Chapter 3 Answer

NSS Exploring Economics 5
Chapter 3
Macroeconomics Problems
Questions
P.68
Think it over
1.
What is inflation?
2.
How does inflation affect your daily life?
3.
As a student, you do not have a job. Are you classified as unemployed?
4.
How does unemployment affect Hong Kongs economy?
P.68
Think it over (Cartoon)
Mom, how do inflation and unemployment affect us?
P.69
Test yourself
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 drops steadily.
b. Suppose that during the 2008 Beijing Olympic Games, prices of all goods and services in
Beijing increased by 10%.
c. A ferry company raises its fare by 20%.

Questions and Answers to Exercises (Chapter 3)
Pearson Education Asia Limited 2010
P.71
Test yourself
3.2
Refer to Table 3.1. Calculate the year-on-year percentage changes in the general price level in
2003 and 2007, respectively.
P.72
Test yourself
3.3
The data below show the year-on-year percentage change in the implicit price deflator of
GDP from 1997 to 2008. Plot the data on Fig 3.4. Do the two curves coincide? Explain.
Year
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
Year-on-year
% change
in the
implicit
price
deflator of
GDP (%)
5.7
0.8
-4.5
-3.6
-1.9
-3.5
-6.2
-3.5
-0.1
-0.3
2.9
P.73
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 Index
Nominal wages ($)
2009
105
10,000
2010
110
10,800

1.5
P.75
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?
b. If the actual inflation rate turns out to be 6% only, what would the actual real interest rate
be?
P.79
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 gain?
Banks and
depositors
Employees and
their employers
Cake shops and
holders of their
cake coupons
3.7
Will providers or recipients of fixed future payments gain under the following situations?
Explain.
a. Anticipated inflation
b. Anticipated deflation
P.83
Fig 3.11
Are they classified as unemployed persons?

P.83
Test yourself
3.8
What are the major similarity and difference between underemployed persons and
unemployed persons?
P.85
Test yourself
3.9
If a large number of people retire, the change in the unemployment rate is uncertain. Do you
agree? Explain.
P.95--96
Exercises
Multiple Choice Questions
1*.
Which of the following statements about inflation, disinflation and deflation is correct?
A. Inflation occurs when the general price level rises.
B. Disinflation occurs when the general price level drops.
C. Deflation occurs when the percentage change in the general price level is persistently
negative.
D. Deflation occurs when the percentage change in the general price level drops
continuously.
2*.
The following table shows the implicit price deflator of GDP in Hong Kong.
Impicit price deflator of
GDP (2007 = 100)
2005
2006
97.4
97. 2
Source: Census and Statistics Department

In 2006,
A. the deflation rate was 0.5%.
B. the nominal GDP decreased.
C. the real GDP increased.
D. the nominal GDP was smaller than the real GDP.

3.
Year
Year-on-year % change
in Composite CPI
1999
-4.0
2000
-3.8
2001
-1.6
2002
-3.0
2003
-2.6
2004
-0.4
2005
+1.0
Which of the following statements concerning the period from 1999 to 2005 is
INCORRECT?
A. Deflation ceased in 2005.
B. The standard of living improved from 1999 to 2004.
C. The purchasing power of money increased from 1999 to 2004.
D. The cost of living decreased from 1999 to 2004.
4.
Which of the following formulae concerning the relation among nominal interest rate, real
interest rate and inflation rate is correct?
Nominal interest rate
A.
Expected real
interest rate
B.
Actual real
interest rate =
C.
Expected
inflation rate
D.
Actual
inflation rate
Expected real
= interest rate
1 + Expected inflation rate

Nominal
interest rate
Expected
inflation rate
Expected real
interest rate
Nominal
interest rate
Expected
+ inflation rate
Actual real
interest rate
5.
Who will gain in times of unanticipated inflation?
A. Tammy, who has a $300 supermarket cash coupon
B. Jacob, who earns a fixed rent from a flat

C. Isabella, who hires an Indonesian maid

D. Michael, who has a time deposit
6*.
Who are classified as unemployed in Hong Kong?
(1) Joshua, a teacher who has just quit his job due to a serious disease
(2) Madison, a housewife who is seeking a part-time job
(3) Eddie, a retired social worker who is searching for voluntary work
(4) Jennifer, a manager who has just resigned and is applying for a post as an accountant
A. (1) and (3) only
B. (2) and (4) only
C. (2), (3) and (4) only
D. All of the above
7.
Number of persons
Population aged 15 and above
Labour force
Employed persons
Underemployed persons
1,000,000
700,000
600,000
80,000
According to the data above, which of the following statements is correct?

A. The unemployment rate is 14.3%.
B. The unemployment rate is 20%.
C. The underemployment rate is 10%.
D. The underemployment rate is 16.7%.
8.
Which of the following is a loss to society resulting from unemployment?
A. An economys output decreases.
B. The government receives less tax revenue.
C. The government needs to increase aid to the unemployed.
D. All of the above

9*.
In the diagram above, A is in a certain phase of a business cycle. Which of the following is a
feature of this phase?
A. Private consumption expenditure increases.
B. Firms earn less profit.
C. The general price level drops.
D. Government expenditure is greater than government revenue.
10.
The following phenomena are observed in an economy:
I. Profits are negative.
II. The interest rate approaches zero.
III. The growth rate of real GDP is the lowest.
IV. The volume of imports drops significantly.
Which phase of the business cycle is the economy in?
A. Recession
B. Trough
C. Recovery
D. Peak
Short Questions.
1.
What are the similarity and difference between inflation, disinflation and deflation? (5 marks)
2*.
Are the following stock or flow? Explain.
a. Nominal interest rate
b. Consumer price index
c. Inflation rate

(2 marks)
(2 marks)
(2 marks)
d. Number of employed persons

e. Unemployment rate
(2 marks)
(2 marks)
3.
a. Under what condition will the imposition of a goods and services tax lead to inflation?
Under what condition will it not?
(4 marks)
b. Suppose there is inflation. Under what condition will the real income of a worker increase?
(2 marks)
4.
a*. Is the nominal interest rate determined by the expected inflation rate or the actual inflation
rate?
(5 marks)
b. Under what condition will the real interest rate be negative?
(3 marks)
Structured Questions.
a. i. Identify which phase of a business cycle Point X is in.

ii. Suggest TWO economic features which can be observed in this phase.
(1 mark)
(2 marks)
b. i. If the nominal interest rate is 6% and the actual real interest rate is 2%, what is the
actual inflation rate?
(2 marks)
ii. Based on the results in (b)(i), explain whether the following would gain or lose if the
expected inflation rate is 5%.
(1) A household with an outstanding home mortgage loan of $2 million at a fixed
interest rate
(3 marks)
(2) A firm which has signed a contract to supply packed lunches to a school at a fixed
price in the year
(3 marks)
iii. Explain how inflation affects private consumption expenditure, investment
expenditure and volumes of exports and imports.
(6 marks)

c. i. Despite a fall in the unemployment rate, the number of unemployed persons increases.
Explain how this may happen.
(3 marks)
ii. State TWO costs of unemployment.
(2 marks)
Activities
p.98
1.
Debate the following topic: A 10% unemployment brings more harmful effects to an
economy than a 10% inflation.
2.
Visit the World Factbook website:
https://www.cia.gov/library/publications/the-world-factbook/index.html
a. According to the inflation rates listed in the World Factbook, which three territories have
the highest inflation rates? Which three have the lowest?
3.
Visit the World Factbook website:
https://www.cia.gov/library/publications/the-world-factbook/index.html
a. According to the unemployment rates listed in the World Factbook, which three territories
have the highest unemployment rates? Which three have the lowest?
4.
a. What are the major types of unemployment? (Hint: You can learn more about the different
types of unemployment from the suggested websites for this topic. You may also refer to
other websites or books for more information.)
b. Based on your findings in (a), identify possible causes of unemployment.
5.
In which phase of an economic cycle are the following economies? Cite evidence from the
statistics of the economies to support your viewpoint. (Hint: you can collect statistics from
the statistics departments of corresponding economies. For example, the website for the
Statistics Bureau of Japan is: http://www.stat.go.jp/english)
a. Hong Kong
b. The mainland of China
c. United States
d. Japan

Answers
P.68
Think it over
1. Inflation is the phenomenon of a persistent increase in the general price level.
2. Free answer, e.g., a rise in the cost of living
3. In Hong Kong, if you are 15 and older, available for work, and seeking work, you are
classified as unemployed. Otherwise, you are not.
4. Free answer, e.g., a drop in GDP
P.68
Think it over (Cartoon)
Free answer
P.69
Test yourself
3.1
a. No. A steady fall in the price of a single good is not an example of deflation.
b. No. A temporary rise in the general price level is not an example of inflation.
c. No. A once-and-for-all rise in the price of a single good is not an example of inflation.
P.71
Test yourself
3.2
The year-on-year percentage change in the general price level in 2003
=
CCPI in 2003 CCPI in 2002 100%

CCPI in 2002
99.8 102.4
100% = -2.54% (deflation)
102.4
The year-on-year percentage change in the general price level in 2007

= CCPI in 2007 CCPI in 2006
CCPI in 2006
=
100%
104.4 102.4
100% = +1.95% (inflation)
102.4

10
P.72
Test yourself
3.3
The two curves do not coincide with one another because the two price indices reflect the
price level of different goods and services. The CCPI reflects the price level of products
generally purchased by domestic households, while the GDP deflator reflects the price level
of products related to GDP. Hence, their year-on-year percentage changes are not the same.
P.73
Test yourself
3.4
The real wage in 2009
=
Nominal wages in 2009

Price index in the base year
Price index in 2009
$10,000
100 = $9,523.8 in the base year
105
The real wage in 2010
Nominal wages in 2010 Price index in the base year

Price index in 2010
$10,800
100 = $9,818.2 in the base year
110
Therefore, the real wages have increased from $9,523.8 to $9,818.2.

P.75
Test yourself
3.5
a. The nominal interest rate = Expected inflation rate + Expected real interest rate
= 10% + 4% = 14%
b. Actual real interest rate = Nominal interest rate Actual inflation rate
= 14% 6% = 8%

11
P.79
Test yourself
3.6
Trading partners
Providers
Recipients
Who gain?
Banks and
depositors
Banks
Depositors
Depositors
Employees and
their employers
Employers
Employees
Employees
Cake shops and

holders of their
cake coupons
Cake shops provide cake (instead of

money) to holders
Holders (cake shops) gain, if

the real value of cakes
increases (decreases)
unexpectedly. This happens
when the price of cakes drops
by a smaller (larger)
percentage than the general
price level.
P.79
Test yourself
3.7
Under anticipated inflation or deflation, providers and recipients of future payments have
correctly anticipated the change in the real value of future payments. Since the actual change
is expected, no party gains or loses due to the anticipated inflation or deflation.
P.83
Fig 3.11
The housewife is not an unemployed person, but the volunteer is.
P.83
Test yourself
3.8
Similarity: Both want to have more work.
Difference: Underemployed persons currently have a job but unemployed persons do not
have one.
P.85

12
Test yourself
3.9
Before retiring, some people were employed and some were unemployed. After retiring, both
the number of unemployed persons and those in the labour force drop. Hence, the change in
the unemployment rate is uncertain, depending on the relative percentage changes.
If the % drop in unemployed persons > % drop in labour force, unemployment rate
decreases.
If the % drop in unemployed persons = % drop in labour force, unemployment rate remains
unchanged.
If the % drop in unemployed persons < % drop in labour force, unemployment rate
increases.
P.33-36
Exercises
Multiple Choice Questions
1. C
Option A is incorrect. When there is a temporary rise or a once-and-for-all rise in the
general price level, it is not inflation.
Option B is incorrect. Disinflation occurs when the general price level continues to rise
but at a decreasing rate.
Option D is incorrect. A continuous drop in the general price level is insufficient in
defining deflation. Deflation occurs when the percentage change in the general price
level is persistently negative, whether it rises or falls.
2.
D
Option A is incorrect. In 2006, the percentage change in price level was
97.2 97.4 ) 100% ]. That is, the deflation rate was 0.21%.
97.4
can reflect the change in the general price
- incorrect. The figures
Options B and C are
0.21
level only, not the change in the nominal
GDP or real GDP.
%
Option D is correct. The derivation is
as follows:
Nominal
GDP
GDP deflator in 2006 =
100 = 97.2
Real GDP
Nominal GDP
= 0.972 < 1
Real GDP
Nominal GDP < Real GDP
-0.21% [= (

13
3.
Option B is incorrect. Although the price level dropped continuously during the period,
had the percentage drop in nominal income been larger than the deflation rate, the
standard of living would have deteriorated.
4.
5.
C
Options A, B and D are not correct. Tammy is a holder of a cash coupon. Jacob and
Michael are recipients of fixed future payments. They lose in times of unanticipated
inflation.
Option C is the answer. Isabella is a provider of fixed future payments who gains in
times of unanticipated inflation.
6.
B
Madison and Jennifer do not have a job but are available for work and are seeking work.
They are unemployed. Joshua is not available for work because of his health, while
Eddie is not seeking work for pay or profit. They are not classified as unemployed.
7.
A
Unemployment rate =
=
Labour force Employed persons

Labour force
700,000 600,000
100% = 14.2
700,000
Underemployment rate =
=
100%
Underemployed persons
Labour force
100%
80,000 100% = 11.43%

700,000
8.
A
Options B and C are incorrect. Though the government loses, the unemployed gain as
they do not have to pay taxes but receive aids. So, on the whole, the society suffers no
losses.
9.
A
As the growth rate of real GDP decreases, the economy is in the phase of recession.
However, since the growth rate is still positive, real GDP and real private consumption

14
expenditure are still increasing. Meanwhile, firms profit level, the general price level
and the size of government expenditure relative to government revenue are
indeterminate.
10. B
Short Questions.
1.
Similarity: They describe a persistent change in the general price level. (2 marks)
Difference: During inflation, disinflation and deflation, the percentage changes in the general
price level are positive, positive but declining, and negative, respectively. (3 marks)
2.a. The nominal interest rate is the rate of change in the money value of an asset over a
specified period of time. Specifying the time period is meaningful. For example, a
nominal interest rate of 3% a month is different from that of 3% a year. It is a flow.
(2 marks)
2.b. The consumer price index is a figure showing the price level of consumer goods and
services generally purchased by households in a specified period relative to the price
level in the base year. Specifying the time period is not meaningful. For example,
saying that the CPI is 120 a month is meaningless. It is a stock. (2 marks)
2. c. The inflation rate is the percentage change in the general price level in a specified
period. Specifying the time period is meaningful. For example, an inflation rate of 3%
a month is different from that of 3% a year. It is a flow. (2 marks)
d. The number of employed persons is the quantity of persons who are at work for pay or
profit or who have a formal job attachment. Specifying the time period is not
meaningful. For example, indicating that the number of employed persons is 1 million
per month is meaningless. It is a stock. (2 marks)
e. The unemployment rate refers to the proportion of unemployed persons in the labour
force. Specifying the time period is not meaningful. For example, saying that the
unemployment rate of 5% a month is meaningless. It is a stock. (2 marks)
3. a. If there is no further increase in the tax payment imposed on each unit of goods and
services, the general price level will increase by one time only. This will not lead to
inflation. (2 marks)

15
However, if the tax payment imposed on each unit of goods or services rises
continuously, the general price level will increase persistently. This will lead to
inflation. (2 marks)
3. b. If the nominal income of a worker rises by a larger percentage than the inflation rate, the
real income of the worker will increase. (2 marks)
4. a. The nominal interest rate is the rate of change in the nominal value of an asset over a
specified period of time. It is equal to the sum of the real interest rate and the inflation
rate. (2 marks)
When the nominal interest rate is stipulated or determined (by the trading parties when
the asset is transacted), the actual inflation rates at present and in future have not been
enumerated and released. (2 marks)
Hence the nominal interest rate has to be determined by the expected inflation rate.
(1 mark)
4. b. Recall that real interest rate = nominal interest rate inflation rate, (1 mark)
when the real interest rate is negative,
nominal interest rate inflation rate < 0 nominal interest rate < inflation rate.
(1 mark)
Thus, when the nominal interest rate is smaller than the inflation rate, the real interest
rate becomes negative. (1 mark)
Structured Questions.
a. i. Point X is on the upswing of the business cycle, i.e., in the recovery phase. (1 mark)
ii. The growth rate of real GDP increases.
The private consumption expenditure increases.
(Accept other reasonable answers. ONE mark each.)
b. i. Actual real interest rate = Nominal interest rate Actual inflation rate (1 mark)
2% = 6% Actual inflation rate
Actual inflation rate = 6% 2% = 4%. (1 mark)

16
b. ii. (1) The household with an outstanding home mortgage loan is a provider of fixed
future payments. (1 mark)
Since the actual inflation rate of 4% is smaller than the expected inflation rate of 5%,
the actual real interest rate paid by households is larger than expected. (1 mark)
Hence, the household loses. (1 mark)
(2) The firm which has signed a contract to supply packed lunches to a school at a fixed
price is a recipient of fixed future payments. (1 mark)
Since the actual inflation rate of 4% is smaller than the expected inflation rate of 5%,
the actual real value of fixed future receipts are larger than expected. (1 mark)
Hence the firm gains. (1 mark)
b. iii.
Private consumption expenditure: During inflation, people expect the prices of

consumer goods to rise continuously. To save money, people tend to purchase
consumer goods earlier. Hence, private consumption expenditure rises. (2 marks)
Investment expenditure: During inflation, firms expect the prices of raw materials
and their products to rise persistently in future. Hence, firms tend to buy their raw
materials earlier to save production costs. On the other hand, firms tend to sell their
products later to increase their sales revenue. Since firms spend more money on
hoarding, less money is available for production and investment. Thus, investment
expenditure falls. (2 marks)
Volumes of exports and imports: During inflation, prices of domestic products rise
relative to those of foreign products. Domestic products become less competitive.
Thus, the volumes of exports drop while the volumes of imports rise. (2 marks)
c.
i.
Unemployment rate =
Unemployed persons
Labour force
100% (1 mark)
It is given that the number of unemployed persons increases as the unemployment

rate drops. This happens only if the percentage rise in the number of unemployed
persons is smaller than the percentage rise in the labour force. (2 marks)
c.
ii.
Costs of unemployment
The living standard of the unemployed and their families drops.
The unemployed may lose their sense of self-esteem or even commit suicide.
Other family problems such as family disputes and marriage breakdowns may also
occur.

17
The knowledge, skills and experience of the unemployed will be lost or become
outdated.
The government may face a huge financial burden due to a drop in revenue from
lower income taxes and a rise in expenditure on higher unemployment benefits.
The aggregate output of the economy drops.
Social problems may appear, e.g., increases in the crime rate and political
instability.
(Any TWO of the above. Accept other reasonable answers. ONE mark each.)
Activities
p.98
1.
Students may list the costs of unemployment and inflation. Then students may argue which
may cause more harmful effects to households, the government and society. Since different
people may have different value judgements, there is no definite answer on whether
unemployment or inflation causes harmful effects.
2.
a. According to estimates by the World Factbook, CIA in April 2010, the three territories with
the highest inflation rates were the Seychelles (), Afghanistan (), and
Venezuela (). In contrast, the three territories with the lowest inflation rates were
Qatar (), San Marino () and Ireland.
3.
a. According to estimates by the World Factbook, CIA in April 2010, the three territories
with the highest unemployment rates were Zimbabwe (), Nauru (), and
Liberia (). In contrast, the three territories with the lowest unemployment rates
were Monaco (), Qatar, and Guernsey ().
4.
Major types of unemployment
Frictional unemployment
Structural unemployment
Cyclical unemployment
Seasonal unemployment
Possible causes of unemployment
The presence of information costs

18
Structural change of an economy

Poor macroeconomic environment
Seasonal effects may have a strong effect on a particular industry, e.g., demand for farmers
drop in winter.

19

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NSS Exploring Economics 5

NSS Exploring Economics 5

Pearson Education Asia Limited 2010

Nominal wages ($)

NSS Exploring Economics 5

Pearson Education Asia Limited 2010

NSS Exploring Economics 5

Pearson Education Asia Limited 2010

Source: Census and Statistics Department

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1 + Expected inflation rate

NSS Exploring Economics 5

Pearson Education Asia Limited 2010

C. Isabella, who hires an Indonesian maid

According to the data above, which of the following statements is correct?

NSS Exploring Economics 5

Pearson Education Asia Limited 2010

NSS Exploring Economics 5

Pearson Education Asia Limited 2010

d. Number of employed persons

a. i. Identify which phase of a business cycle Point X is in.

NSS Exploring Economics 5

Pearson Education Asia Limited 2010

NSS Exploring Economics 5

Pearson Education Asia Limited 2010

CCPI in 2003 CCPI in 2002 100%

The year-on-year percentage change in the general price level in 2007

NSS Exploring Economics 5

Pearson Education Asia Limited 2010

Nominal wages in 2009

Nominal wages in 2010 Price index in the base year

Therefore, the real wages have increased from $9,523.8 to $9,818.2.

NSS Exploring Economics 5

Pearson Education Asia Limited 2010

Cake shops and

Cake shops provide cake (instead of

Holders (cake shops) gain, if

NSS Exploring Economics 5

Pearson Education Asia Limited 2010

Nominal GDP < Real GDP

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Labour force Employed persons

80,000 100% = 11.43%

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NSS Exploring Economics 5

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NSS Exploring Economics 5

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Private consumption expenditure: During inflation, people expect the prices of

It is given that the number of unemployed persons increases as the unemployment

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NSS Exploring Economics 5

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Structural change of an economy

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