NSS Understanding and
Interpreting the Economics
Curriculum
Session 2
Macroeconomics part of the NSS
Economics Curriculum
9 April 2009 (Thu)
Agenda
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Topic F
Topic G
Measurement of Economic Performance
National Income Determination and
Price Level
(Max. 10 mins. Q&A)
Topic H
Money and Banking
Topic I
Macroeconomic Problems and Policies
(Max. 10 mins. Q&A)
Break (15 mins.)
Topic J
International Trade and Finance
Elective 2
Q&A Session
(F) Measurement of Economic Performance
•
•
•
•
National income
General price level
Unemployment and underemployment rates
Recent trends
(F) Measurement of Economic Performance
- National income
(i) National income as a general term for
aggregates like Gross Domestic Product (GDP)
and Gross National Product (GNP)
(F) Measurement of Economic Performance
- National income
(ii) Gross Domestic Product (GDP)
• Definition of GDP
• Concept of resident producing units (RPUs)
• Items included / excluded in calculating GDP
(F) Measurement of Economic Performance
- National income
•
The three approaches to measure GDP:
production approach (value-added approach),
income approach, expenditure approach
• Use the circular flow model to explain why GDP
can be measured by 3 different approaches
(F) Measurement of Economic Performance
- National income
•
Expenditure approach
• Y = C + I + G + NX
• Classification of the components
• GDP by expenditure components in HK
• Simple transformation of the equation
• (e.g. Y – C – G = I + NX => S - I = NX,
where S is the national saving)
(F) Measurement of Economic Performance
- National income
•
Production / value-added approach
• Sum of value-added of all production activities
by RPUs
• Value-added
= value of output – intermediate consumption
• GDP by economic activities in HK
(F) Measurement of Economic Performance
- National income
•
•
Income approach
(N.B. Components of GDP compiled under the
income approach NOT required)
(F) Measurement of Economic Performance
- National income
•
GDP at current and constant market prices
•
•
Meaning of GDP at current market prices
(Nominal GDP)
• Problem of using Nominal GDP : Nominal
GDP for different years are not exactly
comparable with each other in terms of
volume.
Meaning of GDP at constant market prices
(Real GDP)
(F) Measurement of Economic Performance
- National income
•
GDP at factor cost
• Meaning of GDP at factor cost
• GDP at factor cost
= GDP at market prices – indirect taxes +
subsidies
(F) Measurement of Economic Performance
- National income
•
•
per capita GDP
• per capita GDP = GDP / population
• both nominal and real
Growth rate of GDP
• Calculate the year-on-year change
• Growth rate of nominal GDP, real GDP, per
capita nominal GDP, per capita real GDP, etc.
(F) Measurement of Economic Performance
- National income
•
(N.B. Other measures related to GDP
NOT required)
•
Net Domestic Product (NDP) NOT
required
(F) Measurement of Economic Performance
- General price level
(iii) GNP as GDP plus net income from abroad
• Definition of GNP
• GNP = GDP + NIA
• Meaning of residents
• Meaning of NIA and examples
(F) Measurement of Economic Performance
- General price level
•
•
(N.B. Other measures related to GNP NOT
required)
GNP at constant market prices, GNP at factor cost,
NNP, etc. NOT required
(F) Measurement of Economic Performance
- General price level
(iv) Uses and limitations of national income
statistics as an indicator of economic welfare
and for international comparison
• (N.B. Human development index NOT required)
• HDI is required in Elective 2
(F) Measurement of Economic Performance
- General price level
•
General price level as measured by Consumer
Price Index and implicit price deflator of GDP
(N.B. Construction of CPI and implicit price
deflator of GDP NOT required)
(F) Measurement of Economic Performance
- General price level
•
•
Calculate the rate of change in the general price
level (inflation rate) by CPI and GDP deflator
Compare CPI and GDP deflator in terms of
coverage, weighting, etc.
(F) Measurement of Economic Performance
- Unemployment and Underemployment rates
Unemployment and underemployment rates
as measured in terms of the percentage of
unemployed and underemployed persons in
the labour force
(F) Measurement of Economic Performance
- Unemployment and Underemployment rates
•
Unemployment rate
number of unemployed
100%
=
labour force
•
•
Meaning of unemployed in economics (those who
want a job but failed to find one) – Topic I
Meaning of unemployed in compiling
unemployment rate NOT required
(F) Measurement of Economic Performance
- Unemployment and Underemployment rates
•
Underemployment rate
number of underemplo yed
100%
=
labour force
•
Meaning of underemployed in economics (those
who involuntarily work less than a specified
working hours) – Topic I
(F) Measurement of Economic Performance
- Recent trends
Recent trends of national income, general price
level and unemployment in Hong Kong
•
Interpret numerical / graphical data involving GDP
deflator, CPI, and those national income statistics
that are required in the curriculum
(G) National Income Determination and
Price Level
•
AS-AD model
• Aggregate demand
• Aggregate supply
• The determination of level of output and price
(G) National Income Determination and
Price Level
Aggregate demand
(i) Reasons for a downward sloping AD curve
• Wealth effect :
• P decreases  Wealth increases (in real terms)
 Consumption expenditure increases
(G) National Income Determination and
Price Level
•
•
Interest rate effect :
• P decreases  Real interest rate decreases
 Investment expenditure increases
Exchange rate effect :
• P decreases  exports becomes relatively
cheaper and imports becomes relatively more
expensive  net exports increases
(G) National Income Determination and
Price Level
(ii) Determinants of aggregate demand:
• Private consumption expenditure, which in turn
depends on disposable income, the desire to save,
wealth (value of assets), interest rate, etc
• Investment expenditure, which in turn depends
on business prospect, interest rate, etc.
(G) National Income Determination and
Price Level
(ii) Determinants of aggregate demand:
• Government expenditure
• Net exports, which in turn depends on the
economic conditions of trading partners,
exchange rate, etc
(G) National Income Determination and
Price Level
•
(N.B. Derivation of the AD curve, magnitude
of the shift in the AD curve and factors
affecting the slope of the AD curve NOT
required)
•
Why is AD curve downward sloping?
Factors that cause a shift in AD curve
•
(G) National Income Determination and
Price Level
Aggregate supply
(i) Reasons for an upward sloping short run AS
curve
•
•
•
•
sticky-wage model
sticky- price model
worker-misperception model
imperfect-information model
(G) National Income Determination and
Price Level
(ii) Reasons for a vertical long run AS curve
•
As the price level rises / falls, real production
remains constant at the full-employment level.
Due to flexible prices, the same level of real
production is generated at every price level.
(G) National Income Determination and
Price Level
(iii) Factors affecting short run and long run AS
curve
•
Factors affecting SR AS curve
• Cost shocks
• Government policies (changes in taxes,
regulations)
• Other factors, like weather condition
(G) National Income Determination and
Price Level
•
•
Factors affecting LR AS curve
• Factors affecting aggregate supply: factor
endowments (labour, capital, land) and
technological changes, etc
(N.B. Explanation by the Phillips curve and
magnitude of the shift of the AS curve NOT
required)
(G) National Income Determination and
Price Level
The determination of level of output and price
(i) Determination of the equilibrium level of
output and price level in the AS-AD model
• (N.B. Quantity Theory of Money NOT required)
(G) National Income Determination and
Price Level
(G) National Income Determination and
Price Level
(ii) Changes in the equilibrium level of output and
price level caused by change(s) in the AD
and/or AS
•
Both SR and LR effects
(G) National Income Determination and
Price Level
(iii) Relationship between employment and
output level
• Output increases  more resources are needed
 employment increases
•
(N.B. Interest rate is treated as exogenously
determined)
10 Minutes Q&A
(H) Money and Banking
•
•
•
•
•
•
Money
Banks: functions and services
Money supply
Money demand
Determination of interest rate in the money market
Hong Kong as a financial centre
(H) Money and Banking
Money
(i) Definition of money
• Anything that is generally accepted as a
medium of exchange
(ii) Nature and functions of money
• Nature of money : scarce, homogeneous,
stable in value, divisible into smaller
denominations
(H) Money and Banking
•
Functions of money:
• Medium of exchange
• Store of value
• Unit of account
• Standard of deferred payments
(H) Money and Banking
Banks: functions and services
(i) Commercial banks and central bank
• Commercial banks
• Function of commercial banks :
• Channel savings to investment
• Services provided by commercial banks
• Central bank
• Functions of a central bank
(H) Money and Banking
(ii) Licensed banks, restricted licence banks and
deposit-taking companies in Hong Kong
• Features in terms of minimum capital
requirements and types of deposits that could
accept
(iii) How central banking functions are
performed in Hong Kong
(H) Money and Banking
Money supply
(i) Definitions of money supply in Hong Kong
• M1, M2 and M3
(H) Money and Banking
(ii) Credit creation/contraction and the banking
multiplier
• Required reserve ratio, maximum banking
multiplier
• Calculate maximum change in money supply,
deposits, loans, etc.
• Assumptions made in calculating the maximum
change
• Meaning of monetary base
• Describe the process of credit creation / contraction
(H) Money and Banking
Money demand
(i) Meaning of transactions demand for money
and asset demand for money
• MT : holding money for making
transaction (buying goods and services)
• MA : holding money as a form of holding
assets
(H) Money and Banking
(ii) Money demand as a function of nominal
interest rate and income
• Increase in income  more transactions
needed to be made  demand more
transaction balances to make transactions
• Md is a positive function of income
(H) Money and Banking
•
•
Cost of holding money is the nominal interest
rate (holding money gives up the opportunity of
earning interest from holding interest earning
assets – bonds)
 Md is a negative function of nominal interest rate
Return of holding money and other benefits of
holding money
(H) Money and Banking
Determination of interest rate in the money
market
• Interaction of money supply and money
demand
• Alternative models of explaining the
determination of interest rate
(e.g. loanable fund theory) NOT required
(H) Money and Banking
Hong Kong as a financial centre
(i) Factors contributing to its development as
a financial centre
(ii) Effects on the Hong Kong economy
(I) Macroeconomic Problems and Policies
•
•
•
•
•
Business cycles
Inflation and deflation
Unemployment
Fiscal policy
Monetary policy
(I) Macroeconomic Problems and Policies
•
Business cycles: a description of the short run
fluctuations in real GDP around the long run
trend
(N.B. Theories of business cycles NOT required)
• Features of the 4 phrases of a business cycle
(I) Macroeconomic Problems and Policies
Inflation and deflation
(i) Definitions of inflation and deflation
• Inflation: persistent increase in the general
price level
• Deflation: persistent decrease in the general
price level
(ii) Relationship between nominal and real
interest rates
• Nominal interest rate
= real interest rate + expected inflation rate
(I) Macroeconomic Problems and Policies
(iii) Redistributive effects
• Explain why debtors will gain and creditors will
lose (illustrated with example) with
unanticipated inflation
• Explain why debtors will lose and creditors will
gain (illustrated with example) with
unanticipated deflation
• Explanation by comparing expected real interest
rate and realized real interest rate
(I) Macroeconomic Problems and Policies
(iv) Inflation and Quantity Theory of Money
•
•
•
(N.B. Velocity of circulation of money
assumed to be constant)
Quantity equation / equation of exchange
• Mv ≡ Py
Meaning of velocity of circulation : ratio of
nominal GDP to money stock
(I) Macroeconomic Problems and Policies
•
Short-run QTM
• Assumes: v constant
• Prediction:
• % change in money supply = % change in
nominal income
• Both P and y may change
(I) Macroeconomic Problems and Policies
•
Long-run / Classical QTM
• Assumes:
• (1) v constant
• (2) y constant at full-employment (classical
assumption)
• Prediction:
• Only P will change (change in money supply cannot
affect income ; money is neutral)
• % change in money supply = % change in price level
(I) Macroeconomic Problems and Policies
Unemployment
(i) Meaning of unemployment
•
•
See Topic F
Inflationary income gap: Y>Yf when the economy has an
‘excess demand’ for labour
(ii) Meaning of underemployment
•
See Topic F
(iii) Cost of unemployment
•
•
•
to the unemployed
to society
(N.B. Phillips curve NOT required)
(I) Macroeconomic Problems and Policies
Fiscal policy
(i) Meaning of fiscal policy
• Policies that involve changes in government
expenditures (G) and/or taxes (T) to achieve
certain economic goals
• Definition of budget; surplus budget, deficit
budget and balanced budget
(I) Macroeconomic Problems and Policies
•
Taxation:
• Principles
• Adam Smith’s 4 taxation principles
• Economy
• Equity
• Certainty
• Convenient
• Taxation principle in HK : source principle
(I) Macroeconomic Problems and Policies
•
Classification
• Direct and indirect taxes
• Meaning of direct and indirect taxes
• Progressive, proportional and regressive
taxes
• Meaning of progressive, proportional
and regressive taxes
• Effects of the above types of taxes on
income equality (Topic E)
(I) Macroeconomic Problems and Policies
•
Public expenditure: classification by function
•
(N.B. With special reference to Hong Kong)
• Education, Social Welfare, Health,
Security, Infrastructure, Economic,
Housing, Environment and Food,
Community and External Affairs, Support
• Public expenditure as percentage of GDP
• http://www.budget.gov.hk
(I) Macroeconomic Problems and Policies
(ii) Effect of fiscal policy on the level of output
and price
• Explain the effects of expansionary fiscal policy,
contractionary fiscal policy, and balanced
budget change in G and T on price level and
output with the AD-AS model
(I) Macroeconomic Problems and Policies
Monetary policy
(i) Meaning of monetary policy
•
•
Changes in Ms and / or interest rate in affecting the
economy
Monetary tools (methods in affecting the Ms or
interest rate)
• Open market operations, discount rate, required
reserves ratio, printing money
• Brief discussion of monetary policy in HK
(ii) Effect of monetary policy on the level of
output and price
10 Minutes Q&A
Break
(J) International Trade and Finance
•
•
•
Free trade and trade barriers
Brief introduction to the balance of payments
account
Exchange rate
(J) International Trade and Finance
Free trade and trade barriers
(i) Absolute advantage; comparative advantage
and gains from trade
• (N.B. Illustration by the production possibility
frontier NOT required)
(J) International Trade and Finance
•
•
•
•
•
Meaning of absolute advantage and comparative
advantage
Identify which country has an absolute and a
comparative advantage (illustrated with numerical
data)
Calculate the gains from trade (illustrated with
numerical data)
State the principle of comparative advantage
PPF is required in Elective 2
(J) International Trade and Finance
(ii) Using the pattern of trade in Hong Kong to
illustrate the principle of comparative
advantage
(J) International Trade and Finance
(iii) Importance of trade to Hong Kong's economy
• Verbal description of the importance of trade to
HK
• Importance of trade to HK as reflected by the
ratio of exports and imports to GDP
(J) International Trade and Finance
(iv) Trade barriers:

Types
• Tariff, quota, import surcharge, embargo, etc.

Effects of tariff and quota on price and
output for a small open economy
• Discussion on effects of trade barriers is limited
to tariff and quota ONLY
(J) International Trade and Finance
P
S
Pw+ t
Pw
A
B
C
D
D
Tariff
Q
(J) International Trade and Finance
P
P’
Pw
S
SQ
SQ : domestic
supply + supply of
imported goods
with quota
A
B
C
D
D
Quota
Q
(J) International Trade and Finance
(v) Trade barriers faced by Hong Kong and
attempts to overcome them
• Trade promotion
• Role of the HKSAR Government
• Role of international economic institutions (e.g.
World Trade Organisation)
(J) International Trade and Finance
•
Brief introduction to the balance of payments
account
Current account
•
•
Main components of the current account: goods,
services, income and current transfers
(N.B. Sub-classification of these components NOT
required)
(J) International Trade and Finance
•
Capital and financial account
•
•
•
(N.B. Sub-classification of this account NOT
required)
Balance of Payments is always balanced in
accounting sense
Meaning of BoP surplus and deficit
(J) International Trade and Finance
Exchange rate
(i) Meaning of exchange rate
• (N.B. Graphical analysis NOT required)
• Exchange rate: price of a foreign currency in terms
of domestic currency
• Meaning of appreciation and depreciation,
revaluation and devaluation
(J) International Trade and Finance
(ii) Effect of a change in the exchange rate on
import price and export price
• Appreciation of domestic currency
 fall in import price and rise in export price
(iii) Brief introduction to the linked exchange rate
system in Hong Kong
• Brief history
• Note-issuing mechanism (currency broad system)
• (N.B. Mechanism of maintaining the linked
exchange rate NOT required)
Elective 2
•
•
Extension of trade theory
Economic growth and development
Elective 2
Extension of trade theory
(i) Illustration of comparative costs and gains
from trade with the aid of production
possibilities frontier
• (N.B. The use of indifference curve NOT required)
Elective 2
•
•
•
•
•
Slope of PPF as the marginal cost of producing
good X
Illustration of comparative costs with the aid of
PPF
Determination of production point
Determination of consumption point NOT required
(because IC NOT required)
Show the gains from trade
Elective 2
(ii) Comparative advantage and its relation to
globalization
•
Meaning of globalization (focus on the economic
aspects)
•
Comparative advantage and its relation to
globalization (e.g. Mainland China as ‘the world
factory’)
Elective 2
Economic growth and development
(i) Measurement of economic growth and
development
• Changes in real GDP
• Changes in per capita real GDP
• Changes in human development index
Elective 2
•
Human development index
• 3 Dimensions:
• A Long and Healthy life (as measured by life
expectancy at birth)
• Knowledge (as measured by adult literacy rate, the
combined gross enrollment ratio for primary,
secondary and tertiary schools), and
• A decent standard of living (as measured by GDP
per capita in purchasing power parity)
• http://www.undp.org/
Elective 2
(ii) Factors affecting growth of an economy
•
Inputs: physical capital, human capital, natural
resources, technological change
Elective 2
•
•
•
Policies: saving and investment, foreign direct
investment, trade, education, population,
property rights, research and development
(N.B. The analytical framework of aggregate
production function and the theories and
models of economic growth NOT required)
A descriptive approach
Elective 2
(iii) The desirability and costs of economic growth
• Current versus future consumption
• Trade off between current and future
consumption
• Growth, living standard and income distribution
• Resources exhaustion, pollution and sustainable
development
Elective 2
(iv) International/regional comparison
•
Interpret graphical and numerical data
Q&A Session