Cambridge A Level Economics: Exchange rate systems, Marshall-Lerner and J curve (9708) – Practice Questions

These are original questions written for Marlbridge, for revision and practice on this content. They are not reproduced past-paper questions, and they do not replicate the exam’s exact structure, question count or mark tariffs – examination boards hold copyright in their own papers. Use these alongside the official past papers from your board or school.

These questions cover syllabus section 11.2 (Exchange rates), outcomes 11.2.1 to 11.2.5, in the Cambridge International AS and A Level Economics 9708 syllabus for examination in 2026, 2027 and 2028. This is A Level content (topic 11). All countries, currencies and figures are invented. Country R uses the ruv and Country S uses the sab.

Links: study guide, revision notes, course hub, checklist and the free 10-minute diagnostics.

Questions

1. Distinguish between a nominal exchange rate and a real exchange rate. [2]

2. The nominal rate rises from 4.00 to 4.20 sabs per ruv. Country R’s price index rises from 100 to 108 and Country S’s from 100 to 103. Calculate the percentage change in the real exchange rate and explain why it differs from the nominal change. [4]

3. Country R trades with three partners, weighted 45%, 35% and 20%. The ruv’s bilateral indices (base year 100) are now 104, 92 and 108. Calculate the trade-weighted index and interpret it. [4]

4. Explain two differences between a fixed and a managed exchange rate system. [4]

5. Demand for ruvs is D = 480 − 100r and supply is S = 100r − 120, where r is sabs per ruv and quantities are in millions of ruvs. The central bank fixes the rate at 3.20.

(a) Calculate the equilibrium rate. [2] (b) Calculate the foreign exchange reserves, in millions of sabs, needed to hold the peg. [3]

6. (a) Distinguish between devaluation and depreciation. [2] (b) A peg of 4.00 sabs per ruv is cut to 3.60. Calculate the percentage change and the new sab price of an export costing 800 ruvs. [2]

7. Using the market in question 5, demand falls by 60 at every rate, so D′ = 420 − 100r.

(a) Calculate the new rate and the percentage change if the rate floats from 3.00. [3] (b) Calculate the reserves needed to hold a peg at 3.00 instead. [2]

8. (a) State the Marshall-Lerner condition. [1] (b) Use it to decide whether a depreciation improves the trade balance when (i) PEDx is 0.7 and PEDm is 0.5, and (ii) PEDx is 0.4 and PEDm is 0.35. [2]

9. Country R’s exports and imports are both 2,000 ruvs. The ruv falls 5%, so export prices abroad fall 5% and import prices at home rise 5%. In the short run PEDx is 0.2 and PEDm is 0.3. In the long run they are 1.0 and 0.9. Calculate exports, imports and the balance in each period and explain what this shows. [6]

10. Evaluate whether a devaluation will reduce a current account deficit. [8]

11. Assess whether a country should keep a fixed exchange rate or move to a managed rate. [8]

Answers

1. Nominal: the market-quoted value of one currency measured in another [1]. Real: the nominal rate adjusted for differences in price levels, showing what the currency buys in goods [1]. [2] Examiner insight: Answers gain credit by naming what the real rate corrects for. “A more accurate rate” is too vague.

2. Real rate before = 4.00. After = 4.20 × 108 ÷ 103 = 4.404 [1] [1]. Change = (4.404 − 4.00) ÷ 4.00 = +10.1% [1]. The nominal rise is 5.0%. The real rise is larger because prices rose faster in Country R than in Country S [1]. [4] Examiner insight: Show the substitution into the formula and state which price index sits on top. A bare answer leaves the examiner unable to see your method.

3. 0.45 × 104 = 46.8, 0.35 × 92 = 32.2 and 0.20 × 108 = 21.6 [1]. Sum = 100.6 [1]. The ruv has appreciated by 0.6% on average [1]. It rose against the first and third partners but fell 8% against the second; the weights are trade shares, so the overall effect on competitiveness is small [1]. [4] Examiner insight: Interpretation is where marks are won on index questions. Say what the number means for competitiveness.

4. Any two, each explained [2] [2]. Commitment: a fixed system has an official rate that the bank is committed to defend, whereas a managed system leaves the rate mainly to the market and the bank intervenes at its discretion. Reserves: a fixed rate needs large reserves to absorb shocks, whereas a managed rate lets the market take part of the adjustment. Interest rates: under a fixed rate they must serve the peg, whereas a managed rate leaves more freedom. [4] Examiner insight: “Explain two” needs two separate differences, each developed. A one-sided description of fixed rates does not make a difference.

5. (a) 480 − 100r = 100r − 120 [1], so 200r = 600 and r = 3.00 [1]. (b) At 3.20, D = 160 and S = 200 [1]. Excess supply = 40 million ruvs, so the bank must buy 40 million ruvs [1]. Cost = 40 × 3.20 = 128 million sabs [1]. [5] Examiner insight: Say whether the bank buys or sells, and give units. Direction matters as much as the number.

6. (a) Devaluation is a deliberate cut in the official value of a fixed rate by the authorities [1]. Depreciation is a market-driven fall in a floating rate [1]. (b) (3.60 − 4.00) ÷ 4.00 = −10% [1]. Export price = 800 × 3.60 = 2,880 sabs, down from 3,200 [1]. [4] Examiner insight: Match the word to the system. Writing “depreciation” for a government decision is a common slip.

7. (a) 420 − 100r = 100r − 120 [1], so r = 2.70 [1]. Change = (2.70 − 3.00) ÷ 3.00 = −10% [1]. (b) At 3.00, D = 120 and S = 180, excess supply 60 [1]. Cost = 60 × 3.00 = 180 million sabs [1]. [5] Examiner insight: Comparing the two systems makes the point: the price falls under floating, the reserves fall under a peg.

8. (a) A depreciation or devaluation improves the trade balance if PEDx + PEDm > 1 (absolute values) [1]. (b) (i) 0.7 + 0.5 = 1.2, so the balance improves [1]. (ii) 0.4 + 0.35 = 0.75, so it worsens [1]. [3] Examiner insight: The sum is what matters. Saying that each elasticity must exceed 1 is a common error.

9. Short run: exports = 2,000 × (1 + 0.2 × 0.05) = 2,020 [1]. Imports = 2,000 × 1.05 × (1 − 0.3 × 0.05) = 2,068.5 [1]. Balance = −48.5 [1]. Long run: exports = 2,000 × 1.05 = 2,100 and imports = 2,000 × 1.05 × (1 − 0.9 × 0.05) = 2,005.5 [1]. Balance = +94.5 [1]. The balance falls first, then rises, as elasticities increase (J curve), and the sum passes 1 only in the long run [1]. [6] Examiner insight: Link the numbers back to the condition and the J shape. Calculations with no comment on what they show tend to earn less.

10. Any combination of the following, with judgement [1] each, up to 8. Devaluation lowers export prices abroad and raises import prices, which is expenditure switching [1]. It works if PEDx + PEDm > 1 [1]. The J curve means the deficit may widen first [1]. Exports need spare capacity to rise [1]. Dearer imports raise costs and inflation, which erodes the gain [1]. If the deficit has structural causes such as low quality, devaluation treats the symptom [1]. Judgement: it is most likely to work where demand is elastic and capacity is spare, and least likely when imports are essential and the cause is non-price [1]. [8] Examiner insight: Evaluation gains credit when each point is tied to the case and ends with a reasoned judgement. A list of “however” points does not.

11. Any combination, with judgement [1] each, up to 8. A fixed rate gives certainty for traders and investment [1]. It needs large reserves, which can run out [1]. Interest rates must serve the peg, not domestic needs [1]. It is open to speculative attack [1]. A managed rate lets the market absorb shocks and leaves room for domestic policy [1]. It is less certain, and intervention can fail or lack credibility [1]. Judgement: a small open economy with large reserves and low inflation credibility may prefer the peg, while a large economy with volatile shocks may prefer managed [1]. [8] Examiner insight: Weigh the two systems against the same criteria. Describing each in turn and not comparing them leaves the argument unfinished.

Where marks are usually lost

• Using devaluation or revaluation for a floating rate.
• Quoting the rate the wrong way round, or not stating the currency pair.
• Putting the price indices upside down in the real-rate formula.
• Using weights that do not add to 100% in a trade-weighted index.
• Forgetting to say whether the bank buys or sells the currency.
• Requiring each elasticity to exceed 1 instead of the sum.
• Stating that the balance improves at once and omitting the J curve.
• Presenting evaluation as a list with no final judgement.

Next steps

• Re-read the study guide for any step you missed.
• Use the revision notes for a quick recap.
• Tick off the checklist and visit the course hub.
• Try the free 10-minute diagnostics.
• Book a free trial class.

Official syllabus

Cambridge International AS & A Level Economics 9708, syllabus for examination in 2026, 2027 and 2028, published by Cambridge University Press & Assessment (Cambridge International), section 11.2 Exchange rates.