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S6 Economics Practice Paper: National Income, Unemployment and Inflation
S6 Economics: National Income, Unemployment and Inflation
National income equilibrium, multipliers, GDP versus GNP, unemployment and participation rates, types of unemployment, real wages, the CPI, inflation and real interest rates.
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Paper details Level: S6 | Subject: Economics | Time: 75 minutes | Marks: 100 | Questions: 12 | Answers included
Section A: National Income and Equilibrium (34 marks)
Answer all four questions and show your working.
| # | Question | Answer and marking notes |
|---|---|---|
| 1 | 1. A country has the following macro model (in billions of dollars): C = 60 + 0.75Yd, I = 100, G = 120, X = 90, M = 40 + 0.1Y, tax rate t = 0.2 (T = 0.2Y), Yd = Y – T. (a) Find the equilibrium income Y. (b) Find consumption, imports and tax revenue at equilibrium. (c) Find the government budget position (surplus or deficit). (8 marks) | 1. (a) Yd = 0.8Y, so C = 60 + 0.6Y; Y = C + I + G + X – M = 330 + 0.7Y, hence Y = 660 billion. (b) C = 456; M = 106; T = 132 billion. (c) T – G = 132 – 120 = a surplus of 12 billion. [Marks: (a) 3; (b) 3 (1 each); (c) 2] |
| 2 | 2. Referring to Q1, government spending rises from 120 to 160 billion. (a) Find the government spending multiplier. (b) Find the new equilibrium income and the change in income. (c) Find the new budget position and explain why it reverses. (8 marks) | 2. (a) Multiplier = 1 / (1 – 0.6 + 0.1) = 2. (b) change in Y = 2 x 40 = 80 billion, so the new Y = 740 billion. (c) New T = 148 and new G = 160, a deficit of 12 billion: tax revenue rises by 16 billion but spending rises by 40 billion. [Marks: (a) 3; (b) 3; (c) 2] |
| 3 | 3. Referring to Q1, the import propensity rises so that M = 40 + 0.2Y. (a) Find the new multiplier (3 decimal places). (b) Find the new equilibrium income. (c) Explain why an open economy has a smaller multiplier than a closed one. (9 marks) | 3. (a) Multiplier = 1 / (1 – 0.6 + 0.2) = 1.667. (b) Y = 330 / 0.6 = 550 billion. (c) Part of any extra income leaks into imports and is not re-spent domestically, so each round of spending is smaller. [Marks: (a) 4; (b) 2; (c) 3] |
| 4 | 4. A country’s GDP is 660 hundred million dollars, net factor income from abroad is -18 hundred million and the population is 3.0 million. Next year nominal GDP is 726 hundred million and the price index rises from 100 to 110. (a) Find GNP. (b) Find GDP per capita. (c) Find real GDP next year and its real growth rate. (9 marks) | 4. (a) GNP = 660 + (-18) = 642 hundred million. (b) GDP per capita = (660 x 100 million) / 3.0 million = 22,000. (c) Real GDP = 726 / 110 x 100 = 660 hundred million, so real growth = (660 – 660) / 660 x 100% = 0%: the nominal rise is entirely due to prices. [Marks: (a) 2; (b) 3; (c) 4] |
Section B: Unemployment and the Labour Market (32 marks)
Give units with all numerical answers.
| # | Question | Answer and marking notes |
|---|---|---|
| 5 | 5. A territory has a population of 3,000,000, a labour force of 1,800,000 and employment of 1,710,000. (a) Find the number of unemployed. (b) Find the unemployment rate. (c) Find the labour force participation rate. (8 marks) | 5. (a) Unemployed = 1,800,000 – 1,710,000 = 90,000. (b) Unemployment rate = 90,000 / 1,800,000 x 100% = 5.0%. (c) Participation rate = 1,800,000 / 3,000,000 x 100% = 60.0%. [Marks: (a) 2; (b) 3; (c) 3] |
| 6 | 6. Referring to Q5, a prolonged downturn leads 20,000 unemployed workers to give up job search and leave the labour force, while employment is unchanged. (a) Find the new unemployment rate (2 decimal places). (b) Does the fall in the unemployment rate mean the job market has improved? Explain. (8 marks) | 6. (a) New labour force = 1,780,000 and new unemployed = 70,000, so the rate = 70,000 / 1,780,000 x 100% = 3.93%. (b) No. Employment is still 1,710,000, so no jobs were created; the rate fell only because the denominator shrank (the discouraged-worker effect). [Marks: (a) 4; (b) 4] |
| 7 | 7. Explain the causes of frictional, structural and cyclical unemployment and give one Hong Kong example of each. Which type is hardest to fix with short-run demand policy? (8 marks) | 7. Frictional: short spells between jobs or while job-hunting, e.g. a new graduate seeking a first job. Structural: a mismatch of skills after industrial change, e.g. assembly workers displaced when production moved north. Cyclical: insufficient aggregate demand, e.g. retail and catering layoffs in a recession. Structural unemployment is the hardest to fix with short-run demand policy; retraining and education are needed. [Marks: 1.5 cause + 1 example each = 7.5; 0.5 for the policy comment] |
| 8 | 8. An employee’s nominal wage rises by 4% while the CPI rises from 100 to 106.36. (a) Find the percentage change in the real wage. (b) Has purchasing power improved or fallen? (c) What if the nominal wage had risen by only 2%? (8 marks) | 8. (a) Real wage index = (104 / 106.36) x 100 = 97.78, a change of -2.22%. (b) It has fallen, because prices rose by 6.36% against a 4% pay rise. (c) With a 2% rise, the real index = (102 / 106.36) x 100 = 95.90, a fall of 4.10%: a bigger loss. [Marks: (a) 4; (b) 2; (c) 2] |
Section C: Prices, Inflation and Interest Rates (34 marks)
Explain with economic concepts, not numbers alone.
| # | Question | Answer and marking notes |
|---|---|---|
| 9 | 9. The CPI basket has three items only: A, 40 units (base price $20, current price $21); B, 30 units (base price $50, current price $54); C, 10 units (base price $100, current price $105). (a) Find the basket cost in the base and current periods. (b) Find the current CPI (base = 100). (c) Find the inflation rate over the period. (9 marks) | 9. (a) Base = 40 x 20 + 30 x 50 + 10 x 100 = $3,300; current = 40 x 21 + 30 x 54 + 10 x 105 = $3,510. (b) CPI = 3,510 / 3,300 x 100 = 106.36. (c) Inflation = (106.36 – 100) / 100 x 100% = 6.36%. [Marks: (a) 4; (b) 3; (c) 2] |
| 10 | 10. (a) Distinguish demand-pull from cost-push inflation. (b) Give one Hong Kong example of each. (c) Why is cost-push inflation harder to deal with using contractionary policy? (8 marks) | 10. (a) Demand-pull: aggregate demand grows faster than productive capacity and pulls prices up; cost-push: higher input costs such as wages, rents or imported materials push prices up. (b) Demand-pull: a tourist revival lifting hotel room rates; cost-push: dearer imported food raising restaurant prices. (c) Contractionary policy reduces demand, but the source is on the supply side, so output and employment fall as well, worsening stagflation. [Marks: (a) 3; (b) 2; (c) 3] |
| 11 | 11. The nominal interest rate is 7% and inflation over the same period is 6.36%. (a) Find the real interest rate using the approximation. (b) Find it exactly. (c) Who gains more here, savers or borrowers? (9 marks) | 11. (a) Real rate = approx. 7% – 6.36% = 0.64%. (b) Exact = (1.7 / 1.0636 – 1) x 100% = 0.60%. (c) Borrowers gain: they repay in money whose purchasing power has barely changed, so the real burden of the debt falls, while savers earn almost nothing in real terms. [Marks: (a) 3; (b) 4; (c) 2] |
| 12 | 12. An economy experiences unanticipated inflation of 6.36%. (a) Explain the effect on people on fixed incomes, on creditors and on borrowers. (b) How can the government reduce the distributional effects of unanticipated inflation? (8 marks) | 12. (a) People on fixed incomes (e.g. fixed pensions) lose purchasing power; creditors receive unchanged nominal interest, so their real return is eroded; borrowers repay with depreciated money, so their real debt falls and they gain. (b) For example: issue inflation-linked bonds, index pensions and tax brackets, and keep the central bank independent so inflation expectations stay anchored. [Marks: (a) 5; (b) 3] |
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