Chapter 3: Macroeconomic problems

3.1 Inflation and deflation

(a) Definitions

Inflation is the phenomenon of a persistent increase in the

general price level.

Deflation is the phenomenon of a persistent decrease in the

general price level.

1. A temporary rise in the general price level is not inflation

For example, during Chinese New Year, prices of flowers, fruits, vegetables,
etc rise.
However, the general price level returns to its original level afterwards.
Since the price level does not rise persistently, there is no inflation.

2. A once-and-for-all rise in the general price level is not inflation

For example, when a sales tax on all goods and services is imposed, the
general price level rise once and for all.
There are no further changes in the general price level. Since the
price level does not rise persistently, there is no inflation.

3. A persistent fall in the price of a single good only is not deflation

For example, due to technological advancement, the price of memory cards has fallen
continuously.
Since a fall in the price of a single good usually cannot bring about a fall in the general price
level, there is no deflation.

Differences between inflation and deflation

Inflation Deflation
General price level

Value of CPI and

implicit GDP deflator
Growth rates of CPI
and implicit GDP
deflator

F.5 Econ/Chapter 3 Macroeconomic problems/p.1

 Discuss
3.1 According to the definitions above, are the following situations examples of inflation
or deflation? Why?

a. Because of technological improvement, the price of MP3 players drop steadily.

A steady fall in the price of a _______ good is / is not an example of deflation.

b. Suppose during the 2008 Beijing Olympic Games, prices of all goods and services in
Beijing increased by 10%.
A rise in the general price level is / is not an example of
inflation.

c. A ferry company raises its fare by 20%.

A ______________ rise in the price of a single good (or service) is / is not an example
of inflation.

Disinflation ≠ Deflation
Disinflation — a persistent increase in the general price level but at a
declining rate
→Positive but decreasing inflation rate
Deflation — a persistent decrease in the general price level
→Negative inflation rate

The percentage change in the price

level was positive, but declining
persistently.

Hong Kong experienced disinflation from 1996 to 1998.

AL 2007 -1
Name one similarity and one difference between the terms in each of the following pairs:
(a) deflation; disinflation (3 marks)
Similarity: change in the _________________________________ over time.

F.5 Econ/Chapter 3 Macroeconomic problems/p.2

Difference: ……………………………………………………………………………………………………
………………………………………………………………………………………………………………..

(B)Measurement of inflation and deflation

An inflation rate or deflation rate is the percentage change in the general price level in a specified
period (usually a year).
If the percentage change is positive, it is an inflation rate.
If the percentage change is negative, it is a deflation rate.

Suppose PI2 is the price index (which can be the CPI or the GDP deflator) in a specified period while
PI1 is the price index in the preceding period.

If the rate of change of CPI or implicit GDP deflator There is

is continuously
1. Positive and rising
2. Positive but constant
3. Positive and falling
4. zero
5. Negative and rising
6. Negative but constant
7. Negative and falling

Range
Inflation Percentage change in the CCPI is positive
Deflation Percentage change in the CCPI is negative
Disinflation Percentage change in the CCPI is positive but
decreasing

F.5 Econ/Chapter 3 Macroeconomic problems/p.3

Then the inflation or deflation rate in the specified period can be calculated by the following formula:

Inflation rate or deflation rate =%△ in price index

= PI2-PI1 X 100%
PI1

Check your understanding:

Concept Wrong statement Correct statement

1. Inflation is the same as 1. Inflation is different from inflation rate.
Inflation inflation rate. It is important to distinguish between inflation
and and inflation rate.
inflation Inflation rate is a rate which shows the change of
rate inflation.
2. Inflation will disappear 2. Inflation will disappear only when inflation rate is
when the inflation rate zero (no change in price level) or negative ( price
remains constant. level is decreasing).
3. Deflation exists when 3. Deflation exists only when inflation rate is
there is a decrease in negative ( price level is decreasing).
inflation rate.

Year 2003 2004 2005 2006 2007 2008

CCPI 99.8 99.4 100.3 102.4 104.4 108.9
Composite CPI of Hong Kong from 2003 to 2008 (Oct 04 – Sep 05 = 100)
Hong Kong’s annual inflation or deflation rate is calculated as follows:
Example 1
%Δ in general price level in 2004
CCPI in 2004 – CCPI in 2003 × 100%
=
CCPI in 2003
=________________________________________

=________________________________________
Example 2
%Δ in general price level in 2005

=________________________________________

=________________________________________

F.5 Econ/Chapter 3 Macroeconomic problems/p.4

Test yourself 3.2
Year 2002 2003 2004 2005 2006 2007
CCPI 102.4 99.8 99.4 100.3 102.4 104.4

Calculate the year-on-year percentage changes in the general price level in 2003 and 2007,
respectively.

% Δ in general price level in 2003

=_______________________________________________
=_______________________________________________
=_______________________________________________ ( inflation/deflation)

% Δ in general price level in 2007

=_______________________________________________
=_______________________________________________
=_______________________________________________( inflation/deflation)

The following graph shows Hong Kong’s annual rates of inflation and deflation from 1998 to 2012:

Inflation ( deflation) rate can be estimated by the percentage change in CPI in the
period concerned

Inflation( deflation) rate = CPI in current period- CPI in previous period X 100%
CPI in previous period

Multiple Choice Questions:

HKCEE 08-33;09-34
HKAL 98-26

F.5 Econ/Chapter 3 Macroeconomic problems/p.5

Inflation ( deflation) rate can be estimated by the percentage change in implicit
GDP deflator in the period concerned

Inflation( deflation)rate = GDP deflator in current period- GDP deflator in previous period X 100%
GDP deflator in previous period

Multiple Choice Questions:

HKCEE 95-33;97-31;01-32;03-28

(C) Nominal versus real

1. Relation between nominal value and real value
a. What is nominal value?

Nominal value (or money value) in a specified period is value

expressed in units of money in that period.

General price levels in different periods are usually different. Thus, the same nominal value
would have different purchasing power in different periods.
The higher the general price level in a period, the smaller the purchasing power of
nominal values in that period.

Year Composite CPI

2005 100.3
2008 108.9
Table 3.2
CCPI in Hong Kong in 2005 and 2008 (Oct 2004 - Sep 2005 = 100)

$109 in 2008 = $100 in 2005

This implies that the amount of goods and services that could have been purchased for
$__________ in 2005 would generally cost $______________ to buy in 2008.

Purchasing power of Purchasing power of

$100 in 2005 > $100 in 2008

F.5 Econ/Chapter 3 Macroeconomic problems/p.6

 The purchasing power of money is measured by how many goods and services it
can purchase. It is inversely related to the general price level.

In other word, a larger nominal value may not result in a larger purchasing
power. We cannot determine which nominal value has a larger purchasing power
by simply comparing the magnitude of nominal values in different years.

b. What is real value?

Real value is value expressed in units of money in the base

period.

Since all real values are expressed in units of money in the same period, a larger real
value implies a larger purchasing power.
Hence, we can determine which real value has a larger purchasing power by simply comparing
the magnitude of different real values.

c. Finding real value from nominal value

Nominal values need to be transformed into their real values so that we can compare their
magnitude to determine their purchasing power.

Nominal value in a specified period × 100

Real value =
Price index in the period
100 is the price index in the base period.

Year Composite CPI

2005 100.3
2008 108.9

Using the formula above, the real values of $100 and $107 in 2008 are:
The real value of $100 in 2008:
=______________________________________
=______________________________________
=___________________ in 2005.

F.5 Econ/Chapter 3 Macroeconomic problems/p.7

The real value of $107 in 2008:
=______________________________________
=______________________________________
=___________________ in 2005.
Hence, the real value or purchasing power of $100 and $107 in 2008 are both smaller than $100 in
2005(the base year).

Test yourself
3.4 Based on the hypothetical data provided below, find the real wages in 2009 and
2010, respectively. Have the real wages increased between 2009 and 2010?

Year Price Nominal

index wages
($)
2009 105 10,000
2010 110 10,800

Answers:
The real wage in 2009
Nominal wages in 2009 × Price index in
=
Price index in 2009 the base year

=_____________________________________________
=_____________________

The real wage in 2010

Nominal wages in 2010 × Price index in
=
Price index in 2010 the base year

=_____________________________________________
=_____________________
Therefore, the real wages have ___________ from $_________ to
$__________.

F.5 Econ/Chapter 3 Macroeconomic problems/p.8

2. Relation between nominal interest rate and real interest rate
a. What are nominal and real interest rates?

Interest is the price of an earlier availability of goods

it measures the productivity of an asset over time
it is the compensation for the postponed consumption
Whenever there exists a market between the present and future availability of something, interest
exists
Interest exists even in a barter economy.

Nominal interest

Nominal interest rate (n) — the rate of change in the

nominal value or money value of an asset over a specified
period of time. It is also called nominal rate of return.

It is also called the nominal rate of return.

In modern society, interest is calculated in terms of money, which is known as nominal
interest.
Examples: interest rates on deposits, bank loans and bonds.

Real interest

Real interest rate (r) —the rate of change in the real value
or purchasing power of an asset over a specified period of
time.
.
Real interest: The interest calculated in terms of goods/ purchasing power of money

Cost of holding money

Cost is the highest-valued alternative forgone.
If one holds money, one forgoes the opportunity to hold the income-earning asset which yields
the (highest) nominal rate of return or nominal interest rate.
The cost of holding money is the nominal interest rate.
In our economy, there are various types of income-earning assets with different nominal interest
rates.
Moreover, different people have different investment opportunities.

F.5 Econ/Chapter 3 Macroeconomic problems/p.9

 ∴ Different people have different costs of holding money.

Nominal interest rate= Expected Real interest rate+ Expected inflation rate
n= re + ie when ie↑→n↑

Inflation will affect the realized interest rate. Both borrowers and lenders will take the inflation
rate into consideration when they determine the nominal interest rate.
E.g if the expected inflation is 3%, borrowers will need to pay 3% interest on top of the real
interest rate to compensate the lenders for the loss in purchasing power caused by inflation. The
additional 3% is known as an inflation premium.

Multiple Choice Questions:

HKAL 96-21;04-18
SQs: HKDSE:12-11

When inflation is fully anticipated, the nominal interest rate will increase with the inflation rate,
leaving the real interest rate constant.

Nominal interest rate=Expected Real interest rate+ Expected inflation rate

Expected Real interest rate=Nominal interest rate-Expected inflation rate

E.g. If the nominal interest rate is 10% and the expected inflation rate is 4%. The real interest rate
is then 6%, which means that making a loan is expected to yield a real return of 6%.

AL 1989-4
Distinguish between the nominal interest rate and real interest rate. (4 marks)

Nominal interest rate = __________________ + ________________________

Nominal interest rate measures the returns on _____________ value for making investment.
While real interest rate measures the increase in ______________ __________ as a result of
investment.
Hence, if inflation is expected, the expected change in price level will also be considered in
determining the nominal interest rate so as not to suffer from inflation. As a result, the nominal
interest rate will be ____________ than the real interest rate if inflation is expected.

SQs: HKDSE:SP-6;13-3

F.5 Econ/Chapter 3 Macroeconomic problems/p.10

If the inflation rate in a specified period is known,
the actual inflation rate (ia) can be subtracted from the nominal interest rate to find the actual
real interest rate (ra).

Actual real interest rate(ra)=Nominal interest rate(n)-Actual inflation rate(ia)

The actual real interest rate can also be called the realised real interest rate.
Example:
Nominal interest rate (n) of a deposit = 5%
Expected inflation rate (ie) = 3%
Expected real interest rate =________-________=___________- __________=___________
Example:
Nominal interest rate (n) of a deposit = 5%
Expected inflation rate (ie) = 3%
If the actual inflation rate = 4%,
Actual real interest rate (ra)=________-________=___________- __________=___________

Hence, the actual real interest rate may not be the same as the expected one.

Test yourself
3.5 Suppose the expected inflation rate and the expected real interest rate are 10% and
4%, respectively.

a. What is the nominal interest rate?

The nominal interest rate
= _________________ + ______________________
= ______________

b. If the actual inflation rate turns out to be 6% only, what would the actual real interest rate
be?
Actual real interest rate
= Nominal interest rate – Actual inflation rate
= _____________

2005-22
When there is deflation,
A. the real interest rate will be negative.
B. the nominal interest rate will be negative.
C. the real interest rate will be higher than the nominal interest rate.
D. All of the above

F.5 Econ/Chapter 3 Macroeconomic problems/p.11

The effects of changes in the price level on real interest return

Actual real interest rate=Nominal interest rate-Actual inflation rate

If the inflation rate is not zero, the real and the nominal interest rates will be
different.

Suppose the nominal interest rate is 10% per annum, if price level remains unchanged, the
interest return will raise the lender’s purchasing power by 10%. However, if the actual inflation
rate is 10%, the rise in the price level will reduce the purchasing power of money by 10%. The
nominal interest can only offset the adverse effect of inflation on purchasing power, making the
realized real interest zero.

Unanticipated Inflation and the Interest Rate

The actual real interest returns of an interest-bearing asset can be found by deducting the nominal
interest rate (n) by the actual inflation rate.

Actual real interest returns from bonds=Nominal interest rate- Actual inflation rate

Unanticipated inflation reduces the actual real interest returns.

Past Paper Questions:

AL 1994- 2
Explain why people reduce their cash holdings and savings deposit balances in banks when there is
high inflation. (8 marks)
Whether an asset will be held depends on its real rate of return which is equal to nominal interest
rate minus the ____________ inflation rate. As the nominal interest returns to cash holding is
zero, if there is high inflation rate, the real rate of returns will become __________. With a
negative real return, people’s purchasing power will ___________. Thus, in times of high
inflation, people’s cash holdings will ________.

Though interests are paid on savings deposits, the rate is usually __________ than expected
inflation rate. This is particularly so if the inflation rate is high. Thus the real rate of returns to
saving balances is still ___________. Hence, people will switch to other ____________ with
positive real rates.

F.5 Econ/Chapter 3 Macroeconomic problems/p.12

AL 2009-2

(a) Inclusive of the principal, the real interest rate is the price of goods today in terms of __________
tomorrow.

(b) Inclusive of the principal, the nominal interest rate is the price of money today in terms of
_______ tomorrow.
(c)
These two interest rates are related to the rate of ___________ inflation. Both interest rates are
determined today and to be paid tomorrow with certainty. Depending on the actual realization of
the _______ __________ tomorrow ( which is unknown toady).

The nominal interest may yield higher or lower return in real terms tomorrow-i.e, not necessarily
equal to the real interest (ex post). We have to adjust the nominal interest rate by the expected
__________ rate to ensure that the result equals the real interest rate (ex-ante)

(d) The________ interest rate, which is the rate of return on bonds ( i.e., other financial assets forgone
if people hold money), can be interpreted as the opportunity cost of holding money

Exam report:

AL 2003- 2
(a) What is meant by deflation? Is it the same as a fall in the inflation rate(i.e., disinflation)?
(2 marks)
Deflation is …………………………………………………………………………………….
Deflation is/is not the same as disinflation.

F.5 Econ/Chapter 3 Macroeconomic problems/p.13

(b) What is the relation between the nominal and real interest rates when people expect deflation? Will
the nominal rate be higher or lower than the real rate? (4 marks)

The nominal interest rate is equal to the sum of the ___________ interest rate and the
__________ inflation rate. Since expected deflation equals the negative of expected inflation, we
can express the nominal rate as the real rate less expected deflation. Hence, the real rate will
__________ the nominal rate when people expect deflation.

(c) Theoretically, nominal interest rates can be negative. Describe a situation where this possibility
would arise. Why then do we seldom observe negative rates in reality? (4 marks)

In principal, negative nominal interest rate may arise if the expected __________ rate exceeds
the _________ interest rate. In practice, however, we seldom observe negative nominal interest
rate in reality because of the following reasons:

Firstly, the nominal interest rate can be manipulated by the government. When the economy is
experiencing deflation, the government can use expansionary fiscal policy to _________
the_________ interest rate and the general price level.

Secondly, banks have the incentive to maintain a positive/negative interest rate because of profit
consideration. If the nominal interest rate is negative, the banks can/cannot get any deposits from
the public and they will make loss by lending less money to borrowers.

HKDSE SP-6

Answer:
(a)(i) Nominal interest rate=_______________________+_____________________________

(ii) The nominal interest rate would be lower than the real interest rate if the expected inflation rate is
_________________.

(b) The nominal interest rate is the return to holding ____________ _____________ ___________.
Holding money forgones the option of holding interest bearing assets, and the cost of doing so is
the _________________ interest rate.

F.5 Econ/Chapter 3 Macroeconomic problems/p.14

 Read Economics 3.2 at work p.84– Nominal and real savings deposit rates in Hong
Kong

Nominal rate of return of holding money =0%

Real rate of return of holding money= - inflation rate

Multiple Choice Questions:

HKAL 90-24;92-21;99-17;99-18;02-22;03-20;06-08;06-21;10-19
HKDSE SP-28;PP-35;14-32;18-34

SQs: HKDSE- 12-11(a), (c) and (d) and 13-3

(D) Economic effects of inflation and deflation

(a) Effects on the purchasing power of money

Inflation Deflation
 For the same amount of money,  For the same amount of money,
more/less goods can be bought. more/less goods can be bought.

 The purchasing power of money has  The purchasing power of money

increased/decreased has increased/decreased

(b) Effects on real income and standard of living

Real income or real wage is the purchasing power of nominal income.

A higher real income implies a higher living standard and vice versa.

1. <
If the growth
2. rate of Inflation rate Real income and living
nominal
= standard will
3. income is
>

F.5 Econ/Chapter 3 Macroeconomic problems/p.15

(c) Effects on the cost of living

Inflation Deflation
 As more money is required to buy the  As less money is required to buy
same amount of goods, the cost of the same amount of goods, the
living is higher/lower. cost of living is higher/lower.


Important point: Exam Short Questions and MC Questions

⚫ Redistributive effects of inflation / deflation

(d) Redistributive effects of inflation/deflation

Transactions involving future payments are common in our economy.
Normally, future payments are compromised and fixed in advance by their providers and
recipients.
For example, if an inflation is expected, recipients would request larger future payments as
compensation.
However, if the actual change in the price level is different from the expected change,
income is redistributed between providers and recipients of fixed future payments.
In other words, one side gains and the other side loses.

Anticipated vs unanticipated inflation (deflation)

Inflation or deflation can be anticipated or unanticipated.
During anticipated inflation (deflation), people correctly foresee the rate of increase
(decrease) in the general price level. If inflation is fully anticipated and adjustment involves no
costs, all prices can then be adjusted simultaneously without leading to any income
redistribution.
During unanticipated inflation (deflation), people cannot foresee the occurrence of
inflation (deflation).

During unanticipated inflation

The real value or purchasing power of future payments drops unexpectedly,
providers of fixed future payments gain as the real value of payments they pay is lower than
expected;
recipients of fixed future payments lose as the real value of payments they receive is lower than
expected.

F.5 Econ/Chapter 3 Macroeconomic problems/p.16

If inflation/deflation is unanticipated, the following redistributive effects will
occur:
(i) Lenders and borrowers
When borrowing a loan, debtors( borrowers) agree to repay the principal plus a fixed amount of
interest to creditors( lenders).
When depositors deposit money in banks, banks agree to repay the deposit plus a fixed amount of
interest to the depositors.’
When bondholders buy fixed-interest bonds, the companies issuing the bonds agree to repay the
principal plus a fixed amount of interest to the bondholders.

Example: We can also explain the redistributive effects using expected and actual real interest rates.
Suppose a creditor (i.e. lender) lends $100 to a debtor (i.e. borrower) at a nominal interest rate (i) of
12%.
Expected inflation rate =0%
Expected real interest rate =___________________________________
However, if the actual inflation rate turns out to be 5%,
Actual real interest rate =___________________________________

During unanticipated inflation, when the borrower repays the loan,

the debtor (i.e. provider) ________ as the actual real interest rate paid (7%) is lower than the
expected real interest rate (12%) ;
the creditor (i.e. recipient) ________ as the actual real interest rate received (7%) is lower than
the expected real interest rate (12%).

During unanticipated deflation,

the debtor (i.e. provider) _________ as the actual real interest rate paid is higher than the
expected real interest rate ;
the creditor (i.e. recipient) _______ as the actual real interest rate received is higher than the
expected real interest rate .
Inflation Deflation
 The purchasing power or real value of  The purchasing power or real value of
fixed interest is higher/lower. fixed interest is higher/lower.

 Debtors, banks and companies issuing  Debtors, banks and companies issuing
bonds will gain/lose while creditors, bonds will gain/lose while creditors,
depositors and bondholders will depositors and bondholders will
gain/lose. gain/lose.

If loans are made on floating rates, adjustments can be made to eliminate the
effects of inflation.

F.5 Econ/Chapter 3 Macroeconomic problems/p.17

AL 1998 -5
Discuss how inflation affects the wealth creditors and debtors when
(a) the inflation is completely unanticipated. (4 marks)

In determining the nominal interest rate on loans, creditors will take into account the expected
rate of inflation as well as the expected real interest rate.
Thus, nominal interest rate will be equal to the sum of ____________________ and
_________________. However, if inflation is completely unanticipated, the nominal interest rate
will not be equal to the expected real interest rate.
The real interest rate ____________ receive and _________ pay will less than the expected
amount. There will be a redistribution of wealth from ________ to _____________.

(b) the inflation is correctly anticipated. (4 marks)

As mentioned above, the nominal interest charged on loans is equal to the sum of expected
inflation rate and the expected real rate. If inflation is correctly anticipated, creditors will adjust
the __________ interest rates to take into account, the inflation rate and the nominal interest rates
will become ________.
Since the nominal interest rate has already been adjusted, the real interest rate creditors receive
and debtors pay will be the _______________ as the expected amount. As a result neither party
will lose or gain in times of inflation and there will be no redistribution of wealth between
creditors and debtors.

Exam report: Performance was satisfactory in both parts. However, it is surprising to find that a
number of candidates confused creditors with debtors.

(ii) Insurance policy payment

Insurance policy holders receive their contribution and dividend payment from insurance
companies after long period of contribution.
Inflation Deflation
 The purchasing power or real value of  The purchasing power or real value of
contribution and dividend payment contribution and dividend payment
received is higher/lower. received is higher/lower.
 Insurance policy holders gain/lose  Insurance policy holders gain/lose while
while insurance companies gain/lose. insurance companies gain/lose.

F.5 Econ/Chapter 3 Macroeconomic problems/p.18

(iii) Employers and employees
Workers usually work for a fixed nominal income in a contract period.

Inflation Deflation
 The purchasing power or real value of  The purchasing power or real value of
the nominal income received is the nominal income received is
higher/lower. higher/lower.

 Employees gain/lose while employers  Employees gain/lose while employers

gain/lose. gain/lose.

If inflation (deflation) is anticipated, the above income redistribution will not

occur. This is because the people will adjust the nominal amount of
interest/dividend payment and contribution/wage payment accordingly to
keep the real value constant.

Check your understanding:

Concept Wrong statement Correct statement

Effects of When inflation ( deflation) Income redistribution only occurs when inflation
changes in occurs, there must be ( deflation) is unexpected. it will not occur if inflation
the general income redistribution. ( deflation) is expected.
price level

(e) Effects on fixed income recipients

For fixed income recipients e.g. pension holders, social welfare recipients and landlords
receiving fixed rent, the nominal payment they receive is not adjusted according to price changes.

Inflation Deflation
 The purchasing power of the fixed  The purchasing power of the fixed
nominal income received nominal income received
increases/decreases, they gain/lose. increases/decreases, they gain/lose.

(f) Effects on government tax revenue

Inflation Deflation
 As prices are higher, the amount of ad  As prices are lower, the amount of ad
valorem tax collected will valorem tax collected will
increase/decrease. increase/decrease.
 As people’s income increases, salaries  As people’s income decreases, salaries
tax revenue increases/decreases tax revenue increases/decreases

F.5 Econ/Chapter 3 Macroeconomic problems/p.19

(g) Effects on choice of wealth

Inflation Deflation
 As the purchasing power of money  As the purchasing power of money
decreases, people prefer to hold wealth increases, people prefer to hold wealth
in physical form such as gold, jewels in the form of money.
properties to preserve purchasing power
and hedge against inflation.

(h) Effects on cost of production and net exports

Inflation Deflation
 As production cost increases, the prices  As production cost decreases, the prices
of local goods also increase. of local goods also decrease.
 Foreigners will buy less local goods and  Foreigners will buy more local goods
domestic exports will increase/decrease. and domestic exports will
increase/decrease.
 As prices of imported goods become  As prices of imported goods become
relatively cheaper, the quantity relatively expensive, the quantity
demanded for imports demanded for imports
increases/decreases. increases/decreases.
 Import volume increases/decreases.  Import volume increases/decreases.

(i) Resources are reallocated

During inflation, the prices of some goods may rise by a larger percentage than the prices of
others.
To increase profit, some firms and resources will shift from economic sectors with a smaller
percentage rise in prices to those with a greater percentage rise in prices.
Example: from 1970s to the 1990s, property prices in Hong Kong rose by a much larger
percentage than prices of industrial products. Hence, many manufacturers turned to real estate
development.

(j)Consumption rises but savings fall

During inflation, people expect prices of consumer goods to rise. They tend to purchase
consumer goods earlier to save money. Hence, present consumption expenditure rises but savings
fall.

(k)Firms may hoard resources and products

During inflation, firms expect prices of raw materials and their products to rise in future.
Therefore, firms may hoard resources and products because:

The earlier they buy their raw materials, the lower the factor prices they need to pay. To
save on production costs, they will buy raw materials earlier and store them for future use.

F.5 Econ/Chapter 3 Macroeconomic problems/p.20

 The later they sell their products, the higher the product prices they can get. To increase
their sales revenue, they will store their products and sell them later.

Hoarding has adverse effects on an economy. When firms spend more money on hoarding, they
have less money available for production and investment.

Learning 3.2 tips Indexation

Indexation refers to the automatic adjustment of future payments according to a price index that
reflects the cost of living.
This can offset the change in the price level so that the purchasing power of future payments can
be maintained.
Hence, indexed future payments will not bring any income redistributive effects to future
payment providers or recipients.

Multiple Choice Questions:

HKAL 02-18

F.5 Econ/Chapter 3 Macroeconomic problems/p.21

 Test yourself
3.6 Identify the providers and recipients of fixed future payments among the following
trading partners. Determine who will gain during unanticipated deflation.
Trading partners Providers Recipients Who gains?
Banks and
depositors
Employees and
their employers
Holders (cake shops)
gain, if the real value
of cakes increases
(decreases)
Cake shops and unexpectedly. This
holders of their happens when the
cake coupons price of cakes drops
by a smaller (larger)
percentage than the
general price level.

Test yourself
3.7 Will providers or recipients of fixed future payments gain under the following situations?
a. Anticipated inflation
b. Anticipated deflation

Under anticipated inflation or deflation, providers and recipients of future payments have
(correctly / wrongly) anticipated the change in the real value of future payments. Since
the actual change is expected, (no / either) party gains or loses due to the anticipated
inflation or deflation.

AL 2004 -4
In recent years, the Hong Kong economy has been suffering from both unemployment and deflation.
(a) Who gains and who loses from deflation? How does your answer depend on deflation is
anticipated or unanticipated? (5 marks)

In the absence of deflation indexation, unanticipated deflation would create wealth redistribution
effects. People who have to make fixed nominal payments ________ while people who receive
fixed nominal payments _________. Examples include:

F.5 Econ/Chapter 3 Macroeconomic problems/p.22

 1. employers and employees under fixed nominal wage contracts;
2. borrowers and lenders under fixed nominal interest contracts;
3. buyers and sellers under nominal contracts with prices fixed before the delivery of goods.

However, if deflation can be fully anticipated, the effects of the possible wealth redistribution
will be taken into consideration when making the contracts. Hence, all these gains and losses can
be _________.

2005-33
Which of the following would gain when unexpected inflation occur?
A. holders of fixed deposits with banks
B. employees whose salaries are adjusted according to inflation
C. people who receive a fixed amount of unemployment benefits
D. a government which has issued bonds at fixed interest rates

2007-33
Which of the following statements about inflation is correct?
A. A continuous increase in the price of a good is not inflation.
B. During inflation, everyone suffers to the same extent.
C. During inflation, incomes and prices increase at the same rate.
D. Inflation may benefit some people, particularly those people whose incomes are fixed

Answering strategies

Concept Common question Suggested approach

Inflation 1. Explain whether a person (1) write down the effects of
Deflation who receives a fixed amount inflation/deflation on the purchasing
Income of wage/ spend a fixed power of money
redistribution amount of expense will gain (2) explain how the real value /purchasing
or lose in times of power of the fixed amount of
unanticipated income/expense changes.
inflation/deflation (3) only unanticipated inflation/deflation will
cause income redistribution

Multiple Choice Questions:

HKCEE 94-38;00-39;05-33;08-31;09-33
HKAL 91-26;93-20;95-20;96-27;97-11;09-21;10-20
HKDSE PP-31;13-34;15-36;16-37;17-34

F.5 Econ/Chapter 3 Macroeconomic problems/p.23

Past Paper Questions:
2005
Answer Question 6 and 7 by referring to the following information about the Gross Domestic product
(GDP) of Hong Kong.
Table 1:
Year Implicit price Per capita GDP at current market prices
deflator of GDP (HK$)
2001 98.1 188 835
2002 84.6 183 790
2003 89.6 179 333

6. Other than the information given in table 1, state TWO kinds of information that are needed for
an accurate reflection of Hong Kong people’s standard of living. Explain your answer.
(4 marks)
7. Suppose people did not expect any change in the price level. Explain whether the following
persons would gain or lose when the change in the price level indicated in Table 1 occur.
(a) a businessman who obtained a bank loan in 2001 at a fixed interest rate for 2 years
(b) a business whose premises were let in 2001 at a fixed rent for 2 years
(4 marks)
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F.5 Econ/Chapter 3 Macroeconomic problems/p.24

2007(4)

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2003(9)

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1998(7)
(a) Define ‘inflation’. (2 marks)
(b)Suppose the salaries tax allowance in Hong Kong remains unchanged.
Explain why the total tax revenue from this tax would increase at times of inflation.
(3 marks)

F.5 Econ/Chapter 3 Macroeconomic problems/p.25

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2001
9 (d) ‘If an import tax is introduced on all imports to Hong Kong, it would affect Hong Kong’s
general price level but would not necessarily lead to inflation in Hong Kong.’ Explain
why this statement is correct. (5 marks)
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2002
12. (b) In order to cut expenses, Mr Wong reduces the monthly salaries of the staff working in the
bookstore.
(ii) Explain whether the real income of his staff would necessarily fall during deflation.
(5 marks)
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2012-11

F.5 Econ/Chapter 3 Macroeconomic problems/p.26

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F.5 Econ/Chapter 3 Macroeconomic problems/p.27

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F.5 Econ/Chapter 3 Macroeconomic problems/p.28

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F.5 Econ/Chapter 3 Macroeconomic problems/p.29

Past paper questions suggested solution:
2005-6
• Income distribution
• Output composition
• Undesirable effect of production
• Amount of leisure
• Unreported production activities

2005-7
(a)
• He would lose (1m)
• Since during deflation, the real value or purchasing power of the fixed interest he pays increases.
(1m)
(b)
• He would gain (1m)
• Since during deflation, the real value or purchasing power of the fixed rent he receives increases
(1m)

2007(4)
• The table indicates a decrease in the general price level
(i) He would gain because the fixed amount of pension has a higher purchasing power(in times of
unexpected deflation).

(ii) He would lose because the real value of the repayment will increase ( during unexpected deflation).

2003(9)

1998(7)

2001(9)

2002(12)

F.5 Econ/Chapter 3 Macroeconomic problems/p.30

2012-11

13-3

14-5

18-10

19-6

F.5 Econ/Chapter 3 Macroeconomic problems/p.31

20-4

3.2 Unemployment and underemployment

Besides inflation, unemployment is also a common macroeconomic

problem in many economies.

Unemployment: A person is unable to find a job

although he is able and willing to work.

A. Definitions of related concepts

1. Labour force

refers to all persons aged 15 or above;

who engage in production during the reference week ( i.e. 7 days before enumeration),or
who would otherwise engage in production, but are unemployed at that time.
anyone classified as in the labour force is an economically active person.

(The reference week: the week during which the Government carries out its General Household
Survey.)(Enumeration: The act of counting persons in that survey.)

Labour force= Employed Population + Unemployed Population

Labour force participation rate= Labour Force X 100%

Population aged 15 and above

F.5 Econ/Chapter 3 Macroeconomic problems/p.32

Components of the labour force in Hong Kong:

Q.1 Jane’s mother is a housewife. She stays at home and does

housework only. She is considered as economically active/
inactive. She is/ is not in the labour force.

2. Employed persons
All persons aged 15 or above
They perform some work for payment or profit during the reference period or
they have formal job attachment (if they do not perform any work during the reference
period)

The following types of persons are said to have a formal job attachment:
(1) Persons who are temporarily absent from work because they are on leave (e.g.
sick leave and annual leave) or on strike
Example: Mary went on holiday after having renewed his contract with his
employer. She is regarded as formally attached to a job, and so he is
classified as employed.

(2) temporarily out of work and does not receive any wage (assured to return to his
original job); or

(3) on pre-retirement leave: continues to receive wages, but can refuse to take up any job assigned to
him by his employer.

(4) Part-time workers and underemployed workers;

F.5 Econ/Chapter 3 Macroeconomic problems/p.33

(5) Employers;
(6) Unpaid family members — employees who have family ties with employers and work without
regular pay;

Voluntary workers with no other job are excluded from the employed population.

Q.2 John is a hawker who sells vegetables. He is considered as unemployed or

employed.
…………………………………………………………………………………
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3. Underemployed persons

Underemployed persons are those employed persons who have involuntarily worked less
than a specified number of working hours (35 hours a week in the case of Hong Kong).
Available for more work; and
Seeking more work
Example: A construction worker wants to work 45 hours a week. Due to contraction of the
construction industry, he can only work for 30 hours a week. This employed worker is
underemployed.

Examples: ……………………………………………………………………………………………

Q.3 Mrs Au works for 3 hours per day in a fast- food shop. For the rest of the time, she stays at home.
Is she under-employed? Yes/ No

Underemployment rate=Underemployed Population X 100%

Labour Force

The underemployed population is included in the employed population.

4. Unemployed persons

Unemployed persons are persons who want to have a job but fail to find one.
They are available for work and seeking work.

F.5 Econ/Chapter 3 Macroeconomic problems/p.34

 In Hong Kong, employed, underemployed and unemployed persons include only persons aged 15
and above.

Other points related to unemployment:

Persons without a job, and are seeking work but are not available for work during the reference
week because of temporary sickness will be considered as unemployed.
Persons without a job and are available for work, however, are not seeking work because they
have made arrangements to take up a new job or to start a business in the future will be
considered as unemployed.
Persons without a job and are available for work, however, are not seeking work because they
believe that work is not available will be considered as unemployed.

Test yourself
3.8 What are the major similarity and difference between underemployed persons and
unemployed persons?

Similarity: Both want to have (more / less) work.

Difference: _____________ persons currently have a job but ___________ persons do not
have one.

Seasonal unemployment: A type of unemployment explained by a seasonal variation in the structure

of jobs and/or labour offered. Seasonal unemployment typically repeats the same pattern annually.

e.g A large number of graduates join in the labour market during May to July every year. The
unemployment rate is often higher than that of other age groups.

e.g. Construction industry will have a higher unemployment rate during rainy seasons.

Unemployment rate=Unemployed Population X 100%

Labour Force

The percentage of unemployed people in the labour force.

F.5 Econ/Chapter 3 Macroeconomic problems/p.35

Non-labour force
The non-labour force is made up of all residents who are not classified as employed or
unemployed, including:

1. All persons aged under 15;

2. Retirees (do not plan to work to earn incomes);
3. Permanently disabled;
4. Housewives;
5. Full-time students.
Jobless people may be part of the non-labour force and are thus not necessarily unemployed.

1994-37

Which of the following people would be classified as ‘unemployed’ in Hong Kong?

A. Jack, aged 30, who has retired after winning the Mark Six.
B. Peter, aged 14, who cannot find a job after completing Form 3.
C. John, who has quit his job and has gone on a trip to Europe.
D. Mary, who lost her job five weeks ago and has been looking for a new job for one month.
Q.4 State whether the following persons are classified as employed or unemployed.

Not in the Employed Unemployed

labour force
(a) A hawker sells fruits at the corner of the street
(b) Peter works in a youth centre as a programme
officer
(c) Peter’s old grandfather has retired and worked
as a voluntary tutor in the youth centre.
(d) Peter’s father is a construction worker, who has
been waiting for nine days to be called back to
work.
(e) Peter’s mother, a housewife, who works for 2
hours in a 7-eleven store every morning.
(f )Peter, aged 14, is looking for a job.
(g) Mary is a full time student, but she works as a
part-time waitress in a restaurant.

Past Paper Questions:

1996-33
David has quit his job for 2 months because he has been ill and is resting in bed. According to the
Hong Kong government, he is
A. unemployed.
B.underemployed.
C. employed.
D. not in the labour force.

F.5 Econ/Chapter 3 Macroeconomic problems/p.36

Q.5 Given the following information of a certain economy.
Population:6 million
Employment: 3 million
Unemployment: 600,000
(a) Find the labour force of this economy.
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(b) Find the unemployment rate.
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Past Paper Questions:

2003(30)
Study the following data about Hong Kong in the period of July 2002 to September 2002.

Number of Persons
Employed Population 3 243 000
Underemployed Population 101 000
Unemployed Population 267 000

The unemployment rate in the period is%

A. 7.4%
B. 7.6%
C. 8.2%
D. 10.2%

Relationship among labour force, employed population, unemployed population

and under-employed population

F.5 Econ/Chapter 3 Macroeconomic problems/p.37

Calculating underemployment and unemployment rate
Population aged 15 or above = 6000000
Unemployed persons=200 000
Employed persons= 3 800 000
Underemployed persons= 75 000
Illegal immigrants detained= 150 000

Underemployment rate =_____________________________________________=____________

Unemployment rate= _______________________________________________=_____________

Change in unemployment rate

How does the influx of fresh graduates into the labour market affect HK’s unemployment
rate?

Whether fresh graduates can find a job or not, they are included in the _______________. Because:
both employed persons and unemployed persons are included in the ________________.
Some fresh graduates cannot find a job.
Hence, the influx of fresh graduates into the labour market increases both the number of
_____________ persons and the ________________.

1. If all graduates can successfully find jobs, the unemployment rate will _____________.

Unemployment Unemployed persons

= × 100%
rate Labour force

2. If some graduates can successfully find jobs, the change in unemployment rate depends on
the following:

1. <
If %
2. increase in % increases Unemployment rate
unemployed
= in total will
3. persons labour force
>

The unemployment rate does not necessarily increase when fresh graduates enter
the labour market.

F.5 Econ/Chapter 3 Macroeconomic problems/p.38

Case Study:
Given that the unemployment rate of an economy is 5%. Now 1000 school
leavers are seeking jobs. Would there be an increase in labour force? Would the
unemployment rate increase or decrease if none of them can find a job?

Yes, the labour would increase/decrease by ___________ .

If none of them can find a job, the unemployed population would increase
by 1000.
Hence the unemployment rate would increase/decrease.

Original New
Original labour force= New labour force=

Original unemployed population= New unemployed population

Unemployment rate= Unemployment rate=

If both the LF and new unemployed population increase by the same

absolute amount ( e.g 1000 in case study), the U rate( in terms of %)
will increase.

↑U rate= U population ( +1000) X 100%

Labour force ( +1000)

% change in U population (↑_________%= ______________x 100%)

% change in labour force(↑_________%= ______________ X 100%)

↑ U rate= U population (↑ %)
Labour force (↑ %)
Check your understanding:

Concept Wrong statement Correct statement

Change in If the absolute increase in As the percentage increase in the number of
unemployment total labour force and the unemployed is greater than that of total labour
rate number of unemployed are force, unemployment rate will increase.
the same, then
unemployment rate is
constant.

F.5 Econ/Chapter 3 Macroeconomic problems/p.39

 Test yourself
3.9 ‘If a large number of people retire, the change in the unemployment rate is uncertain.’
Do you agree? Explain.

Before retiring, some were employed and some were unemployed. After retiring, both the
number of unemployed persons and those in the __________ drop.

Hence the change in the unemployment rate is uncertain, depending on their relative
percentage changes.

1. % ↓ in unemployed persons (> / < / =) % ↓ in abour force ⇒Unemployment rate

↓
2. % ↓ in unemployed persons (> / < / =) % ↓ in abour force ⇒Unemployment rate
remain unchanged
3. % ↓ in unemployed persons (> / < / =) % ↓ in abour force ⇒Unemployment rate
↑

2005-32
1.

15-5

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F.5 Econ/Chapter 3 Macroeconomic problems/p.40

 Short Questions:
HKCEE 03-6;06-9(c); 07-8
HKDSE PP-6;13-11

B. Costs of unemployment
1. To the unemployed

(a) Lower living standard

The unemployed do not have income. They have to cut their consumption expenditure. Hence,
the living standard of these people and their families is lower.

(b) Family problems

A long period of unemployment together with financial pressure brings great frustration and loss
of self-esteem to the unemployed. Family disputes, marriage breakdowns and suicides may
result.

(c) Loss of skills

If workers are unemployed for a long time, their knowledge, skills and experience will be lost or
become outdated. Their productivity will decline.

Therefore, it will be more difficult for them to find a job. Even if they can find a job, their future
wage rates will usually be lower.

2. To the government
Financial burden

If more workers become unemployed, government revenue from income taxes will drop.
On the other hand, since unemployment may lead to many social problems, the government
needs to use more resources to address them.

3. To society
(a) Loss of output
When some workers are unemployed, human resources which could have been used in
production are wasted. As a result, the aggregate output of an economy is reduced.

(b) Social problems

Unemployment may increase the crime rate as some unemployed people may turn to crimes such
as robbery, theft and trafficking.
Unemployment may bring political instability to society since some unemployed people may be
discontented with the government.

 You are expected to analyze the cost of unemployment to (a) the

unemployed or (b) the society

F.5 Econ/Chapter 3 Macroeconomic problems/p.41

1995-37
Which of the following are the possible losses to society caused by unemployment?
(1) loss of output
(2) a higher crime rate
(3) a greater expenditure in public assistance
(4) a reduction in the government’s tax revenue

A. (1) and (2) only

B. (1) and (3) only
C. (2) and (4) only
D. (3) and (4) only

2007(30)
Unemployment is costly to society because
A. the employed will pay more tax.
B. the potential GDP will fall.
C. the real output of the economy will fall.
D. unemployment benefit is a burden to society.

Short Questions:
HKCEE 04-7
HKDSE 12-6

Answering strategies
Concept Common question Suggested approach
Unemployment
5. Explain how an event Write down the formula of 03-6;06-9;07-8;P
rate affects the unemployment rate, PP-6;13-11;15-5;
unemployment rate of State the changes in the 16-6;18-5
an economy unemployed population/labour
force after the event takes place.
Compare the degree of change in
the unemployed population and/
or labour force. Conclude that the
unemployment rate will
increase/decrease/remain
unchanged.

Past Paper Questions:

04-7
Give TWO losses to society caused by unemployment.
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F.5 Econ/Chapter 3 Macroeconomic problems/p.42

2003-6

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2006-9(c)

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F.5 Econ/Chapter 3 Macroeconomic problems/p.43

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F.5 Econ/Chapter 3 Macroeconomic problems/p.44

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F.5 Econ/Chapter 3 Macroeconomic problems/p.45

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18-5

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F.5 Econ/Chapter 3 Macroeconomic problems/p.46

Past Paper Suggested Solution
2004-7
• Loss of output
• When some workers are unemployed, human resources which could have been used in
production are wasted. As a result, the aggregate output of an economy is reduced.

• Social problems
• Unemployment may increase the crime rate as some unemployed people may turn to crimes such
as robbery, theft and trafficking.
• Unemployment may bring political instability to society since some unemployed people may be
discontented with the government.

2003-6
• Unemployed population/ Labour force x100% =unemployment rate
• An increase in the number of retired persons would not change the unemployed population.
• The retired person will reduce the size of the labour force if they decide not to seek another
full-time paid job.
• The unemployment rate will increase.

2006-9(c)
• Unemployed population/ (Labour force=U population+ E population) x 100%=unemployment
rate
• if there is an increase in the unemployed population and both the labour force and the
unemployed
• population increases at the same percentage/rate
• The unemployment rate will remain unchanged.
2007-8
• Total labour force increases.
• Unemployed population increases as the no of job positions remain unchanged.
• The actual increase in total labour force= The actual increase in unemployed population
OR
• % increase in the unemployed population > % increase in the labour force
• Unemployment rate increases.

PP-6

F.5 Econ/Chapter 3 Macroeconomic problems/p.47

12-6

13-11

15-5

16-6

F.5 Econ/Chapter 3 Macroeconomic problems/p.48

18-5

3.3 Business cycle

The economic growth of a country can be indicated by it growth rate in

real GDP.
If we plot this growth rate over time, a pattern of fluctuations can be
observed. This is termed as the business cycle.

Business cycle: Business cycles refer to short run cyclical fluctuations in the growth
rate of real GDP around the long run trend.

Due to population growth, investment in human capital and fixed capital, and technological
improvements, most economies in the long run experience a positive trend growth rate of
real GDP.

However, in the short run, there are periods of relatively rapid growth and periods of relatively
slow or even negative growth. These upswings and downswings in economic activities are
mostly irregular, with different durations and magnitudes.

1. A business cycle has four

phases
2. The defining feature of
each phase is the
fluctuations in the growth
rate of real GDP.

The different phases of the business cycle

A. Recession/ Contraction
Recession (or contraction) — the downswing in a business cycle with growth in economic
activities slowing down

F.5 Econ/Chapter 3 Macroeconomic problems/p.49

 Defining features:
1. Falling aggregate demand for output and services. Deteriorating business confidence leads
to shrinking economic activities.
2. Growth rate of real GDP↓ continuously and substantially
3. Unemployment rate rises
4. Falling inflation rate. Deflation may even occur.
5. Position: downswing

B. Trough( or depression)
Trough (or depression) — the lowest point of a business cycle in which economic activities are at
the lowest level

Defining features:
1. Low aggregate demand for output and services. Poor business confidence drives economic
activities to their lowest levels in the cycle.
2. Growth rate of real GDP at its lowest
3. High Unemployment rate
4. Low inflation rate ( may even be negative i.e, deflation)
5. Position: Lowest point

F.5 Econ/Chapter 3 Macroeconomic problems/p.50

C. Recovery (or expansion)
Recovery (or expansion) — the upswing of a business cycle with the growth of economic
activities speeding up

Defining features:

1. Growth rate of real GDP↑ continuously and substantially

2. Rising aggregate demand for output and services. Improving business confidence leads to growth
of economic activities.
3. Falling Unemployment rate
4. Rising inflation rate
5. Position: upswing

D. Peak (or prosperity or boom)

Peak (or prosperity or boom) — the highest point of a business cycle in which economic
activities are at their highest level
Defining features:
1. Highest Growth rate of real GDP
2. High aggregate demand for output and services
3. Low Unemployment rate
4. High inflation rate
5. Position: Highest

F.5 Econ/Chapter 3 Macroeconomic problems/p.51

 You are expected to remember the defining features of different stages
of the business cycle.

Q.6 Complete the following table:

Phase Growth rate of real Unemployment rate Inflation rate
GNP
Low High
Decreasing Decreasing
Low Low
Decreasing Increasing

Summary:

Recession / Trough / Recovery / Peak / Prosperity /

Contraction Depression Expansion Boom
Position downswing lowest point upswing highest point

Growth decreases lowest increases highest

rates of continuously and continuously and
real substantially substantially
GDP

Other features of a business cycle

1. Real national income and consumption
When the growth rate of real GDP is positive (negative), real GDP increases (decreases) and so
does the real private consumption.

2. Unemployment rate
In general, when the growth rate of real GDP is larger (smaller) than the growth rate in labour
supply and productivity, i.e., above (below) the trend growth rate, the unemployment rate
decreases (increases).
This happens in the later stage of recovery, the peak and the early stage of a recession (the later
stage of a recession, trough and the early stage of a recovery).

F.5 Econ/Chapter 3 Macroeconomic problems/p.52

 Year-on-year percentage change in real GDP
Unemployment rate (increase or decrease
Year (above or below the trend growth rate of around
relative to preceding year)
4%)
2003 7.9 (increases) 3.0 (below)
2004 6.8 (decreases) 8.5 (above)
2005 5.6 (decreases) 7.1 (above)
2006 4.8 (decreases) 7.0 (above)
2007 4.0 (decreases) 6.4 (above)
2008 3.6 (decreases) 2.2 (below)
2009 5.4 (increases) -2.8 (below)
2010 4.2 (decreases) 6.8 (above)
2011 3.3(decreases) 7.2 ( above)

The analysis is broadly consistent with actual figures from 2003 to 2011 in Hong Kong, except
the one in italics.

Q.7 How are the fiscal balance and trade balance affected by business cycles?
Fiscal balance=government revenue-government expenditure
When the growth rate of real GDP is positive (negative), real GDP increases (decreases).
Normally, government revenue from income taxes and goods and services taxes _________
(______) while government expenditure on transfer payments _____ (_____). The fiscal balance
improves (worsens).

Trade balance=export-import
When the growth rate of real GDP is positive (negative), real GDP increases (decreases).
As people can afford more (fewer) ___________, normally, the value of imports ________
(______) while the value of exports remains unchanged. The trade balance __________
(__________).

F.5 Econ/Chapter 3 Macroeconomic problems/p.53

Economics at work:3.5 The business cycles in Hong Kong between 1997 and 2012.

Asian
financial
crisiscri Recession China
SARS outbreak, Global Earthquake and
ssi and 9/11 entry
Individual Visit financial tsunami in
attacks in into the
Scheme and crisis Japan and the
the US WTO
CEPA EURO debt
crisis

1997-1998: (Downswing)
In 1998, Hong Kong suffered from a serious recession. This was the result of the Asian
financial crisis. During the crisis,Hong Kong’s economy, particularly the stock market and the
property market, was badly hit.

1999-2000: (Upswing)
In 1999 and 2000, A sharp recovery occurred because of a rapid growth in exports. The
optimistic economic outlook also increased private consumption and investment.

2001-2002: (Downswing and Upswing)

In 2001, the US economy fell into a recession and the 9/11 attacks took place. As a result, Hong
Kong’s exports and tourism declined.
At the end of 2001, China joined the World Trade Organization (WTO). This resulted in
significant export growth and an economic upswing.

2003 – 2007: (Downswing and upswing)

In 2003, Hong Kong’s economy was badly hit by the outbreak of SARS.

Hong Kong’s economy began expanding in the third quarter of 2003 due to the following factors:
1. The launch of the Individual Visit Scheme and the signing of the Mainland and Hong Kong
Closer Economic Partnership Arrangement (CEPA);
2. The drastic increase in domestic demand owing to the recovery of Hong Kong’s stock and
property markets and optimistic expectations;

F.5 Econ/Chapter 3 Macroeconomic problems/p.54

2008-2010: (Downswing and Upswing)
The outbreak of the global financial crisis in September 2008 caused the Hong Kong
economy to decline.
China taking the lead in the global economic recovery, Hong Kong had a notable rebound in
mid-2009 and 2010

2011-2012: (Downswing)
The poor external economic environment, including the earthquake and tsunami in Japan, the
worsening Euro debt crisis and the unsteady economic performance in the US once again
slowed economic growth in Hong Kong in 2011 and 2012.

Past Paper Questions:

95-7

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F.5 Econ/Chapter 3 Macroeconomic problems/p.55

2000-6

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2008-5

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F.5 Econ/Chapter 3 Macroeconomic problems/p.56

2010-7

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HKDSE PP-7

F.5 Econ/Chapter 3 Macroeconomic problems/p.57

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HKDSE 12-6

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HKDSE 16-6

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F.5 Econ/Chapter 3 Macroeconomic problems/p.58

17-9

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20-3

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F.5 Econ/Chapter 3 Macroeconomic problems/p.59

Past paper questions suggested solution:
1995-7
• The peak
• High growth rate of real GDP
• Low unemployment rate
• High inflation rate
2000-6
• Recession
• increasing unemployment rate
• falling inflation rate
• growth rate of real GDP decreases continuously and substantially
2008-5
• Recovery
• decreasing unemployment rate
• rising aggregate demand for output and services
• rising inflation rate
2010-7
• Recession
• increasing unemployment rate
• falling inflation rate
• growth rate of real GDP decreases continuously and substantially
PP-7
• Depression (Trough)
• Low aggregate demand for output and services
• High unemployment rate
• Low inflation rate
• Business confidence is at low level
12-6

F.5 Econ/Chapter 3 Macroeconomic problems/p.60

16-6

17-9

20-3

F.5 Econ/Chapter 3 Macroeconomic problems/p.61