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Economics

Economics. Chapter 7 Exchange rate. Currencies. Major currencies USA: US Dollar [Code: USD; Sign: $] British: Pound sterling [Code: GBP; Sign: £] Europe: Euro [Code: EUR; Sign:€] China: Renminbi [Code: RMB; Sign: ¥] Hong Kong Dollar [Code: HKD; Sign: $]

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Economics

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  1. Economics Chapter 7 Exchange rate

  2. Currencies Major currencies • USA: US Dollar [Code: USD; Sign: $] • British: Pound sterling [Code: GBP; Sign: £] • Europe: Euro [Code: EUR; Sign:€] • China: Renminbi [Code: RMB; Sign: ¥] • Hong Kong Dollar [Code: HKD; Sign: $] • Japanese yen [Code: JPY; Sign: ¥]

  3. Exchange rate Exchange rate • the price at which two currencies are exchange • the price of a foreign currency in terms of the local currency, or vice versa • convertibility rate

  4. Exchange rate Expression (assume USD and HKD) • The exchange rate of USD • US$ 1 can be converted into HK$ 7.8 • HKD/USD = 7.8 / 1 = 7.8

  5. Exchange rate Expression (assume USD and HKD) • The exchange rate of HKD • HK$ 1 can be converted into US$ • USD/HKD =

  6. Floating exchange rate • Exchange rate is • Free-floating • Depends on market demand and supply • Appreciation • A rise in exchange rate • Depreciation • A fall in exchange rate

  7. Appreciation • USD Euro • The USD appreciates relative to the EUR • HKD JPY • The HKD appreciates relative to the JPY

  8. Depreciation • USD Euro • The EUR depreciates relative to the USD • HKD JPY • The JPY depreciates relative to the HKD

  9. Floating exchange rate Appreciation: exchange rate Depreciation:  exchange rate • There is only one exchange rate between two currencies. • Appreciation of one currency = Depreciation of the other

  10. Linked exchange rate system in HK Since 1983 • HKD linked with USD at a fixed exchange rate • Aim: To maintain stability of the exchange rate between HKD and USD • Exchange rate: US$1:HK$7.75–7.85 • Controlled by the HKSAR Gov’t (HKMA)

  11. Brief history of linked exchange rates system in HK: Source: http://en.wikipedia.org/wiki/Hong_Kong_dollar

  12. Linked exchange rate system in HK Revaluation • Originally, HKMA fixed the rate at US$1:HK$7.8 • If HKMA set the rate at US$1:HK$6(meaning that less HK dollar can be bought by US$1)(value of HK dollar increases) •  the rate of HKD against USD rises • The government re-pegs exchange rate at a higher level

  13. Linked exchange rate system in HK Devaluation • Originally, HKMA fixed the rate at US$1:HK$7.8 • If HKMA set the rate at US$1:HK$9(meaning that more HK dollar can be bought by US$1)(value of HK dollar decreases) •  the rate of HKD against USD falls • The government re-pegs exchange rate at a lower level

  14. Difference:

  15. Linked exchange rate system in HK Strong reserves support • A currency board system • HK monetary base is support by USD • Maintain the exchange rate when issuing banknotes

  16. Linked exchange rate system in HK Operation • The bank is going to issue $7,800,000 banknotes • It needs to pay USD of equivalent value (US$ 1 : HK$7.8) to HKMA to buy Certificate of Indebtedness [CIs] (負責證明書) • As a support for banknotes issued • In this case, the bank pays US$1 million to HKMA * In reverse, banks return HKD & CIs to the HKMA and get back the USD. US$ 1: HK$7.8 Certificates of Indebtedness HKMA

  17. Linked exchange rate system in HK Exchange rates change with the USD • Under the linked exchange rate system, the exchange rates of the HKD against other foreign currencies change with the USD. • Against other currencies • if USD appreciation  HKD appreciation (against other currencies) • if USD depreciation  HKD depreciation (against other currencies)

  18. HK people suffer from RMB appreciation Exchange rates change with the USD • RMB appreciates against USD since 1994 • Since 2006, exchange rose quickly • USD depreciation is faster • HKD is linked to USD,so HKD follows USD and depreciates against RMB sharply • Meaning that HK people needs to pay more HKD to buy products fromthe mainland • Before that, HK people went shopping in the mainland • Nowadays, mainland visitor come to HKfor shopping

  19. Balance of payment (BOP) account Definition • The record of an economy’s receipts and payments arising from external transactions BOP account of HK • For a specific time period • Economic transactions between HK residents and non-residents

  20. Balance of payment (BOP) account Components of the BOP account: • Current account (經常帳) • Capital and finance account (資本及金融帳) BOP account Capital and financial account Current account International purchases or sales of assets Capital transfers All external transactions not included in capital & financial account

  21. Balance of payment (BOP) account Current account: • Goods (visible trade) • Net receipt brought by merchandise trade (商品貿易) • Receipt: Exports of goods, e.g. garments, jewellery… • Payment: Imports of goods, e.g. rice, cars… Types of BOT: • Balance of visible trade = Total exports of goods – Total imports of goods

  22. Balance of payment (BOP) account Current account: • Services (invisible trade) • Net receipt brought by services • Receipt: Exports of services, e.g. local airline… • Payment: Imports of services, e.g. World Cup broadcasting… • Balance of invisible trade = Total exports of services – Total imports of services

  23. Balance of payment (BOP) account Current account: • Factor income • Net income from abraod • All forms of investment income • Dividends • Interest from deposit • Current transfers • Unilateral(單向) transfer of goods and capital • No economic value being received in return • For example: donations, remittances 匯款 • Net income from abroad • = Factor income from abroad – Factor income paid abroad

  24. Balance of payment (BOP) account Current account balance: Total balance of the 4 components: • Visible trade • Invisible trade • Factor income • Current transfer • Current account balance • = Balance of (Goods + Services + Factor income + Current transfer)

  25. Balance of payment (BOP) account Given the following table, calculate the current account balance of HK: Current account balance = ( $500 - $200 + $350 - $100 + $50 - $80 - $120 ) million = $400 million

  26. Think about: In your own consideration: • Do you think the gov’t should increase subsidies in the above items for you?

  27. Public expenditure (公共開支) • Types of expenditure Functions : Examples • Education : 9-yr free education… • Support :wages of civil servants… • Social welfare : C.S.S.A…. • Health : medical services… • Infrastructure : transportation, water supply… • Security : police, law affairs… • Housing : Public housing… • Economic : postal, airport… • Environment and food: Environment protection • Community and external affairs: culture, sports…

  28. Government revenue • Types of revenue • Taxation • Direct tax • Indirect tax • Fee of selling of services • Medical services • Water supply • Application of ID card… • Fines / Penalties from punishment of illegality • Selling of land

  29. Taxation • Adam Smith’s principles of taxation • Equity • Taxation should be fair. • Taxes are directly proportion to people’s income,i.e. those who earn more income need to pay higher tax • Certainty • Clearly define the responsibilities to taxpayers • Clear tax calculation method • Clear tax payment deadline • Clear modes of payment(in person / online / PPS / credit card…)

  30. Taxation • Adam Smith’s principles of taxation • Convenience • Deadline & payment method: convenient to taxpayers • Allow enough time for payment • E.g. Salary tax in Hong Kong: • May: Submission of Tax Return – Individual • October: Notification of tax payment • January: First installment • April: Secondary installment • Economy • Cost of tax collection should be kept minimum. • Online / PPS tax payment   Cost of tax collection

  31. Tax base (稅基) • The tax base of an economic territory means • activities (e.g. buying car, taking flight overseas) • revenue (e.g. salaries, profits) • assets (e.g. properties, cars) on which taxes are charged. • The government’s scope of taxation. • Broader the tax base  more people need to pay tax  more source of taxation  more stable tax revenue

  32. Classification of tax • By tax burden • Direct tax • Indirect tax • By tax rate • Progressive tax • Proportional tax • Regressive tax

  33. Classification by tax burden • Direct tax • The tax burden cannot be shifted to others by taxpayers. • Examples: • Salaries tax • Charges directly on the salary • Profits tax • Charges directly on profit-making firms • Property tax • Charges directly on rental income earned from land or properties.

  34. Classification by tax burden • Indirect tax • The tax burden can be shifted to others by taxpayers • Examples: • Duties (應課稅品) • Liquors (酒類) • Tobacco(煙草) • Hydrocarbon(燃油) • Methyl alcohol(甲醇) • Rates(差餉) • Betting duty(博彩稅) • Stamp duty(印花稅) • First registration tax (汽車首次登記稅)

  35. Classification by tax burden • Indirect tax • How is the tax burden shifted? • Examples: • Duties:Tobacco • Gov’t charges tax on tobacco traders Tobacco traders raise the price of cigarettes  Consumers need to pay more for the cigarettes • i.e. The tax burden is shifted to consumers through increase in price •  all kinds of sales taxes are indirect tax

  36. Tax base: Direct tax vs. Indirect tax • Direct tax • Levied on companies and salaried workers • Only tax on profit or income earning • Number of taxpayers is limited • Even worse if no profit or salary •  Tax base is narrow • Indirect tax • Imposed on taxable goods and services • Tax on anyone who made consumption • Number of taxpayers is large •  Tax base is broader

  37. Tax base (稅基) Which of the following can broaden (擴闊)the tax base of Hong Kong? • Greatly decrease the basic tax allowance of the salaries tax. • Impose a general sales tax. • Increase the current indirect tax rate. • (2) only • (1) and (2) only • (2) and (3) only • (1), (2) and (3) Answer: B

  38. Stable tax revenue: Direct tax vs. Indirect tax Gov’t revenue fluctuates with economic cycles (經濟週期) • Direct tax • During economic recession (經濟衰退) • Companies: Low profit • Workers: Low salaries • Therefore, gov’t has less profit and salaries taxes • During the time of economic boom (經濟繁榮) • Greatly increase in tax revenue •  Tax revenue is not stable • Indirect tax • No matter what the time is, people need to consume •  Tax revenue is relatively more stable

  39. Tax rate and tax revenue:Why is there smuggling (走私)? • Suppose the gov’t wants to raise tax revenue • Way to achieve:  tax rate (e.g. duty on tobacco) • Traders shift the tax burden to consumer • People needs to pay more • To avoid higher price, consumers buy smuggled cigarettes •  incentive of smuggling market • Finally, lower tax revenue gained • Conclusion • Higher tax rate  illegal activities: smuggling and tax evasion (逃稅)   tax revenue   cost to fight crime

  40. Tax rate and tax revenue • Laffer Curve (textbook p.189) • Two extremes (e.g. salaries tax): • 0% tax rate  No tax revenue • 100% tax rate  All income paid for tax (i.e. no personal income)  No one will work  No tax revenue • Optimum level (t*) • If current tax rate < t*,  tax rate   tax revenue • If current tax rate > t*,  tax rate   tax revenue • To  tax revenue • Increase tax rate if tax rate < t* • Decrease tax rate if tax rate > t* Tax revenue ($) Tax rate (%) 0 100 t*

  41. Classification by tax rate • Basic terms • Taxable income • Tax rate • Tax payment • Basic calculation • Tax rate = • Taxable income = Total income – Tax allowance – Tax deduction e.g. parent, children… e.g. donation, study fee…

  42. Classification by tax rate • Calculate the tax rates on each person at different scheme.

  43. Classification by tax rate • Progressive tax(累進稅) • Higher the taxable income, higher the tax rate. • When taxable income increases, the tax rate increases.

  44. Classification by tax rate • Progressive tax • Relationship between • Taxable income • Tax rate Tax rate (%) 15 10 5 Taxable income ($) 0 300,000 100,000 200,000

  45. Classification by tax rate • Progressive tax • Relationship between • Taxable income • Tax payment Tax payment ($) 45,000 20,000 5,000 Taxable income ($) 0 300,000 100,000 200,000

  46. Classification by tax rate • Proportional tax(比例稅) • No matter the taxable income is, the same tax rate. • When taxable income increases or decreases, the tax rate remains unchanged.

  47. Classification by tax rate • Proportional tax • Relationship between • Taxable income • Tax rate Tax rate (%) 5 Taxable income ($) 0 300,000 100,000 200,000

  48. Classification by tax rate • Proportional tax • Relationship between • Taxable income • Tax payment Tax payment ($) 15,000 10,000 5000 Taxable income ($) 0 300,000 100,000 200,000

  49. Classification by tax rate • Regressive tax(累退稅) • Higher the taxable income, lower the tax rate. • When taxable income increases, the tax rate decreases.

  50. Classification by tax rate • Progressive tax • Relationship between • Taxable income • Tax rate Tax rate (%) 12 10 8 Taxable income ($) 0 300,000 100,000 200,000

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