Chapter 22 Fiscal Policy and Monetary Policy

Economics Inquiry for HKDSE Macroeconomics 2 Chapter 22 Fiscal Policy and Monetary Policy
Multiple Choice Questions |!|EM52001|!| Which of the following is an example/are examples of fiscal policy? (1) raising the profits tax rate (2) lowering the discount rate (3) increasing government expenditure on infrastructure
A. B. C. D.
(1) only (2) only (1) and (3) only (2) and (3) only
## C Fiscal policy refers to intentional changes or adjustments in government expenditures and/or taxes to achieve certain economic goals. (2) is incorrect. Lowering the discount rate is a monetary policy as it affects the money supply. ##
|!|EM52002|!| Which of the following statements is CORRECT? A. A surplus budget means the actual government revenue is greater than the actual government expenditure. B. A budget deficit means the actual government revenue is smaller than the actual government expenditure. C. A deficit budget means the planned government revenue is greater than the planned government expenditure. D. A budget surplus means the planned government revenue is smaller than the planned government expenditure.
## B ##
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|!|EM52003|!| (revised) In the government budget, it was estimated that the government expenditure will be smaller than the government revenue. However, at the end of the fiscal year, the actual government expenditure was greater than the actual government revenue. That means a _______________ resulted in a _______________. A. B. C. D. deficit budget budget deficit surplus budget budget surplus surplus budget budget deficit deficit budget budget surplus
## C ##
|!|EM52004|!| The table below shows the estimated data of an economy in a specific year.
Government expenditure Government revenue
Estimated ($ billion) 5.7 4.5
From the above information, there is a _______________. A. B. C. D. budget surplus budget deficit surplus budget deficit budget
## D Since the estimated government expenditure is greater than the estimated government revenue, there is a deficit budget. ##
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|!|EM52005|!| In Hong Kong, people can use various methods to make their tax payments. Methods include via telephone, the Internet or ATM, by post or in person. This is in accordance with the taxation principle of _______________ put forth by Adam Smith. A. B. C. D. equality economy convenience certainty
## C ##
|!|EM52006|!| Study the following information about two tax systems carefully.
Tax A - a regressive tax - requires a new government department with additional manpower and a new computer system to administer the tax system - a proportional tax
Tax B
- the existing government department is capable of administrating the tax system with existing manpower and computer system
Comparing the two tax systems, _______________ is in accordance with the taxation principle of equality and _______________ is in accordance with the taxation principle of economy put forth by Adam Smith. A. B. C. D. Tax A Tax A Tax A Tax B Tax B Tax A Tax B Tax B
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## D According to the taxation principle of equality, taxpayers tax payments should be in proportion to their income. Tax B is a proportional tax which takes a fixed proportion of income as tax payment when income increases. People with higher taxable income need to pay more. According to the taxation principle of economy, the cost of administering the tax system should be kept as low as possible. The cost of using the existing government department is lower than the cost of setting up a new government department with additional manpower and a new computer system. ##
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|!|EM52007|!| Which of the following diagrams show(s) a relationship in accordance with the taxation principle of equality put forth by Adam Smith? (1)
Tax payment
(2)
Tax payment
Income
Income
(3)
Average tax rate
(4)
Average tax rate
Income
Income
A. B. C. D.
(1) only (1) and (3) only (2) and (3) only (2) and (4) only
## B According to the taxation principle of equality, taxpayers tax payments should be in proportion to their income. (1) and (3) are proportional tax systems which take a fixed proportion of income as tax payment when income increases. (2) and (4) are incorrect. They are regressive tax and progressive tax respectively. ##
22-5
|!|EM52008|!| Mrs. Tai is a Hong Kong resident. According to the tax systems of Hong Kong, which of the following incomes of Mrs. Tai need to be taxed? (1) rental income earned by Mrs. Tai from renting out her apartment in Canada (2) wages earned by Mrs. Tai from working part-time in a boutique in Hong Kong (3) dividend received by Mrs. Tai from holding shares of a bank in Hong Kong
A. B. C. D.
(2) only (1) and (3) only (2) and (3) only (1), (2) and (3)
## A In Hong Kong, taxes are based on source of income or where the income is generated. Only income earned in Hong Kong is subject to taxation. (1) is incorrect. Income earned outside Hong Kong is not taxable. (3) is incorrect. Dividend income is not taxable in Hong Kong. ##
|!|EM52009|!| The following items are taxable in Hong Kong EXCEPT A. B. C. D. rental income received from leasing out a property. profits generated from running a tutorial school. dividend received from holding shares of a listed company. commission earned from being a stockbroker.
## C Dividend income is not taxable in Hong Kong. ##
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|!|EM52010|!| Which of the following about taxation in Hong Kong are CORRECT? (1) The Hong Kong Government follows the residence principle of taxation. (2) All incomes earned by Hong Kong residents are taxed. (3) Only income earned in Hong Kong is subject to taxation. (4) Salaries tax is an example of direct tax in Hong Kong.
A. B. C. D.
(1) and (2) only (2) and (4) only (3) and (4) only (1), (3) and (4) only
## C (3) is correct. In Hong Kong, taxes are based on source of income or where the income is generated. Only income earned in Hong Kong is subject to taxation. (4) is correct. As the tax burden of salaries tax in Hong Kong cannot be shifted to other parties, it is a direct tax. (1) is incorrect. Hong Kong adopts the territoriality basis of taxation. (2) is incorrect. For example, income earned by residents outside Hong Kong is not subject to taxation. ##
|!|EM52011|!| Which of the following statements about indirect tax is/are CORRECT? (1) The tax burden of indirect tax can be shifted to other parties. (2) To improve income inequality, imposing an indirect tax is better than imposing a direct tax. (3) Government revenue generated from levying indirect tax is more than that from direct tax.
A. B. C. D.
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## A (2) is incorrect. Whether imposing a tax can improve income inequality or not depends on whether the tax is progressive, proportional or regressive. As direct taxes are proportional or progressive (e.g. income tax) while indirect taxes are regressive (e.g. sales tax) in general, it is likely that imposing a direct tax is better than an indirect tax in improving income inequality. (3) is incorrect. There is no direct relationship between the type of tax and the amount of tax revenue received. ##
|!|EM52012|!| Which of the following about taxes in Hong Kong is INCORRECT? A. Salaries tax is first progressive, then proportional. B. Air passenger departure tax is a proportional tax. C. Betting duty is an indirect tax. D. Property tax is a direct tax.
## B Air passenger departure tax is a tax which levies a fixed amount per individual. It is a regressive tax. The tax payment takes a higher proportion of income from the low-income group. ##
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|!|EM52013|!| Study the following information.
Income ($) 10,000 20,000 30,000 40,000
Tax payment ($) 600 1,600 3,000 4,800
The above tax is a A. B. C. D. progressive tax. proportional tax. regressive tax. lump-sum tax.
## A Income ($) 10,000 20,000 30,000 40,000 Tax payment ($) 600 1,600 3,000 4,800 Average tax rate (%) 6 8 10 12
It is a progressive tax, as the average tax rate increases when income increases. ##
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|!|EM52014|!| Which of the following represents a regressive tax? A.

Tax payment
B.
Tax payment
Income
Income
C.
Average tax rate
D.
Average tax rate
Income
Income
## A The tax takes a decreasing proportion of income as tax payment when income increases. Therefore, it is a regressive tax. Options B and C are incorrect. They are progressive taxes. Option D is incorrect. It is a proportional tax. ##
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|!|EM52015|!| Which of the following diagrams represent(s) a progressive tax? (1)

Tax payment
(2)
Tax payment
Income
Income
(3)
Average tax rate
(4)
Average tax rate
Income 0 Income
A. B. C. D.
(2) only (3) only (1) and (3) only (1), (3) and (4) only
## B The average tax rate increases when income increases. Therefore, it is a progressive tax. (1) and (4) are incorrect. They are regressive taxes. (2) is incorrect. It is a proportional tax. ##
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|!|EM52016|!| (revised) The diagram below shows the relationship between tax payment and income of a certain tax.
Tax payment
Income
Which of the following statements about the above tax is/are CORRECT? (1) This tax will worsen the problem of income inequality. (2) When income increases, the average tax rate decreases. (3) The increase in tax payment is faster than the increase in income.
A. (3) only B. (1) and (2) only C. (2) and (3) only D. (1), (2) and (3)
## B The tax system shown in the diagram is a regressive tax. (1) is correct. A regressive tax worsens income inequality, as the tax payment takes a higher proportion of income from the low-income group. The distribution of income therefore becomes more uneven. (2) is correct. The tax takes a decreasing proportion of income as tax payment when income increases. Therefore, the average tax rate decreases when income increases. (3) is incorrect. As the tax takes a decreasing proportion of income as tax payment when income increases, the increase in tax payment is slower than the increase in income. ##
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|!|EM52017|!| The diagram below shows the relationship between tax payment and income of a certain tax.
Tax payment
Income
Which of the following statements about the above tax is CORRECT? A. It represents the profits tax in Hong Kong. B. It helps reduce income inequality. C. It is a proportional tax. D. The average tax rate decreases when income increases.
## D As the tax payment is the same for all levels of income, the average tax rate decreases when income increases. It is therefore a regressive tax. Option A is incorrect. Profits tax in Hong Kong is a proportional tax. Option B is incorrect. As the tax payment takes a higher proportion of income from the low-income group, the income gap between the rich and the poor will be widened. ##
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|!|EM52018|!| The diagrams below show the relationship between tax payment and income before and after the change of a tax system. Old tax system
Tax payment Tax payment
New tax system
Income
Income
Which of the following statements is TRUE? A. Government revenue received from the tax increases under the new tax system. B. The tax changes from a direct tax to an indirect tax. C. The working incentive of the high-income group is lower under the new tax system. D. The distribution of income becomes more uneven under the new tax system.
## C The old tax system is a proportional tax while the new tax system is a progressive tax. As the new tax system takes an increasing proportion of income as tax payment when income increases, while the old tax system takes a fixed proportion of income as tax payment when income increases, the new tax system weakens peoples incentive for earning a higher income. Option A is incorrect. There is not enough information to determine the change in government revenue. Option B is incorrect. There is not enough information to determine whether the tax is a direct tax or an indirect tax. Option D is incorrect. Compared with a proportional tax, the high-income group has to pay a higher average tax rate than the low-income group under a progressive tax. The gap between the rich and the poor can therefore be narrowed. ##
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Income ($) 10,000 20,000 30,000
Tax payment ($) Old system New system 1,400 1,000 2,400 2,400 3,000 4,200
From the above information, which of the following statements is CORRECT? A. B. Compared to the old system, more people fall into the tax net. Government revenue from the new system is relatively more susceptible to economic fluctuations than the old system. C. The average tax rate of the new system is higher than that of the old system for all levels of income. D. Compared to the old system, income of the economy under the new system is more evenly distributed.
## D Income ($) 10,000 20,000 30,000 Old system Tax payment ($) Average tax rate (%) 1,400 14 2,400 12 3,000 10 New system Tax payment ($) Average tax rate (%) 1,000 10 2,400 12 4,200 14
From the above table, we can conclude that the old system is regressive while the new system is progressive. Under a progressive tax system, the high-income group has to pay a higher average tax rate than the low-income group. The income gap between the rich and the poor can be narrowed. Income is therefore more evenly distributed. ##
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Income ($) 10,000 20,000 30,000
Tax payment ($) 500 1,800 X
If the tax is progressive, a possible value of X is _______________. A. B. C. D. 1,900 2,100 2,400 3,300
## D Income ($) 10,000 20,000 30,000 Tax payment ($) 500 1,800 X Average tax rate (%) 5 9 r
If the tax is progressive, r must be greater than 9%. Therefore, X must be greater than $30,000 9% = $2,700. The only possible value of X is 3,300. ##
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|!|EM52021|!| Refer to the following information.
Income ($) 10,000 20,000 30,000 Tax A 1,000 1,600 1,800
Tax payment ($) Tax B 1,200 2,400 3,600
Tax C 800 2,000 3,600
From the above information, _______________ helps to narrow the income gap between the rich and the poor while _______________ is in accordance with the taxation principle of equality put forth by Adam Smith. A. B. C. D. Tax A Tax C Tax B Tax A Tax C Tax B Tax C Tax A
## C Income ($) Tax A Tax B Tax C Tax payment Average tax Tax payment Average tax Tax payment Average tax ($) rate (%) ($) rate (%) ($) rate (%) 1,000 10 1,200 12 800 8 1,600 8 2,400 12 2,000 10 1,800 6 3,600 12 3,600 12
10,000 20,000 30,000
From the above table, Tax A is a regressive tax, Tax B is a proportional tax, and Tax C is a progressive tax. As a progressive tax, Tax C helps to narrow the income gap between the rich and the poor because the high-income group has to pay a higher average tax rate than the low-income group. According to the taxation principle of equality, taxpayers tax payments should be in proportion to their income. As a proportional tax, Tax B is in accordance with the principle because it takes a fixed proportion of income as tax payment when income increases. ##
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|!|EM52022|!| In Country X, an income of $10,000 is subject to a $1,200 tax payment. If the tax is progressive, which of the following is possible? A. B. C. D. An income of $20,000 is subject to a $2,000 tax payment. An income of $30,000 is subject to a $3,600 tax payment. An income of $40,000 is subject to a $6,000 tax payment. An income of $50,000 is subject to a $5,500 tax payment
## C If the tax is progressive, the average tax rate increases when income increases. If an income of $10,000 is subject to a $1,200 tax payment, the average tax rate = $(1,200 / 10,000) = 12%. The average tax rate of income higher than $10,000 is higher than 12%. With an income of $40,000, the average tax rate = $(6,000 / 40,000) = 15% (>12%) Option A is incorrect. With an income of $20,000, the average tax rate = $(2,000 / 20,000) = 10%. Option B is incorrect. With an income of $30,000, the average tax rate = $(3,600 / 30,000) = 12%. Option D is incorrect. With an income of $50,000, the average tax rate = $(5,500 / 50,000) = 11%. ##
|!|EM52023|!| Study the following information carefully.
Income ($) 10,000 20,000 30,000 Tax A 1,000 1,000 1,000
Tax payment ($) Tax B 1,000 2,000 3,000
In order to reduce income inequality, the government should adopt A. B. C. D. Tax A. Tax B. either Tax A or Tax B. neither Tax A nor Tax B.
## D
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Income ($) 10,000 20,000 30,000
Tax A Tax payment ($) Average tax rate (%) 1,000 10 1,000 5 1,000 3.33
Tax B Tax payment ($) Average tax rate (%) 1,000 10 2,000 10 3,000 10
According to the above table, Tax A is a regressive tax. As the tax payment takes a higher proportion of income from the low-income group, income inequality is worsened. Tax B is a proportional tax and thus will have no effect on the income distribution. Therefore, neither Tax A nor Tax B reduces income inequality. ##
|!|EM52024|!| In a time of recovery, inflation occurs. Peoples money income is fully adjusted according to the inflation rate. Under a regressive tax system, which of the following must be TRUE? (1) (2) (3) The amount of tax to be paid will increase. The purchasing power of peoples pre-tax income will decrease. A taxpayers tax payment in terms of purchasing power will decrease.
A. B. C. D.
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## B (3) is correct. If it is a lump-sum tax, the tax payment remains unchanged while money income increases. The same amount of tax payment can buy fewer goods and services under inflation. The tax payment in terms of purchasing power will thus decrease. If the tax payment increases when income increases, the percentage increase in tax payment will be smaller than the percentage increase in money income and the price level under a regressive tax system. Therefore, less tax will be paid in terms of purchasing power during inflation. (1) is incorrect. The amount of tax paid will remain unchanged if it is a lump-sum tax. (2) is incorrect. As peoples pre-tax money income increases at the same rate of inflation, peoples purchasing power will not be affected. ##
|!|EM52025|!| Which of the following items are regarded as recurrent expenditure? (1) maintenance expenses on the government buildings (2) expenditure on building a new airport (3) expenditure on constructing a new highway (4) salary of the Financial Secretary
A. B. C. D.
(1) and (2) only (1) and (4) only (2) and (3) only (2), (3) and (4) only
## B (2) and (3) are incorrect. Expenditure on building a new airport and constructing a new highway are capital expenditure. ##
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Year 2006 2007 2008 2009
Growth rate of public expenditure (%) 8 8 8 8
Growth rate of GDP (%) 3 4 5 6
According to the above information, the ratio of public expenditure to the GDP from 2006 to 2009 A. B. C. D. is increasing. is decreasing. remains unchanged. There is not sufficient information to determine.
## A The ratio of public expenditure to GDP is increasing because the growth rate of public expenditure (8% constantly) is higher than that of GDP (<8%). This implies that public expenditure increases proportionately more than GDP. ##
|!|EM52027|!| In an economy with a budget balance, if the government cuts the wage rate of civil servants, it is most likely that: (1) (2) (3) the governments recurrent expenditure will decrease. the price level will decrease. the quantity of output will increase.
A. B. C. D.
(1) and (2) only (1) and (3) only (2) and (3) only (1), (2) and (3)
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## A (1) is correct. As the wages of civil servants are regarded as recurrent expenditure, cutting the wage rate of civil servants will lead to a decrease in governments recurrent expenditure. (2) is correct. Cutting the wage rate of civil servants will lead to a decrease in peoples disposable income. Private consumption expenditure will decrease, thus leading to a decrease in aggregate demand. The price level will decrease. (3) is incorrect. When aggregate demand decreases, the quantity of output will decrease. ##
|!|EM52028|!| Which of the following is an example of expansionary fiscal policy? A. B. C. D. lowering the discount rate raising the salaries tax rate increasing government expenditure printing more money
## C An expansionary fiscal policy refers to an increase in government expenditure and/or a decrease in net taxes by the government. Options A and D are incorrect. Lowering the discount rate and printing more money are expansionary monetary policies. Option B is incorrect. Raising the salaries tax rate is a contractionary fiscal policy. ##
|!|EM52029|!| Lowering the profits tax rate is _______________ fiscal policy and will result in _______________. A. B. C. D. a contractionary a rightward shift of the SRAS curve a contractionary a leftward shift of the AD curve an expansionary a leftward shift of the SRAS curve an expansionary a rightward shift of the AD curve
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## D Lowering the profits tax rate leads to an increase in investment expenditure and results in an increase in aggregate demand. The AD curve will shift to the right. ##
|!|EM52030|!| Suppose the Hong Kong economy experienced a budget deficit. If the government lowers the standard tax rate of the salaries tax, (1) the income gap between the rich and the poor will narrow. (2) the real GDP will increase. (3) the budget deficit will improve.
A. B. C. D.
(2) only (1) and (2) only (1) and (3) only (2) and (3) only
## A (2) is correct. Lowering the standard tax rate of the salaries tax will lead to an increase in high-income earners disposable income. Private consumption expenditure will increase, leading to an increase in aggregate demand. The real GDP will increase. (1) is incorrect. Lowering the standard tax rate of the salaries tax will lead to an increase in disposable income of the high-income group. The income gap between the rich and the poor will widen. (3) is incorrect. If the government lowers the standard tax rate of the salaries tax, government revenue will decrease. The budget deficit will worsen. ##
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|!|EM52031|!| Suppose Country X initially operates at the long-run macroeconomic equilibrium. When there is a sudden increase in investment expenditure, the government should _______________ in order to let the economy attain full employment. A. B. C. D. increase government consumption expenditure raise the profits tax rate lower the required reserve ratio buy government bonds from the public
## B When there is a sudden increase in investment expenditure, there is an inflationary gap. A contractionary fiscal/monetary policy should be adopted. Raising the profits tax rate leads to a decrease in investment expenditure and results in a decrease in aggregate demand. Option A is incorrect. It results in a further increase in aggregate demand. Options C and D are incorrect. They are expansionary monetary policies. ##
|!|EM52032|!| Which of the following would be the MOST effective to alleviate recession? A. B. C. D. increasing government expenditure and raising the salaries tax rate increasing government expenditure and lowering the profits tax rate reducing government expenditure and raising the salaries tax rate reducing government expenditure and lowering the sales tax rate
## B To alleviate recession, an expansionary fiscal/monetary policy should be adopted so as to increase the quantity of output. Increasing government expenditure and lowering the profits tax rate lead to an increase in aggregate demand. The output level will increase. ##
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|!|EM52033|!| Which of the following about a contractionary fiscal policy is/are CORRECT? (1) Raising the profits tax rate is an example of contractionary fiscal policy. (2) A contractionary fiscal policy leads to a decrease in the price level. (3) A contractionary fiscal policy is represented by a rightward shift of the AD curve.
A. B. C. D.
## B A contractionary fiscal policy refers to a decrease in government expenditure and/or an increase in net taxes by the government. Adopting a contractionary fiscal policy leads to a decrease in aggregate demand. The AD curve will shift to the left and the price level will decrease. ##
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|!|EM52034|!| Refer to the following diagram.

Price level LRAS SRAS
E0
AD 0 Quantity of output (real GDP)
Suppose the economy initially operates at E0. Which of the following fiscal policies help to improve the employment situation without raising the price level? A. B. C. D. increasing government consumption expenditure reducing the salaries tax rate reducing the profits tax rate reducing the sales tax imposed on producers
## D Reducing the sales tax imposed on producers will lead to an increase in the short-run aggregate supply, which will result in a lower price level and a higher real GDP. Options A, B and C are incorrect. All of them will lead to an increase in aggregate demand, which will result in a higher price level. ##
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|!|EM52035|!| Refer to the following diagram.

Price level LRAS
SRAS
P0
AD Yf
Y0 Quantity of output (real GDP)
The output level of the economy is currently at Y0. Suppose the government imposes a sales tax on all goods and services and the tax will be paid by the producers. Which of the following statements are CORRECT? (1) The real GDP will decrease. (2) The price level will decrease. (3) The government will have a budget surplus. (4) The income distribution will become more uneven.
A. B. C. D.
(1) and (2) only (1) and (4) only (2) and (3) only (2) and (4) only
## B (1) is correct. Imposing a sales tax on all goods and services will lead to a decrease in the short-run aggregate supply. The real GDP will decrease and the price level will increase. (4) is correct. As a sales tax is a regressive tax, the tax payment takes a higher proportion of income for the low-income group than the high-income group. Income distribution will become more uneven. (3) is incorrect. There is insufficient information to determine whether the government will have a budget surplus. ##
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|!|EM52036|!| If a government increases her expenditure on infrastructure, in the long run, (1) aggregate demand must increase. (2) the quantity of output must increase. (3) the price level must increase.
A. B. C. D.
## A (1) is correct. Since government expenditure is a component of aggregate demand, an increase in government expenditure leads to an increase in aggregate demand. (2) is correct. An increase in government expenditure on infrastructure helps to accumulate capital and hence raises productivity. This leads to an increase in both short-run and long-run aggregate supply. With an increase in aggregate demand, the quantity of output must increase. (3) is incorrect. An increase in aggregate demand leads to an increase in the price level while an increase in aggregate supply leads to a decrease in the price level. The change in the price level will be uncertain, depending on the relative magnitude of the changes in aggregate demand and aggregate supply. ##
|!|EM52037|!| If the government consumption expenditure and tax revenue decrease by the same amount, real GDP will _______________ and the price level will _______________. A. B. C. D. increase increase increase decrease decrease increase decrease decrease
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## D The government expenditure will decrease by that amount. However, a reduction in tax revenue will lead to an increase in consumption by less than that amount as people will save part of the money. The decrease in aggregate demand due to the decrease in government expenditure is greater than the increase in aggregate demand due to the decrease in tax revenue. As a result, the aggregate demand will decrease. Both the price level and real GDP will decrease. ##
|!|EM52038|!| In an economy with severe inflation, the government can lower the price level without widening the income gap between the rich and the poor by A. B. C. D. imposing a sales tax on goods and services. reducing government expenditure on medical services. cutting the personal allowance of the salaries tax. increasing the average salaries tax rate for the high-income group.
## D Increasing the average tax rate for the high-income group leads to a decrease in private consumption expenditure and results in a decrease in aggregate demand. As a result, the price level will decrease, while the income gap between the rich and the poor will not be widened. Option A is incorrect. Imposing a sales tax on goods and services leads to a decrease in the short-run aggregate supply. The price level will increase. Options B and C are incorrect. Both reducing government expenditure on medical services and cutting the basic personal allowance of the salaries tax harms mainly the low-income group. The income gap between the rich and the poor would be widened. ##
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|!|EM52039|!| In Country X, the economy initially operates at the full-employment equilibrium. Suppose the short-run aggregate supply decreases. The government wants to restore output and price levels to the fullemployment equilibrium level. Which of the following measures should be adopted? (1) increasing the amount of tax rebate for salaries tax (2) increasing the amount of subsidy to producers (3) selling government bonds to the public
A. B. C. D.
## B Increasing the amount of subsidy to producers lowers the cost of production and the short-run aggregate supply will increase. The output and price levels can be restored to the full-employment equilibrium level. (1) is incorrect. It is an expansionary fiscal policy, which leads to an increase in aggregate demand. The price level will rise further. (3) is incorrect. It is a contractionary fiscal policy, which leads to a decrease in aggregate demand. The output level will fall further. ##
|!|EM52040|!| Which of the following is an example of a contractionary monetary policy? A. B. C. D. The government prints more money. The government sells government bonds to the public. The government lowers the discount rate. The government lowers the required reserve ratio.
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## B A contractionary policy refers to a decrease in money supply and/or an increase in interest rate. Selling government bonds to the public will lead to a decrease in money supply. Options A, C and D are incorrect. Printing more money, lowering the discount rate and lowering the required reserve ratio are expansionary monetary policies as they would lead to an increase in money supply. ##
|!|EM52041|!| Which of the following are examples of expansionary monetary policy? (1) buying government bonds from the public (2) lowering the discount rate (3) raising the required reserve ratio
A. B. C. D.
## A An expansionary monetary policy refers to an increase in money supply and/or a decrease in interest rate. (1) is correct. Buying government bonds from the public leads to an increase money supply. (2) is correct. A lower discount rate leads to an increase in money supply. (3) is incorrect. A higher required reserve ratio leads to a decrease in money supply. It is a contractionary monetary policy. ##
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|!|EM52042|!| Suppose the government of an economy raises the required reserve ratio. Which of the following is her possible aim? A. B. C. D. to make income more evenly distributed to eliminate a deflationary gap to lower the price level to reduce unemployment
## C A higher required reserve ratio leads to a decrease in money supply. The interest rate increases and this weakens investment and private consumption, leading to a decrease in aggregate demand. The price level will decrease. Option A is incorrect. Raising the required reserve ratio will not affect income distribution. Option B is incorrect. A higher required reserve ratio will lead to a decrease in aggregate demand. It cannot be used to eliminate a deflationary gap. Option D is incorrect. The decrease in aggregate demand due to a higher required reserve ratio will lower the output level and therefore cannot be used to reduce unemployment. ##
|!|EM52043|!| Which of the following government policies will lead to a fall in interest rate? (1) printing more money (2) buying government bonds from the public (3) raising the discount rate (4) lowering the required reserve ratio
A. B. C. D.
(1) and (4) only (2) and (3) only (1), (2) and (4) only (2), (3) and (4) only
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## C (1), (2) and (4) are correct. Printing more money, buying government bonds from the public and lowering the required reserve ratio lead to an increase in money supply. The interest rate decreases. (3) is incorrect. A higher discount rate leads to a decrease in money supply. The interest rate increases. ##
|!|EM52044|!| Which of the following about open market operation is CORRECT? A. B. C. D. Open market operations refer to the sale and purchase of government bonds by firms. Selling government bonds to the public will lead to an increase in interest rate. Buying government bonds from the public will lead to a decrease in money supply. Open market operations must be expansionary.
## B Selling government bonds to the public will lead to a decrease in money supply. The interest rate will increase. Option A is incorrect. Open market operations refer to the sale and purchase of government bonds by the central bank to affect the level of bank reserves and hence money supply. Option C is incorrect. Buying government bonds from the public will lead to an increase in money supply. Option D is incorrect. Open market operations can be expansionary or contractionary, depending on whether it is a sale or a purchase of government bonds by the central bank. ##
|!|EM52045|!| Lowering the discount rate will lead to _______________ in money supply and hence _______________ in the interest rate. A. B. C. D. an increase an increase an increase a decrease a decrease an increase a decrease a decrease
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## B The discount rate refers to the interest rate that the central bank charges on its loans to commercial banks. Lowering the discount rate will lead to an increase in money supply. The interest rate will thus decrease. ##
|!|EM52046|!| A government can eliminate an inflationary gap by _______________ the discount rate or _______________ government bonds to/from the public. A. B. C. D. raising buying raising selling lowering buying lowering selling
## B In order to eliminate an inflationary gap, a contractionary fiscal/monetary policy should be adopted. Raising the discount rate and selling government bonds to the public lead to a decrease in money supply and increased interest rate. This weakens investment and private consumption, leading to a decrease in aggregate demand. The output level will decrease. ##
|!|EM52047|!| To eliminate a deflationary gap, the government can _______________. As a result, _______________ and the full-employment output level will be restored. A. B. C. D. print more money the SRAS curve will shift to the left lower the required reserve ratio the AD curve will shift to the right raise the discount rate the AD curve will shift to the left sell government bonds to the public the SRAS curve will shift to the right
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## B To eliminate a deflationary gap, an expansionary fiscal/monetary policy should be adopted. Lowering the required reserve ratio leads to an increase in money supply and a decrease in the interest rate. This stimulates investment and private consumption, leading to an increase in aggregate demand. The AD curve will shift to the right. Option A is incorrect. Printing more money will not affect the short-run aggregate supply. Options C and D are incorrect. They are contractionary monetary policies which cannot be used to eliminate a deflationary gap. ##
|!|EM52048|!| Lowering the discount rate will cause the aggregate demand to _______________ and the output level will _______________. A. B. C. D. rise increase rise decrease fall increase fall decrease
## A A lower discount rate leads to an increase in money supply and a decrease in interest rate. This stimulates investment and private consumption, leading to an increase in aggregate demand. The output level will increase. ##
|!|EM52049|!| One of the purposes of adopting a contractionary monetary policy is to A. B. C. D. stimulate investment. lower the interest rate. cool down an overheated economy. alleviate a recession.
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## C A contractionary monetary policy refers to a decrease in money supply and/or an increase in interest rate. This discourages investment and private consumption and will result in a decrease in aggregate demand. Both the price level and output level of the economy will decrease. Option D is incorrect. A contractionary monetary policy leads to a fall in aggregate demand and therefore the quantity of output will decrease. It will only worsen the recession. ##
|!|EM52050|!| In a country with an extremely high unemployment rate, which of the following measures can help to ease the problem? (1) The government buys government bonds from the public. (2) The government lowers the discount rate. (3) The government lowers the profits tax rate.
A. B. C. D.
## D To ease the problem of a high unemployment rate, expansionary fiscal/monetary policies should be adopted. (1) and (2) are correct. They are expansionary monetary policies. Money supply increases and the interest rate decreases. This stimulates investment and private consumption, leading to an increase in aggregate demand. The output level will increase. (3) is correct. Lowering the profits tax rate is an expansionary fiscal policy which encourages investment and results in an increase in aggregate demand. The output level will increase. ##
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|!|EM52051|!| Study the following diagram.

P0
AD 0 Y0 Yf Quantity of output (real GDP)
The current output level of the economy is Y0. Suppose the government purchases government bonds from the public and reduces the required reserve ratio at the same time. In the long run, (1) the price level will be higher than P0. (2) the output level will be higher than Yf. (3) the long-run aggregate supply will remain unchanged.
A. B. C. D.
## B (1) is correct. Purchasing government bonds from the public and reducing the required reserve ratio lead to an increase in money supply and thus a decrease in interest rate. This stimulates investment and private consumption, leading to an increase in aggregate demand. The price level will increase. (3) is correct. As both factors do not affect the quantity or quality of resources of the economy, the long-run aggregate supply will not change. (2) is incorrect. In the long run, the output level will always be at Yf. ##
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|!|EM52052|!| Suppose an economy is initially at the full-employment equilibrium. If the central bank raises the discount rate, A. B. C. D. the short-run aggregate supply will decrease in the long run. the output level will decrease in the long run. the price level will decrease in the long run. the output level will remain unchanged in the short run.
## C Raising the discount rate leads to a decrease in money supply and thus an increase in the interest rate. This weakens investment and private consumption, leading to a decrease in aggregate demand. The price and output levels will decrease. In the long run, the price expectations of people will be adjusted and the short-run aggregate supply will increase. The price level will further decrease, while the output level will return to the full-employment level. ##
|!|EM52053|!| If an economy faces a severe recession, which of the following sets of fiscal and monetary policies will be the MOST appropriate to stimulate the economy? A. lowering the required reserve ratio and the salaries tax rate, as well as decreasing government expenditure B. printing more money, selling government bonds to the public as well as increasing government expenditure C. lowering the profits tax rate and the discount rate, as well as buying government bonds from the public D. lowering the required reserve ratio and the discount rate, as well as selling government bonds to the public
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## C During recession, expansionary fiscal and/or monetary policies should be adopted. Lowering the profits tax rate stimulates investment, leading to an increase in aggregate demand. Lowering the discount rate and buying government bonds from the public lead to an increase in money supply and a decrease in interest rate. This stimulates investment and private consumption, leading to an increase in aggregate demand. The output level will increase. Option A is incorrect. Decreasing government expenditure is a contractionary fiscal policy which will result in a decrease in aggregate demand and a lower output level. Options B and D are incorrect. Selling government bonds to the public is a contractionary monetary policy which will result in a decrease in aggregate demand and a lower output level. ##
Plan A 1. cutting the profits tax rate 2. selling government bonds to the public
Plan B 1. lowering the required reserve ratio 2. decreasing government expenditure
Plan C 1. raising the discount rate 2. raising the salaries tax rate
Which of the above plans will be the MOST effective to cool down an overheated economy? A. B. C. D. Plan A Plan B Plan C Plan A, Plan B or Plan C
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## C To cool down an overheated economy, the government should adopt contractionary fiscal and/or monetary policies. A higher discount rate leads to a decrease in money supply, and thus an increase in interest rate. This weakens investment and private consumption, leading to a decrease in aggregate demand. Raising the salaries tax rate results in a decrease in peoples disposable income. This leads to a decrease in private consumption, and hence a decrease in aggregate demand. The government should neither adopt Plan A nor Plan B. Cutting the profits tax rate is an expansionary fiscal policy, while lowering the required reserve ratio is an expansionary monetary policy. ##
|!|EM52055|!| Suppose an economy initially operates at the above-full employment equilibrium. If the government lowers the profits tax rate and sells government bonds to the public at the same time, the price level will ____________ and the output level will ____________ in the short run. A. B. C. D. increase increase increase increase, decrease or remain unchanged increase, decrease or remain unchanged increase increase, decrease or remain unchanged increase, decrease or remain unchanged
## D Lowering the profits tax rate stimulates investment. Aggregate demand will increase. The price and output levels will increase. Selling government bonds to the public leads to a decrease in money supply and an increase in interest rate. This weakens investment and private consumption, leading to a decrease in aggregate demand. The price and output levels will decrease. Therefore, the overall effect on the price and output levels is uncertain. ##
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|!|EM52056|!| In an economy, the government announced that there will be a rise in the sales tax rate and will print more money. Which of the following are CORRECT? (1) The distribution of income will become more uneven. (2) The price level will increase. (3) The real GDP will increase.
A. B. C. D.
## A (1) is correct. As the sales tax is a regressive tax, the tax payment takes a higher proportion of income from the low-income group. The distribution of income will become more uneven. (2) is correct. Raising the sales tax rate leads to a decrease in the short-run aggregate supply. The real GDP will decrease and the price level will increase. Printing more money leads to an increase in money supply and a decrease in interest rate. This stimulates investment and private consumption, leading to an increase in aggregate demand. The price and output levels will increase. Therefore, the price level will increase, but the overall effect on the real GDP will be uncertain. ##
|!|EM52057|!| In an economy, the government decided to refund part of the salaries tax to the low-income group and lower the discount rate. The real GDP of the economy will _____________ and the level of income inequality will _____________. A. B. C. D. increase remain unchanged increase, decrease or remain unchanged increase increase decrease increase, decrease or remain unchanged remain unchanged
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## C Refunding part of the salaries tax to the low-income group raises the disposable income of that group. Aggregate demand will increase. On the other hand, lowering the discount rate leads to an increase in money supply. The interest rate decreases and this stimulates investment and private consumption, leading to an increase in aggregate demand. The output level will increase. As refunding part of the salaries tax to the low-income group only benefits that group, the level of income inequality will decrease. ##
|!|EM52058|!| Which of the following statements about a contractionary monetary policy are CORRECT? (1) A contractionary monetary policy will cause a leftward shift of the aggregate demand curve. (2) A contractionary monetary policy will lead to a rise in the price level. (3) A contractionary monetary policy will lead to a fall in real GDP. (4) A contractionary monetary policy will cause an increase in total quantity demanded.
A. B. C. D.
(1) and (3) only (2) and (4) only (1), (3) and (4) only (2), (3) and (4) only
## A (1) is correct. A contractionary monetary policy leads to a decrease in money supply and/or an increase in the interest rate. This weakens investment and private consumption, leading to a decrease in aggregate demand. The price and output levels will decrease. The AD curve will shift to the left. (3) is correct. Given the aggregate supply, a fall in aggregate demand leads to a fall in real GDP. (2) is incorrect. Given the aggregate supply, a fall in aggregate demand leads to a fall in the price level. (4) is incorrect. A contractionary monetary policy causes a decrease in aggregate demand. ##
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|!|EM52059|!| An expansionary monetary policy will lead to A. B. C. D. increases in both the price level and real GDP. an increase in the price level and a decrease in real GDP. a decrease in the price level and an increase in real GDP. decreases in both the price level and real GDP.
## A An expansionary monetary policy leads to an increase in money supply and/or a decrease in interest rate. This stimulates investment and private consumption, leading to an increase in aggregate demand. The price and output levels will increase. ##
|!|EM52060|!| The Hong Kong Government has not actively implemented monetary policies over the years because (1) the interest rates of Hong Kong are influenced by the interest rates of the United States. (2) there are only a few bonds issued by the listed companies in Hong Kong. (3) the discount rate is calculated based on the US Federal Funds Target Rate and the Hong Kong Interbank Offered Rate.
A. B. C. D.
## C (1) is correct. Under the linked exchange rate system, the interest rates of Hong Kong are heavily influenced by the interest rates of the United States. It is difficult for the government to affect the money supply and/or interest rate independently. (2) is incorrect. The government has not actively implemented monetary policies because there are only a few bonds issued by the Hong Kong Government, but not by listed companies. ##
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Short Questions |!|ES52001|!| The Hong Kong Government developed the e-Tax system, enabling people to manage their tax affairs online. (a) What principle of taxation put forward by Adam Smith is related to the above statement? Explain. (3 marks) (b) State and explain any TWO other principles of taxation put forward by Adam Smith. (4 marks)
## (a) The taxation principle of convenience. (1 mark)
The methods of processing tax returns and collecting or paying tax should be as convenient as possible, for both taxpayers and the government. The development of the e-Tax system enables taxpayers to manage their tax affairs more conveniently. (b) Other principles of taxation include: - Equality: Taxpayers tax payments should be in proportion to their income. - Economy: The cost of administering the tax system should be kept as low as possible. - Certainty: Rules and procedures about the processing of tax returns and the collection of tax revenue should be clearly defined and made clear to the taxpayers. (Mark the FIRST TWO points only, 2 marks each) ## (2 marks)
|!|ES52002|!| Mrs. Lam is the owner of a hotel. In the past, she needed to pay both the profits tax and hotel accommodation tax to the government. (a) Explain whether the above two taxes are direct tax or indirect tax respectively. (4 marks)
(b) Explain whether the profits tax in Hong Kong is a progressive, proportional or regressive tax. (2 marks)
## (a) Profits tax is a direct tax because the tax is charged directly on the profit earned by Mrs. Lam. The tax burden cannot be shifted to other parties. (2 marks)
Hotel accommodation tax is an indirect tax because the tax burden can be shifted from Mrs. Lam to the customers by charging higher room prices. (2 marks)
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(b) Profits tax in Hong Kong is a proportional tax. The tax payment is directly proportional to the profits earned. The average tax rate of profits tax is the same for all levels of income. ## (2 marks)
|!|ES52003|!| Explain the effect of the following events on income distribution of society, and state whether the tax is a progressive, proportional or regressive. (a) a lump-sum sales tax imposed on general goods and services (3 marks) (3 marks)
(b) raising the standard tax rate of salaries tax
## (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. Therefore, the distribution of income will become more uneven. A lump-sum sales tax imposed on general goods and services is a regressive tax. (2 marks) (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, the distribution of income will become more even. Salaries tax calculated by the standard tax rate is a proportional tax. ## (2 marks) (1 mark)
|!|ES52004|!| Study the following information carefully.
Income ($) 10,000 20,000 30,000
Tax payment ($) 1,000 1,800 2,400
(a) Calculate the average tax rates when the income is $10,000, $20,000 and $30,000 respectively. (3 marks) (b) Identify and explain whether the above tax is progressive, proportional or regressive. (c) Explain the effect of the above tax on income distribution. ## (2 marks) (2 marks)
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(a) When the income is $10,000, the average tax rate = $(1,000 / 10,000) 100% = 10% When the income is $20,000, the average tax rate = $(1,800 / 20,000) 100% = 9% When the income is $30,000, the average tax rate = $(2,400 / 30,000) 100% = 8% (b) When income increases, the average tax rate decreases. Therefore, it is a regressive tax. (c) As the tax payment takes a higher proportion of income from the low-income group, the distribution of income becomes more uneven. ##
(1 mark) (1 mark) (1 mark) (1 mark) (1 mark)
(2 marks)
|!|ES52005|!| Explain whether the items below are subject to taxation in Hong Kong. (a) the rental income Mr. Chow received from renting out his apartment in Singapore (b) the profit Mrs. Cheung earned from running a restaurant in Hong Kong (2 marks) (2 marks)
## (a) The rental income is not subject to taxation in Hong Kong. (1 mark)
This is because the income is earned outside Hong Kong. Only income earned in Hong Kong is subject to taxation. (b) The profit is subject to taxation in Hong Kong. This is because the income is earned in Hong Kong. ## (1 mark) (1 mark) (1 mark)
|!|ES52006|!| To deal with macroeconomic problems, the government can make use of fiscal policy, monetary policy or both. (a) What is fiscal policy? What is monetary policy? (4 marks)
(b) State ONE example of expansionary fiscal policy and expansionary monetary policy respectively. (2 marks)
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## (a) Fiscal policy refers to intentional changes or adjustments in government expenditures and/or taxes to achieve certain economic goals. (2 marks)
Monetary policy refers to intentional changes in money supply and/or the interest rate by the central bank or the government to achieve certain economic goals. (b) Example of expansionary fiscal policy: - increasing government expenditure - lowering tax rates - Any reasonable answer (Mark the FIRST point only, 1 mark) Example of expansionary monetary policy: - buying government bonds from the public - lowering the discount rate - lowering the required reserve ratio - printing more money (Mark the FIRST point only, 1 mark) ## (2 marks)
|!|ES52007|!| If the government expenditure and tax revenue increase by the same amount, the price level and output level of the economy will remain unchanged. Do you agree with this statement? Explain. (5 marks)
## No. (1 mark)
It is observed that when people have more disposable income, they would consume only part of it and save the remaining. If the government expenditure and tax revenue both increase by the same amount, the decrease in consumption expenditure due to the increase in tax revenue will be smaller than the increase in government expenditure, because people will cut down both consumption expenditure and saving to pay for the tax. As a result, aggregate demand will increase. Both the price level and output level will increase. ## (2 marks) (1 mark) (1 mark)
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|!|ES52008|!| Suppose an economy is experiencing a deflationary gap. What type of fiscal policy can help the economy to restore the full-employment output level? Explain with the aid of an AS-AD diagram. (7 marks)
## When there is a deflationary gap, the output level is lower than the full-employment output level. An expansionary fiscal policy can be used. Aggregate demand will increase and the AD curve will shift to the right from AD0 to AD1. (1 mark) (1 mark)
The price level will increase from P0 to P1. The output level will increase from Y0 to Y1 and the fullemployment output level is restored.
(2 marks)
P1 P0
AD0 0 Y0 Y1
AD1 Quantity of output (real GDP)
(3 marks) ##
|!|ES52009|!| The quantity of output of Country X exceeds the full-employment output level. The government decides to raise the salaries tax rate to cool down the overheated economy. (a) Is the above policy an expansionary fiscal policy or a contractionary fiscal policy? (1 mark)
(b) With the aid of a diagram, explain how the above policy affects the price level and real GDP of the economy. (7 marks)
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## (a) It is a contractionary fiscal policy. (1 mark)
(b) When the salaries tax rate increases, peoples disposable income will decrease. This lowers private consumption expenditure. Aggregate demand will decrease and the AD curve will shift to the left from AD0 to AD1. The price level will decrease from P0 to P1. The real GDP will decrease from Y0 to Y1.
(2 marks) (1 mark) (1 mark)
P0 P1
AD0 AD1 0 Y1 Y0 Quantity of output (real GDP)
(3 marks) ##
|!|ES52010|!| Currently, the output level of Country X is below the full-employment output level. To tackle the problem, the government is considering adjusting the profits tax rate. (a) Explain whether the government should raise or lower the profits tax rate. (2 marks)
(b) With the aid of a diagram, explain how the adjustment in the profits tax rate helps the economy to restore full-employment output level. (7 marks)
## (a) When the output level is below the full-employment output level, there is a deflationary gap. The government should therefore lower the profits tax rate to raise the aggregate demand and the output level. (2 marks)
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(b) When the profits tax rate decreases, the incentive for firms to invest will increase and firms will increase their investment expenditure. Aggregate demand will increase and the AD curve will shift to the right from AD0 to AD1. (2 marks)
The price level will increase from P0 to P1 and the output level will increase from Y0 to Y1. The full-employment output level is restored.
(2 marks)
P1 P0
AD0 0 Y0 Y1
(3 marks) ##
|!|ES52011|!| Country X is under recession. The government wants to alleviate the problem of unemployment without causing inflation in the economy. The government is considering the following proposals: Proposal 1: raising the discount rate Proposal 2: cutting the sales tax rate on goods and services (a) Distinguish whether the above measures belong to fiscal or monetary policy respectively. (2 marks) (b) Which proposal should the government adopt? Explain with the aid of a diagram, how the proposal helps to attain the goal of the government. (8 marks)
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## (a) Proposal 1 is a monetary policy, while Proposal 2 is a fiscal policy. (b) The government should adopt Proposal 2. (2 marks) (1 mark)
When the government lowers the sales tax rate, producers will find it more profitable to produce the goods. The short-run aggregate supply will increase. The SRAS curve will shift to the right from SRAS0 to SRAS1. The price level will decrease from P0 to P1. There will be no inflation. (2 marks) (1 mark)
The output level will increase from Y0 to Y1. The employment situation will be improved.(1 mark)
Price level LRAS SRAS0 SRAS1
P0 P1
AD 0 Y0 Y1 Quantity of output (real GDP)
(3 marks) ##
|!|ES52012|!| Suppose an economy is suffering from serious inflation and the current output level is higher than the full-employment level. The government plans to increase the personal allowance of the salaries tax in order to alleviate the problem of inflation. Can the measure alleviate the problem of inflation? Explain with the aid of a diagram. (7 marks)
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## The measure cannot alleviate the problem of inflation. (1 mark)
When the government increases the personal allowance of the salaries tax, peoples disposable income will increase. Private consumption expenditure will increase. Aggregate demand will increase and the AD curve will shift to the right from AD0 to AD1. The price level will increase from P0 to P1. The problem of inflation will worsen.
(2 marks) (1 mark)
P1 P0
AD0 0
AD1
Y0 Y1
Quantity of output (real GDP)
(3 marks) ##
|!|ES52013|!| Some people argue that adopting an expansionary fiscal policy will have no effect on the fullemployment output level in the long run. However, some argue that this will increase the fullemployment output level in the long run. Explain under what condition they are correct. (6 marks)
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## If the government increases her expenditure (e.g. raising the wage rate of civil servants) and/or reduces the taxes (e.g. lowering the profits tax rate), the aggregate demand will increase. The AD curve will shift to the right, leading to an increase in the real output in the short run. However, the fullemployment output level will not be affected because the long-run aggregate supply will not be affected. (3 marks)
If the government increases her expenditure on investment (e.g. constructing more infrastructures) and/or reduces the taxes that increase the availability of funds for long-term capital investment (e.g. offering tax credits for long-term capital investment), there will be an accumulation of capital. The potential output level will increase. Therefore, an expansionary fiscal policy will lead to an increase in the full-employment output level in the long run. ## (3 marks)
|!|ES52014|!| Suppose the economy is initially experiencing a surplus budget. The government plans to raise the tobacco tax rate and increase the expenditure on publicity campaigns for a smoking ban at the same time. (a) Which type of policy do the above measures belong to, respectively: fiscal policy or monetary policy? Are they expansionary or contractionary? (2 marks)
(b) How will these two measures, as a whole, affect the budgetary condition of the government? Explain. (3 marks)
## (a) Both measures belong to fiscal policy. (1 mark)
Raising the tobacco tax rate is contractionary, while increasing the expenditure on publicity campaigns for smoking ban is expansionary. (1 mark)
(b) Increasing the expenditure on publicity campaigns for a smoking ban will lead to an increase in government expenditure. (1 mark)
Raising the tobacco tax rate may cause the government revenue to increase, decrease or remain unchanged, depending on the elasticity of demand for tobacco products. As a result, the effect of the two measures, as a whole, on the budgetary condition of the government is uncertain. ## (1 mark) (1 mark)
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|!|ES52015|!| (a) What are open market operations? (b) Explain how open market operations help to boost the economy. (2 marks) (4 marks)
## (a) Open market operations refer to the sale and purchase of government bonds by the central bank to affect the level of bank reserves and hence money supply. (b) To boost the economy, the central bank can buy government bonds from the public. (2 marks) (1 mark)
Buying government bonds from the public increases the currency in circulation which increases money supply. An increase in money supply causes the equilibrium interest rate to decrease. This stimulates investment spending and private consumption expenditure, causing aggregate demand to increase. As a result, the real GDP will increase. ## (3 marks)
|!|ES52016|!| Suppose the price level of Country Y deviates from the long-run equilibrium price level. To restore the price level to the long-run equilibrium level, the government plans to raise the required reserve ratio. If the measure is effective, what problem Country Y is possibly facing? Explain with the aid of an AS-AD diagram. (8 marks)
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## Given the same amount of reserves held, with a higher required reserve ratio, commercial banks may not have enough required reserves for their deposits. They may need to reduce their lending or even call back loans from the public. Through deposit contraction, money supply will decrease. The decrease in money supply will raise the interest rate and weaken investment and private consumption. Aggregate demand will decrease. The AD curve will shift to the left from AD0 to AD1. The price level will decrease from P0 to P1. (3 marks) (1 mark)
If the measure is effective, this implies that lowering the price level is the aim of the government. Country Y is possibly facing the problem of inflation.
(1 mark)
P0 P1
AD1 0 Y1 Y0
AD0
(3 marks) ##
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|!|ES52017|!| Suppose an economy is operating at the short-run equilibrium. If the government considers printing more money and reducing the personal allowance of the salaries tax at the same time, explain how the two measures will affect the price level of the economy. (5 marks)
## Printing more money will lead to an increase in money supply and thus lower interest rate. This will stimulate private consumption and investment expenditure. Aggregate demand will increase. (2 marks) Lowering the personal allowance of the salaries tax will lead to a decrease in peoples disposable income. Private consumption expenditure will decrease and aggregate demand will decrease. (2 marks) Since the overall change in aggregate demand is uncertain, the change in the price level will be uncertain. (1 mark) ##
|!|ES52018|!| Explain whether the following will have an expansionary effect on the Hong Kong economy. (a) The Hong Kong Jockey Club invested over HK$1.2 billion in building the venues for the Olympic Equestrian Events. (b) The government raised the profits tax rate for limited companies. (c) The government raised the rent for public rental housing. (2 marks) (2 marks) (2 marks)
## (a) Yes. The expenditure of The Hong Kong Jockey Club on building the venues will lead to an increase in Hong Kongs investment expenditure. Aggregate demand will increase. This will have an expansionary effect on the Hong Kong economy. (2 marks)
(b) No. Raising the profits tax rate for limited companies will decrease the incentive for firms to invest, causing the investment expenditure to decrease. Aggregate demand will decrease. This will have a contractionary effect on the Hong Kong economy. (2 marks)
(c) No. Raising the rent for public rental housing will decrease the disposable income of the tenants. Private consumption expenditure will decrease. Aggregate demand will decrease. This will have a contractionary effect on the Hong Kong economy. ## (2 marks)
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|!|ES52019|!| Refer to the following diagram. The original short-run equilibrium of the economy is at E0.
Price level LRAS SRAS0
E0
AD0
0 Quantity of output (real GDP)
Suppose there is a good harvest due to the good weather, which leads to an increase in the short-run aggregate supply of the economy. The government would like to restore the full-employment output level by adjusting the discount rate without causing inflation. With the aid of a diagram, explain how the discount rate should be adjusted in order to achieve the governments aim. (10 marks)
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## When there is an increase in the short-run aggregate supply, the SRAS curve will shift to the right from SRAS0 to SRAS1. This will widen the inflationary gap. To restore the full-employment output level, the government should raise the discount rate. (1 mark) (1 mark)
When the discount rate increases, it is more costly for commercial banks to borrow from the central bank. With fewer reserves, the banks can make fewer loans to the public. Through deposit contraction, money supply will decrease. The interest rate will increase. (2 marks)
This will weaken investment and private consumption. Aggregate demand will decrease. The AD curve will shift to the left from AD0 to AD1. The price level will decrease from P0 to P1. The real GDP will decrease from Y0 to Y1.
Price level LRAS SRAS0 SRAS1 E0 P0
(1 mark) (1 mark) (1 mark)
P1 AD0 AD1 0 Y1 Y0 Quantity of output (real GDP)
Widened inflationary gap
(3 marks) ##
|!|ES52020|!| Country X is initially at its long-run equilibrium. Suppose the country relies heavily on exports. Owing to the financial tsunami, most of its major trading partners are experiencing economic recession. (a) With the aid of an AS-AD diagram, discuss the effect on the price level and real GDP of the country in the short run. (7 marks)
(b) Suggest and explain ONE monetary policy tool that can help the economy restore the fullemployment output level. (3 marks)
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## (a) When the major trading partners of Country X experience economic recession, the demand for Country Xs exports will decrease and net exports will decrease. This will result in a decrease in aggregate demand. The AD curve will shift to the left from AD0 to AD1. In the short run, the price level will decrease from P0 to P1. The real GDP will decrease from Y0 to Y1.
(2 marks) (1 mark) (1 mark)
P0 P1
AD1 0 Y1 Y0
(3 marks)
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(b) The government can buy government bonds from the public. This leads to an increase in currency in circulation. Money supply will increase. The interest rate will decrease. This will stimulate investment and private consumption. Aggregate demand will increase and the output level will return to the full-employment output level. OR The government can lower the discount rate. Commercial banks can then borrow money from the central bank at a lower cost. With more reserves, the banks can make more loans to the public. Through deposit creation, money supply will increase. The interest rate will decrease. This will stimulate investment and private consumption. Aggregate demand will increase and the output level will return to the full-employment output level. OR The government can lower the required reserve ratio. Commercial banks then do not need to hold the amount of reserves previously required. Given the same amount of reserves held, commercial banks will have more excess reserves and can make more loans to the public. Through deposit creation, money supply will increase. The interest rate will decrease. This will stimulate investment and private consumption. Aggregate demand will increase and the output level will return to the full-employment output level. OR The government can print more money. With deposit creation, money supply will increase. The interest rate will decrease. This will stimulate investment and private consumption. Aggregate demand will increase and the output level will return to the full-employment output level. (3 marks) ## (3 marks) (3 marks) (3 marks)
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Long Questions |!|EL52001|!| The diagram below shows the growth rate of real GDP of Country X over a period of time.
% change in real GDP
Average growth rate
0 A Time
(a) (i)
According to the above diagram, identify the phase that Country X is in at point A. (1 mark) (2 marks)
(ii) Give any TWO general economic phenomena which occur at point A. (b) Suppose at point A, the government aims at boosting the economy.
(i) Is lowering the salaries tax rate an appropriate policy? Explain with the aid of a diagram. (7 marks) (ii) If the government prefers to adopt monetary policies, suggest TWO monetary policy tools that the government can use. (2 marks)
## (a) (i) Country X is in recession at point A. (ii) - real GDP decreases - the general price level decreases - Any reasonable answer(s) (Mark the FIRST TWO points only, 1 mark each) (1 mark)
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(b) (i) Lowering the salaries tax rate is an appropriate policy.
(1 mark)
Lower salaries tax rate leads to an increase in peoples disposable income. This stimulates private consumption. Private consumption expenditure increases. (1 mark)
Aggregate demand increases and the AD curve shifts to the right from AD0 to AD1. (1 mark) The real GDP increases from Y0 to Y1.
(1 mark)
AD0 0 Y0 Y1
(3 marks) (ii) The government can use the following monetary policy tools: - buying government bonds from the public - reducing the discount rate - reducing the required reserve ratio - printing more money (Mark the FIRST TWO points only, 1 mark each) ##
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|!|EL52002|!| Study the following table.
Year 2007 2008 2009
Implicit price deflator of GDP 89.8 95.6 98.3
(a) Suppose people expected the price level to remain unchanged between 2007 and 2009. Explain whether the following persons would gain or lose during this period. (i) Mrs. Wong deposited a sum of money into the bank in 2007 at a fixed interest rate for two years. (ii) Mr. Chan obtained a bank loan in 2007 at a fixed interest rate for two years. (2 marks) (2 marks)
(b) In order to stabilise the price level, the government plans to raise the required reserve ratio and raise the sales tax rate imposed on producers at the same time. (i) With the aid of a diagram, explain how the increase in the required reserve ratio will affect the interest rate. (4 marks)
(ii) With the aid of a diagram, explain whether the two policies can help to stabilise the price level. (8 marks)
## (a) (i) Mrs. Wong would lose. (1 mark)
During unanticipated inflation, the real value of loans and interest payments decreases. Therefore, lenders lose. (ii) Mr. Chan would gain. (1 mark) (1 mark)
During unanticipated inflation, the real value of loans and interest payments decreases. Therefore, borrowers gain. (1 mark)
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(b) (i) A higher required reserve ratio will lead to a decrease in money supply.
(1 mark)
The money supply curve will shift to the left from MS0 to MS1. Given the same money demand, the interest rate will increase from r0 to r1.
Nominal interest rate MS1 MS0
(1 mark)
r1 r0
Md 0 M1 M0 Quantity of money
(2 marks) (ii) A higher required reserve ratio leads to an increase in interest rate. This weakens investment and private consumption. Aggregate demand will decrease and the AD curve will shift to the left from AD0 to AD1. The price level will decrease. (2 marks)
Raising the sales tax rate imposed on producers will lead to a decrease in the short-run aggregate supply. The SRAS curve will shift to the left from SRAS0 to SRAS1. The price level will increase. (2 marks)
The final change in the price level is uncertain, depending on the extent of the decreases in aggregate demand and the short-run aggregate supply.
Price level SRAS1 SRAS0
(1 mark)
(3 marks)
##
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|!|EL52003|!| In economy A, firms need to pay a fixed percentage of their profit as profits tax. To boost the economy, the government decides to lower the profits tax rate. At the same time, more expenditure will be spent on research and development on information technology. (a) Explain whether the profits tax is a progressive, proportional or regressive tax. (2 marks)
(b) Are lowering the profits tax rate and increasing expenditure on research and development on information technology fiscal or monetary policy respectively? (c) (i) (2 marks)
With the aid of a diagram, explain the effects of lowering the profits tax rate and increasing expenditure on research and development on information technology on the price level and real output in the short run. (8 marks) (3 marks)
(ii) How will the two policies affect the real output in the long run?
## (a) The profits tax is a proportional tax. The average tax rate is the same for all levels of profit. (2 marks) (b) Both lowering the profits tax rate and increasing expenditure on research and development are fiscal policies. (2 marks)
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(c)
(i)
Lowering the profits tax rate raises the incentive for firms to invest. Firms will increase their investment expenditure, leading to an increase in aggregate demand. (1 mark)
Increasing government expenditure on research and development on information technology leads to an increase in aggregate demand. (1 mark)
Aggregate demand will increase and the AD curve will shift to the right from AD0 to AD1. (1 mark) In the short run, the price level will increase from P0 to P1. The real output will increase from Y0 to Y1.
Price level SRAS
(1 mark) (1 mark)
P1 P0
(3 marks) (ii) Lowering the profits tax rate will not affect the real output in the long run. (1 mark)
Increasing expenditure on research and development on information technology can increase the productivity of the economy. Real output will increase in the long run. ## (1 mark) (1 mark)
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|!|EL52004|!| After the outbreak of the financial tsunami, Country X suffered from economic recession. The government of Country X plans to lower the salaries tax rate and control the money supply so as to boost the economy. (a) Explain whether the salaries tax is a direct tax or an indirect tax. (2 marks)
(b) If the government of Country X wants to alleviate the problem of recession through controlling the money supply, explain whether she should raise or lower the required reserve ratio. (2 marks) (c) With the aid of a diagram, explain how the policy mentioned in (b) and the decrease in salaries tax rate can help to boost the economy of Country X. (7 marks)
(d) After imposing the policy mentioned in (b), the change in money supply is lower than that expected by the government. Suggest TWO reasons to explain this phenomenon. (4 marks)
## (a) Salaries tax is a direct tax. It is levied on the salaries of the taxpayers. The tax burden is borne by the taxpayers and cannot be shifted to other parties. (2 marks)
(b) To alleviate the problem of recession, the government should adopt expansionary monetary policy. Therefore, she should lower the required reserve ratio. (2 marks)
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(c) Lowering the required reserve ratio leads to an increase in money supply. The interest rate decreases and this stimulates investment and private consumption, leading to an increase in aggregate demand. (1 mark)
Lowering the salaries tax rate leads to an increase in peoples disposable income. This stimulates private consumption and leads to an increase in aggregate demand. The AD curve shifts to the right from AD0 to AD1. The real GDP increases from Y0 to Y1.
(1 mark) (1 mark) (1 mark)
AD0 0 Y0 Y1
AD1
(3 marks) (d) - This may be due to cash leakage. If some of the loans are not redeposited into the banking system but are held by the public as cash, the amount of deposits created will become smaller. - This may be due to the existence excess reserves kept by banks. The actual amount of deposits created will be less than the maximum possible amount. - Any reasonable answer(s) (Mark the FIRST TWO points only, 2 marks each) ##
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Chapter 22 Fiscal Policy and Monetary Policy

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Chapter 22 Fiscal Policy and Monetary Policy

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Economics Inquiry for HKDSE Macroeconomics 2 Chapter 22 Fiscal Policy and Monetary Policy

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Government expenditure Government revenue

Estimated ($ billion) 5.7 4.5

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## C Dividend income is not taxable in Hong Kong. ##

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|!|EM52013|!| Study the following information.

Income ($) 10,000 20,000 30,000 40,000

Tax payment ($) 600 1,600 3,000 4,800

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|!|EM52014|!| Which of the following represents a regressive tax? A.

Average tax rate

Average tax rate

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|!|EM52015|!| Which of the following diagrams represent(s) a progressive tax? (1)

Average tax rate

Average tax rate

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New tax system

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|!|EM52019|!| Study the following information.

Income ($) 10,000 20,000 30,000

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|!|EM52020|!| Study the following information.

Income ($) 10,000 20,000 30,000

Tax payment ($) 500 1,800 X

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|!|EM52021|!| Refer to the following information.

Income ($) 10,000 20,000 30,000 Tax A 1,000 1,600 1,800

Tax payment ($) Tax B 1,200 2,400 3,600

Tax C 800 2,000 3,600

10,000 20,000 30,000

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|!|EM52023|!| Study the following information carefully.

Income ($) 10,000 20,000 30,000 Tax A 1,000 1,000 1,000

Tax payment ($) Tax B 1,000 2,000 3,000

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Income ($) 10,000 20,000 30,000

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|!|EM52026|!| Study the following information carefully.

Year 2006 2007 2008 2009

Growth rate of public expenditure (%) 8 8 8 8

Growth rate of GDP (%) 3 4 5 6

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|!|EM52034|!| Refer to the following diagram.

AD 0 Quantity of output (real GDP)

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|!|EM52035|!| Refer to the following diagram.

Y0 Quantity of output (real GDP)

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