Question

Part A: Short Questions (20 marks). Explain your answers briefly (with no more than 100 words for each question). Each question carries 10 marks. Question 1 (10 marks) (a) Hong Kong's real GDP reached HK$2,703 (in chained 2017 dollars) in 2019. However, it is argued that this number cannot truly reflect the living standard of Hong Kong citizens. Suggest ONE reason and explain why it might be correct. (5 marks) (b) Hong Kong's CPI reached 111.4 (October 2014 September 2015 = 100) in 2019. However, it is also that this number is likely overstating the true cost of living in Hong Kong, Suggest ONE reason and explain why it might be correct. (5 marks)

Answer 1

a) The GDP is the total value of the output generated within a geographical limit of the economy in a given period of time. If we calculate the GDP using current year quantity and prices then it is called as the nominal GDP. Nominal GDP distorts the number because it could be influenced by the inflation numbers and so that real GDP is taken into account.
Real GDP is calculated by current year quantity but  some reference year or base year prices. However, it is quite true that such method is also not prefect as it can not depict the true picture of the living standard. The consumer preferences change over the period of time and technological progress could change the price and quantity drastically.
The personal computer is the integral part of today's life but it was very expensive a decade ago. It's price in current situation has fallen too much while quantity demanded is on rise.
It indicates that the real GDP can not be a prefect measurement tool.

b) CPI is the index of the consumer prices of selected basket of goods. The CPI measures the rising price level over the period of time. However, there are some disadvantages while assuming the CPI as the real measure of inflation or cost of living. The CPI does not take into account substitution effect or quantity changes over the period of time.
In the case of rise in price of butter, people will prefer margarine. If the CPI does take into account the substitution by the people then it will likely to overstate the inflation effect.
Similarly, cost of fuel has been low because of a higher than expected output. However, if the base year price was high then the larger share of consumption of fuel in current period and higher price will overstate the inflation in the economy.