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CONTENT

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CONTENT .................................................................................. 1 Ch.1 Basic Economic Concepts .................................................. 3 Ch. 2 Basic economic problems ............................................... 10 Ch. 3 Ownership of Firms ........................................................ 12 Ch. 4 Production & Division of Labour ................................... 18 Ch. 5 Factors of Production ...................................................... 22 Ch. 6 Production & costs in the Short Run and Long Run ....... 30 Ch. 7 Objectives and expansion of firms .................................. 39 Ch. 8 Determination of Market Price ....................................... 43 Ch. 9 Change in Market Price ................................................... 46 Ch. 10 Price Elasticity .............................................................. 49 Ch. 11 Market intervention ....................................................... 53 Ch.12 Market Structure ............................................................ 69 Ch.13 Efficiency, equity and role of government ..................... 73 Ch.13 Efficiency, Equity & Role of Government (I) – Government intervention .......................................................... 75 Ch.13 Efficiency, Equity & Role of Government (I) – Externalities .............................................................................. 78 Ch. 14 Efficiency, Equity & Role of Government (II) ............. 88 Ch. 15 - 16 National Income accounting ................................ 101 Ch.17 Aggregate Demand & aggregate supply ...................... 124



Ch. 18 Determination of Output and Prices ............................ 133 Ch.21 Business cycle, changes in general price level and unemployment ........................................................................ 171 Ch.22 Fiscal Policy & Monetary Policy ................................. 178 Ch.23 Absolute and Comparative Advantage ........................ 196 Ch.24 Trade Barriers .............................................................. 206 Ch.25 Balance of Payments & Exchange rate ........................ 215 Ch.26 Monopoly Pricing ........................................................ 224 Ch.27 Anti-competitive Behaviors ......................................... 229



Ch.1 Basic Economic Concepts

☆Overview

☆Scarcity

= resources available are not enough to satisfy all people’s

wants

☆Opportunity cost

= Highest valued option forgone

= Money cost + non-money cost (e.g. time cost)

☆Sunk cost

= Cost which has been incurred, cannot be recovered

☆Interest

- To borrowers: Cost of earlier availability of resources

(positive time preference)

choice

discrimination

scarcity

Limited resources Limited resources

competition opportunity cost



- To lenders: compensation for deferred consumption

*Also exists in barter economy (not necessarily calculated in

money)

☆Free/Economic goods

Free goods Economic goods

Sufficient to satisfy all human

wants

not enough to satisfy all human

wants

People do not prefer more of it People prefer more of it

No cost involved in production

Cost involved in production.

* Free-of-charge goods ≠ free goods

• e.g. free newspaper

① People want more of it

② Not enough to satisfy all human wants

(scarce production resources without any use)

③ Cost involved on production (e.g. printing)

• Free goods = Free of charge (MUST)

9 No one needs to incur a cost

☆Specialization & Exchange

* Specialization



= increase output of an economy

= person only produces the good at a lower opportunity cost

*Exchange

= Necessary condition for specialization

⸪ Without possibility to exchange, you have to produce

everything by yourself.

☆Circular Flow Model

Factor market Product market

real flow

money flow

☆Positive vs normative statements

Positive Normative

① What is /was /will be

② No value judgement

③ Can be tested with evidence

① What should be

② With value judgement

③ Cannot be tested (irrefutable)



☆ Ch.1 Questions Remarks

�Scarcity implies

(1) limited resources

(2) people need to make choices

(3) unlimited wants

Soln: Only (1) and (2) are correct. Scarcity can still exist when

wants are limited, as long as resources available cannot

satisfy all human wants.

�(a) Explain how an increase in traffic congestion in the Cross

Harbour Tunnel would effect the opportunity cost to its

users of crossing the harbour.

(b) Explain whether the opportunity cost of crossing the

harbour would definitely be the same to every tunnel user.

Soln: (a) -Opportunity cost increases.

-They have to spend more time in crossing the tunnel

which has alternative uses. The value of highest-valued

option forgone increases.

(b) -No.

-Different users have different highest-valued

alternative use of time.



�David wants to spend $8 to buy a pack of sandwiches or a

bowl of noodle. Explain the sandwiches if a cockroach is found

inside the noodle soup.

Soln: - The opportunity cost of buying sandwiches is noodles.

- Opportunity cost decreases (value of the noodle with a

cockroach decreases)

☆The existence of scarcity implies that

A. there is no such thing as free goods

B. human wants are unlimited

C. each and every economic good has a positive money price.

D. there is a cost in obtaining some goods.

Soln: When there is scarcity, there are not enough resources to

satisfy all human wants. They have to make choices and it

involves a cost.

∴The answer is D.

9 A is incorrect because there are both economic goods and

free goods. The existence of scarcity does not imply that

there are no free goods.

☆May invites Mary to have high tea together in the afternoon.

Mary will NOT have opportunity cost if

A. May pays the fee for him.



B. Mary has nothing more worthwhile to do in the afternoon.

C. Mary likes to play tennis with May.

D. None of the above is a correct answer.

Soln: A is incorrect. Mary still has time cost.

B is incorrect. She has ‘nothing more worthwhile to do’

doesn’t mean ‘she has nothing to do’

C is incorrect. She still has time cost /$$ cost.

∴D is the answer.

☆Good X is a ‘free good’ when

A. there is no opportunity cost involved in using it.

B. its quantity supplied is greater than what consumers are

willing to purchase in the market.

C. nobody wants more of it.

D. its supply is so abundant that consumers place no value on it.

Soln: A free good is a good whose quantity is sufficient to

satisfy all human wants, so nobody wants more of it.

∴ The answer is C.

* A is wrong because although there is no O.C. in using the

good, there may be a cost in obtaining it.

☆A department store reduced the price of its television sets but

there was still unsold stock. These television sets are



A. free goods because the quantity supplied is greater than the

quantity demanded.

B. consumer goods because they are sold at a department of

store.

C. Capital goods because they are man-made.

D. economic good because people have to pay a price for

them.

Soln: Economic goods cannot satisfy all wants so people need to

pay a price to get it.

*C is wrong. Capital ≠ capital goods.

☆In a one-man economy, which of the following may exist?

(1) free good

(2) market price

(3) competition

(4) discrimination

Soln: -Only free good may exist.

9 satisfy all the wants of the person.

-no exchange

∴No Market price

-no other people

9 no competition / discrimination



Ch. 3 Ownership of Firms

☆Limited Company

��

① Legal entity:

- Can sue / can be sued

- Can buy properties / sign contracts

- Owner does not have to bear legal responsibilities

②Limited liability: Liability of shareholders is limited to the

amount of investment in the company

③ Lasting continuity

④ Higher Profits tax rate

⑤ Wider source of capital: issuing shares / bonds

⑥ More complicated Set-up procedures

⑦ Separation of ownership / management

Private Public

-owners < 50 -owners: unlimited

-cannot issue shares and bonds

to public

-can issue shares and bonds to

public

-shares have to be transferred

under consent of all

shareholders

-shares can be transferred freely

-need not disclose financial info -need to disclose financial into



regularly

☆Partnership / Sole proprietorship

① Not a legal entity:

- Owners have to bear responsibilities

- Cannot sue / be sued

② Unlimited liability: Liability is not limited to the amount of

investment in the company

③ Lack of continuity

④ Lower profits tax rate

⑤ Simple set-up procedures

⑥ Financial into kept secret

no upper limit of shareholders.

↓

Sole proprietorship Partnership

-bear all risks / responsibility

-more prompt decision-making

-narrower source of capital

-better relationships with

employees

-collective responsibility

-less prompt decision-making

-more sources of capital

-Admission / withdrawal needs

consent of all shareholders

-wider scope of specialization

☆Public Enterprise

*Govt. Departments / public corporations



��

① Higher average production costs

② Easy access to into & data

→ better business decisions

③ Adequate & stable capital

④ Reliable supply of goods at lower price

→not profit - maximizing.

☆Partnership / Sole proprietorship

① Not a legal entity:

● owners have to bear responsibilities

● cannot sue / be sued

② Unlimited liability: Liability is not limited to the amount of

investment in the company

③ Lack of continuity

④ Lower profits tax rate

⑤ Simple set-up procedures

⑥ Financial into kept secret

no upper limit of shareholders.

↓

Sole proprietorship Partnership

-bear all risks / responsibility

-more prompt decision-making

-narrower source of capital

-collective responsibility

-less prompt decision-making

-more sources of capital



-better relationships with

employees

-Admission / withdrawal needs

consent of all shareholders

-wider scope of specialization

☆Public Enterprise

*Govt. Departments / public

(H-E-A-R)

① Adequate & Stable capital

② Easy access to info data

→better business decisions

③ Reliable supply of goods

④ Higher average product

→not profit maximizing.

Advantages of public enterprise

over govt. department:

- better control of employees

- higher incentive to lower

product cost

- more responsive to demand

- profit - motive

- more flexible operation

- more innovative

☆Bonds vs Shares

Firm’s Perspective:

Bonds Shares

Pros ① Not diluting existing

shareholder’s power of

Control

② No risk of being taken

over

① No obligation to pay

dividend

② No fixed redemption

date (no need to buy back

shares)

Cons ① Obligated to pay fixed ① Dilute existing



interest

② Fixed redemption date

(pay face value upon

maturity)

shareholder’s power of

control

② High risk of being taken

over (shares are freely

transferable)

Investors’ Perspective:

Bonds Shares

Pros ① Lower risk: higher

priority in claiming

repayment when the firm

liquidates

② More stable return

(interest rate is fixed

regardless of loss)

① Higher potential return

② Has voting rights (affect

management of firm)

Cons ① No voting rights

② Fixed rate of return

(regardless of profit)

① Higher risk: last in

claiming repayment when

the firm liquidates

② Less stable return

* Priority of claiming repayment upon liquidation:

1) employees

2) debenture holders

3) preference shareholders

4) ordinary shareholders



Ch. 4 Production & Division of Labour

☆Productions vs Consumption

Production = turning inputs into outputs

Consumption = using goods and services to directly satisfy

human wants

☆Types of production

Type Definition Examples

①Primary extracting raw

materials from nature

mining, fishery, farming

②Secondary turning raw

materials, in semi -

finished / finished

products

construction, garment,

manufacturing

③Tertiary providing service transportation, banking,

education



*A firm can engage in more than one production stage

e.g. Bakery

① Secondary: flour → bread

(raw materials à finished product)

② Tertiary: wholesaling service

☆Producer goods vs Consumer goods

Producer Consumer

- used in production process

e.g. TV at karaoke

- used for consumption

- directly satisfy wants

e.g. TV at home

☆Private goods vs Public goods

Private: Public:

① Not concurrent (rival)

→one’s consumption will

reduce its availability to others

① Concurrent (non-rival)

→one’s consumption will not

reduces it availability to others

② Excludable

→can exclude people from

using it

② Non-excludable

→cannot exclude people from

using it

e.g. economics book

an apple

a place to view the moon

e.g. economic theory

lighthouse

a moon



* public goods = too costly to charge

∴ easy to free-ride

*The way to derive the market demand curve is horizontal

summation, while that for public good is not.

☆Types of Division of labour

Type Definition Example

① Simple -specializes in producing a

particular good

-do not depend on each other

teachers &

doctors

② Complex -specialize in a particular

production stage

-interdependent

cook & waiter

③ Regional -a region specializes in

producing a particular good

HK = finance

Thailand = rice

☆Advantages of division of labour

�Q�S-M-S-P-R

① Saves tire in training

② Stimulate Mechanization

③ Saves time in moving around tasks

④ Practice makes perfect



⑤ Right people do the right task

⑥ Efficient use of capital goods (each worker = one set of

capital goods)

⑦ Living standard↑

(output level↑= ↑goods for consumption)

☆Disadvantages of division of labour

�Q�M-O-G-E-L

① Monotony

② Over-interdependence

(one stage disrupts = hinders other stages)

③ Greater risk of unemployment

(only specializes in one skill)

④ Excessive standardization

⑤ Loss of craftmanship

☆Limitations of division of labour

① Nature of product

e.g. painting / poetry

→requires creativity

② Size of market

→small amount of output

→small no. of workers



→X large Scale of division of labour

Ch. 5 Factors of Production

☆Summary

Factor Definition Return

Capital Man-made resources in production Interest

Land Natural resources in production Rent

Labour Human effort used in production Wage

Entrepreneurship Human effort provided by owner

of the firm, including risk bearing

+ decision-making

Profits

☆Capital

* Man-made resources in production

* Return = interest

* Change in capital stock

= Capital formation (production / purchase of capital) - Capital

depreciation (reduction of value due to capital consumption /

obsolescence)

Remarks for Capital Formation:

- It cannot be negative



- It is an investment (sacrificing capital consumption for

more future consumption)

* Net increase in capital stock = capital accumulation (can be

negative)

→ production capacity

→ output level↑

(gives up present consumption for future consumption)

☆Land

* Natural resources in production

* Return = rent

- Emergence of land: no choice à No opportunity cost

(BUT use of land might have opportunity cost!)

Capital Land

man-made resource natural resources

human effort applied no human effort applied

can be artificially increase can increase but cannot be

artificially increased

can be relocated by human

effort

cannot be relocated by human

effort

production involves cost emergence involves no cost

☆Labour



* Human effort used in production

* Return = wage

* Labour supply

- (number of worker) × average working hours) × [man-hour]

(unit!!!)

* Factors affecting labour supply

①Size of labour force

-population size

-legal working age

-age and sex distribution

-years of schooling

②Average working hours

-no. of public holidays

-max. legal working hours

*Labour Productivity

= (output) ÷ (man-hour) [output per man-hour]

①Education and training

②Working conditions

③Incentive to work

(e g. bonuses, job prospect)



④Capital good per worker

⑤Management

(division of labour)

⑥Health of workers

*Wage payment menthod

Producti

vity

Cost of

Supervis

ion

Quality Cost of

quality

control

(to

employe

rs)

Cost of

wage

calculati

on

Time

rate

↓ ↑ ↑ ↓ ↓

Piece

rate

↑ ↓ ↓ ↑ ↑

Basic

salary

plus

commiss

ion

(Maintai

ns a

stable

team of

staff.)

↑ ↓ ↑ ↓

(commis

sion

already

reflects

quality)

↑



profit-

sharing

(employ

er shares

risk with

employe

e.)

↑ ↓ ↑ ↓ ↑

tips ↑ ↓ ↑ ↓ ↓

Risk of income

fluctuation

Reward to better

work

Time-rate ↓ ×

Piece-rate ↑ √

Basic salary plus

commission

depends √

profit sharing ↑ √

tips ↑ √

Payment Method Suitable when

Time rate - Contribution too costly to measure

- High quality is required

Piece rate - Contribution easily measured

- Product quality easy to control

Basic salary plus

commission

- Output easily measured but not

standardized



Profit-sharing - Decisive to firm’s profits

*Factor mobility

①Occupational mobility (The ease with which a factor moves

from one occupation to another.)

-monetary / non-monetary rewards

-skill and education requirements

(requirement↑= harder to enter industry)

-trade union restriction

-availability of retraining programmes

-market information

②Geographical mobility

-transportation network & cost

-economic / political / social condition

-immigration / emigration policies

-market information

☆Entrepreneurship

* Human effort provided by owner of the firm, including risk

bearing + decision-making

* Return = profits

- Labour = stable wage / known in advance

- Entrepreneurship = fluctuating (can be negative)



* Basic salary + commission is better than commission only

→ maintain a team of staff more easily



☆Question Remarks for Ch. 5

� Which of the followings are correct?

(1) The supply of both capital and land can be reduced by

human effort.

(2) There is no cost in producing and using land for production.

(3) Both capital and land can increase the wealth of a society.

(4) Capital formation can be negative.

Soln: (1) and (3) are correct.

(1): Correct. The supply of both capital and land can be reduced

by human effort. For example, the killing of whale and the

demolition of old buildings of humans.

(2): Incorrect. A piece of land has alternative way to be used.

The use of land in one way implies giving up of its use in

another way.

(3): Correct. As factors of production, both capital and land

increase output and help humans accumulate wealth.

(4): Incorrect. Both capital formation and capital consumption

can be either positive or zero. They cannot be negative. Only

capital accumulation can be negative.



☆Question Remarks – Demand & Supply

☆Point out the difference between ‘quantity demanded’ and

‘quantity bought’.

Soln: ‘Quantity demanded’ is the amount that a consumer is

willing and able to buy. It only shows the consumer’s plan and

does not imply what will be actually bought.

‘Quantity bought’ is the actual amount consumers buy at the

ongoing price. It is determined only after the act of purchase.

☆When the tax on commodity X is doubled, its tax revenue is

also doubled. This indicates that

A. The demand for X is perfectly elastic.

B. The demand for X is unitarily elastic.

C. The supply of X is perfectly elastic.

D. The supply of X is perfectly inelastic.

Soln:

When the supply is perfectly inelastic, the supply curve will not

shift upwards. When per-unit tax doubles, tax revenue doubles.



☆People tend to consume less live poultry but more canned

food. As a result, the price of the canned food changed by 50%

and its quantity transacted rose from 1000 cans to 1350 cans per

month we can conclude it had

A. an elastic demand

B. An inelastic demand

C. An elastic supply

D. An inelastic supply

Soln: Demand increases.

∴Must be movement along supply curve.

∴A and B are wrong.

Elasticity of supply

∴The answer is D.

☆ Price Qd Qs

$6 60 40

$9 55 45

$12 50 50

$15 45 55

$18 40 60



(a) If the govt. fixes the production quota at 45 units, the market

price will be

A. $9

B. $12

C. $15

D. $18

(b) If the govt. uses a unit tax instead to fix the output at 45

units, the unit tax imposed will be

A. $3

B. $6

C. $9

D. $12

Soln: (a)

The answer is C.

(b) To make the seller only receive $9 when the price is at $15

(so that the output is 45), an unit tax of $6 should be imposed.

∴The answer is B.



☆ Price $20 $25 $30 $35 $40

Qd 120 100 80 75 60

Qs 80 80 80 80 80

If the govt. impose a tax of $5, the new equilibrium price

inclusive of tax will be

A. $25

B. $30

C. $35

D. $40

Soln: The supply is perfectly inelastic.

∴Supply curve won’t shift.

∴Equilibrium price remains at $30.

∴The answer is B.

☆The housing authority has offered to sell rental flats in public

housing to the public tenants. However, not many tenants have

expressed a desire to buy the flats they are living in. Which of

the following would make the tenants more willing to buy them?

A. increasing the supply of flats in the private sector.

B. increasing the rents of public housing units.

C. increasing the interest rate on home mortgage loan.

D. increasing the quantity of Home Ownership Scheme flats

allocated to tenants.



Soln: Renting and buying the flats are substitutes.

When price of rent↑, Qd for rent↓, D of buy↑

∴The answer is B.

☆Suppose there is a technological advancement in the

production of a normal good. In which of the following

situations may the market price of the good remain unchanged?

A. The income of consumers decreases.

B. The government raises the unit sales tax on the good.

C. The demand for the good is perfectly inelastic.

D. The supply of the good is perfectly inelastic.

Soln: Supply increases due to technological advancement.

☆Producer A goes bankrupt and closes down at the beginning of

the year. The price of ball pens of producer B increases from $6

to $8 while the quantity transacted increases by 50%. We can

conclude

A. the price elasticity of demand is greater than 1.

B. the price elasticity of demand is smaller than 1

C. the price elasticity of supply is greater than 1

D. the price elasticity of supply is smaller than 1

Soln: P↑, Q↑ Þdemand increases.

Þmovement along supply curve.



elasticity=

∴The answer is C.

☆The imposition of a per-unit sales tax on a good will reduce its

equilibrium quantity if

A. the demand is inelastic.

B. the demand is elastic.

C. the demand is unitarily elastic.

D. All of the above is correct.

Soln: The upward shift of the supply curve will reduce the

equilibrium quantity unless there is a perfectly inelastic demand.

∴The answer is D.

A. B. C.

☆HK’s recent economic recession has caused a decline in

people’s income. In view of this, the government decided to

lower the effective minimum wage level of Filipino maids. As a

result of these two changes,

(1) the demand for Filipino maids showed decrease.

(2) the quantity supplied of Filipinos maids should decrease.



(3) the excess supply of Filipino maids should decrease.

(4) the total expenditure on the employment of Filipino maids

should drop.

Soln: (1) is correct. Income↓ so D↓.

(2) is correct. P↓ So Qs↓.

(3) is incorrect. It depends on the extent of decrease in demand.

(4) is incorrect because TE may ↑/↓/ remains unchanged,

depending on the extent of decrease in demand & decrease in

minimum wage.

☆

If price decreases

from $3 to P, the total

revenue will be

A. equal to $30

B. greater than $30

C. smaller than $30

Soln: it is a movement along lower part of the demand curve, the

demand is inelastic



∴%decrease in price > % increase in quantity

∴TR↓

∴The answer is C.

☆Suppose the government provides a subsidy to vegetable

suppliers in order to encourage the consumption of vegetables.

In which of the following situations will the subsidy have no

effect on the quantity transacted?

(1) The price elasticity of demand is equal to zero.

(2) The price elasticity of demand is equal to infinity.

(3) The price elasticity of supply is equal to zero.

(4) The price elasticity of supply is equal to infinity.

Soln: elasticity = 0, perfectly inelastic supply/ demand

∴The answer is (1) and (3) only.

☆ Price ($) 9 8 7 6 5 4 3 2 1

Qs 17 16 15 14 13 12 11 10 9

Qd 7 8 9 10 11 12 13 14 15

Suppose a per-unit fax of $4 is imposed on the supply of Good

X. The total social surplus is maximized without the tax. After

the tax, the deadweight loss is

A. $2

B. $4

C. $6



D. $8

Soln: -before the tax, price is $4 and quantity is 12

-after the tax, price is $6 and quantity is 10

∴The 11th and 12th output are not produced after the tax.

① For the 12th unit, MB=$4, MC=$4

9 loss in TSS=$0

For the 11th unit, MB=$5, MC=$3

9 loss in TSS=$2

∴The answer is A.

② -Before the tax, marginal costs of 11th and 12th units are $3

and $4 respectively. Total cost = $7.

-Total benefit=MB of 11th & 12th units

=$5+$4

=$9

∴Loss in TSS=$9–$7=$2#

☆ The original market price is at $6 per unit. Suppose the

government imposes an effective price floor at $9 per unit. How

does the consumer surplus change?

Unit price ($) Quantity demanded (unit)

12 0

9 1

6 2

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