chapter 18 determination of output and price

8/13/2019 Chapter 18 Determination of Output and Price

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Economics Inquiry for HKDSE – Macroeconomics 1Chapter 18 Determination of Output and Price

Multiple Choice Questions

|!|EM44001|!|

Which of the following best explains the situation shown in the above diagram?

A. The price of private residential housing falls.

B. Net exports decreases.

C. The prices of factors of production rise.

D. Interest rate drops.

##

D

When interest rate drops, consumption and investment expenditures will increase. Aggregate demand

will increase.

Option A is incorrect. When the price of private residential housing falls, the value of wealth people

own will fall and they will tend to spend less. Aggregate demand will decrease.

Option B is incorrect. When the net exports decreases, aggregate demand will decrease.

Option C is incorrect. This will raise the cost of production. Short-run aggregate supply will decrease.

Aggregate demand will remain unchanged.

##

© Aristo Educational Press Ltd. 164

0 Quantity of output

(real GDP)

Price level

P1

P0

Y1

SRAS

AD0

AD1

Y0




|!|EM44002|!|

Which of the following best explain the situation shown in the above diagram?

A. an increase in government spending on medical services

B. a fall in oil prices

C. an increase in the price of raw materials

D. a decrease in the total working hours of the economy

##

B

When there is a fall in oil prices, the cost of production will decrease. The short-run aggregate supply

will increase.

Option A is incorrect. An increase in government spending on medical services will lead to an increase

in aggregate demand. The short-run aggregate supply will not be affected.

Option C is incorrect. An increase in the price of raw materials will lead to a decrease in the short-run

aggregate supply of the economy.

Option D is incorrect. A decrease in the total working hours of the economy will lead to a decrease in

the factor endowments. The short-run aggregate supply will decrease.

##



(real GDP)

Price level

P0

P1

Y1

SRAS0

AD

Y0

SRAS1




|!|EM44003|!|

Which of the following diagrams shows the effect of a depreciation of the domestic currency on an

economy in the short run?

A. B.

C. D.

##

A

When there is a depreciation of the domestic currency, the relative prices of domestic goods and

services will decrease and the relative prices of imports will increase. This will increase exports and

reduce imports. Net exports will increase and aggregate demand will increase.

##



(real GDP)

Price level

P1

P0

Y1

SRAS

AD0

AD1

Y0


(real GDP)

Price level

P0

P1

Y0

SRAS

AD1

AD0

Y1


(real GDP)

Price level

P0

P1

Y1

SRAS0

AD

Y0

SRAS1


(real GDP)

Price level

P1

P0

Y0

SRAS1

AD

Y1

SRAS0




|!|EM44004|!|

Which of the following will most likely cause the change shown in the diagram in the short run?

A. Government’s tax revenue increases.

B. Households’ income increases.

C. The government provides subsidies to producers.

D. Firms are pessimistic about their business prospects.

##

C

If the government provides subsidies to producers, producers will find it more profitable to produce the

goods. The short-run aggregate supply will increase, leading to a rightward shift of the SRAS curve.

Option A is incorrect. An increase in government’s tax revenue will not lead to an increase in the short-

run aggregate supply.

Option B is incorrect. An increase in households’ income will lead to an increase in aggregate demand.

There will be no change in the short-run aggregate supply.

Option D is incorrect. When firms are pessimistic about their business prospects, they will spend less

on new plants and equipment. The investment expenditure will decrease. Aggregate demand will

decrease. The short-run aggregate supply will not be affected.

##



(real GDP)

Price level

P0

P1

Y1

SRAS0

AD

Y0

SRAS1




|!|EM44005|!|

What would be the effect of an increase in the investment in biotechnology on an economy?

A. The short-run aggregate supply will increase.

B. The long-run aggregate supply will increase.

C. Both the short-run aggregate supply and long-run aggregate supply will increase.

D. All the aggregate demand, short-run aggregate supply and long-run aggregate supply will

increase.

##

D

An increase in the investment in biotechnology will lead to an increase in aggregate demand.

Developing biotechnology increases the productivity of the economy. The productive capacity will

increase and the long-run aggregate supply will increase. As any factors causing the long-run aggregate

supply to increase will also cause the short-run aggregate supply to increase, the short-run aggregate

supply will also increase.

##

|!|EM44006|!|

In economics, macroeconomic equilibrium refers to the situation in which

A. the quantity of output demanded of an economy is equal to its quantity of output supplied.

B. the quantity of producer goods demanded of an economy is equal to its quantity of producer

goods supplied.

C. the quantity of consumer goods demanded of an economy is equal to its quantity of

consumer goods supplied.

D. the quantity of output demanded of an economy is higher than, lower than or equal to its

quantity of output supplied.

##

A

##





|!|EM44007|!|

Which of the following diagrams can best illustrate the effect of an increase in the supply of steel?

A. B.

C. D.

##

C

An increase in the supply of steel will lead to an increase in the factor endowments of an economy. The

short-run aggregate supply will increase and the SRAS curve will shift to the right from SRAS0 to

SRAS1.

##



(real GDP)

Price level

P1

P0

Y1

SRAS

AD0

AD1

Y0


(real GDP)

Price level

P0

P1

Y0

SRAS

AD1

AD0

Y1


(real GDP)

Price level

P0

P1

Y1

SRAS0

AD

Y0

SRAS1


(real GDP)

Price level

P1

P0

Y0

SRAS1

AD

Y1

SRAS0




|!|EM44008|!|

Which of the following diagrams can best illustrate the effect of an increase in interest rate?

A. B.

C. D.

##

B

An increase in the interest rate will lead to a decrease in private consumption and investment

expenditures. Aggregate demand will decrease and the AD curve will shift to the left. At the same time,

an increase in the interest rate will raise firms’ cost of production. The short-run aggregate supply will

decrease and the SRAS curve will shift to the left.

##


0 Quantity of output(real GDP)

Price level

P0

Y1

SRAS0

AD0

AD1

Y0

SRAS1


(real GDP)

Price level

P0

Y0

SRAS1

AD1

AD0

Y1

SRAS0


(real GDP)

Price level

P0

SRAS0

AD1

AD0

Y0

SRAS1

P1


(real GDP)

Price level

P1

SRAS1

AD0

AD1

Y0

SRAS0

P0




|!|EM44009|!|

The interaction between aggregate demand and aggregate supply determines

(1) the equilibrium real GDP.

(2) the equilibrium exchange rate.

(3) the equilibrium price level.

A. (3) only

B. (1) and (2) only

C. (1) and (3) only

D. (2) and (3) only

##

C

##

|!|EM44010|!|

In the long run, the quantity of output demanded is equal to the full-employment output level because

(1) the government intervenes prices.

(2) prices and wages are fully flexible.

(3) the perceptions of people about the price level have fully adjusted.

A. (1) only

B. (1) and (2) only

C. (2) and (3) only

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

##

C

In the long run, since prices and wages are fully flexible and the perceptions of people about the price

level have fully adjusted, the economy operates at the full-employment output level when it reaches the

long-run equilibrium.

##





|!|EM44011|!|

The short-run macroeconomic equilibrium of the economy is attained at point

A. E1.

B. E2.

C. E3.

D. E1, E2 and E3.

##

B

At point E2, the short-run macroeconomic equilibrium is attained where the AD curve intersects the

SRAS curve.

##

|!|EM44012|!|

In the long run,

A. the equilibrium output level is higher than the short-run equilibrium output level.

B. the equilibrium output level is lower than the short-run equilibrium output level.

C. the equilibrium output level is equal to the full-employment output level.

D. the equilibrium output level can be higher than, lower than or equal to the full-employment

output level.



(real GDP)

Price level LRAS

SRAS

AD

E1

E2

E3




##

C

In the long run, since prices and wages are fully flexible and the perceptions of people are fully

adjusted, the economy operates at the full-employment output level when it reaches the long-run

equilibrium.

##

|!|EM44013|!|

If an economy experiences a rising price level and lower output in the short run, it is possibly due to

A. a rightward shift of the SRAS curve.

B. a leftward shift of the SRAS curve.

C. a leftward shift of the AD curve.

D. a rightward shift of the AD curve.

##

B

When the short-run aggregate supply decreases, the SRAS curve shifts to the left. The price level will

increase and the output level will decrease.

##





|!|EM44014|!|

Which of the following descriptions about the diagram is/are CORRECT?

(1) The price level of the economy is the lowest.

(2) The short-run equilibrium is equal to the long-run equilibrium.

(3) Neither an inflationary gap nor a deflationary gap exists.

A. (2) only

B. (1) and (3) only

C. (2) and (3) only

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

##

C

Both (2) and (3) are correct. In the diagram, the SRAS curve intersects the LRAS curve and the AD

curve at point E. The short-run equilibrium coincides with the long-run equilibrium. There is neither an

inflationary gap nor a deflation gap.

(1) is incorrect. The price level may not be the lowest.

##



(real GDP)

Price level LRAS

SRAS

E

AD




|!|EM44015|!|

If the short-run equilibrium deviates from the long-run equilibrium,

A. an inflationary gap and a deflationary gap may occur at the same time.

B. the long-run equilibrium will change until it coincides with the short-run equilibrium.

C. government intervention is required to help the economy restore the long-run equilibrium.

D. the short-run equilibrium will change until it coincides with the long-run equilibrium.

##

D

If the short-run equilibrium deviates from the long-run equilibrium, an inflationary gap or a

deflationary gap results. If an inflationary (deflationary) gap exists, there is an excess demand for

(supply of) resources. The cost of production will increase (decrease) and the SRAS curve will shift to

the position until the gap is closed, i.e. the short-run equilibrium coincides with the long-run

equilibrium.

##

|!|EM44016|!|

Suppose the short-run aggregate supply changes from SRAS0 to SRAS1, while the aggregate demand

changes from AD0 to AD1.

According to the above diagram, the new long-run macroeconomic equilibrium is at point

A. E1.

B. E2.

C. E3.

D. E4.



(real GDP)

Price level

P0

P1

Y0

LRAS

SRAS0

E1

SRAS1

E2

E3

E4

P2

AD0

AD1

Y1




##

A

The new SRAS curve intersects the LRAS curve and the AD curve at point E1, i.e. the new long-run

equilibrium is attained.

##

|!|EM44017|!|

The short-run equilibrium output level ____________________ the long-run equilibrium output level.

A. is always higher than

B. is always lower than

C. is always equal to

D. can be higher than, equal to or lower than

##

D

The economy can produce at a level higher or lower than the full-employment output level as prices

and wages are not fully flexible and the perceptions of people have not fully adjusted in the short run.

##

|!|EM44018|!|

A deflationary gap is the amount by which

A. the short-run equilibrium price level is in excess of the long-run equilibrium price level.

B. the short-run equilibrium price level falls below the long-run equilibrium price level.

C. the short-run equilibrium output level is in excess of the long-run equilibrium output level.

D. the short-run equilibrium output level falls below the long-run equilibrium output level.

##

D

##





|!|EM44019|!|

Suppose an economy is initially operating at the long-run equilibrium. Which of the following will

result in an inflationary gap?

(1) People are optimistic about their job prospects.

(2) Many listed companies decide to pay out dividends.

(3) Many trading partners of the economy are suffering from recession.

A. (3) only

B. (1) and (2) only

C. (1) and (3) only

D. (2) and (3) only

##

B

(1) is correct. When people are optimistic about their job prospects, they will tend to increase

consumption. Aggregate demand will increase. The short-run equilibrium output will be higher than the

full-employment output level, resulting in an inflationary gap.

(2) is correct. When the listed companies pay out dividends, people’s income and wealth increase and

they tend to spend more. Aggregate demand will increase. The short-run equilibrium output will be

higher than the full-employment output level, resulting in an inflationary gap.

(3) is incorrect. If many trading partners are suffering from recession, exports of goods and services

will decrease. Aggregate demand will decrease. The short-run equilibrium output will be lower than the

full-employment output level, resulting in a deflationary gap.

##





|!|EM44020|!|

An inflationary gap

(1) is an “above-full employment equilibrium”.

(2) results in a short-run equilibrium price level higher than the long-run equilibrium price level.

(3) may be caused by an increase in aggregate demand.

A. (1) only

B. (3) only

C. (1) and (2) only

D. (1) and (3) only

##

B

(3) is correct. Suppose the economy is initially at the long-run equilibrium. When there is an increase in

aggregate demand, the equilibrium level of output is higher than the full-employment output level and

an inflationary gap is resulted.

(1) is incorrect. An inflationary gap is the amount by which the equilibrium level of output is in excess

of the full-employment output. “Above-full employment equilibrium” is the short-run equilibrium

where the short-run equilibrium output level is higher than the full-employment output level.

(2) is incorrect. An inflationary gap can result in a short-run equilibrium price level higher than, lower

than or equal to the long-run equilibrium price level.

##





|!|EM44021|!|

The diagram below shows the fluctuations in output over a period of time. The full-employment level

of output (Yf ) is assumed to be constant over time.

Which of the following descriptions about the diagram is CORRECT?

A. From point A to point B, the equilibrium output level in the short run decreases.

B. There is an inflationary gap at point C.

C. From point A to point E, the economy reaches the long-run equilibrium four times.

D. There is a negative supply shock from point C to point D.

##

C

The economy achieves the long-run equilibrium when the current output level is equal to the full-

employment output level (Yf ). From point A to point E, the current output level intersects with the full-

employment output level for four times.

Option A is incorrect. From point A to point B, the short-run equilibrium output level increases.

Option B is incorrect. The economy experiences a deflationary gap at point C where the output level is

lower than the full-employment output level.

Option D is incorrect. A negative supply shock adversely affects the short-run aggregate supply of an

economy. When the short-run aggregate supply decreases, the equilibrium output level will decrease.

However, the output level increases from point C to point D.

##


Yf

A

B

C

D

E

Output

Time0




|!|EM44022|!|

Suppose an economy is experiencing a deflationary gap. In the long run, ________________ will shift

to the ________________ to restore the full-employment output level without causing an increase in

the price level.

A. the aggregate demand curve … right

B. the aggregate demand curve … left

C. the short-run aggregate supply curve … right

D. the long-run aggregate supply curve … left

##

C

In order not to cause the price level to increase in the long run, the only option available to restore the

full-employment output level is for the short-run aggregate supply curve to shift to the right until the

AD curve intersects the new SRAS and the LRAS curves.

##

|!|EM44023|!|

Suppose the economy is initially operating at the long-run equilibrium (E0). The government increases

its expenditure on education. The new short-run equilibrium is ______.

A. E1

B. E2

C. E3

D. E4


0

Quantity of output(real GDP)

Price level LRAS

SRAS0

E1

SRAS1

E2

E3

E4

AD0

AD1

SRAS2

AD2

E0




##

D

An increase in government expenditure will lead to an increase in aggregate demand. The AD curve

will shift to the right from AD0 to AD1. There is no change in aggregate supply in the short run.

Therefore, the new short-run equilibrium is E4.

##

|!|EM44024|!|

If both consumers and firms are pessimistic about the prospect of the economy, the short-run

equilibrium output level _______________.

A. increases

B. decreases

C. remains unchanged

D. is lower than the long-run equilibrium output level

##

B

If both consumers and firms are pessimistic about the prospects of the economy, both private

consumption expenditure and investment expenditure of the economy will fall. The aggregate demand

will decrease, leading to a lower short-run equilibrium output level.

##

|!|EM44025|!|

The yields of agricultural products fall as a result of bad weather. This is an example of a/an

A. favourable demand shock.

B. unfavourable demand shock.

C. favourable supply shock.

D. unfavourable supply shock.





##

D

Unfavourable supply shocks are events that lead to a decrease in the short-run aggregate supply for a

period of time.

Bad weather that reduces the yields of agricultural products will lead to a decrease in the short-run

aggregate supply, so it is an unfavourable supply shock.

##

|!|EM44026|!|

Which of the following will cause the short-run equilibrium price level to increase?

(1) Investors are optimistic about their business prospects.

(2) Households prefer to save more.

(3) Scientists have successfully invented new oil-refining technology.

A. (1) only

B. (3) only

C. (1) and (2) only

D. (2) and (3) only

##

A

(1) is correct. If investors are optimistic about their business prospects, investment expenditure

increases. Aggregate demand will increase. The equilibrium price level and output level will increase.

(2) is incorrect. If households prefer to save more, private consumption expenditure decreases.

Aggregate demand will decrease. The equilibrium price level and output level will decrease.

(3) is incorrect. The invention of new oil-refining technology will lower the production cost and raise

the productivity of the economy. Hence, both the short-run aggregate supply and long-run aggregate

supply will increase. The equilibrium price level will decrease and the output level will increase.

##





|!|EM44027|!|

If the government increases her military spending, the output level ____________ and the price level

____________ in the short run.

A. increases … increases

B. decreases … increases

C. increases … decreases

D. decreases … decreases

##

A

If the government increases her military spending, government expenditure increases. Aggregate

demand increases. Both the output level and the price level increase.

##

|!|EM44028|!|

Suppose an economy is initially operating at the long-run equilibrium. Which of the following will

result in a deflationary gap?

A. a decrease in the salaries tax rate

B. a fall in the price of oil

C. an increase in the government’s subsidy to the film industry

D. a drastic drop in property prices





##

D

If property prices drop drastically, households’ wealth decreases, leading to a decrease in private

consumption expenditure. Aggregate demand will decrease. The short-run output level will decrease to

a level lower than the full-employment output level. A deflationary gap results.

Option A is incorrect. If there is a decrease in the salaries tax rate, people’s disposable income

increases. Aggregate demand will increase. The short-run output level will increase to a level higher

than the full-employment output level.

Option B is incorrect. A fall in the price of oil will lead to a decrease in production costs. The short-run

aggregate supply will increase. The short-run output level will increase to a level higher than the full-

employment output level.

Option C is incorrect. An increase in the government’s subsidy to the film industry raises the profits of

producers. The short-run aggregate supply will increase. The short-run output level will increase to a

level higher than the full-employment output level.

##

|!|EM44029|!|

Suppose an economy initially operates at the long-run equilibrium. Which of the following will cause

the price level to decrease in the short run?

A. The government encourages investment by lowering the profits tax rate.

B. The government invests in the construction of the Guangzhou-Shenzhen-Hong Kong

Express Rail Link.

C. The government increases the salaries tax rate after a fiscal deficit is recorded.

D. The government recruits more teaching assistants to support the teaching of Liberal Studies

for two years.





##

C

Increasing the salaries tax rate will lead to a reduction of the disposable income of households.

Aggregate demand will decrease. Both the price and output levels will decrease in the short run.

Option A is incorrect. Lowering the profits tax rate will encourage investment. Aggregate demand will

increase. Both the price and output levels will increase in the short run.

Option B is incorrect. Government’s investment in the construction of the Guangzhou-Shenzhen-Hong

Kong Express Rail Link will increase government expenditure. Aggregate demand will increase. Both

the price and output levels will increase in the short run.

Option D is incorrect. Recruiting more teaching assistants will increase government expenditure on

education in the short run. Aggregate demand will increase. Both the price and output levels will

increase in the short run.

##

|!|EM44030|!|

Suppose an economy initially operates at the long-run equilibrium. When ______________________,

the economy will experience an inflationary gap.

A. the long-run aggregate supply increases

B. the short-run aggregate supply decreases

C. aggregate demand increases

D. aggregate demand decreases





##

C

When aggregate demand increases, the equilibrium price level will increase and the output level will

increase to a level higher than the full-employment output level. The economy will experience an

inflationary gap.

Option A is incorrect. When the long-run aggregate supply increases, the full-employment output level

will increase.

Option B is incorrect. When the short-run aggregate supply decreases, the equilibrium price level will

increase while the equilibrium output level will decrease to a level lower than the full-employment

output level. The economy will experience a deflationary gap.

Option D is incorrect. When aggregate demand decreases, the equilibrium price level will decrease and

the output level will decrease to a level lower than the full-employment output level. The economy will

experience a deflationary gap.

##

|!|EM44031|!|

Suppose China and Japan are close trading partners. If the Renminbi appreciates against the Japanese

Yen, the price level of China will __________ and the output level will __________ in the short run.

A. increase … increase

B. increase … decrease

C. decrease … increase

D. decrease … decrease

##

D

If the Renminbi appreciates against the Japanese Yen, the relative price of goods of China will increase

and the relative price of goods of Japan will decrease. This will reduce the exports of China and

increase the imports from Japan. Therefore, net exports will decrease and the aggregate demand will

decrease. Both the price level and the output level of China will decrease in the short run.

##





|!|EM44032|!|

Which of the following can be illustrated by the above diagram?

(1) The government spends more resources on the implementation of curriculum reforms.

(2) Stock prices fall drastically.

(3) The price of gold is in a rising trend.

A. (2) only

B. (1) and (3) only

C. (2) and (3) only

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

##

A

A fall in stock prices decreases households’ wealth. Aggregate demand will decrease.

(1) is incorrect. An increase in government spending on the implementation of curriculum reforms will

lead to an increase in aggregate demand.

(3) is incorrect. A rise in the price of gold increases households’ wealth. Aggregate demand will

increase.

##



(real GDP)

Price level

P0

P1

Y0

SRAS

AD1

AD0

Y1




|!|EM44033|!|

Suppose the economy is initially at the long-run equilibrium (E0). If there is an increase in consumption

of imported Japanese goods, the new short-run equilibrium will be at ________.

A. E1

B. E2

C. E3

D. E4

##

A

When people increase consumption of imported Japanese goods, net exports will decrease. Aggregate

demand will decrease. The AD curve will shift to the left from AD0 to AD2, while there is no change in

aggregate supply. The new short-run equilibrium will be at E1.

##



(real GDP)

Price level LRAS

SRAS0

E1

SRAS1

E2

E3

E4

AD0

AD1

SRAS2

AD2

E0




|!|EM44034|!|

Suppose the average wage rate of workers increases. In the ________________, the price level will

____________.

A. short-run … increase

B. short-run … decrease

C. long-run … increase

D. long-run … decrease

##

A

When the average wage rate of workers increases, the cost of production will increase and the short-run

aggregate supply will decrease. In the short run, the price level will increase.

##

|!|EM44035|!|

Which of the following is an example of a positive supply shock?

A. The government provides a subsidy for Internet access to needy students.

B. The government increases the tariff imposed on imported cigarettes.

C. The government increases its expenditure on research and development.

D. The government lowers the sales tax rate for one year.

##

D

Positive supply shocks are events that lead to an increase in the short-run aggregate supply for a period

of time.

If the government lowers the sales tax rate for one year, producers will find it more profitable to

produce the goods, and the short-run aggregate supply will increase.

##





|!|EM44036|!|

In an economy, it is observed that the price level is increasing while the output level is falling. The

unemployment is increasing at the same time. This economy is experiencing

A. an inflationary gap.

B. a deflationary gap.

C. stagflation.

D. stagnation.

##

C

Stagflation refers to the situation that the economy faces both stagnation (falling output and increasing

unemployment) and inflation (rising prices).

##

|!|EM44037|!|

When an economy experiences stagflation,

(1) the output level is falling.

(2) the price level is rising.

(3) the unemployment rate is falling.

A. (1) and (2) only

B. (1) and (3) only

C. (2) and (3) only

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

##

A

Stagflation refers to the situation that the economy faces both stagnation (falling output and increasing

unemployment) and inflation (rising prices).

##





|!|EM44038|!|

Suppose an earthquake destroys most of the infrastructure in an economy. Which of the following are

CORRECT in the short run?

(1) The short-run aggregate supply decreases.

(2) The price level increases.

(3) The output level decreases.

A. (1) and (2) only

B. (1) and (3) only

C. (2) and (3) only

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

##

D

When most of the infrastructure is destroyed, the factor endowments of the economy decrease. The

short-run aggregate supply will decrease. In the short run, the price level will increase, while the output

level will decrease.

##

|!|EM44039|!|

Suppose an earthquake destroys most of the infrastructure in an economy. In the long run,

(1) the full-employment output level decreases.

(2) there is an inflationary gap.

(3) the price level increases.

A. (1) and (2) only

B. (1) and (3) only

C. (2) and (3) only

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





##

B

(1) and (3) are correct. As most of the infrastructure is destroyed, the economy’s productive capacity

decreases. The long-run aggregate supply will therefore decrease. The full-employment output level

will decrease while the price level will increase.

(2) is incorrect. In the long run, the output level is always at the full-employment output level.

##

|!|EM44040|!|

Suppose an economy is initially at the long-run equilibrium. If there is a negative supply shock, which

of the following is/are CORRECT?

(1) In the short run, the price level falls.

(2) In the short run, the output level falls.

(3) In the long run, the price level and output level remain unchanged.

A. (2) only

B. (1) and (2) only

C. (2) and (3) only

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

##

C

If there is a negative supply shock, the short-run aggregate supply will decrease. In the short run, the

price level will rise, while the output level will fall. Since the employment level is lower than the full-

employment level, there is a downward pressure on wages. Production costs decrease and the short-run

aggregate supply increases. In the long run, the price level and output level will remain unchanged.

##





|!|EM44041|!|

When an economy faces stagflation,

(1) there is a downward pressure on workers’ wages.

(2) the bargaining power of workers falls.

(3) the full-employment output level falls.

A. (1) only

B. (2) only

C. (1) and (2) only

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

##

C

When an economy faces a stagflation, the lower output level and higher unemployment level exerts a

downward pressure on workers’ wages. Workers lose their bargaining power because of the increased

level of unemployment.

Option C is incorrect. When an economy faces stagflation, the output level will decrease in the short

run. However, the full-employment output level will remain unchanged.

##





|!|EM44042|!|

Suppose an economy initially operates at the long-run equilibrium (E0). When the government raises

the sales tax which is imposed on consumers, the new short-run equilibrium will be at __________.

A. E1

B. E2

C. E3

D. E4

##

C

When the government increases the sales tax which is imposed on consumers, the aggregate demand

will decrease. The AD curve will shift to the left from AD0 to AD1. The new short-run equilibrium will

be at E3.

##



(real GDP)

Price level LRAS

SRAS0

E1

SRAS1

E2

E3

E4

AD0

AD1

SRAS2

AD2

E0




|!|EM44043|!|

When the government increases the profits tax rate,

(1) in the short run, the price level will decrease.

(2) in the short run, the output level will decrease.

(3) in the short run, the change in the price and output levels will be uncertain.

A. (1) and (2) only

B. (1) and (3) only

C. (2) and (3) only

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

##

A

(1) and (2) are correct. When the government increases the profits tax rate, the incentive for firms to

invest will decrease and firms will cut their investment expenditure. The aggregate demand will

decrease. In the short run, the price level and the output level will decrease.

##

|!|EM44044|!|

A natural gas supplier gets a franchise from the government to provide electricity to the public. Due to

the severe competition, other electric companies have to lower their prices. Which of the following is

CORRECT?

A. The aggregate demand and the price level will decrease.

B. The nominal wages of workers will decrease.

C. The government will receive higher tax revenue.

D. The short-run aggregate supply will increase and the price level will decrease.

##

D

With lower electricity price, the cost of production will decrease and the short-run aggregate supply

will increase. The price level will decrease.

##





|!|EM44045|!|

With the introduction of a new logistic system, an economy has shortened the time of handling goods

in container terminals. Which of the following are CORRECT?

(1) In the long run, the output level will increase.

(2) In the short run, the output level will remain unchanged.

(3) The productive capacity of the economy will increase.

A. (1) and (2) only

B. (1) and (3) only

C. (2) and (3) only

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

##

B

The shortening of time for handling goods in container terminals implies that the productive capacity of

the economy increases. The long-run aggregate supply will increase. In the long-run, the output level

will increase while the price level will decrease.

Any factor causing the LRAS curve to shift will also cause the SRAS curve to shift. Therefore, the

short-run aggregate supply will also increase. In the short run, the output level will increase.

##

|!|EM44046|!|

In 2010, the Gulf of Mexico oil spill led to serious damage to the natural resources of the United States.

Assume the economy of the United States was initially at the long-run equilibrium. Which of the

following concerning the effect of the oil spill on the economy of the United States is CORRECT?

A. There would be a deflationary gap in the short run.

B. The aggregate demand would increase.

C. The price level in the long run would decrease.

D. The potential output level would decrease.





##

D

The oil spill event would lead to a decrease in the natural resources of the United States. The long-run

aggregate supply would decrease. The potential output level would fall.

Option A is incorrect. There would be an inflationary gap in the short run.

Option B is incorrect. The aggregate demand would not increase.

Option C is incorrect. As the long-run aggregate supply decreased, the price level in the long run would

increase.

##

|!|EM44047|!|

With the “Quality Migrant Admission Scheme”, highly skilled and talented persons are allowed to

settle in Hong Kong. What will be the effect of the scheme to Hong Kong’s economy?

A. The price level will increase.

B. The nominal GDP will increase.

C. The real GDP will increase.

D. Both the nominal GDP and the real GDP will increase.

##

C

With the scheme, both the quality and quantity of labour resources will increase. The productive

capacity of Hong Kong will increase and the long-run aggregate supply will increase. The output level

will increase.

Option A is incorrect. The price level will decrease as the long-run aggregate supply increases.

Options B and D are incorrect. With a higher output level but a lower price level, the change in nominal

GDP is uncertain.

##

|!|EM44048|!|

Which of the following will lead to an increase in the price level?

A. A drop in crop yields due to a persistent rain lasting for nearly a month.

B. The economy operates at the short-run equilibrium.

C. The government decreases its military expenses.

D. Banks raise the interest rate on loans.





##

A

If there is a drop in crop yields due to the bad weather, the short-run aggregate supply will decrease.

The price level will increase.

Option B is incorrect. When the economy operates at the short-run equilibrium, the price level may be

higher than, lower than or equal to the level at the long-run equilibrium. Therefore, we do not know

how the price level will change.

Option C is incorrect. When the government decreases its military expenses, the aggregate demand will

decrease. The price level will decrease.

Option D is incorrect. When banks raise the interest rate on loans, private consumption expenditure and

investment expenditure will decrease, leading to a decrease in the aggregate demand. The price level

will decrease. At the same time, a rise in the interest rate on loans will raise firms’ cost of production.

The short-run aggregate supply will decrease. The price level will increase. Therefore, the change in

the price level is uncertain, depending on the extent of the changes in aggregate demand and the short-

run aggregate supply.

##

|!|EM44049|!|

Which of the following will lead to a decrease in the output level?

A. Investors are optimistic about economic prospects.

B. People expect their income to increase in the future.

C. There is an increase in the education level of the general public.

D. Many infrastructures are destroyed by flooding.





##

D

When many infrastructures are destroyed by flooding, the aggregate supply will decrease. The output

level will decrease.

Option A is incorrect. When investors are optimistic about economic prospects, investment expenditure

will increase and the aggregate demand will increase. The output level will increase.

Option B is incorrect. When people expect their income to increase in the future, they will increase

their consumption expenditure and the aggregate demand will increase. The output level will increase.

Option C is incorrect. An increase in the education level of the general public will raise the productivity

of the economy. The long-run aggregate supply will increase. The output level will increase.

##

|!|EM44050|!|

Suppose the Hong Kong Government decides to build more universities. In the long run, this will lead

to shifts of the ________________ curves and the price level will ________________.

A. SRAS and LRAS … decrease

B. SRAS and LRAS … be undetermined

C. AD, SRAS and LRAS … increase

D. AD, SRAS and LRAS … be undetermined

##

D

If the Hong Kong Government decides to build more universities, government expenditure will

increase. Aggregate demand will increase and the AD curve will shift to the right, leading to an

increase in the price level. On the other hand, the productive capacity of Hong Kong will increase. Both

the short-run and long-run aggregate supply will increase. The SRAS and LRAS curves will shift to the

right, leading to a decrease in the price level. Therefore, the change in the price level will be uncertain,

depending on the extent of changes in aggregate demand and aggregate supply.

##





Short Questions

|!|ES44001|!|

(a) What is the macroeconomic equilibrium? (2 marks)

(b) “The intersection point of the aggregate demand curve and the aggregate supply curve determines

the equilibrium price of a particular good.” Do you agree with this statement? Explain your

answer. (3 marks)

##

(a) Macroeconomic equilibrium refers to the situation in which the quantity of output demanded of an

economy is equal to its quantity of output supplied. (2 marks)

(b) No. (1 mark)

The intersection point of the aggregate demand curve and the aggregate supply curve determines

the general price level, but not the equilibrium price of a particular good. The equilibrium price of

an individual good is determined by its market demand and supply. (2 marks)

##

|!|ES44002|!|

(a) What is the short-run macroeconomic equilibrium? (2 marks)

(b) “In the short run, the equilibrium output level is always at the full-employment output level.” Do

you agree? Explain your answer. (3 marks)

##

(a) Short-run macroeconomic equilibrium refers to the situation in which the quantity of output

demanded of an economy is equal to its quantity of output supplied in the short run. (2 marks)

(b) No. (1 mark)

Short-run equilibrium is achieved as long as the quantity of output demanded is equal to the

quantity of output supplied in the short run. The equilibrium output level may be greater than,

equal to or smaller than the full-employment output level. (2 marks)

##

|!|ES44003|!|

With the aid of a diagram, explain what a deflationary gap is. (4 marks)





##

At point E1, the short-run equilibrium output level (Y*) is lower than the full-employment output level

(Yf ). This is a “below-full employment equilibrium”. The amount by which the equilibrium level of

output falls below the full-employment output level, i.e. (Yf – Y*), is called the deflationary gap.

(2 marks)

(2 marks)

##

|!|ES44004|!|

(a) Define the long-run macroeconomic equilibrium. (2 marks)

(b) With the aid of a diagram, explain under what conditions an economy will attain the long-run

macroeconomic equilibrium. (3 marks)

##

(a) Long-run macroeconomic equilibrium refers to the situation in which the quantity of output

demanded of an economy is equal to its quantity of output supplied in the long run. In other

words, in the long run, the quantity of output demanded is equal to the full-employment or

potential output level. (2 marks)



(real GDP)

Price level LRAS

SRAS

E1

AD

Deflationary gap

Yf

Y*




(b) An economy will attain the long-run macroeconomic equilibrium when the SRAS curve intersects

the LRAS curve and the AD curve. (1 mark)

(2 marks)

##

|!|ES44005|!|

(a) What is an inflationary gap? (2 marks)

(b) Suppose an economy is facing an inflationary gap that is caused by an increase in the aggregate

demand.

(i) Explain how the short-run aggregate supply will be adjusted to restore the full-employment

output level. (3 marks)

(ii) With the aid of a diagram, explain how the price level and output level will be affected in the

long run. (6 marks)

##

(a) An inflationary gap is the amount by which the short-run equilibrium level of output is in excess

of the full-employment output level. (2 marks)

(b) (i) As the output level is higher than the full-employment level, there is an upward pressure on

wages. Production costs will increase and the short-run aggregate supply will decrease to

restore the full-employment output level. (3 marks)


Price level LRAS

SRAS

E


(real GDP)

AD




(ii) In the long run, the SRAS curve will continue to shift leftwards until it intersects the AD

curve and the LRAS curve. (2 marks)

At the new long-run equilibrium, the price level increases and the output level returns to the

full-employment level. (2 marks)

(2 marks)

##

|!|ES44006|!|

(a) What is aggregate demand? (2 marks)

(b) Suppose an economy is operating at the short-run equilibrium. With the aid of a diagram, illustrate

the effects of an increase in households’ disposable income on the price level and output level in

the short run. (6 marks)

##

(a) Aggregate demand refers to the total demand for all goods and services in an economy at given

price levels in a given period of time. (2 marks)


Price level LRASSRAS

1

E0


(real GDP)

AD0

SRAS0

AD1

E1

E2

Y1

Y0

P0

P1

P2




(b) With higher disposable income, consumers can spend more. As a result, private consumption

expenditure will increase and the aggregate demand will increase. 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.

(2 marks)

(2 marks)

##

|!|ES44007|!|

Assume an economy is initially at the long-run equilibrium. What will be the effects of an increase in

the interest rate on the price level and output level in the short run? Explain with the aid of a diagram.

(8 marks)



(real GDP)

Price level

P1

P0

Y1

SRAS

AD0

AD1

Y0

E0

E1




##

An increase in the interest rate will lead to a decrease in private consumption and investment

expenditures. The aggregate demand will decrease. The AD curve will shift to the left from AD0 to

AD1. (2 marks)

At the same time, a rise in the interest rate will raise the firms’ cost of production. The short-run

aggregate supply will decrease. The SRAS curve will shift to the left from SRAS0 to SRAS1. (2 marks)

The output level will decrease from Y0 to Y1. However, the change in the price level will be uncertain,

depending on the extent of changes in aggregate demand and the short-run aggregate supply. (2 marks)

(2 marks)

##

|!|ES44008|!|

Suppose the United States and Japan are close trading partners. When the US dollar appreciates against

the Japanese Yen, how will the price level and output level of Japan be affected in the short run?

(4 marks)

##

Other things being constant, when there is an appreciation of the US dollar against the Japanese Yen,

the relative prices of domestic goods and services in Japan will decrease and the relative prices of

imports from the United States will increase. This will increase exports and reduce imports. As a result,

Japan’s net exports will increase and aggregate demand will increase. (2 marks)

In the short run, both the price level and the output level will increase. (2 marks)

##



(real GDP)

Price level

P0

Y0

SRAS0

AD1

AD0

Y1

E0

E1

SRAS1




|!|ES44009|!|

Assume an economy is initially at the long-run equilibrium. If the government increases the subsidies

granted to the recycling industry, what will be the effects on the price level and the output level in the

short run? Explain your answer with the aid of a diagram. (6 marks)

##

If the government increases the subsidies to the recycling industry, the producers in the recycling

industry will find it more profitable to provide the services. The short-run aggregate supply will

increase and the SRAS curve will shift to the right from SRAS0 to SRAS1. (2 marks)

The price level will decrease and the output level will increase. (2 marks)

(2 marks)

##

|!|ES44010|!|

“If the government raises the standard rate of the salaries tax and lowers the profits tax rate at the

same time, the real GDP must increase.” Do you agree? Explain with the aid of a diagram. (9 marks)



(real GDP)

Price levelSRAS

0

AD

SRAS1

Y1

Y0

P1

P0

E0

E1




##

No. (1 mark)

An increase in the standard rate of the salaries tax will lower the disposable income of the high-income

group. Private consumption expenditure will decrease and aggregate demand will decrease. The output

level will decrease. (2 marks)

A decrease in the profits tax rate will increase the incentive for firms to invest. Investment expenditure

will increase and aggregate demand will increase. The output level will increase. (2 marks)

The final change in the output level (real GDP) is uncertain, depending on the relative strength of the

two effects on aggregate demand. (1 mark)

(3 marks)

##

|!|ES44011|!|

(a) What is stagflation? (2 marks)

(b) Under the AS-AD model, under what condition will stagflation occur? Explain with the aid of a

diagram. (4 marks)

##

(a) Stagflation is the situation in which an economy faces both stagnation (falling output and

increasing unemployment) and inflation (rising prices). (2 marks)



(real GDP)

Price level

P0

P1

Y0

SRAS

AD1

AD0

Y1

AD2

Y2

P2




(b) Stagflation will occur when there is a decrease in the short-run aggregate supply of an economy.

The SRAS curve will shift to the left. The price level will increase and the output level will

decrease. (2 marks)

(2 marks)

##



(real GDP)

Price level LRAS

SRAS1

E1

AD

Y0

Y1

SRAS0

E0

P1

P0




|!|ES44012|!|

Suppose an economy has already reached the full-employment output level. With the aid of a diagram,

explain how a decrease in oil prices affects the price level and the output level in both the short run and

the long run? (11 marks)

##

A decrease in oil prices leads to a decrease in the cost of production. The short-run aggregate supply

will increase. The SRAS curve will shift to the right from SRAS0 to SRAS1. (2 marks)

In the short run, the price level will decrease from P0 to P1 while the output level will increase from Y0

to Y1. (2 marks)

A decrease in production costs due to a decrease in oil prices will not affect the productive capacity of

the economy, so the long-run aggregate supply will remain unchanged. (2 marks)

In the long run, due to adjustment of price expectations, the SRAS curve will shift leftwards until the

AD curve intersects the SRAS curve and the LRAS curve again at point E0. The price level will return

to P0 and the output will return to the full-employment level (Y0). (2 marks)

(3 marks)

##

|!|ES44013|!|

Suppose an economy is initially at the long-run equilibrium. Discuss the effects of a favourable supply

shock on the price level and the output level in both the short run and the long run. (8 marks)



(real GDP)

Price level

P0

P1

Y1

SRAS0

AD

Y0

SRAS1

E0

E1

LRAS




##

When there is a favourable supply shock, the short-run aggregate supply increases. (2 marks)

In the short run, the price level decreases while the output level increases to a level higher than the full-

employment level. (2 marks)

Since the output level is higher than the full-employment level, there is an upward pressure on wages.

The cost of production increases and the short-run aggregate supply decreases. (2 marks)

In the long run, the price level returns to the level before the supply shock and the output level returns

to the full-employment level. (2 marks)

##

|!|ES44014|!|

Assume the economy is initially operating at the long-run equilibrium. If people become more eager to

save money, how will the price level and output level be affected in the short run and the long run?

Explain with the aid of a diagram. (11 marks)





##

If people become more eager to save money, private consumption expenditure will decrease. The

aggregate demand will decrease and the AD curve will shift from AD0 to AD1. (2 marks)

In the short run, the price level will decrease from P0 to P1 and the output level will decrease from Y0 to

Y1. (2 marks)

Since the output level is lower than the full-employment level, there is a downward pressure on wages.

The cost of production decreases and the SRAS curve shifts to the right until it intersects with the AD

curve and the LRAS curve. (2 marks)

In the long run, the price level decreases to P2 and the output level returns to the full-employment

output level (Y0). (2 marks)

(3 marks)

##

|!|ES44015|!|

Assume Hong Kong is initially at the long-run equilibrium. How will the introduction of the

“Admission Scheme for Mainland Talents and Professionals” affect the price level and potential GDP

of Hong Kong in the long run? Explain your answer with the aid of a diagram. (6 marks)



(real GDP)

Price level

P2

P1

Y0

LRAS

SRAS1

E0

SRAS0

E1

E2

P0

AD1

AD0

Y1




##

The scheme will attract immigrants who have special talents to Hong Kong. The quantity and quality of

labour resources will rise, which will increase the productive capacity of Hong Kong. The long-run

aggregate supply will increase. The LRAS curve will shift to the right from LRAS0 to LRAS1. (2 marks)

The price level will decrease from P0 to P1. The potential output level will increase from Y0 to Y1.

(2 marks)

(2 marks)

##

|!|ES44016|!|

An economy has already reached the full-employment level. Suppose some of its infrastructure was

destroyed due to internal wars. With the aid of separate AS-AD diagrams, explain the changes in the

price level and the output level in both the short run and the long run. (12 marks)


Price level

P1

LRAS0

LRAS1

P0


(real GDP)

Y1

AD

Y0

SRAS

E1

E0




##

In the short run, the factor endowments of the economy will decrease. The short-run aggregate supply

will decrease. The SRAS curve will shift to the left from SRAS0 to SRAS1. (2 marks)

The price level will increase from P0 to P1 and the output level will decrease from Y0 to Y1. (2 marks)

(2 marks)

In the long run, the capital of the economy will decrease. The productive capacity of the economy will

decrease. The long-run aggregate supply will decrease. The LRAS curve will shift to the left from

LRAS1 to LRAS1. (2 marks)

The price level will increase to P2 and the output level will decrease to Y2. (2 marks)

(2 marks)

##



(real GDP)

Price level

P1

P0

Y0

SRAS1

AD

Y1

SRAS0

E0

E1


(real GDP)

Price level

P2

P0

Y0

AD

Y2

SRAS0

LRAS1

LRAS0

E0

E2




Long Questions

|!|EL44001|!|

Suppose an economy is initially at the long-run equilibrium.

(a) With the aid of an AS-AD diagram, explain the effects of a labour strike on the economy in both

the short run and the long run. (11 marks)

(b) According to your answer in (a), explain why stagnation is a short-run phenomenon. (3 marks)

##

(a) When there is a negative supply shock (e.g. a labour strike), the short-run aggregate supply will

decrease. The SRAS curve will shift to the left from SRAS0 to SRAS1. (2 marks)

In the short run, the price level will increase from P0 to P1. The output level will decrease from Y0

to Y1, which is lower than the full-employment output level. (2 marks)

Since the output level is lower than the full-employment output level, there is a downward

pressure on wages. The cost of production decreases and the SRAS curve eventually shifts back to

SRAS0. (2 marks)

In the long run, the economy is back to E0. The price level will return to P0 and the output will

return to the full-employment level (Y0). (2 marks)

(3 marks)

(b) Stagflation refers to the situation that the economy faces both stagnation (falling output and

increasing unemployment) and inflation (rising prices). (1 mark)

A negative supply shock will lead to stagnation in the short run. However, in the long run, the full-

employment output level (Y0) will be restored and stagnation will eventually disappear. Therefore,

stagnation is a short-run phenomenon. (2 marks)

##


0

Quantity of output(real GDP)

Price level LRAS

SRAS1

E1

AD

Y0Y1

SRAS0

E0

P1

P0




|!|EL44002|!|

Suppose there is an inflationary gap in an economy.

(a) With the aid of a diagram, explain what an inflationary gap is. (4 marks)

(b) Assume the government aims to attain the full-employment output level without raising the price

level.

(i) Suggest ONE policy that can be used by the government to restore the full-employment

output level. (2 marks)

(ii) With the aid of a diagram, explain how the full-employment output level can be restored by

the policy suggested in (b)(i). (6 marks)

##

(a) At point E1, the short-run equilibrium output level (Y*) is higher than the full-employment output

level (Yf ). This is an “above-full employment equilibrium”. The amount by which the equilibrium

level of output is in excess of the full-employment output level, i.e. (Y* – Yf ), is called the

inflationary gap. (2 marks)

(2 marks)

(b) (i) Any policy that leads to a decrease in aggregate demand:

- increase the profits tax rate

- decrease in government expenditure

- Any reasonable answer

(Mark the FIRST point only, 2 marks)



(real GDP)

Price level LRAS

SRAS

E1

AD

Inflationary gap

Yf

Y*




(ii) When the aggregate demand decreases, the AD curve will shift to the left from AD1 to AD2.

(2 marks)

The price level will decrease from P1 to P2. The output will return to the full-employment

output level (Yf ). (2 marks)

(2 marks)

##

|!|EL44003|!|

Suppose an economy is initially operating at the long-run equilibrium. If the stock market is booming,

with the aid of AS-AD diagrams, explain what will be the effect on the following:

(a) the price level and the output level in the short run (6 marks)

(b) the price level and the output level in the long run (7 marks)


Price level LRAS

SRAS

E1

E2

P2


(real GDP)

AD1

Yf

Y*

AD2

P1




##

(a) When the stock market is booming, people can enjoy capital gains from investment and they tend

to spend more. Private consumption expenditure will increase and aggregate demand will increase.

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.

(2 marks)

(2 marks)

(b) The booming stock market will not affect the productive capacity of the economy, so the long-run

aggregate supply will remain unchanged. (2 marks)

In the long run, the price level will increase from P0 to P2 and the output level will return to the

full-employment level (Y0). (2 marks)

(3 marks)

##



(real GDP)

Price level

P1

P0

Y1

SRAS

AD0

AD1

Y0

E0

E1

0Quantity of output

(real GDP)

Price level LRAS

SRAS0

E1

AD1

Y0

Y1

AD0

E0

P1

P0

E2

P2




|!|EL44004|!|

The Greek debt crisis of 2010 is threatening the recovery of the world economy. Greece’s fiscal deficit

was 12.9% of the GDP in 2009, which was much higher than the EU’s cap of 3%. The Greek

government is going to lower the proportion of its deficit to the GDP by 2010 through various

measures. These measures include increasing the sales tax on fuel imposed on suppliers and raising the

incomes tax rate as well as cutting income allowances for civil servants.

(a) How will the price level and the real GDP of Greece be affected by the above measures in the

short run? Explain with the aid of an AS-AD diagram. (8 marks)

(b) After the exposure of the Greek debt crisis, the potential debt problems of other European

countries have been a great concern, especially for the “PIIGS” (an acronym representing five

European countries: Portugal, Italy, Ireland, Greece and Spain). This exerted a downward pressure

on the value of the Euro. Suppose Hong Kong and the European countries are close trading

partners. With the aid of an AS-AD diagram, explain the effects on the price level and the real

GDP of Hong Kong in the long run. (9 marks)





##

(a) Increasing the income tax rate will lower the disposable income of people, and the private

consumption expenditure will decrease. Cutting income allowances of civil servants will lead to a

decrease in government expenditure. Both measures will lead to a decrease in aggregate demand.

The aggregate demand curve will shift to the left. (2 marks)

Increasing the sales tax on fuel imposed on suppliers will raise the production cost. The short-run

aggregate supply will decrease. The SRAS curve will shift to the left. (2 marks)

As a result, in the short run, the output level (real GDP) will decrease. The final change in the

price level is uncertain, depending on the relative strength of the decreases in aggregate demand

and the short-run aggregate supply. (2 marks)

(2 marks)


Price level

SRAS0

E0P

0


(real GDP)

AD0

Y1

Y0

AD1

SRAS1




(b) Other things being constant, when there is a depreciation of the Euro, the relative prices of Hong

Kong’s domestic goods and services will increase and the relative prices of imports from

European countries will decrease. This will reduce exports and increase imports. As a result, net

exports will decrease and aggregate demand will decrease. The AD curve will shift to the left.

(2 marks)

The short-run equilibrium is now at E1. Since the employment level is lower than the full-

employment level, there is a downward pressure on wages. Production costs decrease. This results

in a rightward shift of the SRAS curve. (2 marks)

In the long run, the price level will decrease to P2 and the output level will return to the full-

employment level (Y0). (2 marks)

(3 marks)

##


(real GDP)

Price level

P2

P1

Y0

LRAS

E0

SRAS

E1

E2

P0

AD1

AD0

Y1

chapter 18 determination of output and price

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