chapter 22 fiscal policy and monetary policy

Economics Inquiry for HKDSE – Macroeconomics 2Chapter 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. (1) only

B. (2) only

C. (1) and (3) only

D. (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

##

© Aristo Educational Press Ltd. 22-1


|!|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. deficit budget … budget deficit

B. surplus budget … budget surplus

C. surplus budget … budget deficit

D. deficit budget … budget surplus

##

C

##

|!|EM52004|!|

The table below shows the estimated data of an economy in a specific year.

Estimated ($ billion)Government expenditure 5.7

Government revenue 4.5

From the above information, there is a _______________.

A. budget surplus

B. budget deficit

C. surplus budget

D. deficit budget

##

D

Since the estimated government expenditure is greater than the estimated government revenue, there is

a deficit budget.

##



|!|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. equality

B. economy

C. convenience

D. 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

Tax B

- a proportional tax

- 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. Tax A … Tax A

B. Tax A … Tax B

C. Tax B … Tax A

D. Tax B … Tax B



##

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.

##



|!|EM52007|!|

Which of the following diagrams show(s) a relationship in accordance with the taxation principle of

equality put forth by Adam Smith?

A. (1) only

B. (1) and (3) only

C. (2) and (3) only

D. (2) and (4) only

##

B


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.

##


0

(1)Tax payment

Income 0

(2)Tax payment

Income

0

(3)Average tax

rate

Income 0

(4)Average tax

rate

Income


|!|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. (2) only

B. (1) and (3) only

C. (2) and (3) only

D. (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. rental income received from leasing out a property.

B. profits generated from running a tutorial school.

C. dividend received from holding shares of a listed company.

D. commission earned from being a stockbroker.

##

C

Dividend income is not taxable in Hong Kong.

##



|!|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. (1) and (2) only

B. (2) and (4) only

C. (3) and (4) only

D. (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. (1) only

B. (1) and (2) only

C. (2) and (3) only

D. (1), (2) and (3)



##

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.

##



|!|EM52013|!|

Study the following information.

Income ($) Tax payment ($)10,000 60020,000 1,60030,000 3,00040,000 4,800

The above tax is a

A. progressive tax.

B. proportional tax.

C. regressive tax.

D. lump-sum tax.

##

A

Income ($) Tax payment ($) Average tax rate (%)10,000 600 620,000 1,600 830,000 3,000 1040,000 4,800 12

It is a progressive tax, as the average tax rate increases when income increases.

##



|!|EM52014|!|

Which of the following represents a regressive tax?

##

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.

##


0

D.Average tax

rate

Income

0

B.Tax payment

Income0

A.Tax payment

Income

0

C.Average tax

rate

Income


|!|EM52015|!|

Which of the following diagrams represent(s) a progressive tax?

A. (2) only

B. (3) only

C. (1) and (3) only

D. (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.

##


0

(1)Tax payment

Income

0

(3)Average tax

rate

Income

0

(2)Tax payment

Income

0

(4)Average tax

rate

Income


|!|EM52016|!| (revised)

The diagram below shows the relationship between tax payment and income of a certain tax.

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.

##


0

Tax payment

Income


|!|EM52017|!|

The diagram below shows the relationship between tax payment and income of a certain tax.

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.

##


0

Tax payment

Income


|!|EM52018|!|

The diagrams below show the relationship between tax payment and income before and after the

change of a tax system.

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 people’s 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.

##


0

Tax payment

Income0

Tax payment

Income

Old tax system New tax system


|!|EM52019|!|


Income ($) Tax payment ($)Old system New system

10,000 1,400 1,00020,000 2,400 2,40030,000 3,000 4,200

From the above information, which of the following statements is CORRECT?

A. Compared to the old system, more people fall into the tax net.

B. 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 ($) Old system New systemTax payment ($) Average tax rate (%) Tax payment ($) Average tax rate (%)

10,000 1,400 14 1,000 1020,000 2,400 12 2,400 1230,000 3,000 10 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.

##



|!|EM52020|!|


Income ($) Tax payment ($)10,000 50020,000 1,80030,000 X

If the tax is progressive, a possible value of X is _______________.

A. 1,900

B. 2,100

C. 2,400

D. 3,300

##

D

Income ($) Tax payment ($) Average tax rate (%)10,000 500 520,000 1,800 930,000 X 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.

##



|!|EM52021|!|

Refer to the following information.

Income ($) Tax payment ($)Tax A Tax B Tax C

10,000 1,000 1,200 80020,000 1,600 2,400 2,00030,000 1,800 3,600 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. Tax A … Tax C

B. Tax B … Tax A

C. Tax C … Tax B

D. Tax C … Tax A

##

C

Income ($) Tax A Tax B Tax CTax payment

($)Average tax

rate (%)Tax payment

($)Average tax

rate (%)Tax payment

($)Average tax

rate (%)10,000 1,000 10 1,200 12 800 820,000 1,600 8 2,400 12 2,000 1030,000 1,800 6 3,600 12 3,600 12

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.


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.

##



|!|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. An income of $20,000 is subject to a $2,000 tax payment.

B. An income of $30,000 is subject to a $3,600 tax payment.

C. An income of $40,000 is subject to a $6,000 tax payment.

D. 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 ($) Tax payment ($)Tax A Tax B

10,000 1,000 1,00020,000 1,000 2,00030,000 1,000 3,000

In order to reduce income inequality, the government should adopt

A. Tax A.

B. Tax B.

C. either Tax A or Tax B.

D. neither Tax A nor Tax B.

##

D



Income ($) Tax A Tax BTax payment ($) Average tax rate (%) Tax payment ($) Average tax rate (%)

10,000 1,000 10 1,000 1020,000 1,000 5 2,000 1030,000 1,000 3.33 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. People’s money income is fully adjusted according to the

inflation rate. Under a regressive tax system, which of the following must be TRUE?

(1) The amount of tax to be paid will increase.

(2) The purchasing power of people’s pre-tax income will decrease.

(3) A taxpayer’s tax payment in terms of purchasing power will decrease.

A. (1) only

B. (3) only

C. (1) and (3) only

D. (2) and (3) only



##

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 people’s pre-tax money income increases at the same rate of inflation, people’s

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. (1) and (2) only

B. (1) and (4) only

C. (2) and (3) only

D. (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.

##



|!|EM52026|!|


Year Growth rate of public expenditure (%) Growth rate of GDP (%)2006 8 32007 8 42008 8 52009 8 6

According to the above information, the ratio of public expenditure to the GDP from 2006 to 2009

A. is increasing.

B. is decreasing.

C. remains unchanged.

D. 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) the government’s recurrent expenditure will decrease.

(2) the price level will decrease.

(3) the quantity of output will increase.

A. (1) and (2) only

B. (1) and (3) only

C. (2) and (3) only

D. (1), (2) and (3)



##

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 government’s recurrent expenditure.

(2) is correct. Cutting the wage rate of civil servants will lead to a decrease in people’s 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. lowering the discount rate

B. raising the salaries tax rate

C. increasing government expenditure

D. 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. a contractionary … a rightward shift of the SRAS curve

B. a contractionary … a leftward shift of the AD curve

C. an expansionary … a leftward shift of the SRAS curve

D. an expansionary … a rightward shift of the AD curve



##

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. (2) only

B. (1) and (2) only

C. (1) and (3) only

D. (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.

##



|!|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. increase government consumption expenditure

B. raise the profits tax rate

C. lower the required reserve ratio

D. 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. increasing government expenditure and raising the salaries tax rate

B. increasing government expenditure and lowering the profits tax rate

C. reducing government expenditure and raising the salaries tax rate

D. 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.

##



|!|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. (1) only

B. (1) and (2) only

C. (2) and (3) only

D. (1), (2) and (3)

##

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.

##



|!|EM52034|!|

Refer to the following diagram.

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. increasing government consumption expenditure

B. reducing the salaries tax rate

C. reducing the profits tax rate

D. 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.

##


0

Price level

Quantity of output(real GDP)

AD

SRAS

LRAS

E0


|!|EM52035|!|

Refer to the following diagram.

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. (1) and (2) only

B. (1) and (4) only

C. (2) and (3) only

D. (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.

##


LRAS

0

Price level


AD

Yf

SRAS

Y0

P0


|!|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. (1) and (2) only

B. (1) and (3) only

C. (2) and (3) only

D. (1), (2) and (3)

##

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. increase … increase

B. increase … decrease

C. decrease … increase

D. decrease … decrease



##

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. imposing a sales tax on goods and services.

B. reducing government expenditure on medical services.

C. cutting the personal allowance of the salaries tax.

D. 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.

##



|!|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 full-

employment 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. (1) only

B. (2) only

C. (1) and (3) only

D. (2) and (3) only

##

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. The government prints more money.

B. The government sells government bonds to the public.

C. The government lowers the discount rate.

D. The government lowers the required reserve ratio.



##

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. (1) and (2) only

B. (1) and (3) only

C. (2) and (3) only

D. (1), (2) and (3)

##

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.

##



|!|EM52042|!|

Suppose the government of an economy raises the required reserve ratio. Which of the following is her

possible aim?

A. to make income more evenly distributed

B. to eliminate a deflationary gap

C. to lower the price level

D. 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. (1) and (4) only

B. (2) and (3) only

C. (1), (2) and (4) only

D. (2), (3) and (4) only



##

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. Open market operations refer to the sale and purchase of government bonds by firms.

B. Selling government bonds to the public will lead to an increase in interest rate.

C. Buying government bonds from the public will lead to a decrease in money supply.

D. 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. an increase … an increase

B. an increase … a decrease

C. a decrease … an increase

D. a decrease … a decrease



##

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. raising …buying

B. raising … selling

C. lowering … buying

D. 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. print more money … the SRAS curve will shift to the left

B. lower the required reserve ratio … the AD curve will shift to the right

C. raise the discount rate … the AD curve will shift to the left

D. sell government bonds to the public … the SRAS curve will shift to the right



##

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. rise … increase

B. rise … decrease

C. fall … increase

D. 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. stimulate investment.

B. lower the interest rate.

C. cool down an overheated economy.

D. alleviate a recession.



##

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. (1) and (2) only

B. (1) and (3) only

C. (2) and (3) only

D. (1), (2) and (3)

##

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.

##



|!|EM52051|!|

Study the following diagram.

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. (1) and (2) only

B. (1) and (3) only

C. (2) and (3) only

D. (1), (2) and (3)

##

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.

##


Price level

0Quantity of output

(real GDP)

AD

SRAS

LRAS

Yf

Y0

P0


|!|EM52052|!|

Suppose an economy is initially at the full-employment equilibrium. If the central bank raises the

discount rate,

A. the short-run aggregate supply will decrease in the long run.

B. the output level will decrease in the long run.

C. the price level will decrease in the long run.

D. 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



##

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.

##

|!|EM52054|!|


Plan A Plan B Plan C1. cutting the profits tax rate

2. selling government bonds to

the public

1. lowering the required reserveratio

2. decreasing government

expenditure

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. Plan A

B. Plan B

C. Plan C

D. Plan A, Plan B or Plan C



##

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 people’s 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. increase … increase

B. increase … increase, decrease or remain unchanged

C. increase, decrease or remain unchanged … increase

D. 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.

##



|!|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. (1) and (2) only

B. (1) and (3) only

C. (2) and (3) only

D. (1), (2) and (3)

##

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. increase … remain unchanged

B. increase, decrease or remain unchanged … increase

C. increase … decrease

D. increase, decrease or remain unchanged … remain unchanged



##

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. (1) and (3) only

B. (2) and (4) only

C. (1), (3) and (4) only

D. (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.

##



|!|EM52059|!|

An expansionary monetary policy will lead to

A. increases in both the price level and real GDP.

B. an increase in the price level and a decrease in real GDP.

C. a decrease in the price level and an increase in real GDP.

D. 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. (1) only

B. (2) only

C. (1) and (3) only

D. (2) and (3) only

##

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.

##



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. (2 marks)

(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)

##

|!|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)



(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)

(b) raising the standard tax rate of salaries tax (3 marks)

##

(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. (2 marks)

A lump-sum sales tax imposed on general goods and services is a regressive tax. (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. (2 marks)

Salaries tax calculated by the standard tax rate is a proportional tax. (1 mark)

##

|!|ES52004|!|


Income ($) Tax payment ($)10,000 1,00020,000 1,80030,000 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. (2 marks)

(c) Explain the effect of the above tax on income distribution. (2 marks)

##



(a) When the income is $10,000, the average tax rate = $(1,000 / 10,000) 100% = 10% (1 mark)

When the income is $20,000, the average tax rate = $(1,800 / 20,000) 100% = 9% (1 mark)

When the income is $30,000, the average tax rate = $(2,400 / 30,000) 100% = 8% (1 mark)

(b) When income increases, the average tax rate decreases. (1 mark)

Therefore, it is a regressive tax. (1 mark)

(c) As the tax payment takes a higher proportion of income from the low-income group, the

distribution of income becomes more uneven. (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 (2 marks)

(b) the profit Mrs. Cheung earned from running a restaurant in Hong Kong (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. (1 mark)

(b) The profit is subject to taxation in Hong Kong. (1 mark)

This is because the income is earned in Hong Kong. (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)



##

(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. (2 marks)

(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)

##

|!|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. (2 marks)

As a result, aggregate demand will increase. (1 mark)

Both the price level and output level will increase. (1 mark)

##



|!|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. (1 mark)

Aggregate demand will increase and the AD curve will shift to the right from AD0 to AD1. (1 mark)

The price level will increase from P0 to P1. The output level will increase from Y0 to Y1 and the full-

employment output level is restored. (2 marks)

(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)


Price level

0Quantity of output

(real GDP)

AD0

SRAS

LRAS

AD1

Y1

Y0

P1

P0


##

(a) It is a contractionary fiscal policy. (1 mark)

(b) When the salaries tax rate increases, people’s 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. (2 marks)

The price level will decrease from P0 to P1. (1 mark)

The real GDP will decrease from Y0 to Y1. (1 mark)

(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)


Price level

0


AD1

SRAS

LRAS

AD0

Y0

Y1

P0

P1


(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)

(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)


Price level

0Quantity of output

(real GDP)

AD0

SRAS

LRAS

AD1

Y1

Y0

P1

P0


##

(a) Proposal 1 is a monetary policy, while Proposal 2 is a fiscal policy. (2 marks)

(b) The government should adopt Proposal 2. (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. (2 marks)

The price level will decrease from P0 to P1. There will be no inflation. (1 mark)

The output level will increase from Y0 to Y1. The employment situation will be improved.(1 mark)

(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)


Price level

0


SRAS0

LRAS

AD

Y0

Y1

SRAS1

P0

P1


##

The measure cannot alleviate the problem of inflation. (1 mark)

When the government increases the personal allowance of the salaries tax, people’s 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. (2 marks)

The price level will increase from P0 to P1. The problem of inflation will worsen. (1 mark)

(3 marks)

##

|!|ES52013|!|

Some people argue that adopting an expansionary fiscal policy will have no effect on the full-

employment output level in the long run. However, some argue that this will increase the full-

employment output level in the long run. Explain under what condition they are correct. (6 marks)


Price level

0Quantity of output

(real GDP)

AD1

SRAS

LRAS

AD0

Y0

Y1

P1

P0


##

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 full-

employment 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. (1 mark)

As a result, the effect of the two measures, as a whole, on the budgetary condition of the

government is uncertain. (1 mark)

##



|!|ES52015|!|

(a) What are open market operations? (2 marks)

(b) Explain how open market operations help to boost the economy. (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. (2 marks)

(b) To boost the economy, the central bank can buy government bonds from the public. (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)



##

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. (3 marks)


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)

(3 marks)

##


Price level

0Quantity of output

(real GDP)

AD0

SRAS

LRAS

AD1

Y1

Y0

P1

P0


|!|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 people’s 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. (2 marks)

(b) The government raised the profits tax rate for limited companies. (2 marks)

(c) The government raised the rent for public rental housing. (2 marks)

##

(a) Yes. The expenditure of The Hong Kong Jockey Club on building the venues will lead to an

increase in Hong Kong’s 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)

##



|!|ES52019|!|

Refer to the following diagram. The original short-run equilibrium of the economy is at E0.

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 government’s aim. (10 marks)


Price level

0Quantity of output

(real GDP)

AD0

SRAS0

LRAS

E0


##

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. (1 mark)

To restore the full-employment output level, the government should raise the discount rate. (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. (1 mark)



(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 full-

employment output level. (3 marks)


Price level

0Quantity of output

(real GDP)

AD0

SRAS0

LRAS

Y0

Y1

P0

P1

SRAS1

AD1

E0

Widenedinflationary gap


##

(a) When the major trading partners of Country X experience economic recession, the demand for

Country X’s 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. (2 marks)

In the short run, the price level will decrease from P0 to P1. (1 mark)


(3 marks)


Price level

0Quantity of output

(real GDP)

AD0

SRAS

LRAS

AD1

Y1

Y0

P0

P1


(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. (3 marks)

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. (3 marks)

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. (3 marks)

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)

##



Long Questions

|!|EL52001|!|

The diagram below shows the growth rate of real GDP of Country X over a period of time.

(a) (i) According to the above diagram, identify the phase that Country X is in at point A. (1 mark)

(ii) Give any TWO general economic phenomena which occur at point A. (2 marks)

(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. (1 mark)

(ii) - real GDP decreases

- the general price level decreases

- Any reasonable answer(s)

(Mark the FIRST TWO points only, 1 mark each)


0

% change in real GDP

TimeA

Average growth rate


(b) (i) Lowering the salaries tax rate is an appropriate policy. (1 mark)

Lower salaries tax rate leads to an increase in people’s 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)

(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)

##


Price level

0Quantity of output

(real GDP)

AD1

SRAS

LRAS

AD0

Y0

Y1


|!|EL52002|!|

Study the following table.

Year Implicit price deflator of GDP2007 89.82008 95.62009 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. (2 marks)

(ii) Mr. Chan obtained a bank loan in 2007 at a fixed interest rate for two years. (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. (1 mark)

(ii) Mr. Chan would gain. (1 mark)

During unanticipated inflation, the real value of loans and interest payments decreases.

Therefore, borrowers gain. (1 mark)


Price level

0Quantity of output

(real GDP)

AD1

SRAS0

AD0

Y0

Y1

P

SRAS1


(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 de-

mand, the interest rate will increase from r0 to r1. (1 mark)

(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. (1 mark)

(3 marks)

##


Nominalinterest rate

0Quantity of money

MS0

Md

M1

M0

r0

MS1

r1


|!|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? (2 marks)

(c) (i) 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)

(ii) How will the two policies affect the real output in the long run? (3 marks)

##

(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)



(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. (1 mark)

The real output will increase from Y0 to Y1. (1 mark)

(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. (1 mark)

Real output will increase in the long run. (1 mark)

##


Price level

0Quantity of output

(real GDP)

AD0

SRAS

AD1

Y1

Y0

P1

P0


|!|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)



(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 people’s disposable income. This stimulates

private consumption and leads to an increase in aggregate demand. (1 mark)

The AD curve shifts to the right from AD0 to AD1. (1 mark)

The real GDP increases from Y0 to Y1. (1 mark)

(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)

##


Price level

0Quantity of output

(real GDP)

AD1

SRAS

LRAS

AD0

Y0

Y1

chapter 22 fiscal policy and monetary policy

Documents

government budget

deficit budget budget

deficit budget budget

surplus budget budget

surplus budget budget

actual government revenue

tax systems

estimated government