Cambridge International AS and A Level Economics: Floating exchange rates (9708)

This guide covers syllabus section 6.4 (Exchange rates), outcomes 6.4.1 to 6.4.5, in the Cambridge International AS and A Level Economics 9708 syllabus for examination in 2026, 2027 and 2028. Topic 6 is AS Level content. The syllabus states that AS Level content is assumed knowledge for A Level Paper 3 and Paper 4, so A Level candidates need it too.

All countries, currencies and figures below are invented for illustration. They are not real statistics. Country A uses the kora and Country B uses the dalo.

Related pages: the Cambridge A Level Economics hub, the printable checklist, the revision notes, the practice set, the aggregate demand and aggregate supply guide, the international economic issues practice set and the free 10-minute diagnostics.

What this unit covers

Outcome	What you must be able to do
6.4.1	Define an exchange rate
6.4.2	Explain how a floating exchange rate is determined
6.4.3	Distinguish depreciation from appreciation
6.4.4	Explain causes of change: demand for and supply of the currency
6.4.5	Use AD/AS analysis to show the effect of exchange rate changes on equilibrium national income, real output, the price level and employment

6.4.1 Definition of exchange rate

An exchange rate is the price of one currency expressed in terms of another currency. It can be quoted either way round, so always say which currency is being priced.

If 1 kora = 2.00 dalos, then 1 dalo = 0.50 kora.

Worked example. A machine costs 3,000 dalos in Country B. Cost in koras = 3,000 ÷ 2.00 = 1,500 koras. A Country A export costs 400 koras. Price in dalos = 400 × 2.00 = 800 dalos.

Rule: to convert into the currency you are pricing (koras here), divide by the rate. To convert out of it, multiply.

6.4.2 Determination of a floating exchange rate

A floating exchange rate is set by the demand for and supply of the currency in the foreign exchange market, without the government or central bank fixing it. The syllabus asks you to explain how the rate is determined, so you need the diagram in words.

• Axes: vertical axis is the price of the kora in dalos; horizontal axis is the quantity of koras traded.
• The demand curve for koras slopes downwards. Foreign buyers need koras to pay for Country A exports, to invest in Country A or to visit it. A higher kora price makes these dearer for them, so they demand fewer koras.
• The supply curve of koras slopes upwards. Country A residents supply koras to buy dalos for imports, investment abroad and travel. A higher kora price makes foreign goods cheaper, so they supply more.
• Equilibrium is where the two curves cross.

Illustrative schedule (millions of koras per period):

Dalos per kora	Demand for koras	Supply of koras	Position
1.20	160	40	Excess demand 120
1.60	130	70	Excess demand 60
2.00	100	100	Equilibrium
2.40	70	130	Excess supply 60
2.80	40	160	Excess supply 120

The equations behind the table are D = 250 − 75r and S = 75r − 50, where r is dalos per kora. Setting them equal: 250 − 75r = 75r − 50, so 150r = 300 and r = 2.00. Quantity is 250 − 150 = 100.

At 2.40 there is excess supply of 60. Sellers of koras compete, the price of the kora falls, and the market moves back to 2.00. At 1.60 excess demand pushes the rate up. Quote the adjustment mechanism whenever you explain equilibrium.

The words “floating” and “free” mean the rate moves with the market. Fixed and managed systems are A Level topic 11 and are not part of this unit.

6.4.3 Depreciation and appreciation

• Depreciation: a fall in the value of a floating currency against another currency. One kora buys fewer dalos.
• Appreciation: a rise in the value of a floating currency. One kora buys more dalos.

Percentage change in the rate = (new − old) ÷ old × 100.

Worked example. The rate moves from 2.00 to 1.60 dalos per kora.

• Kora: (1.60 − 2.00) ÷ 2.00 × 100 = −20%. The kora has depreciated by 20%.
• Dalo: the rate in koras per dalo moves from 0.50 to 0.625. (0.625 − 0.50) ÷ 0.50 × 100 = +25%. The dalo has appreciated by 25%.

When one currency depreciates, its partner appreciates, but the percentages differ because the base changes. Do not use “devaluation” or “revaluation” here: those words describe deliberate changes to a fixed rate.

“Weaker” does not mean “worse”. Whether a depreciation helps depends on the effects in 6.4.5.

6.4.4 Causes of changes in a floating exchange rate

Each cause acts through one of the two curves in the market. In your answer, say which curve moves, which way, and where the new equilibrium lies.

Demand for koras increases (appreciation) when:

• foreign demand for Country A goods and services rises, for example because of higher foreign incomes, better quality or lower Country A prices relative to prices abroad;
• foreigners want to invest in Country A firms or assets;
• Country A interest rates rise relative to those abroad, attracting short-term deposits;
• speculators expect the kora to rise.

Supply of koras increases (depreciation) when:

• Country A households prefer imports, for example because of rising incomes at home;
• Country A firms invest abroad;
• Country A interest rates fall relative to those abroad;
• speculators expect the kora to fall and sell it. Expectations can make this self-fulfilling.

A fall in demand for koras or a fall in supply gives the opposite result.

Worked example 1. Demand rises by 30 at every rate: D′ = 280 − 75r. Then 280 − 75r = 75r − 50, so 150r = 330 and r = 2.20. Quantity is 115. The kora appreciates by (2.20 − 2.00) ÷ 2.00 = 10%.

Worked example 2. Supply rises by 30 at every rate: S′ = 75r − 20. Then 250 − 75r = 75r − 20, so 150r = 270 and r = 1.80. Quantity is 115. The kora depreciates by 10%.

A shift of demand to the right raises both the rate and the quantity. A shift of supply to the right lowers the rate but raises the quantity. Check which axis you are reading.

6.4.5 AD/AS analysis of exchange rate changes

Link the exchange rate to aggregate demand and short-run aggregate supply.

Chain of reasoning: depreciation

1. The kora falls from 2.00 to 1.60 dalos.
2. Exports become cheaper to foreign buyers. A 400-kora export falls from 800 to 640 dalos, which is −20%.
3. Imports become dearer to Country A. A component costing 600 dalos rises from 300 to 375 koras, which is +25%.
4. If demand responds enough, exports rise and imports fall. Net exports (X − M) increase, so aggregate demand (AD = C + I + G + X − M) shifts right.
5. Along a given short-run aggregate supply curve, real output rises, the price level rises and employment rises as firms hire to meet demand.

Worked example. Country A’s AD is C 600 + I 200 + G 250 + X 300 − M 350 = 1,000 (millions of koras). Net exports are −50. After the depreciation, X rises to 340 and M falls to 320. AD = 600 + 200 + 250 + 340 − 320 = 1,070. Net exports are +20, so AD rises by 70.

If the multiplier is 2.5, because the marginal propensity to withdraw is 0.4 (1 ÷ 0.4), national income rises by 70 × 2.5 = 175 in this simplified model.

A sketch of the diagram in words: price level on the vertical axis, real output on the horizontal axis. AD1 shifts right to AD2 along upward-sloping SRAS. Equilibrium moves from (Y1, P1) to (Y2, P2) with both higher.

Chain of reasoning: appreciation

Dearer exports and cheaper imports reduce net exports, so AD shifts left. Real output, employment and the price level fall (or inflation slows). Cheaper imported inputs can also shift SRAS right, which lowers the price level further and softens the loss of output.

Summary table

	Depreciation	Appreciation
Export prices abroad	Fall	Rise
Import prices at home	Rise	Fall
AD	Shifts right	Shifts left
Imported input costs	Rise (SRAS shifts left)	Fall (SRAS shifts right)
Real output and employment	Tend to rise	Tend to fall
Price level	Tends to rise	Tends to fall

Evaluation

• Spare capacity matters. With unemployed resources, the AD shift raises output and employment more than prices. Near full capacity, it mostly raises prices.
• Responsiveness matters. If demand for exports and imports is price inelastic, net exports may not improve, or only slowly. Contracts and habits cause delays.
• Imported inputs matter. A firm that relies on imported materials faces higher costs after depreciation. This can shift SRAS left, so output may rise by less, or fall, while prices rise by more.
• Other countries may respond, and their incomes and prices also affect demand for Country A exports.
• Time period matters. Judge short run and long run separately.

A balanced conclusion names the most important factor for the case given and explains why.

Common errors

• Reading the rate the wrong way round. Always state “dalos per kora”.
• Saying the demand curve shifts when the price of the currency changes. That is a movement along the curve.
• Writing “appreciation” for a change in a fixed rate.
• Claiming depreciation always improves the economy.
• Forgetting that import costs enter SRAS as well as net exports entering AD.
• Stopping at “AD shifts right” without stating output, price level and employment.

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 6.4 Exchange rates.