Question 9

Suppose that a fall in consumer spending causes a recession.

a. Illustrate the changes in the economy using both an aggregate supply/aggregate demand diagram and a Phillips curve diagram. What happens to inflation and unemployment in the short run? (5%)

b. Now suppose that over time, expected inflation changes in the same direction that actual inflation changes. What happens to the position of the short-run Phillips curve? After the recession is over, does the economy face a better or worse set of inflation- unemployment combinations? (5%)

Q10

Suppose the quality of Hong Kong products relative to foreign products deteriorates. a. Explain how the quality deterioration of Hong Kong products affects Hong Kong's exports at any given exchange rate. (3%)

b. Explain how the quality deterioration of Hong Kong products affects Hong Kong's real exchange rate and trade balance. (5%)

c. Is it possible that the quality deterioration of Hong Kong products increases Hong Kong's trade deficit? (2%)