School / IB / ECON SL / Exchange rates and the balance of payments Exam-style + marking analysis
Exchange rates and the balance of payments Exchange rate determination, balance of payments accounts, and policies to correct imbalances.
Economics SL Exchange rates and the balance of payments
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1 The exchange rate between the British pound (GBP) and the US dollar (USD) moves from £1 = $1.25 to £1 = $1.35. (a) Calculate the percentage change in the value of the pound. (b) State whether the pound has appreciated or depreciated against the dollar. Paper 1 style Easy 3 marks Calculator + 2 Marking analysis: A learner attempts the following task: “The exchange rate between the British pound (GBP) and the US dollar (USD) moves from £1 = $1.25 to £1 = $1.35. (a) Calculate the percentage change in the value of the pound. (b) State whether the pound has appreciated or depreciated against the dollar.” Their response addresses only this point: “Calculates the percentage change as (1.35 − 1.25)/1.25 × 100.” Evaluate the response against the complete 3-mark task. Identify what earns credit and state every additional requirement needed for full marks. Marking analysis Easy 3 marks Calculator + 3 Explain, using a demand and supply diagram for a currency in words, how an increase in a country's interest rate relative to other countries is likely to affect the value of its currency under a floating exchange rate system. Paper 1 style Medium 4 marks No calculator + 4 Marking analysis: A learner attempts the following task: “Explain, using a demand and supply diagram for a currency in words, how an increase in a country's interest rate relative to other countries is likely to affect the value of its currency under a floating exchange rate system.” Their response addresses only this point: “States that a higher interest rate makes financial assets denominated in that currency (e.g., bonds, savings accounts) more attractive to foreign investors seeking higher returns.” Evaluate the response against the complete 4-mark task. Identify what earns credit and state every additional requirement needed for full marks. Marking analysis Medium 4 marks No calculator + 5 Explain how a government operating a fixed exchange rate system could intervene in the foreign exchange market to prevent its currency from depreciating below the fixed rate. Paper 1 style Easy 3 marks No calculator + 6 Marking analysis: A learner attempts the following task: “Explain how a government operating a fixed exchange rate system could intervene in the foreign exchange market to prevent its currency from depreciating below the fixed rate.” Their response addresses only this point: “States that the central bank would need to increase demand for its own currency to support its value.” Evaluate the response against the complete 3-mark task. Identify what earns credit and state every additional requirement needed for full marks. Marking analysis Easy 3 marks No calculator + 7 Classify each of the following transactions into the correct component of the balance of payments (current account or financial account): (a) A domestic company exports machinery to a foreign buyer. (b) A foreign company buys a 30% ownership stake in a domestic firm. (c) A resident receives dividend income from shares held in a foreign company. (d) A domestic bank deposits funds in a foreign bank account. Paper 1 style Medium 4 marks No calculator + 8 Marking analysis: A learner attempts the following task: “Classify each of the following transactions into the correct component of the balance of payments (current account or financial account): (a) A domestic company exports machinery to a foreign buyer. (b) A foreign company buys a 30% ownership stake in a domestic firm. (c) A resident receives dividend income from shares held in a foreign company. (d) A domestic bank deposits funds in a foreign bank account.” Their response addresses only this point: “Classifies the machinery export as part of the current account (trade in goods).” Evaluate the response against the complete 4-mark task. Identify what earns credit and state every additional requirement needed for full marks. Marking analysis Medium 4 marks No calculator + 9 A country has been running a persistent current account deficit for several years. Explain two possible consequences of a persistent current account deficit for this country's economy. Paper 1 style Easy 2 marks No calculator + 10 Marking analysis: A learner attempts the following task: “A country has been running a persistent current account deficit for several years. Explain two possible consequences of a persistent current account deficit for this country's economy.” Their response addresses only this point: “Explains that a persistent current account deficit must be financed by a corresponding financial account surplus, often meaning the country is increasingly borrowing from or selling assets to foreigners, building up external debt or foreign ownership of domestic assets over time.” Evaluate the response against the complete 2-mark task. Identify what earns credit and state every additional requirement needed for full marks. Marking analysis Easy 2 marks No calculator + 11 Explain how a real depreciation of a country's currency could help correct a current account deficit, and state one condition needed for this to actually improve the trade balance (the Marshall-Lerner condition). Paper 1 style Easy 3 marks No calculator + 12 Marking analysis: A learner attempts the following task: “Explain how a real depreciation of a country's currency could help correct a current account deficit, and state one condition needed for this to actually improve the trade balance (the Marshall-Lerner condition).” Their response addresses only this point: “Explains that a depreciation makes the country's exports cheaper for foreign buyers (in foreign currency terms) and imports more expensive for domestic buyers (in domestic currency terms).” Evaluate the response against the complete 3-mark task. Identify what earns credit and state every additional requirement needed for full marks. Marking analysis Easy 3 marks No calculator + 13 Explain the 'J-curve effect' that can occur following a currency depreciation, describing why the trade balance might initially worsen before it improves. Paper 1 style Easy 3 marks No calculator + 14 Marking analysis: A learner attempts the following task: “Explain the 'J-curve effect' that can occur following a currency depreciation, describing why the trade balance might initially worsen before it improves.” Their response addresses only this point: “States that in the short run, the quantities of exports and imports are relatively unresponsive to the price change (demand is inelastic), since existing trade contracts and consumer habits take time to adjust.” Evaluate the response against the complete 3-mark task. Identify what earns credit and state every additional requirement needed for full marks. Marking analysis Easy 3 marks No calculator + 15 The theory of purchasing power parity (PPP) suggests that a Big Mac costs $5 in the United States and £4 in the United Kingdom. (a) Calculate the PPP-implied exchange rate between the pound and the dollar. (b) If the actual market exchange rate is £1 = $1.35, state whether the pound is overvalued or undervalued according to this comparison, and by approximately what percentage. Paper 2 style Medium 4 marks Calculator + 16 Marking analysis: A learner attempts the following task: “The theory of purchasing power parity (PPP) suggests that a Big Mac costs $5 in the United States and £4 in the United Kingdom. (a) Calculate the PPP-implied exchange rate between the pound and the dollar. (b) If the actual market exchange rate is £1 = $1.35, state whether the pound is overvalued or undervalued according to this comparison, and by approximately what percentage.” Their response addresses only this point: “Calculates the PPP-implied exchange rate as the ratio of the two prices: $5/£4 = $1.25 per pound.” Evaluate the response against the complete 4-mark task. Identify what earns credit and state every additional requirement needed for full marks. Marking analysis Medium 4 marks Calculator + 17 Distinguish between a fixed exchange rate system and a floating exchange rate system, and state one advantage of a floating exchange rate for a country's macroeconomic policy. Paper 1 style Easy 3 marks No calculator + 18 Marking analysis: A learner attempts the following task: “Distinguish between a fixed exchange rate system and a floating exchange rate system, and state one advantage of a floating exchange rate for a country's macroeconomic policy.” Their response addresses only this point: “States that under a fixed exchange rate, the government or central bank sets and maintains the exchange rate at a specific value, intervening in the market as needed.” Evaluate the response against the complete 3-mark task. Identify what earns credit and state every additional requirement needed for full marks. Marking analysis Easy 3 marks No calculator + 19 Explain how an increase in a country's inflation rate relative to its trading partners, with a floating exchange rate, is likely to affect its currency's value over time. Paper 1 style Easy 3 marks No calculator + 20 Marking analysis: A learner attempts the following task: “Explain how an increase in a country's inflation rate relative to its trading partners, with a floating exchange rate, is likely to affect its currency's value over time.” Their response addresses only this point: “Explains that higher relative inflation makes the country's exports relatively more expensive and imports relatively cheaper, reducing demand for the country's goods (and therefore its currency) abroad while increasing demand for foreign goods (and foreign currency) domestically.” Evaluate the response against the complete 3-mark task. Identify what earns credit and state every additional requirement needed for full marks. Marking analysis Easy 3 marks No calculator + 21 Explain why a current account deficit does not necessarily indicate a weak or poorly performing economy, using the example of a developing country attracting significant foreign direct investment. Paper 1 style Easy 3 marks No calculator + 22 Marking analysis: A learner attempts the following task: “Explain why a current account deficit does not necessarily indicate a weak or poorly performing economy, using the example of a developing country attracting significant foreign direct investment.” Their response addresses only this point: “Explains that a current account deficit is always matched by a financial account surplus of equal size, meaning net capital is flowing into the country.” Evaluate the response against the complete 3-mark task. Identify what earns credit and state every additional requirement needed for full marks. Marking analysis Easy 3 marks No calculator + 23 State and explain two expenditure-switching policies a government could use to reduce a current account deficit (other than exchange rate depreciation). Paper 1 style Easy 2 marks No calculator + 24 Marking analysis: A learner attempts the following task: “State and explain two expenditure-switching policies a government could use to reduce a current account deficit (other than exchange rate depreciation).” Their response addresses only this point: “States and explains protectionist measures (tariffs or quotas) on imports: these directly raise the price or restrict the quantity of imported goods, encouraging consumers to switch to domestically produced substitutes.” Evaluate the response against the complete 2-mark task. Identify what earns credit and state every additional requirement needed for full marks. Marking analysis Easy 2 marks No calculator + 25 Explain two likely effects of a significant depreciation of a country's currency on its domestic economy. Paper 1 style Easy 3 marks No calculator + 26 Marking analysis: A learner attempts the following task: “Explain two likely effects of a significant depreciation of a country's currency on its domestic economy.” Their response addresses only this point: “Explains that exports become cheaper in foreign currency terms and imports dearer in domestic currency terms, which can raise export volumes and reduce import volumes, increasing aggregate demand.” Evaluate the response against the complete 3-mark task. Identify what earns credit and state every additional requirement needed for full marks. Marking analysis Easy 3 marks No calculator + 27 A US firm sells a machine for $200. The exchange rate is $1 = 3.67 AED. (a) Calculate the price in AED. (b) The US dollar depreciates to $1 = 3.50 AED. Calculate the new AED price and the percentage change in the AED price, to 1 decimal place. (c) State what this implies for the machine's price competitiveness in the UAE. Paper 2 style Medium 4 marks Calculator + 28 Marking analysis: A learner attempts the following task: “A US firm sells a machine for $200. The exchange rate is $1 = 3.67 AED. (a) Calculate the price in AED. (b) The US dollar depreciates to $1 = 3.50 AED. Calculate the new AED price and the percentage change in the AED price, to 1 decimal place. (c) State what this implies for the machine's price competitiveness in the UAE.” Their response addresses only this point: “Calculates the original AED price as 200 × 3.67 = 734 AED.” Evaluate the response against the complete 4-mark task. Identify what earns credit and state every additional requirement needed for full marks. Marking analysis Medium 4 marks Calculator + 29 Distinguish between a freely floating exchange rate and a managed float, and explain one reason a central bank might manage its currency's value. Paper 1 style Easy 3 marks No calculator + 30 Marking analysis: A learner attempts the following task: “Distinguish between a freely floating exchange rate and a managed float, and explain one reason a central bank might manage its currency's value.” Their response addresses only this point: “States that in a free float the exchange rate is set purely by market demand and supply with no central bank intervention.” Evaluate the response against the complete 3-mark task. Identify what earns credit and state every additional requirement needed for full marks. Marking analysis Easy 3 marks No calculator + Self-assessed 0 / 0
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