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ELEMENTARY ECONOMICS FOR HONG KONG (4th Edition)
© Pilot Publishing Company Ltd. 2001
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© PILOT PUBLISHING COMPANY LTD. 2001
ELEMENTARY ECONOMICS FOR HONG KONG (4th Edition)
Contents
1.
Introduction
1
2.
National Income
2
3.
Money
4
4.
The Banking and Financial System of Hong Kong
7
5.
Banking: the Process of Deposit Creation
10
6.
Unemployment, Inflation and Business Cycle
12
7.
Public Finance
15
8.
International trade: Theoretical Principles
18
9.
Free Trade and Trade Restrictions
21
10. Exchange Rates and the Balance of Payments
25
11. Hong Kong's International Trade
28
Websites for Reference
29
© PILOT PUBLISHING COMPANY LTD. 2001
2
ELEMENTARY ECONOMICS FOR HONG KONG (4th Edition)
Ch.1 Introduction
Students’ Difficulties and Teaching Guidelines
1.
2.
3.
4.
Students find it difficult to distinguish between microeconomics and macroeconomics.
It is not so urgent to let them know the differences. They will learn the differences in
the course of time.
The most important thing teachers should do before starting a formal lesson or opening
the textbook, is to hold a discussion with students. The themes of the discussion can be
as follows:
•
What are the biggest economic problems that Hong Kong economy is facing
now?
•
If I were the government, what should I do to safeguard people’s standard of
living?
Students might suggest different economic problems. The job of teachers is to help
students analyse them and if possible, make a clear classification of them according to
the macroeconomics topics. For instance, students may point out the fact that prices are
going up. Teachers should then ask the students why rising prices create economic
problems and help them understand the importance of stable prices. Teachers can
follow on and introduce the terms ‘inflation’ and ‘general price level’, telling students
that these key concepts in macroeconomics will be dealt with in Chapter 6.
Right after the discussion, teachers may ask students to take a close look at the table of
contents on the first few pages of the textbook. Teachers should tell students what they
will learn from the various chapters in general.
© PILOT PUBLISHING COMPANY LTD. 2001
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ELEMENTARY ECONOMICS FOR HONG KONG (4th Edition)
Ch.2 National Income
Students’ Difficulties and Teaching Guidelines
1.
2.
3.
4.
The circular flow of national income
In a simple relationship among output, expenditure and income, explain why these three
variables are all equal in monetary terms.
The three different approaches of measuring national income:
•
The meaning of ‘final goods’ and how to avoid double counting
•
Why transfer payments should be deducted from GNP calculations
•
The interrelationship among GNP, GDP, NNI, NNP and NDP — simple
blackboard calculations would help
•
The meaning of ‘value added’
•
The meaning of ‘GDP at factor cost’: to get the value of national income at
factor cost, we have to deduct indirect business taxes less subsidies from the
corresponding national income.
GDP at Factor Cost = GDP – (Indirect Business Taxes – Subsidies)
GDP = GNP – (Factor Income from Abroad – Factor Income Paid Abroad)
Production side – Since GDP is concerned only with goods and services produced by
resident producing units within the country or territory, in the
calculation of GDP, we do not care who generates the income, we
only care whether the products are produced by resident producing
units or not.
Income side – GNP focuses on the income earned by the residents of a country or
territory by engaging in various economic activities irrespective of
whether the activities are carried out within or outside the territory.
For more detailed study about GDP and GNP, please refer to “Understanding the
concepts of GDP and GNP” by Census and Statistics Department, HKSAR.
According to ‘System of National Accounts’ published in 1993 by IMF, UN and OECD,
etc., several concepts should be clarified as below:
(a)
Illegal tradings, unreported transactions are supposed to be estimated and
included in the calculation of GDP.
(b)
Not all non-marketed goods are excluded from GDP calculation, only those
mentioned on p.11 are excluded.
(c)
The implicit GNP deflator is computed by the method described on p.32.
GDP at market price
(d)
Real GDP is not obtained by
, detailed method please refer
GDP deflator
to documents issued by the Census and Statistics Department.
© PILOT PUBLISHING COMPANY LTD. 2001
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ELEMENTARY ECONOMICS FOR HONG KONG (4th Edition)
Suggested Answers to Revision Exercises 2 of Textbook
Multiple-choice Questions
1.
D
2.
D
3.
C
4.
D
5.
B
Short Questions
1.
(a)
(b)
2.
(i)
(ii)
GDP emphasizes on the total market value of goods and services produced by
resident producing units of an economy;
(2 marks)
while GNP emphasizes on the total income of the residents of an economy.
(2 marks)
(i) $5000 x 6 = $30 000
(2 marks)
(ii) $30 000 + $10 000 x 3 = $60 000
(2 marks)
By expenditure approach, the GNP is $12 000 (which is expenditure on final
goods).
(2 marks)
By output approach, the GNP is $12 000, i.e.,
{($2 000 – 0) + ($6 000 – $2 000) + ($12 000 – $6 000)}.
(2 marks)
3.
Peter is correct.
(1 mark)
The new house was built in 1994, the contribution to GDP is the total expenditure on
the construction at that year.
(2 marks)
4.
Since non-marketed goods and services are not counted in GNP statistics, GNP figures
will underestimate the living standard of a country if a significant level of non-marketed
goods and services are consumed by consumers.
(4 marks)
5.
•
•
Contribution to GDP refers to the value added of the production process.
Therefore, cost of material should be excluded from this $228 800.
(3 marks)
Some of the flowers were produced in 1996 and sold in 1997. They were not
included in GDP of 1997.
(2 marks)
© PILOT PUBLISHING COMPANY LTD. 2001
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ELEMENTARY ECONOMICS FOR HONG KONG (4th Edition)
Ch. 3 Money
Students’ Difficulties and Teaching Guidelines
1.
2.
3.
4.
5.
6.
The barter economy
Teachers should explain clearly the limitations of the barter economy, e.g., lack of
double coincidence of wants.
How does money solve the problems of a barter economy?
•
With the use of money, all goods are priced in terms of money. People can use
money to exchange for what they want, there is no need to have double
coincidence of wants.
•
In a barter economy, there is a lack of a common measure of value. Goods are
swapped for one another. The exchange ratios between goods may be different
with different individuals. Even if the exchange ratio is fixed for each pair of
goods, the multiplication of goods, as the economy grows, will lead to a
multiplication of exchange ratios. Consequently, people are confused with the
exchange ratios and it is very difficult to determine how much money is needed
to exchange for another good. With the use of money, the values of goods are
clearly shown by the prices. There is no more confusion.
•
In a barter economy, indivisibility of goods may hinder transactions. However,
all transactions of various volumes can be entertained in a monetary economy,
because money is divisible.
Functions of money
The most important function of money is a medium of exchange. Another important
function is a store of value. M1, M2 and M3 are classified according to these two
important functions of money.
Qualities of money
Students may have no difficulties in understanding the qualities of money, but some
may regard scarcity as the most important quality of money. In fact, the most important
quality of money is its acceptability. Without its acceptability, money will be nothing
more than a piece of paper or metal.
The issuing of notes in Hong Kong
Explain the different roles performed by the note-issuing banks, the Hong Kong
Monetary Authority and the Exchange Fund.
Money supply
Give clear definitions of money supply — M1, M2 and M3 — by explaining the
different components of M1, M2 and M3, so that students will be able to point out their
differences.
© PILOT PUBLISHING COMPANY LTD. 2001
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ELEMENTARY ECONOMICS FOR HONG KONG (4th Edition)
Suggested Answers to Revision Exercises 3 of Textbook
Multiple-choice Questions
1.
5.
C
C
2.
6.
D
B
3.
7.
B
C
4.
8.
D
B
Structured Questions
1
(a)
(b)
2.
(a)
(b)
(c)
No. Cattle were not a good form of money because of the following reasons:
•
Cattle are not portable. It is troublesome to carry them about from place to
place.
(2 marks)
•
Cattle are not divisible. No one wants a dead cow divided into pieces. It is
impossible to engage in transactions worth less than one cow.
(2 marks)
•
Cattle are not homogeneous. Some are fatter, older or bigger in size.
(2 marks)
•
Cattle are not durable. Diseases may kill them.
(2 marks)
•
MONDEX cards serve as a medium of exchange as they are accepted for
payments. However, there is a limit to the payment it can support.
(2 marks)
•
MONDEX cards do not have intrinsic value like gold. Its value is based on
the stored value of the card, which is limited. These cards are thus not a
good store of value.
(2 marks)
•
MONDEX cards cannot serve as units of accounts. No one is going to use
these cards to measure values.
(2 marks)
•
MONDEX crads are not means of deferred payments as the money is
debited right away upon completion of the transaction.
(2 marks)
Demand deposits serve as a better medium of exchange
(1 mark)
because payment can be made anytime by cheques.
(1 mark)
Time deposits have a maturity period and are not readily available for use.
(1 mark)
Time deposits serve as the best store of value
(1 mark)
because it gives depositors the highest interest earnings.
(2 marks)
M1 places more emphasis on the 'medium of exchange' function of money.
(2 marks)
Time deposits do not perform well as a medium of exchange.
3.
(a)
(1 mark)
M1 decreases by $100 000 because demand deposits decrease by $100 000.
(3 marks)
Although demand deposits decrease by $100 000, deposits in the form of
certificates of deposit increase by $100 000. M2 is thus not affected. (3 marks)
© PILOT PUBLISHING COMPANY LTD. 2001
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ELEMENTARY ECONOMICS FOR HONG KONG (4th Edition)
(b)
M3 remains unchanged as M2 has not been affected.
(3 marks)
There is no law in Hong Kong to make US dollars a medium of exchange
generally acceptable in Hong Kong.
(2 marks)
Thus, the US$ 100 note is not a legal tender in Hong Kong.
© PILOT PUBLISHING COMPANY LTD. 2001
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(2 marks)
ELEMENTARY ECONOMICS FOR HONG KONG (4th Edition)
Ch.4 The Banking and Financial System of Hong Kong
Students’ Difficulties and Teaching Guidelines
1.
2.
3.
4.
Functions of a central bank
•
How are central bank functions carried out in Hong Kong?
Note that although the Hong Kong Monetary Authority performs some of the
functions of a central bank, it is by no means the central bank in Hong Kong.
•
A central bank is generally a government bank which manages the
government’s financial assets and serves as the government’s banker and adviser
in the matter of money and banking.
–
The Hong Kong Monetary Authority helps manage the government’s
foreign exchange assets. It therefore performs some of the functions of a
government bank.
–
The Hongkong and Shanghai Banking Corporation and the Standard
Chartered Bank operate banking accounts on behalf of the government.
Thus, they are bankers to the government.
–
The Hong Kong Monetary Authority and the note-issuing banks all serve
as the government’s advisers in the matter of money and banking. Thus,
they jointly perform another important function of a government bank.
Distinguish licensed banks, restricted licence banks and deposit-taking companies.
Hong Kong as a financial centre
•
Explain briefly the three important financial markets: the capital market, the
money market and the foreign exchange market.
•
Detailed analysis of these markets is not required. Teachers should explain to
students that cosmopolitanism and well-developed financial institutions and
services are major features of a financial centre.
•
In recent years, financial markets in Hong Kong experienced rapid growth and
development, especially the capital market, which is an important source of
finance for corporate borrowers. The two main types of negotiable debt
instruments traded are certificates of deposit issued by authorized institutions
and commercial papers by other private sector companies. Foreign institutions
are actively involved in the tapping of funds from the capital market. In 1989
and 90, the World Bank launched three issues of Hong Kong dollar bonds.
•
The Exchange Fund Bills launched in 1990 signalled the government’s active
effort in the capital market. The bills are available in minimum denominations
of HK$500 000 and are issued on a discount basis by tender. All 91-day bills are
issued weekly and 182-day bills are issued fortnightly.
Regulation of the financial sector
•
The Hong Kong Monetary Authority is responsible for the supervision of
licensed banks, restricted licence banks and deposit-taking companies.
© PILOT PUBLISHING COMPANY LTD. 2001
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ELEMENTARY ECONOMICS FOR HONG KONG (4th Edition)
•
5.
The Securities and Futures Commission, established in 1989, supervises the
securities, financial investment and commodities futures industry in Hong Kong.
It administers the Securities and Futures Commission Ordinance, the Securities
Ordinance, the Protection of Investors Ordinance and the Commodities Trading
Ordinance.
•
The office of the Commissioner of Insurance supervises the insurance industry
in Hong Kong. It administers the Insurance Companies Ordinance.
Monetary policies
•
The study of monetary policies is outside the syllabus. A general and brief
description of monetary policies is recommended to satisfy inquisitive minds.
Teachers should warn students against sweeping statements that suggest causal
relationships between monetary policies and inflation/recession. Monetary
policies in theory have limitations. Time lag is one of the most important
limitations of monetary policies. In practice, they may not be very effective in
tackling economic problems.
•
How the economy performs is determined by many factors. There is no simple
solution, such as lowering or increasing interest rates, to an economic problem.
Suggested Answers to Revision Exercises 4 of Textbook
Multiple Choice Questions
1.
B
2.
A
3.
D
4.
B
5.
B
6.
B
Structured Questions
1.
(a)
(b)
(c)
2.
(a)
Licensed banks accept all types of deposits.
(1 mark)
However, restricted licence banks accept only time deposits and negotiable
certificates of deposits. They cannot accept demand deposits and savings
deposits.
(1 mark)
Both accept deposits of any maturity.
(2 marks)
The minimum paid-up capital of licensed banks is $150 million,
(1 mark)
but that of restricted licence banks is $100 million.
(1 mark)
•
•
•
•
•
It issues banknotes.
It is the lender of last resort. It has the duty to help banks in difficulties and
solve bank crisis.
It is a government bank. It serves as a government banker, agent and
advisor in the matter of money, banking and finance.
It is a bank of central clearance, where cheques are cleared and mutual
debts among banks are settled.
It carries out monetary policies.
© PILOT PUBLISHING COMPANY LTD. 2001
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ELEMENTARY ECONOMICS FOR HONG KONG (4th Edition)
(b)
•
•
•
•
•
•
It supervises banking activities.
(2 marks each, total: 12 marks)
It is the lender of last resort.
It carries out monetary policies.
It supervises banking activities in Hong Kong.
It manages the Exchange Fund and stabilizes the exchange value of the
Hong Kong dollar.
It advises the government on financial and monetary affairs.
(Any 4 points, 3 marks each, maximum: 12 marks)
© PILOT PUBLISHING COMPANY LTD. 2001
9
ELEMENTARY ECONOMICS FOR HONG KONG (4th Edition)
Ch.5 Banking: the Process of Deposit Creation
Students’ Difficulties and Teaching Guidelines
1.
2.
3.
Deposit creation
•
The basic assumptions underlying deposit creation should be stated clearly.
•
The limitations of deposit creation: total deposits created are in practice less
than the theoretical maximum because of different limitations.
•
Remind students that total deposits created usually include the initial deposit.
Some students have confusion in the understanding of minimum reserve ratio, cash
reserve ratio and liquidity ratio.
Banking multiplier
Simple calculations can help students grasp the concept of banking multiplier. Note that
in reality because of cash leakage or under-utilization of excess reserves, the actual
amount of deposits created and the value of banking multiplier are all less than what are
theoretically possible.
Suggested Answers to Revision Exercises 5 of Textbook
Multiple-choice Questions
1.
D
2.
B
3.
C
4.
B
Structured Questions
1.
(a)
(b)
2.
(a)
(i)
(ii)
(iii)
(iv)
$1 000
(2 marks)
$2 000
(2 marks)
60%
(2 marks)
An additional $2 000 can be used as loans and this will create a maximum
1
 $10 000 .
total deposits of $2 000 
(4 marks)
20%
From June to July, demand deposits increase from $10 to $30. Other things
being constant, this means that M1 increases by $20.
(2 marks)
M1 includes only currency in circulation and demand deposits.
(1 mark)
In July, the increase in demand deposits is balanced exactly by a decrease in the
total sum of savings deposits and time deposits.
(2 marks)
Thus, M2 remains the same.
(1 mark)
20%
© PILOT PUBLISHING COMPANY LTD. 2001
(2 marks)
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ELEMENTARY ECONOMICS FOR HONG KONG (4th Edition)
(b)
The balance sheet will change as follows:
Assets ($)
Reserves $ 500
Loans
$4 000
Total
$4 500
(c)
(d)
(e)
3.
(a)
(b)
(c)
4.
(a)
(b)
Liabilities ($)
Demand Deposits $4 500
Total
$4 500
(3 marks)
Given a minimum reserve ratio of 20%, the bank should keep $900 as reserves.
(1 mark)
The reserves fall short of the legal requirement by $900  $500 = $400. (1 mark)
Cash can be borrowed from other banks, i.e., inter-bank money, to make up for
the shortage
(2 marks)
or loans can be called back to get the necessary cash.
(2 marks)
1
$500 
 $2 500
(2 marks)
20%
Total deposits decrease by $2 500
(1 mark)
M1 (before the withdrawal) = $100 + $5 000 = $5 100
(1 mark)
M1(after the withdrawal) = $100 + $500 + $2 500 = $3 100
(1 mark)
M1 decreases by $2 000
(2 marks)
Liabilities because they are money borrowed from depositors.
(2 marks)
The maximum amount of deposit created would decrease
(1 mark)
because the maximum banking multiplier is smaller.
(1 mark)
The actual reserve ratio may be bigger than the required reserve ratio (1 mark)
for the following reasons :
• banks may be conservative and they keep more reserves than what is
required.
(1 mark)
• excess reserves are not fully utilized as the economy is not good enough and
the demand for loans is small.
(1 mark)
• excess reserves are not fully utilized as the number of qualified borrowers
decreases.
(1 mark)
In this case, there will be no change in total deposits.
(1 mark)
Deposits of the developer will offset the initial withdrawal by the local buyers
later. This is only a switch from one’s deposits to another’s.
(3 marks)
The overseas remittance gives extra reserves to the banking system.
(1 mark)
The maximum increase in total deposits
1
 $1 million 
20%
(3 marks)
 $5 million
© PILOT PUBLISHING COMPANY LTD. 2001
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ELEMENTARY ECONOMICS FOR HONG KONG (4th Edition)
Ch.6 Unemployment, Inflation and Business Cycle
Students’ Difficulties and Teaching Guidelines
1.
2.
3.
4.
5.
6.
Simple calculations on unemployment rate and labour participation rate would be
helpful.
Distinguish between social costs of unemployment and economic costs of
unemployment.
Types and causes of unemployment are not required in the public examination because
the understanding of these concepts requires theories too advanced for F.4 and F.5
students. Teachers can simply explain that when the economy is not doing well,
unemployment will increase and more shops will close down.
Inflation
•
A rise in the general price level reflects the presence of inflation.
•
How to use GDP/GNP deflator to get GDP/GNP at constant dollars and the
inflation rate.
•
Simple calculations on inflation rate using the price indices would be useful.
Note that the causes of inflation are too advanced for F.4 and F.5 students. The
spirit of the new syllabus is to provide students with vigorous training in basic
concepts. Avoiding complicated theories is important because incomplete or
poor learning will give rise to wrong concepts. Thus, the types of inflation, such
as cost-push, demand-pull and imported inflation are out of the syllabus. When
students ask why inflation occurs, teachers may briefly mention the effects of
rising costs of production, rising wages or increasing demand for goods and
services, without going into the theoretical models.
Distinguish between recession and depression.
‘Business cycle’ is a new addition to the syllabus starting from 1994. It is only meant to
give students a general picture of what will happen when the economy goes from one
phase to another phase of the cycle. All theories regarding the concept, like those that
explain the economic forces that drive the economy from one phase to another, are not
required in the public examination. They are too advanced for F.4 and F.5 students.
Students may ask whether there is a daily-life example of business cycle. This is again
not required in the examination, teachers may give a brief description of the Hong Kong
economy in the years 1973–92.
•
1973–75 (Recession)
The world energy crisis caused a drastic rise in oil prices which did a lot of harm
on the Hong Kong economy and the rest of the world. In 1973, the stock market
collapsed. The Hong Kong economy experienced a period of recession.
Depression came in 1975.
•
1975–76 (Recovery)
© PILOT PUBLISHING COMPANY LTD. 2001
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ELEMENTARY ECONOMICS FOR HONG KONG (4th Edition)
•
•
•
•
•
Exports expanded rapidly because of enormous overseas demand, resulting in
great industrial growth.
1977–82 (Prosperity)
During these years, the economy enjoyed high employment and real economic
growth at high rates.
Prices were going up.
1983–85 (Recession)
The property market declined drastically in the years 1982–83 partly because of
political uncertainties after 1997. The Chinese government and the British
government negotiated and made a Joint Declaration on the political future of
Hong Kong after 1997. This confidence crisis retarded the economic growth of
Hong Kong.
1985–86 (Recovery)
China’s modernization led to the rapid development of Hong Kong’s exporting
industries and the growth of re-exports.
1986–88 (Prosperity)
The prosperity reached its peak in 1987. In 1988, the economy went downhill.
1989–92 (Recession)
The world economy slowed down and so did the US economy and the Hong
Kong economy. Unemployment increased. The June-Four Incident caused a
collapse in the stock market and a decline in investment because of political
uncertainties. In early 1992, the world economy still had no signs of recovery. It
was generally believed that the US economy could pick up in the latter half of
1992.
The above description is meant to be a general picture of the ups and downs of
the Hong Kong economy in the period 1973–92. It is not supported by vigorous
theoretical treatment. The division into the four phases of a business cycle is
somewhat arbitrary. Nevertheless, the description is helpful in leading students
to get the general picture. Teachers must be aware of two facts. First, the Hong
Kong economy is strongly supported by the Chinese economy. Second, very
often, it is difficult to trace the four phases of a business cycle because the ups
and downs are not clearly identifiable.
Suggested Answers to Revision Exercises 6 of Textbook
Multiple-choice Questions
1.
B
2.
D
3.
C
Short Questions
1.
When inflation is unexpected, the money returned from debtors to creditors will be
lower in real values, i.e., lower purchasing power.
(2 marks)
© PILOT PUBLISHING COMPANY LTD. 2001
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ELEMENTARY ECONOMICS FOR HONG KONG (4th Edition)
It is a redistribution of income from creditors to debtors.
(1 mark)
2.
It depends on whether he is willing to work or not.
If he is willing to find a job and cannot find one, then he is classified as ‘unemployed’.
(1 mark)
If he is not willing to work, he is not in the labour force, so he should not be classified
as ‘unemployed’.
(1 mark)
If he is working for a payment or profit, he is classified as ‘employed’.
(1 mark)
3.
The four phases are: prosperity, recession, depression and recovery.
(4 marks)
Structured Questions
1.
(a)
(b)
(c)
(d)
(e)
2.
(a)
(b)
3.
(a)
(b)
(125  110)
 100%
110
(1 mark)
 13.6%
$(300  200) million
 100%
Real GNP growth rate 
200 million
(1 mark)
 50%
Since both the real GNP and deflator increased, money GNP must increase.
(2 marks)
125
Money GNP in 2000  $300 
100
(1 mark)
 $375
The GNP deflator has a wider coverage of goods and services,
(1 mark)
while the CPI only covers those consumer goods.
(1 mark)
The inflation rate in 2000 
He will gain.
The real value of the amount of repayment and interest decreased.
He will loss.
The real value of his income decreased.
(1 mark)
(2 marks)
(1 mark)
(2 marks)
He will gain.
The real value of the repayment and interest will fall.
He will loss.
The real value of the repayment and interest will rise.
(1 mark)
(2 marks)
(1 mark)
(2 marks)
© PILOT PUBLISHING COMPANY LTD. 2001
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ELEMENTARY ECONOMICS FOR HONG KONG (4th Edition)
Ch.7 Public Finance
Students’ Difficulties and Teaching Guidelines
1.
2.
3.
4.
5.
6.
What is the public sector?
Name some institutions, e.g., Trade Development Council, and explain whether they are
included in the public sector.
Classification of taxes
Teachers should remind students of the criteria for tax classification:
•
Classification according to the incidence of taxation — direct or indirect taxes.
Some students fail to distinguish between direct taxes and indirect taxes because
they overlook the incidence of taxation.
•
Classification according to the proportion of income taken as tax when income
changes — proportional, progressive or regressive taxes.
It is the proportion of income taken as tax that determines the types of taxes.
Many students fail to identify this criterion for classification. The classification
adopted in the text focuses on the relative effects of the tax on different income
groups. A more specific classification is as follows:
–
Proportional taxes are those taxes for which the proportion of income
taken as tax stays the same as income increases.
–
Progressive taxes are those taxes for which the proportion of income
taken as tax rises when income increases.
–
Regressive taxes are those taxes for which the proportion of income taken
as tax decreases when income increases. For example, rates in Hong Kong
are regressive. A given sum of rates takes up a decreasing proportion of
income as income increases. For the same reason, sales taxes are also
regressive.
•
Graphical analysis of these taxes should be emphasized.
Memorizing the definitions of taxes in Hong Kong is not necessary. However, students
should be able to give examples of both direct and indirect taxes in Hong Kong.
Distinguish between tax revenue and non-tax revenue.
It is important to understand the economic effects of taxation and government
expenditure. Such an understanding may help students comprehend how the
government improves the economy by implementing fiscal policies.
Fiscal policies
•
Like monetary policies, the study of fiscal policies is not required in the public
examination.
•
Fiscal policies can be broadly divided into:
–
expansionary fiscal policies which consist of a cut in taxes and/or an
increase in government expenditures.
© PILOT PUBLISHING COMPANY LTD. 2001
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ELEMENTARY ECONOMICS FOR HONG KONG (4th Edition)
–
7.
contractionary fiscal policies which consist of an increase in taxes and/or
a cut in government spending.
•
The government may make use of the government budget in implementing
expansionary or contractionary fiscal policies. Surplus budgeting is
contractionary because government revenue exceeds government expenditure.
Deficit budgeting is expansionary because government expenditure exceeds
revenue.
•
Students may ask how the govenment can do something to fight inflation or
recession. Teachers may ignore the term fiscal policies, while drawing students’
attention to the economic effects of taxation and government spending. For
instance, at times of inflation, increasing taxes may reduce disposable income
and dampen investment incentives. Consequently, consumption and investment
may decline, and this would curb inflationary movement.
•
Teachers, however, have to note the limitations of fiscal policies. Lags often
exist and fiscal policies may not seem effective.
Major proposals in the government budget
Teachers may use the latest newspaper cuttings on the HKSAR government budget to
help students understand some of the basic concepts involved in this topic.
Example: Estimated revenue and expenditure
•
Proposed tax cuts
•
Tax allowances
•
Proposed tax increases
•
Proposed expenditures in major areas
Suggested Answers to Revision Exercises 7 of Textbook
Multiple-choice Questions
1.
D
2.
D
3.
D
4.
C
5. D
6. A
Structured Questions
1.
(a)
(b)
(c)
Direct tax is a tax in which the tax burden cannot be shifted to another person or
party.
(2 marks)
Indirect tax is a tax in which the tax burden can be shifted to another party.
(2 marks)
Rate is an indirect tax.
(1 mark)
Property tax is a direct tax.
(1 mark)
Salaries tax: With a certain range of taxable income, marginal tax rate increases
with income, so it is progressive.
(2 marks)
Beyond a limit of income, overall effective rate of 15% taxes is restricted, so it
is proportional.
(1 mark)
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ELEMENTARY ECONOMICS FOR HONG KONG (4th Edition)
Profits tax: The same percentage is taxed to all income earners. Therefore, it is a
proportional tax.
(1 mark)
2.
(a)
(b)
3.
(a)
(b)
A sales tax is a tax on goods and services.
(1 mark)
Sellers will shift the sales tax burden to consumers through raising prices,
(1 mark)
so the price level will increase.
(1 mark)
When government increases the profits tax rate, investment will be discouraged.
(1 mark)
Thus, investment will fall and so as GDP.
(2 marks)
Direct tax: salaries tax; profits tax
(2 marks)
Indirect tax: sales tax
(1 mark)
(i) Policy B: An increase in profits tax will lead to a fall in net profit.
(1 mark)
It will discourage investment.
(1 mark)
With less investment, fewer goods and services will be produced. Thus,
GDP will fall.
(1 mark)
(ii) Policy C: The introduction of a sales tax will widen the wealth gap
(1 mark)
as people in the lower income groups will pay a larger proportion of their
income as tax than those in the higher income groups.
(2 marks)
(iii) Policy A: An increase in tax allowances will reduce the tax on the lower
income groups.
(1 mark)
An increase in standard tax rate will reduce the income of the higher
income groups.
(1 mark)
This will result in a more even distribution of income.
(1 mark)
© PILOT PUBLISHING COMPANY LTD. 2001
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ELEMENTARY ECONOMICS FOR HONG KONG (4th Edition)
Ch.8 International Trade: Theoretical Principles
Students’ Difficulties and Teaching Guidelines
1.
Distinguish between absolute advantage and comparative advantage. Note that it is
comparative advantage, not absolute advantage, that determines whether trade is
desirable or not. Teachers can use hypothetical data to illustrate that trade is not
desirable between two countries when their opportunity costs are the same.
Study the following table.
Unit of Output per Man-hour
Country
Food
A
B
2.
Clothing
1
2
2
4
Since both countries have the same opportunity cost in producing food and clothing,
trade between them is not desirable as there will be no gain from trade.
Simple calculations on opportunity costs, terms of trade and gains from trade would be
helpful. As students in general are quite weak in opportunity cost calculations, class
explanation to some of the related questions from the practice book would be fruitful in
consolidating students’ knowledge. Some students ignore units in calculating
opportunity costs and produce meaningless ratios, e.g., 1 : 2, they have not shown the
understanding that the opportunity cost of producing 1 unit of food is 2 units of clothing
forgone.
Suggested Answers to Revision Exercises 8 of Textbook
Multiple-choice Questions
1.
C
2.
C
3.
C
4.
B
Structured Questions
1.
(a)
The table can be re-arranged as follows:
Country
X
Y
© PILOT PUBLISHING COMPANY LTD. 2001
Production per Man-hour
1
B
1A
or
3
1
1
A
B
or
2
4
18
ELEMENTARY ECONOMICS FOR HONG KONG (4th Edition)
Country X should specialize in and export Good A, because it has lower
opportunity cost in its production. For each unit of Good A produced, it gives up
1
1
unit of Good B, but Country Y is B.
(3 marks)
2
3
(b)
Country X has an absolute advantage in the production of Good A
(1 mark)
because it can produce more of it with given amount of resources than
Country Y.
(2 marks)
(c)
Yes. The following terms of trade is mutually acceptable:
1
1
B  1A  B
(3 marks)
2
3
1
The given terms of trade 1A: B is within the above limits. Thus, trade is
3
mutually beneficial and it will occur.
(3 marks)
Alternative answer :
1
Locally in Country X: 1A = B
3
1
With trade: 1A = B
3
Gain from trade per unit of good A exported = 0 B
(2 marks)
Locally in Country Y: 1B = 2A
With trade:1B = 3A
Gain from trade per unit of good B exported =1A
(2 marks)
Given that Country X has no gain form trade, but country Y has gains, according
to trade theories, trade is still mutually beneficial.
(2 marks)
(d)
(i) Country X specializes in Good A. If 300 units of Good A are exported,
1
according to the terms of trade (1A: B), it will get 100 units of Good B.
3
(1 mark)
Locally, it can also get 100 units of Good B, if it gives up producing 300
units of Good A with the same resources.
(1 mark)
Thus, there are no gains from trade.
(1 mark)
1
(ii) Locally in Country X, 1A  B
3
With trade, 1A = 0.5B
Therefore, after adding in the transportation cost, Country X’s gains from
trade per unit of good A exported
1
= 0.5B  B  0.1B
(0.1B = transportation cost)
3
= 0.5B  0.33B  0.1B
= 0.07B
(3 marks)
Locally in Country Y, 1B = 2A
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19
ELEMENTARY ECONOMICS FOR HONG KONG (4th Edition)
Terms of trade (with transportation cost ) 1.1B = 2A
1B = 1.82 A
Country Y loses 0.18 unit of A per unit of good B exported.
Since trade is not mutually beneficial, there will be no trade.
2.
(a)
(b)
(c)
3.
(a)
(b)
(3 marks)
(1 mark)
A country is said to have an absolute advantage over others if it is able to
produce more of a good with the same amount of resources.
(2 marks)
A country is said to have a comparative advantage over others if it is able to
produce a good at a lower opportunity cost than other countries.
(2 marks)
The law of comparative advantage states that the total output will increase as
long as countries specialize in producing goods in which they have a
comparative advantage.
(2 marks)
•
Wars or political unrest in the trading areas.
•
The terms of trade is not mutually beneficial.
•
Transportation cost may be too high.
(2 marks each, total: 6 marks, elaboration is needed)
The statement argues that specialization is based on absolute advantage.
Countrie should specialize in productions with comparative advantage, not
absolute advantage.
(2 marks)
The Law has been wrongly stated.
The law of comparative advantage states that the total output will increase as
long as countries specialize in producing goods in which they have a
comparative advantage.
(2 marks)
Differences in opportunity costs imply that comparative advantage exists and
there are potential gains from trade.
(2 marks)
Whether trade will actually take place or not depends on the terms of trade , and
the costs of conducting trade, e.g., transportation, which jointly determine the
actual gains from trade.
(2 marks)
Trade will not occur when actual gains from trade are negative for any trading
partner.
(2 marks)
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20
ELEMENTARY ECONOMICS FOR HONG KONG (4th Edition)
Ch.9 Free Trade and Trade Restrictions
Students’ Difficulties and Teaching Guidelines
1.
2.
Explain, with the aid of diagrams, how different forms of trade restrictions help reduce
imports. Note that quotas are more effective than tariffs in restricting imports because:
•
The effect of a tariff is dampened if the demand for imports is inelastic.
•
A quota specifies the upper limit of imports and thus its effect is guaranteed.
There are too many arguments for and against trade restrictions. The teacher can arrange
a debate on this.
Suggested Answers to Revision Exercises 9 of Textbook
Multiple-choice Questions
1.
B
2.
D
3.
B
Structured Questions
1.
(a)
(b)
(c)
Free trade refers to the unrestricted exchange of goods and services among
nations.
(2 marks)
(i) Free trade improves the standard of living because a bigger variety of
goods can be consumed by people in trading nations at lower prices.
(2 marks)
(ii) Free trade provides more employment because trade activities increase and
there are more investments and expansion in the trading sector. (2 marks)
(iii) Free trade increases price stability because the shortage of goods or
resources can be overcome by the importation of foreign goods or
resources.
(2 marks)
Trade restrictions may help protect local industries and employment because
imports are reduced.
(1 mark)
However, it slows down the improvement of local industries.
(1 mark)
It also reduces the amount of goods available to local residents. People have to
pay more for imports.
(2 marks)
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21
ELEMENTARY ECONOMICS FOR HONG KONG (4th Edition)
2.
(a)
Shoes from Country X
Price ($)
S2
S1
P2
P1
D
S1
0
(b)
(c)
Q2
Quantity/period
Q1
(2 marks)
The quota will raise the equilibrium price of the shoes from Country X but
decrease its equilibrium quantity.
(2 marks)
Product diversification: devloping new industries and products.
(2 marks)
Developing new markets other than Country Y.
(2 marks)
Raising the quality of the shoes exported to increase sales revenue even though the
maximum quantity of exports is fixed by the quota.
(2 marks)
(i)
Shoes made in Country Y
Price ($)
S
P2
P1
D2
D1
0
Quantity/period
Q1
Q2
Shoes from Country X and local shoes made in Country Y are substitutes.
(1 mark)
Since the shoes from Country X become more expensive after the
imposition of the quota, people will increase the demand for local shoes.
(2 marks)
Both the equilibrium price and quantity of local shoes will rise. (2 marks)
© PILOT PUBLISHING COMPANY LTD. 2001
22
ELEMENTARY ECONOMICS FOR HONG KONG (4th Edition)
(ii)
3.
(a)
Total revenue of shoes manufacturers will increase.
(2 marks)
As local shoes industry increases output, there will be greater employment
in Country Y.
(2 marks)
(b)
Toys consumers in Country B suffer from higher prices of imported toys.
(2 marks)
Since the quantity imported also decreases, they have a smaller quantity of
imported toys to choose from.
(2 marks)
The quota sets a maximum quantity of imported toys.Thus, the effect of quota on
the quantity of imported toys is certain.
(2 marks)
The effect of the tariff on the quantity of imported toys depends on the price
elasticity of demand for the imported toys. In case demand is inelastic, the
decrease in the quantity of imported toys is limited.
(2 marks)
(c)
•
The local toys industry may rely too much on the subsidies and such
reliance will restrict its growth in efficiency.
•
The money alloted for the subsidies has alternative uses. Subsidizing the
local toys industry may not be the best use.
•
Other industries may also apply for subsidies and it is financially
impossible for the government to entertain all requests.
•
(d)
4.
(a)
(b)
Subsidizing a local industry is against the principle of a free economy.
(Any 2 points, 2 marks each, maximum: 4 marks )
Since the per-unit tariff is $10, which is very high, the percentage increase in the
equilibrium price of cheaper imported toys will be very great too.
(1 mark)
People in Country B may demand less of the imported toys, but more of the toys
produced locally.
(1 mark)
Expensive toys with better quality may have a smaller percentage increase in the
prices because of the tariff. Thus, the expensive toys may suffer from a smaller
decline in demand or sales.
(1 mark)
In conclusion, the quality of toys exported from Country A will improve. (1 mark)
Mainland China will engage in more direct trade with other trading nations.
(1 mark)
China and other countries will make less use of Hong Kong as an entrepot .
(1 mark)
The volume of Hong Kong entrepot trade will decline.
(2 marks)
Local motor vehicles industry in Mainland China are not well developed as their
counterparts in U.S.A, Europe and Japan.
(1 mark)
The demand for locally produced vehicles will fall as consumers increase their
demand for imported cars.
(2 marks)
The sales revenue of the local motor vehicle industry will fall.
(1 mark)
© PILOT PUBLISHING COMPANY LTD. 2001
23
ELEMENTARY ECONOMICS FOR HONG KONG (4th Edition)
(c)
Since China is open to the world, China will have more imports and exports.
(2 marks)
The volume of China trade increases.
(2 marks)
© PILOT PUBLISHING COMPANY LTD. 2001
24
ELEMENTARY ECONOMICS FOR HONG KONG (4th Edition)
Ch.10 Exchange Rates and the Balance of Payments
Students’ Difficulties and Teaching Guidelines
•
•
•
Distinguish between balance of trade and balance of payments.
Distinguish between visible and invisible items of the current account.
Classify payments and receipts correctly so that they appear in the right accounts.
Suggested Answers to Revision Exercises 10 of Textbook
Multiple-choice Questions
1.
B
2.
A
3.
B
4.
D
5.
C
Structured Questions
1.
(a)
(b)
The balance of trade is the difference between the values of visible exports and
imports of a country.
(2 marks)
(i) Hong Kong may increase textile exports to the U.S.A. Thus, there is a
favourable effect on the balance of trade.
(2 marks)
An increase in textile exports also has a favourable effect on the balance of
payments.
(2 marks)
(ii) The devaluation of Hong Kong dollar reduces the prices of Hong Kong
exports in terms of foreign currencies. Therefore, more Hong Kong
exports will be exported overseas. Imports, on the other hand, will
decrease because imports become more expensive in terms of local
currency.
(2 marks)
Thus, there is a favourable effect on both the balance of trade and balance
of payments.
(2 marks)
(iii) This increases Hong Kong’s invisible earnings. Since invisible earnings
are not included in the balance of trade, this has no effect on the balance of
trade.
(3 marks)
However, the invisible earnings will have a favourable effect on the
balance of payments.
(1 mark)
(iv) This is an outflow from the capital account of Hong Kong. It does not
affect Hong Kong’s balance of trade.
(3 marks)
However, this has an unfavourable effect on Hong Kong’s balance of
payments.
(1 mark)
(v) This increases Hong Kong’s imports from Japan.
(2 marks)
Thus, both the balance of trade and balance of payments of Hong Kong
will be adversely affected.
(2 marks)
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ELEMENTARY ECONOMICS FOR HONG KONG (4th Edition)
2.
(a)
(b)
3.
(a)
The Hong Kong dollar will appreciate against other foreign currencies. (1 mark)
Hong Kong exports will become more expensive, in terms of foreign
currencies. People in other countries will demand less of Hong Kong
exports.
(2 marks)
The decline in the export sector will lower employment in Hong Kong.(2 marks)
(i) Current account, debit
(ii) Current account, debit
(iii) Capital and Financial account, credit
(iv) Current account, debit
(v) Capital and Financial account, credit
(2 marks each, total: 10 marks)
(i)
After the appreciation of the Japanese Yen, the Japanese fashions will be
more expensive in terms of Hong Kong dollars, even though their prices in
Japanese Yen remain the same.Thus, the owner of the boutique has to raise
the prices of Japanese fashions.
(5 marks)
(ii) The demand for Japanese fashions may be inelastic.
(1 mark)
The percentage increase in price is greater than the percentage decrease in
quantity transacted.
(1 mark)
Gain in revenue is greater than the loss in revenue
(2 marks)
Price ($)
(2 marks)
P2
Gain
P1
0
(b)
D
Loss
Q2
Q1
Quantity/period
European fashions and Japanese fashions are substitutes.
(1 mark)
Since European fashions become relatively cheaper, demand increases.
(2 marks)
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ELEMENTARY ECONOMICS FOR HONG KONG (4th Edition)
Price ($)
S
P2
(2 marks)
P1
D2
D1
0
© PILOT PUBLISHING COMPANY LTD. 2001
Quantity/period
Q1
Q2
27
ELEMENTARY ECONOMICS FOR HONG KONG (4th Edition)
Ch.11 Hong Kong’s International Trade
Students’ Difficulties and Teaching Guidelines
1.
2.
The principle of comparative advantage and the Hong Kong economy
According to the principle of comparative advantage, explain why Hong Kong
specializes in manufacturing industries.
Distinguish between product sophistication and industrial diversification.
Suggested Answers to Revision Exercises 11 of Textbook
Multiple Choice Questions
1.
D
2.
B
3.
B
4.
A
5.
C
Structured Questions
1.
(a)
•
•
•
2.
Through trade, Hong Kong industries import the necessary raw materials,
capital goods and fuel.
(2 marks)
Trade also enables Hong Kong manufacturers to learn from foreign
technology.
(2 marks)
Trade provides a big world market for Hong Kong manufacturers, so that
mass production can be practised to reap the benefits of economies of scale.
(2 marks)
Keen competition
Worldwide protectionism
Over-reliance on a few markets and products
(2 marks each, elaboration is needed, total: 6 marks)
(b)
•
•
•
(a)
A country is said to have a comparative advantage over others if it is able to
produce a good at a lower opportunity cost than other countries.
(2 marks)
Hong Kong should not specialize in the production of motor cars because it had
a high opportunity cost.
(2 marks)
Hong Kong’s opportunity cost of specializing in motor car production is the
forgone income from tertiary production.
(2 marks)
At present, tertiary production contributes most to Hong Kong’s GDP and
employment. It would be a great loss if we give up tertiary production. (1 mark)
(b)
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28
ELEMENTARY ECONOMICS FOR HONG KONG (4th Edition)
Websites for Reference
Chapter
2
National
Income
Website
Related concept
UNSD-System of national account
National income accounting
1993(updated version):
method issued by UN
http://esa.un.org/unsd/sna1993/toctop.
asp
Technical notes on OECD National
Account:
http://esa.un.org/unsd/sna1993/toctop.
asp
3
Money
Barter:
http://www.bargainnbarter.com
Barter economy
EURO:
http://europa.eu.int/euro/
4
The Banking and
Fiancial System of
Hong Kong
American Express card:
http://www.americanexpress.
com/cards/
Credit card
Goldman Sachs (Asia):
http://www.goldmansachs.com/
Restricted licence bank
JCG Finance Limited:
http://www.jcg.com.hk/
Deposit-taking company
E-banking:
http://www.hangseng.com.hk/
5
Taipei Times Online:
Liquidity ratio
Banking: the Process http://www.taipeitimes.com/chnews/20
of Deposit creation 00/06/13/brief/0000007508
9
European Union:
Free Trade and Trade http://www.hkbu.edu.hk/~europe/
Restrictions
euro3130/euro3130.htm
Board of Foreign Trade:
http://www.trade.gov.tw/
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29
Free trade
ELEMENTARY ECONOMICS FOR HONG KONG (4th Edition)
11
Hong Kong’s
International Trade
Commerce & Industry Bureau:
http://www.info.gov.hk/cib
Government assistance
Innovation and Technology:
Commission
http://www.info.gov.hk/itc
Intellectual Property Department:
http://www.info.gov.hk/ipd
Investment Support Services in Hong
Kong:
http://www.investhk.gov.hk/
Business & Services Promotion Unit,
Commerce and Industry Bureau:
http://www.info.gov.hk/bspu
Hong Kong Productivity Council:
http://www.hkpc.org/
Census and Statistics Department:
http://www.info.gov.hk/censtatd/
Trade Statistics
Asia Goods: Daily New Product
Catalog:
http://www.asiagoods.com/
E-commerce
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30