 (a) A reduction in firms willingness to supply goods and services will lead to a leftward shift of the AS curve while a reduction in their willingness to invest will lead to a leftward shift of the AD curve. As a result, output will decrease and the price level may rise or fall, depending on the magnitude of the shifts in the AD and AS curves. (4 marks)

(4 marks) (b) Once the government waives on rates, which is a kind of indirect tax. It raise the disposable income of those public housing tenants. Private consumption expenditure and aggregate demand would rise. Price level will continue to increase. Hence, this policy is ineffective in combating the inflation problem. (5 marks)

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Question 12 (a) (i) The introduction of an effective minimum wage would raise the wage rate above the equilibrium and result in a decrease in the number of workers employed in that industry. (2 marks)

(2 marks) (ii) The total earnings of the workers in that industry may rise or fall, depending on the elasticity of demand. If the demand is elastic, the % increase in the wage rate is smaller than the % decrease in the number of workers employed. The total wage earnings will decrease. If the demand is inelastic, the % increase in the wage rate is larger than the % decrease in the number of workers employed. The total wage earnings will decrease. Indicate in the diagram: G and L (irrespective of sizes) (7 marks)

(b) A minimum wage would definitely reduce employment and should not be introduced if securing
employment is regarded as being in the interest of low-income workers. Workers who manage to secure employment after the introduction of a minimum wage would gain, as they would earn a higher income than before. However, it would be a burden to the production side. The cost of operation would rise due to the higher labour cost. Number of workers used would be cut.Those who lost their jobs due to such a law would suffer. There is no objective rule to decide whether or not these results better serve the interests of the workers. Even if the total wage earnings of the workers are used as the yardstick in making such a decision, a definite answer could not be obtained ex ante, as the effect of a minimum wage on the total wage earnings is ambiguous without reference to the empirical data concerning the elasticity of those workers. With this complication, the question could only be addressed by resorting to value judgements on what constitutes the best interests of the workers. (7 marks)

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