Secondary 5 Second Term Examination – Paper 1

(Suggested answers) (2018/19)

1. B 6. C 11. A 16. B 21. A 26. D 31. C 36. D 41. D

2. C 7. C 12. D 17. B 22. B 27. A 32. B 37. C 42. C
3. B 8. A 13. C 18. C 23. C 28. A 33. A 38. B 43. B
4. C 9. A 14. D 19. A 24. B 29. D 34. C 39. B 44. D
5. D 10. B 15. B 20. A 25. B 30. C 35. A 40. A 45. A

1. Answer: B
• Item (1): Actual changes in total amount of deposits = Changes in initial deposits × Actual
banking multiplier
$120 000 = $30 000 × Actual banking multiplier
Actual banking multiplier = 4
• Item (2): $120 000 is just the actual increase in bank deposits. It can be smaller or equal to
the largest possible increase. Therefore, we can calculate actual banking multiplier only but
not maximum banking multiplier and legal reserve ratio.
• Item (3): △ Money supply = △ Cash held by non-bank public + △ Deposits
The cash held by non-bank public remains unchanged and the actual increase in deposits is
$120 000. Therefore, the actual increase in money supply is $120 000. However, since the
maximum possible increase in deposits is not known, the maximum possible increase in
money supply is uncertain.
• Item (4): △ Monetary base = △ Cash held by non-bank public + △ Actual reserves of banks
= $0 + $30 000
= $30 000
2. Answer: C
• After deposit creation, the balance sheet will be:

Assets ($) Liabilities ($)

Reserves 3 000 Deposits 12 000

(= 3 000 × 1 ÷ 25%)

Loans 9 000
(= 12 000 – 3 000)

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• Option A: The reserves held by banks will remain at $3 000.
• Option B: The maximum banking multiplier will remain at 4 (= 1 ÷ 25%).

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 • Option C: △ Money supply = △ Cash held by non-bank public + △ Deposits
= $0 + $(12 000 – 8 000)
= $4 000
Monetary base = Cash held by non-bank public + Actual reserves of banks. Since cash held
by non-bank public and actual reserves of banks remain unchanged, monetary base remains
unchanged.
• Option D: The maximum possible increase in loans is $4 000 (= $9 000 – $5 000). The
maximum possible increase in deposits is $4 000 (=$12 000 – $8 000). Therefore, they are
the same.
3. Answer: B
• New legal reserve ratio is 10% (= 25%  15%). After deposit creation, the balance sheet
will become:

Assets ($) Liabilities ($)

Reserves 4 000 Deposits 40 000

(= 4 000 × 1 ÷ 10%)

Loans 36 000
(= 40 000 – 4 000)

• Option A: The reserves held by banks will remain at $4 000.

• Option B: Old actual banking multiplier = $12 000 ÷ $4 000 = 3. New actual banking
multiplier = $40 000 ÷ $4 000 = 10. Therefore, actual banking multiplier increases.
• Option C: Money supply = Cash held by non-bank public + Deposits = $0 + $40 000
= $40 000
Monetary base = Cash held by non-bank public + Actual reserves of banks. Since the cash
held by non-bank public and bank reserves remain unchanged, monetary base remains
unchanged.
• Option D: The maximum possible increase in loans = $36 000 – $8 000 = $28 000. The
maximum possible increase in deposits = $40 000 – $12 000 = $28 000. Therefore, they are
the same.
4. Answer: C
• Legal reserve ratio is 25% [= $(4 000 – 1 500) ÷ 10 000 × 100%].
• Item (1): New total amount of deposits is $12 000 [= $(4 000 – 1 000) ÷ 25%]. Total amount
of deposits increases by $2 000 (= $12 000 ‒ $10 000).
• Item (2): New total amount of loans is $9 000 [= $12 000 – $(4 000 – 1 000)]. Total amount
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 of loans increases by $3 000 (= $9 000 ‒ $6 000).
• Item (3): Cash held by the public increases by $800 (= $1 000 – $200) and bank deposits
increase by $2 000. Therefore, money supply increases by $2 800.
• Item (4): Cash held by the public increases by $800 (= $1 000 – $200) and banks’ actual
reserves decrease by $1 000. Therefore, monetary base decreases by $200.

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5. Answer: D
• Legal reserve ratio = (700 + 500) ÷ 6 000 × 100% = 20%
• Item (1): Maximum possible amount of deposits = $700 million ÷ 20% = $3 500 million.
Maximum possible amount of loans = $3 500 million – $700 million = $2 800 million.
• Item (2): Maximum possible amount of deposits = $(700 + 500) million ÷ 20% = $6 000
million. Money supply = Cash held by the public + Bank deposits = $(0 + 6 000) million =
$6 000 million.
• Item (3): Monetary base = Cash held by the public + Banks’ actual reserves = $[0 + (700 +
500)] million = $1 200 million.
6. Answer: C
• Banks’ actual reserves × Actual banking multiplier = Deposits
Banks’ actual reserves × 5 = $100 billion
Banks’ actual reserves = $200 billion
• Option A: Money supply = Cash held by the public + Deposits
$130 billion = Cash held by the public + $100 billion
Cash held by the public = $30 billion
• Option B: Actual banking multiplier can be smaller than or equal to maximum banking
multiplier. Therefore, we cannot calculate maximum banking multiplier and legal reserve
ratio.
• Option C: Monetary base = Cash held by the public + Banks’ actual reserves = $30 billion +
$20 billion = $50 billion
• Option D: Loans = Deposits – Banks’ actual reserves = $100 billion – $20 billion = $80
billion
7. Answer: C
• Item (1): After withdrawal, the amount is remitted overseas. The amount of cash held by the
public remains unchanged and banks’ actual reserves decrease. Therefore, monetary base
will decrease.
• Item (2): After withdrawal, the amount is remitted overseas. The amount of cash held by the
public remains unchanged and deposits decrease. Therefore, money supply will decrease.
• Item (3): Maximum banking multiplier = 1 ÷ Legal reserve ratio. Since legal reserve ratio
remains unchanged, maximum banking multiplier will remain unchanged.
• Item (4): Maximum possible amount of deposits = Banks’ actual reserves ÷ Legal reserve
ratio. Since the banking system’s actual reserves decrease, maximum possible amount of
deposits will decrease.

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8. Answer: A
• Option A: This increases transaction demand for money and total money demand and leads
to rightward shift of money demand curve.
• Option B: This leads to changes along the money demand curve and the money demand
curve will not shift.
• Option C: This decreases transaction demand for money and total money demand and leads
to leftward shift of money demand curve.
• Option D: This increases money supply and leads to rightward shift of money supply curve.
However, money demand curve will not shift.
9. Answer: A
• When residents’ real income increases, transaction demand for money and hence total
money demand increases. Money demand curve shifts rightwards.
• When the government raises the legal reserve ratio, money supply decreases and money
supply curve shifts leftwards.
10. Answer: B
• Transaction demand for money and total money demand increase. Therefore, interest rate
increases. When the following incidents cause interest rate to fall, it can offset the effect of
the above incident on interest rate.
• Item (1): Selling government bonds in the open market will increase money supply and
interest rate decreases.
• Item (2): Raising discount rate will reduce money supply and interest rate increases.
• Item (3): Lowering legal reserve ratio will increase money supply and interest rate
decreases.
11. Answer: A
• When asset demand for money increases, total money demand and interest rate increase.
Private consumption, investment expenditure and aggregate demand therefore decrease.
When the following incidents cause aggregate demand to increase, it can offset the effect of
the above incidents on aggregate demand.
• Option A: The appearance of economic recovery of the trading partners will increase the net
exports of the economy. Aggregate demand therefore increases.
• Option B: Selling government bonds in the open market will decrease money supply and
interest rate increases. Private consumption, investment expenditure and aggregate demand
therefore decrease.
• Option C: Increasing the salaries tax rate will decrease disposable income. Therefore,
private consumption and aggregate demand decrease.

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• Option D: Increasing the production subsidy for firms will increase short run aggregate
supply. However, aggregate demand remains unchanged.

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12. Answer: D
• When investors are optimistic about the financial market, they will hold more shares and
bonds, leading to a decrease in asset demand for money and hence money demand
decreases. Nominal interest rate therefore decreases. Private consumption and investment
expenditure increase and hence aggregate demand increases. Therefore, real output
increases. If the following incidents can decrease actual output, this can offset the effect of
the above incidents on real output.
• Option (1): When the government increases welfare transfer, disposable income increases.
Private consumption expenditure increases. Aggregate demand and real output increases.
• Option (2): When the government reduces personal tax allowance, disposable income
decreases. Private consumption expenditure decreases. Aggregate demand and real output
decreases.
• Option (3): When the central bank issues more banknotes, money supply increases and
interest rate decreases. Private consumption expenditure and investment expenditure
increase. Aggregate demand and real output increases.
• Option (4): When people’s preference towards liquidity of assets increases, asset demand
for money increases and total money demand increases. Interest rate increases. Private
consumption expenditure and investment expenditure decrease. Aggregate demand and real
output decreases.
13. Answer: C
• When more and more companies change from paying salary monthly to weekly, this will
decrease in transaction demand for money and hence total money demand decreases.
Nominal interest rate therefore decreases. Private consumption and investment expenditure
increase and hence aggregate demand increases. Therefore, price level increases. If the
following incidents can decrease price level, this can offset the effect of the above incidents
on price level.
• Option A: When local currency depreciates, exports increase and imports decrease.
Aggregate demand increase. Therefore, price level increases.
• Option B: When firms expect price level to increase, short run aggregate supply decreases
and price level therefore increases.
• Option C: When the trading partners of the country have economic recession, the exports of
the country decrease and aggregate demand decreases. Therefore, price level decreases.
• Option D: When the central bank lowers the discount rate, money supply increases and
interest rate decreases. Private consumption and investment expenditure increase. Aggregate
demand increase and price level therefore increases.
14. Answer: D

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• Opportunity cost of holding cash = Nominal interest rate = 8%
• Actual real rate of return of holding cash = Nominal rate of return of holding cash – Actual
inflation rate = 0 – (-7%) = 7%
• Expected real interest rate = Nominal interest rate – Expected inflation rate = 8% – (-5%) =
13%

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15. Answer: B
• Cost of holding cash = Nominal interest rate = Expected real interest rate + Expected
inflation rate = 8% + 5% = 13%
• Actual real interest rate = Nominal interest rate – Actual inflation rate = 13% – 7% = 6%
16. Answer: B
• Options A and C: Nominal interest rate = Expected real interest rate + Expected inflation
rate. When expected inflation rate = 0, nominal interest rate = expected real interest rate.
Therefore, only when expected inflation rate = 0, will the cost of holding cash be expected
real interest rate.
• Option B: If people hold cash but not invest in bonds, they need to give up the interest
earned from investing in bonds. Therefore, nominal interest rate is the opportunity cost of
holding cash.
• Option D: No matter whether inflation rate is accurately predicted, nominal interest rate is
the opportunity cost of holding cash.
17. Answer: B
• The growth rate of CPI is smaller than zero, implying that actual inflation rate is smaller
than zero.
• Item (1): Nominal interest rate = Expected real interest rate + Expected inflation rate. Since
we do not know whether expected inflation rate is smaller than 0, it is not sure whether
nominal interest rate will be lower than expected real interest rate.
• Item (2): Nominal interest rate = Actual real interest rate + Actual inflation rate. Since
actual inflation rate < 0, nominal interest rate < actual real interest rate.
• Item (3)：Actual real rate of return of holding cash = Nominal rate of return of holding cash
– Actual inflation rate = 0 – Actual inflation rate. Since actual inflation rate < 0, actual real
rate of return of holding cash > 0.
18. Answer: C
• Item (1)：General sales tax is an indirect tax but Hong Kong does not levy such tax.
• Item (3)：This is Hong Kong’s direct tax.
19. Answer: A
• Option A: Since the tax rate increases with an increase in taxable income, it is a progressive
tax. This causes income distribution to become more even. The Lorenz curve will be closer
to the line of perfect equality.
• Options B, C and D: Since the tax rate decreases with an increase in taxable income, it is a
regressive tax. This causes income distribution to become less even. The Lorenz curve will
be further away from the line of perfect equality.

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20. Answer: A
• Item (1): During economic recovery, income increases. The annual income of some low-
income people did not exceed the basic allowance in the past. However, their income will
exceed such basic allowance after a pay rise and they need to pay salaries tax now. The
number of taxpayers increases.

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 • Item (2): During economic recovery, GDP will increase. Workers’ income and firms’ profits
will increase. Direct tax (income tax and profits tax) revenue will increase. On the other
hand, during economic recovery, consumption and transaction of shares increase. Indirect
tax (sales tax and stamp duty) revenue will increase. When the percentage increase in direct
tax revenue is larger than the percentage increase in indirect tax revenue, the ratio of direct
tax revenue to indirect tax revenue will increase.
• Item (3): Since we do not know whether the government’s revenue is higher than its
expenditure, it is uncertain whether the government will have fiscal surplus.
21. Answer: A
• Items (1) and (2): When income increases, the annual income of some low-income people
whose income did not excess the basic allowance in the past now exceeds such basic
allowance after a pay rise and they need to pay salaries tax. The number of taxpayers
increases. Moreover, the income of some taxpayers is needed to be taxed a higher marginal
tax rate. Therefore, the salaries tax revenue of the government will increase by more than
10%.
• Item (3): The tax band is not affected.
22. Answer: B
• Item (1): Since tax rate decreases, disposable income increases. Private consumption and
aggregate demand increase. Actual output increases. This will increase employment
opportunities and employed population.
• Item (2): When salaries tax rate decreases, this will increase working incentive. People’s
income and the government’s salaries tax revenue increase. Moreover, when salaries tax rate
decreases, the government’s salaries tax revenue decreases. Only when the increase in
salaries tax revenue (caused by higher working incentive) is larger than the decrease in
salaries tax revenue (caused by a decrease in salaries tax rate), will salaries tax revenue
increase.
• Item (3): The progressivity of the new tax system is lower and income distribution becomes
less even. Therefore, Gini coefficient (calculated in income after tax) will increase.
23. Answer: C
• Option A: In 2019, the percentage decrease in nominal government expenditure is larger
than the percentage decrease in nominal GDP. Therefore, the ratio of nominal government
expenditure to nominal GDP decreased.
• Option B: In 2019, since the year-on-year percentage change in nominal GDP was negative,
nominal GDP decreased. Moreover, since the year-on-year percentage change in nominal
government expenditure was negative, nominal government expenditure decreased.
• Option C: The scale of public sector is reflected as the ratio of government expenditure to

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 nominal GDP. In 2019, the percentage decrease in nominal government expenditure was
lower than the percentage decrease in nominal GDP, the ratio of government expenditure to
nominal GDP increased. This implies that the scale of public sector increased.
• Option D: Since we do not know whether the government’s revenue is higher than the
government’s expenditure, it is uncertain whether the government will have fiscal surplus.

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24. Answer: B
• Item (1): Since the percentage change in direct tax revenue was larger than 0, it implies that
direct tax revenue increased. The percentage change in nominal GDP is larger than 0,
implying that nominal GDP increased.
• Items (2) and (3): From 2015 to 2019, since the percentage increase in direct tax revenue
was higher than the percentage increase in nominal GDP, the ratio of direct tax revenue to
nominal GDP increased.
25. Answer: B
• A change in the equilibrium point from point A to point B is caused by a decrease in
aggregate demand.
• Option A: The central bank lowering the discount rate will cause money supply to increase.
Interest rate decreases. Private consumption expenditure and investment expenditure
increase and hence aggregate demand increases.
• Option B: An increase in interest rate decreases private consumption expenditure and
investment expenditure. Aggregate demand decreases.
• Option C: The government providing cash consumption subsidy for residents will increase
disposable income. Private consumption expenditure and hence aggregate demand increase.
• Option D: The government providing production subsidy to firms will cause production cost
to decrease. Short run aggregate supply increases and aggregate demand remains
unchanged.
26. Answer: D
• Since transfer payment does not involve production, it is not included in government
consumption expenditure.
• When transfer payment decreases, disposable income decreases. Private consumption
expenditure and aggregate demand decrease. Aggregate demand curve shifts leftwards.
27. Answer: A
• Option A: When there is a strike in the economy, short run aggregate supply decreases. Real
output decreases and inflationary gap narrows. Moreover, when real output decreases,
imports decrease and trade deficit decreases.
• Option B: When there is an improvement in the production technique of the economy, short
run aggregate supply increases. Real output increases and inflationary gap widens.
Moreover, when real output increases, imports increase and trade deficit increases.
• Option C: When households expect the performance of the economy in the future to be
better, they expect their income to increase. Private consumption and aggregate demand
increase. Real output increases and inflationary gap widens. Moreover, when real output
increases, imports increase and trade deficit increases.

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• Option D: When the central bank buys government bonds, money supply increases and
interest rate decreases. Private consumption and investment expenditure increase. Aggregate
demand and real output increase, and inflationary gap widens. Moreover, when real output
increases, imports increase and trade deficit increases.

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28. Answer: A
• When the government of Country A cancels the talent importation scheme, the number and
productivity of workers in Country A decrease. Short run aggregate supply and long run
aggregate supply decreases. Therefore, short run aggregate supply curve and long run
aggregate supply curve shift leftwards.
• When other countries ban the imports of goods from Country A, exports of Country A
decrease and aggregate demand decreases. Aggregate demand curve shifts leftwards.
29. Answer: D
• When asset price increases, wealth increases. Private consumption and aggregate demand
increase. Real output increases and hence becomes further away from potential output.
Inflationary gap widens.
• When income increases, income tax revenue increases. The government’s revenue will be
larger than its expenditure. The economy will therefore have fiscal surplus.
30. Answer: C
• When oil price decreases, production cost decreases and the short run aggregate supply
increases. The short run aggregate supply curve will shift rightwards from SRAS 1 to SRAS2.
The short run equilibrium will be at point D and there will be an inflationary gap in the
short run.
• In the long run, input price increases and the short run aggregate supply decreases. The
short run aggregate supply curve will shift leftwards from SRAS3 to SRAS1, until real
output decreases to potential output level. Therefore, long run equilibrium is at point A.
31. Answer: C
• Option A: Implementing a contractionary monetary policy will reduce money supply,
leading to an increase in interest rate. Private consumption and investment expenditure
decrease and aggregate demand decreases. Price level and real output decrease.
Unemployment level increases.
• Option B: Lowering the unit subsidy on firms’ production will reduce production cost. The
short run aggregate supply increases. Price level decreases and real output increases.
Unemployment level increases.
• Option C: Cancelling all the production subsidy for all resident producing units will
increase production cost. The short run aggregate supply decreases. Price level increases
and real output decreases. Unemployment level increases.
• Option D: Increasing the allowance under the salaries tax system will increase disposable
income. Private consumption and aggregate demand inicreases. Price level and real output
increase. Unemployment level decreases.
32. Answer: B

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• When people’s incentive to consume increases, private consumption and aggregate demand
increase. Real output increases. The gap between potential output and real output will
decrease. Inflationary gap therefore narrows.
• Since an increase in real output will cause an increase in the government’s tax revenue, its
fiscal balance increases. However, it is uncertain whether the government’s revenue will be
larger than its expenditure. There may not be fiscal surplus.

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 • Since real income increases, imports increase and balance of trade decreases. However, it is
uncertain whether imports will be larger than exports. There may not be trade deficit.
33. Answer: A
• Item (1): When interest rate increases, private consumption and investment decrease.
Aggregate demand decreases and real output decreases. The government’s tax revenue
decreases, leading to fiscal deficit. Moreover, when real output decreases, imports decrease.
Trade surplus will appear.
• Item (2): When the market is pessimistic about investment environment, investment
decreases. Aggregate demand and real output decreases. The government’s tax revenue
decreases, leading to fiscal deficit. Moreover, when real output decreases, imports decrease.
Trade surplus will appear.
• Item (3): When the market is optimistic about the financial market, people hold more shares
and bonds, leading to decreases in asset demand for money and total money demand.
Interest rate therefore decreases. Private consumption expenditure and investment
expenditure increase. and aggregate demand increases. Therefore, real output increases. The
government’s tax revenue increases and hence fiscal surplus appears. Moreover, when real
output increases, imports increase and hence trade deficit appears.
34. Answer: C
• When the HKSAR government increases its investment in innovation and technology,
investment expenditure will increase. Aggregate demand therefore increases. At the same
time, an increase in investment in innovation and technology will increase productivity.
Potential output will increase. Therefore, long run aggregate supply increases. As a result,
real output increases.
• Whether the price level will increase, decrease or remain unchanged depends on extents of
rightward shift of aggregate demand curve and long run aggregate supply curve.
35. Answer: A
• Option A: When the central bank increases the discount rate, money supply decreases and
interest rate increases. Private consumption and investment decrease. Aggregate demand
decreases. Moreover, when the firms of the country expect price level to increase, short run
aggregate supply decreases. As a result, short run real output must decrease.
• Option B: Increasing production subsidy will reduce production cost. Short run aggregate
supply increases. Moreover, when the central bank sells government bonds, money supply
decreases and interest rate increases. Private consumption and investment decrease and
aggregate demand decreases. As a result, the change in real output is uncertain, depending
on the extent of increase in short run aggregate supply and the extent of decrease in
aggregate demand.
• Option C: When the price of raw materials increases, production cost increases and the short
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run aggregate supply decreases. Moreover, an increase in transfer payment will increase
disposable income. Private consumption and aggregate demand increase. As a result, the
change in real output is uncertain, depending on the extent of decrease in short run
aggregate supply and the extent of increase in aggregate demand.

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 • Option D: When the trading partners of the country have economic recession, the exports of
the country decrease and aggregate demand decreases. Moreover, reducing legal reserve
ratio will increase money supply and interest rate decreases. Private consumption and
investment increase. Aggregate demand increases. As a result, the change in real output is
uncertain, depending on the extent of decrease in aggregate demand (caused by a decrease
in exports) and the extent of increase in aggregate demand (caused by increases in private
consumption and investment).
36. Answer: D
• If investors are optimistic about investment environment, investment expenditure and
aggregate demand will increase. In the short run, price level and real output level increase.
• In the short run, since real output level is higher than full employment output, an
inflationary gap appears. Since there is excess demand in the factor market, input price
increases. The short run aggregate supply will decrease and price level will increase until
real output decreases to full employment output level.
37. Answer: C
Price level (P)
LRAS

SRAS2
E1
P1

E2
P2
AD1

AD2
0 Output
Y2 Y1 YF

• Item (1): Potential national income remains unchanged at YF.

• Item (2): Real national income decreases from Y1 to Y2.
• Item (3): Since price level and real national income decrease, nominal national income will
decrease.
38. Answer: B
• Items (1) and (2): These two policies do not affect money supply. Therefore, they are not
monetary policies.
• Items (3) and (4): These two policies increase money supply, causing the interest rate to
decrease. Private consumption expenditure and investment expenditure increase. Aggregate
demand and real output increase. Therefore, they have expansionary effect on the economy.

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39. Answer: B
• An expansionary monetary policy increases money supply and interest rate decreases.
Private consumption and investment increase. Aggregate demand increases and price level
therefore increase. When the following incidents cause price level to decrease, it can offset
the effect of an expansionary monetary policy on price level.

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 • Item (1): When the government increases the production subsidy to firms, production cost
decreases. Short run aggregate supply increases and price level decreases.
• Item (2): When the government increases the living subsidy to low-income people,
disposable income increases. Private consumption and aggregate demand increase. Price
level increases.
• Item (3): When oil price decreases, production cost decreases. Short run aggregate supply
increases and price level decreases.
40. Answer: A

• %△M = (1 100 － 1 000) 1 000 × 100% = 10%

• %△P = (75 － 50) 50 × 100% = 50%

• MV = PY, where M is quantity of money, V is velocity of circulation of money, P is the

general price level and Y is real output. Assume that V remains unchanged.
• In the short run, %△M = %△ Nominal output ≈ %△P + %△Y. Since %△M < %△P, this
implies that %△Y < 0, i.e. real national income decreases.
41. Answer: D
• MV = PY where M is quantity of money, V is velocity of circulation of money, P is the
general price level and Y is real output. Assume that V remains unchanged in the long run.
• %△M = %△ Nominal output = %△P
• Option A: %△M = %△P. Since money supply increases, price level increases.
• Option B: %△M = %△ Nominal output. Since the annual percentage increase in money
supply decreases, nominal output increases in the same percentage. Therefore, growth rate
of nominal output is positive and decreases continuously.
• Options C and D: %M = %P. Since the annual percentage increase in money supply
decreases, price level increases in the same percentage. Therefore, growth rate of price level
(inflation rate) is positive and decreases continuously.
42. Answer: C
• MV = PY, where M is quantity of money, V is velocity of circulation of money, P is the
general price level and Y is real output. Assume that V remains unchanged.
• %△M = %△ Nominal output ≈ %△P + %△Y
• Since %△M > %△Y, %△P > 0 and P increases.
• Since %△M = %△ Nominal output and %△M > %△Y, %△ Nominal output > %△Y.
43. Answer: B
• According to the short run quantity theory of money, MV = PY, where M is quantity of

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 money, V is velocity of circulation of money, P is the general price level and Y is real
output. Assume that V remains unchanged.
• Item (1): %△M ≈ %△P + %△Y, i.e. %△P ≈ %△M – %△Y. If the percentage decrease in Y >
Percentage decrease in M, even though M decreases, P may still increase.
• Item (2): When money supply decreases, potential output will not change.
• Item (3): %△M ≈ %△P + %△Y. If %△P is not 0, %△M will not equal %△Y. Therefore, the
decrease in money supply will not cause real output to decrease at the same percentage.
• Item (4): %△M = %△ Nominal output. When money supply decreases, nominal output will
decrease at the same percentage.

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44. Answer: D
• According to the long run quantity theory of money, MV = PY, where M is quantity of
money, V is velocity of circulation of money, P is the general price level and Y is real
output. Assume that V and Y remain unchanged.
• %△M = %△ Nominal output = %△P
• Option A: When money supply decreases, price level must decrease.
• Options B and C: The long run quantity theory of money assumes full employment and
potential output and real output remain unchanged.
• Option D: When money supply decreases, nominal output decreases at the same percentage.
45. Answer: A
• According to the short run quantity theory of money, MV = PY, where M is quantity of
money, V is velocity of circulation of money, P is the general price level and Y is real
output. Assume that V remains unchanged.
• Item (1): %△M = %△ Nominal output. When M decreases, nominal output will also
decrease.
• Item (2): %△M ≈ %△P + %△Y. When the percentage decrease in M > the percentage
decrease in P, %△Y < 0. Therefore, Y decreases.
• Item (3): V is assumed to be unchanged.

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