2005-06 AL ECON II MOCK EXAM

1. 2005-06 AL ECON II MOCK EXAM 9-3-2006

2. 1. B 2. B 3. D 4. A 5. D • 6. C 7. C 8. D 9. B 10.C • 11. A 12. cancelled 13. A 14.D 15.A • 16. B 17. A 18. C 19. B 20. D • 21. A 22. C 23. C 24. C 25. B • 26. A 27. B 28. A 29. D 30. B

3. State whether each of the following statements is true or false. Explain your answer.An unanticipated inflation will result in a higher rate of interest. (4 marks) Expected inflation rate 預期通漲率 Nominal Interest Rate 名義利率 Real Interest Rate 實質利率 ＝ ＋ False. Nominal interest rate is equal to the sum of desired real interest rate and anticipated inflation rate. Unanticipated inflation has no influence on the real interest rate nor the nominal interest rate.

4. Inflation cannot exist in a barter economy. (4 marks) • True. In a barter economy, as there is no common measure of relative prices, the general price level cannot be measured. Moreover, a rise in the relative price of good X in terms of good Y implies a fall in the relative price of the good Y in terms of the good X at the same time. Thus, there cannot be a general rise in relative prices.

5. Unemployment rate cannot fall below the natural rate. • False. An unanticipated increase in the price level will lead to money illusion and reduce the unemployment rate below the natural rate in the short run. An unexpected accelerating inflation may sustain the situation continuously.In the short run • 在短期，名義工資貨幣錯覺 • 尋選的邊際成本MC ，因為放棄的工資上升 • 尋選時間失業率 

6. Liquidity trap 流動性陷阱 What? 什麼﹖ The situation that the demand for money is perfectly interest elastic. Investors will keep all their wealth only in the form of money. 是指貨幣性需求的利率彈性為無限大 (即完全彈性)。投資者會將其財富全以貨幣形式儲存，不會購買債券。 Why? 為什麼﹖ People expect interest rate to rise and holding income-earning assets will bring loss therefore people hold all wealth in money 人們預期利率將上升，如現時持有債券，將有資本損失。 When? 何時 When interest rate falls to a sufficiently low level.當利率趺至一相當低水平

7. No. Classical economists focus solely on Mt, they proclaim the nominal money demand is mainly a stable function of nominal income (Md=kPY). In other words, k=1/V is a constant within a lengthy period. • However, according to Keynesians, Ma is also significant, Ma has many non-P and non-Y determinants, Md=kPY, k=1/V must be a variable. • It is because that under liquidity trap, any increase in the money supply will be absorbed by the decrease in the income velocity of money, leaving the price level unaffected. (4 marks)

8. IS curve is downward sloping 向下傾斜 injection> withdrawal 注入 >流出. r  I  I >S • Unintended fall in inventories 非預期存貨減少 • Firms will increase output 公司增產 • Until the goods market equilibrium can be reached, Y  so that S/Withdrawal . 當收入上升，儲蓄/流出增加， 投資與儲蓄就會相等，產品市場回覆均衡

9. Interest elasticity of investment (b) 投資的利息彈性 Slope of IS curve斜率 Marginal propensity to save (s) 邊際儲蓄傾向

10. Greater steeper 較大 較斜 Smaller more gentle較小 較平坦

11. IS曲線與財政政策的效能 The effect of the IS curve and the effectiveness of fiscal policy r LM IS2’ IS1’ IS1 IS2 Y 0 More gentle IS- less effective 較斜的IS曲線會更有效 Greater rEI (b) (Greatercrowding out) 較大的投資的利息彈性

12. b Mt  Md>Ms  r I  G Y  Greater b , smaller Y

13. Not due to higher mps, smaller mps means greater multiplier , a greater shift of IS curve, which make fiscal policy more effective. • 如果IS曲線的斜率較低高是因為較小的邊際儲蓄傾向(s)，財政政策會有效，因為支出乘數會較大，IS曲線的幅度較大。

14. Derive the function of private saving. Under what condition is private saving equal to private investment? • - In equilibrium, withdrawal = injection. • SP+ T + M = I + G + X (1marks) • SP= I + (G – T) + (X – M) • - If private saving is equal to private investment, • SP= I • (G – T) + (X – M) = 0 • X – M = T – G • Trade balance = Fiscal balance In equilibrium, aggregate supply equals aggregate demand. If resources saved by households are consumed by firms, then resources saved by the public sector (=T - G) have to be consumed by the foreign sector as net exports (= X - M).

15. Derive the function of public saving. Discuss the relation between fiscal deficit and trade deficit. • In equilibrium, withdrawal = injection. • SP+ T + M = I + G + X • (T – G) = Public saving (SG) = (I – SP) + (X – M) From the above relation, we can derive that • (G – T) = Fiscal deficit (-SG) = (SP- I) + (M – X) • In equilibrium, aggregate supply equals aggregate demand. If there exists fiscal deficit, the resources have to be supplied by the private sector and / or the foreign sector, by issuing internal debt (SP- I) and / or external debt (and hence the economy has net imports, M – X). If SP= I, the whole fiscal deficit has to be financed by external debt and hence fiscal deficit equals trade deficit.

16. Derive the function of national saving. If national saving equals private investment, what are the balance of current account and capital account respectively? • By definition, SN = SP+ SG= [I + (G – T) + (X – M)] + (T – G) • by definition, SN= I + (X – M) • If national saving equals private investment, (X – M) = 0. In other words, the current account (CA) is balanced. • In equilibrium, the sum of current account balance (CA) and the capital account balance (KA) is equal to zero. If the current account is balanced, the capital account must also be balanced. • Mathematically, CA + KA = 0 • CA = X – M • = -KA • =0

17. Interest rate in HK 港元利率 Interest rate in US美元利率 < • Capital outflows from HK to US 港元資金外流 • Demand for US$ 對美元的需求 • Market Rate 市場匯率 • Licensed Bank buy US$ from Exchange Fund and sell it to the market for the HK$ arbitrage 持牌銀行由外匯基金買入美元及出售予市場 • Supply of HK$ 港元供給 • Interest rate of HK$ 港元利率

18. Under the linked exchange rate system, the country with a higher inflation rate will import more and export less. Money supply and the price level of the smaller country (the price-taker) will change until its inflation rate comes close to that of the larger country.

19. However, the interest rates in Hong Kong are not exactly equal to those in the U.S. because: • Capital flow between countries involves transaction costs and hence a positive interest rate differential remains. The differential is to cover the transaction costs involved.) • From time to time, people may speculate that the HK dollar will appreciate or depreciate against the US dollar. If many people speculate that the HK dollar will appreciate, they will buy HK dollars and sell US dollars at present. The excess supply of the US dollar will increase the pressure for the HK dollar to appreciate. (2marks) • To safeguard the linked rate, the Hong Kong government may deliberately create an interest rate differential. By reducing the interest return of HK dollar deposits, the inflow of US dollars is discouraged. (2marks)

20. However, the inflation rate in Hong Kong is not exactly equal to that in the U.S. because: • Transportation and transaction costs and protectionist measures hinder international trade Hence a price differential caused by the different inflation rates may sustain. (3marks) • Besides exports and imports, inflation rate of a country is determined by the price level of many other goods. Hence the difference in inflation rates may not bring a consequential transaction of exports and imports to equalize the two inflation rates. (3marks)