These are original Marlbridge practice questions, not past exam questions. All questions use two fictional countries: Valdoria, whose currency is the valda (VD), and Ostria, whose currency is the ostro (OS). All data are fictional. The rubrics are a suggested Marlbridge rubric to help you check your work; they are not an official scoring guideline. Assumptions: exchange rates are flexible; financial capital can move freely between the two countries; quantities of currency are in millions per month; round exchange rates to 4 decimal places and percentages to 2 decimal places.
Question 1 (multiple choice · foundation)
Incomes in Ostria rise sharply while incomes in Valdoria do not change. What is the most likely effect in the foreign exchange market for valdas?
- (A) Demand for valdas increases, and the valda appreciates.
- (B) Supply of valdas increases, and the valda depreciates.
- (C) Demand for valdas decreases, and the valda depreciates.
- (D) Supply of valdas decreases, and the valda appreciates.
Answer and explanation
Answer: (A). Richer Ostrians buy more Valdorian exports and holidays. They need more valdas, so demand for valdas increases and the valda appreciates.
- (B) Would follow from higher Valdorian incomes, which raise Valdorians’ imports.
- (C) Gets the direction wrong: higher foreign incomes raise, not lower, spending on Valdorian goods.
- (D) Ostrian incomes do not change how many valdas Valdorians offer for ostros.
Question 2 (multiple choice · core)
Valdoria introduces a quota that limits imports of Ostrian clothing. Assuming nothing else changes, which of the following is most likely?
- (A) Demand for valdas increases, and the ostro appreciates.
- (B) Supply of valdas decreases, and the valda appreciates.
- (C) Supply of valdas increases, and the valda depreciates.
- (D) Demand for ostros increases, and the ostro appreciates.
Answer and explanation
Answer: (B). With fewer Ostrian clothes imported, Valdorians need fewer ostros, so they offer fewer valdas. The supply of valdas decreases and the valda appreciates.
- (A) The quota does not change what Ostrians want to buy from Valdoria, and an appreciating valda means the ostro depreciates.
- (C) Reverses the effect: the quota reduces imports, so the supply of valdas falls.
- (D) In the market for ostros, the quota decreases the demand for ostros, so the ostro depreciates.
Question 3 (multiple choice · core)
Valdoria’s central bank carries out expansionary monetary policy. Which of the following correctly describes the effect on Valdoria’s interest rate and on the value of the valda?
- (A) The interest rate falls and the valda depreciates.
- (B) The interest rate falls and the valda appreciates.
- (C) The interest rate rises and the valda appreciates.
- (D) The interest rate rises and the valda depreciates.
Answer and explanation
Answer: (A). Expansionary monetary policy lowers Valdorian interest rates. Valdorian assets become less attractive, so demand for valdas decreases (and Valdorians supply more valdas to buy foreign assets). The valda depreciates.
- (B) Gets the interest rate right but the currency wrong: lower returns reduce, not raise, demand for valdas.
- (C) Describes contractionary monetary policy.
- (D) Both parts are wrong: expansionary policy lowers interest rates, and a higher rate would raise the valda.
Question 4 (multiple choice · core)
Valdoria’s inflation rate rises well above Ostria’s. In the market for valdas, which combination of shifts is most likely?
- (A) Demand for valdas decreases and supply of valdas increases, so the valda depreciates.
- (B) Demand for valdas increases and supply of valdas decreases, so the valda appreciates.
- (C) Demand for valdas and supply of valdas both decrease, so the effect on the valda is uncertain.
- (D) Demand for valdas and supply of valdas both increase, so the exchange rate does not change.
Answer and explanation
Answer: (A). Valdorian goods become relatively dearer, so Ostrians buy fewer (demand for valdas decreases). Ostrian goods become relatively cheaper for Valdorians, so they import more (supply of valdas increases). Both shifts lower the rate.
- (B) Reverses both shifts: higher prices make Valdorian goods less, not more, attractive.
- (C) The supply of valdas rises, not falls, because Valdorians import more.
- (D) Demand for valdas falls, not rises. Even if both curves rose, the rate change would be uncertain, not zero.
Question 5 (calculation · core)
In the market for valdas, quantity demanded is Qd = 160 − 40e and quantity supplied is Qs = −20 + 50e, where e is in ostros per valda and quantities are millions of valdas a month.
(a) Find the equilibrium exchange rate and quantity. (b) Valdoria places tariffs on Ostrian goods. At every exchange rate, Valdorians now supply 18 million fewer valdas a month. Find the new equilibrium. (c) Calculate the shortage or surplus at the original exchange rate after the tariff. (d) Calculate the percentage change in the value of the valda and of the ostro.
Worked solution
(a) 160 − 40e = −20 + 50e, so 180 = 90e and e = OS 2.0. Quantity = 160 − 80 = 80 million valdas.
(b) New supply: Qs = −38 + 50e. Set 160 − 40e = −38 + 50e, so 198 = 90e and e = OS 2.2. Quantity = 160 − 88 = 72 million valdas.
(c) At OS 2.0, quantity demanded is still 80 million but quantity supplied is now −38 + 100 = 62 million. There is a shortage of 18 million valdas, which bids the valda up.
(d) Valda: (2.2 − 2.0) ÷ 2.0 × 100 = +10% (appreciation). Ostro: from 1 ÷ 2.0 = VD 0.50 to 1 ÷ 2.2 = VD 0.4545, so (0.4545 − 0.50) ÷ 0.50 × 100 = −9.09% (depreciation).
Suggested mark points (4): 1 for the original equilibrium; 1 for the new equilibrium (a student who adds 18 to supply instead gets e = 1.8 and earns no credit for (b)); 1 for the shortage of 18 at OS 2.0; 1 for both percentage changes with the correct directions.
Question 6 (constructed response · core)
Valdoria’s government increases its spending and finances the larger budget deficit by borrowing. Assume the loanable funds market and financial capital flows work as in the course model.
(a) State and explain the effect on Valdoria’s real interest rate. (b) Draw a correctly labelled graph of the foreign exchange market for valdas. Show the effect of the change in (a) on the equilibrium exchange rate. (c) State the effect on the value of the ostro relative to the valda. (d) Suppose instead that Valdoria’s central bank had used expansionary monetary policy to increase aggregate demand by the same amount. Explain the effect on the value of the valda.
Worked solution and suggested Marlbridge rubric
(a) The real interest rate rises. Government borrowing increases the demand for loanable funds, which raises the real interest rate.
(b) Vertical axis “Exchange rate (OS per VD)”; horizontal axis “Quantity of valdas”. The demand curve for valdas shifts right (D₁ to D₂), because higher Valdorian real interest rates make Valdorian financial assets more attractive to foreign savers. The new equilibrium exchange rate e₂ is above e₁: the valda appreciates. (A graph that also shifts supply of valdas to the left, with the rate rising, is equally correct.)
(c) The ostro depreciates relative to the valda.
(d) Expansionary monetary policy lowers Valdorian interest rates. Valdorian assets become less attractive, so foreign demand for valdas decreases (and Valdorians supply more valdas to buy Ostrian assets). The valda depreciates. So the two policies have opposite effects on the exchange rate even though both raise aggregate demand.
| Point | What earns it |
|---|---|
| 1 | Real interest rate rises, explained by higher demand for loanable funds from government borrowing |
| 1 | Correctly labelled foreign exchange graph for valdas |
| 1 | Demand for valdas shifts right (or supply shifts left) with a higher equilibrium exchange rate shown |
| 1 | Ostro depreciates |
| 1 | Expansionary monetary policy lowers the interest rate, reducing demand for valdas, so the valda depreciates |
The graph point in row 3 needs the reason linked to interest rates in the explanation. In (d), “the valda depreciates” with no reasoning earns no credit.
Question 7 (constructed response · stretch)
Two events happen at the same time: Ostria’s central bank raises Ostrian interest rates, and Valdoria’s inflation rate rises above Ostria’s.
(a) For each event, identify which curve or curves shift in the market for valdas, and in which direction. (b) State the combined effect on the equilibrium exchange rate of the valda. Is this effect certain? (c) State the combined effect on the equilibrium quantity of valdas traded. Is this effect certain? Explain. (d) State the effect on the value of the ostro.
Worked solution and suggested Marlbridge rubric
(a) Higher Ostrian interest rates make Ostrian assets more attractive. Valdorians buy more Ostrian assets, so the supply of valdas increases; Ostrians buy fewer Valdorian assets, so the demand for valdas decreases. Higher Valdorian inflation makes Valdorian goods relatively dearer: demand for valdas decreases; and Ostrian goods relatively cheaper for Valdorians: supply of valdas increases.
(b) Every shift lowers the exchange rate, so the valda depreciates. This is certain.
(c) The decrease in demand lowers the quantity traded, but the increase in supply raises it. The combined effect on quantity is uncertain (indeterminate) without knowing the sizes of the shifts.
(d) The ostro appreciates.
| Point | What earns it |
|---|---|
| 1 | Correct shift(s) for the Ostrian interest rate rise, with the reason |
| 1 | Correct shift(s) for the higher Valdorian inflation, with the reason |
| 1 | Valda depreciates, and this is certain because all shifts push the rate down |
| 1 | Quantity change is uncertain, because the demand and supply shifts push quantity in opposite directions |
| 1 | Ostro appreciates |
For (a), naming one correct shift per event with a valid reason is enough for each point. In (c), “quantity falls” or “quantity rises” earns no credit.
How did you do?
- Q1 or Q7(a) wrong: re-read “What shifts the demand for a currency” and “What shifts the supply of a currency” in the study guide.
- Q2 or Q5 wrong: revisit trade barriers and Worked example 2(b), then the method in Worked example 1.
- Q3, Q6(a) or Q6(d) wrong: re-read “Fiscal policy and the exchange rate” and “Monetary policy and the exchange rate”.
- Q4 or Q7(b)–(c) wrong: revisit “When two things change at once”.
Then tick off the topic checklist.