Pearson Edexcel International Advanced Level Economics: Exchange rate effects (YEC11) – 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 follow 4.3.3 item 2, points a to g, of the Pearson Edexcel International Advanced Subsidiary/Advanced Level in Economics (YEC11) specification, Issue 2, June 2018. This is International A2 content in Unit 4, Developments in the global economy. All data are invented: the cor is Country C’s currency and the dun is Country D’s, with rates quoted in duns per cor. Read the study guide and revision notes first. The course hub and checklist are linked, and the free diagnostics offer a quick check.

Questions

1. A basket of goods costs 80 cors in Country C and 144 duns in Country D. The market rate is 1.50 duns per cor. Calculate the purchasing power parity rate and the percentage by which the cor is undervalued or overvalued against it. [3]

2. Distinguish between devaluation and depreciation. [4]

3. The rate moves from 3.00 to 2.40 duns per cor. Calculate the percentage change in the value of the cor and the percentage change in the value of the dun, measured in cors. [3]

4. A saver in Country D has 90,000 duns. Deposits pay 6% in Country C and 2% in Country D. The rate is 3.00 duns per cor now and 2.88 in a year. Calculate her outcome from each choice and comment on what it shows. [5]

5. Country C pegs at 2.20 duns per cor. Demand for cors is Qd = 150 − 30R and supply is Qs = 30 + 30R, where R is duns per cor and quantities are in billions of cors.

(a) Calculate the equilibrium rate and quantity. [2] (b) Calculate the central bank’s purchases of cors needed to hold the peg and their cost in duns. [3] (c) Explain two limits to this policy. [2]

6. Explain how quantitative easing may reduce the exchange rate. [4]

7. Short-run price elasticities of demand are 0.25 for exports and 0.30 for imports. Long-run elasticities are 0.80 for exports and 0.60 for imports.

(a) Apply the Marshall-Lerner condition to each period. [2] (b) Explain what this implies for the current account after a depreciation. [3]

8. Imports are 25% of the consumer price basket. A depreciation raises import prices in cors by 12%.

(a) Calculate the direct rise in the price level if the rise is fully passed on. [2] (b) Calculate the rise if half is passed on and state one further effect. [2]

9. After a depreciation, net exports rise by 36 million cors. The withdrawal rate is 0.6 and GDP is 1,200 million cors.

(a) Calculate the change in GDP as a value and a percentage, and the jobs created at 0.05 million cors of output per worker. [3] (b) Explain two reasons the result might be smaller. [2]

10. A factory costs 800 million cors to buy. The rate falls from 2.00 to 1.60 duns per cor.

(a) Calculate the change in its price in duns. [2] (b) Explain why FDI might still not rise. [2]

11. Explain two consequences of competitive depreciations for the countries involved. [6]

12. Evaluate whether a depreciation of its currency will reduce a current account deficit and raise growth in a country. [12]

Answers

1. PPP rate = 144 ÷ 80 = 1.80 duns per cor [1]. The market rate is lower [1], so the cor is undervalued by 1.50 ÷ 1.80 − 1 = 16.7% [1]. [3] Examiner insight: Show which way you divided, and state “undervalued” or “overvalued” explicitly; a bare percentage leaves the reader to guess.

2. Devaluation is a deliberate official cut [1] in a fixed or managed rate [1]. Depreciation is a fall caused by market forces [1] in a floating rate, through falling demand or rising supply [1]. [4] Examiner insight: Answers that name who causes the fall (government or market) and which system it belongs to tend to give both halves of a distinction.

3. Cor: 2.40 ÷ 3.00 − 1 = −20% [1]. Dun in cors: from 0.3333 to 0.4167 [1], a rise of 25% [1]. [3] Examiner insight: Giving both values in the same units before dividing shows why the percentages differ; leave the sign in.

4. Convert: 90,000 ÷ 3.00 = 30,000 cors [1]. Interest: 30,000 × 1.06 = 31,800 cors [1]. Reconvert: 31,800 × 2.88 = 91,584 duns [1]. Staying: 90,000 × 1.02 = 91,800 duns, so staying is better by 216 [1]. Comment: the interest rate gap was cancelled by the 4% fall in the cor, so expected exchange rate movements can outweigh interest differentials [1]. [5] Examiner insight: Comparing in the saver’s own currency at the end is what makes the conclusion valid; mixed currencies lose the comparison.

5. (a) 150 − 30R = 30 + 30R [1], so R = 2.00 and Q = 90 billion cors [1]. (b) At 2.20: Qd = 84, Qs = 96 [1]. Excess supply = 12 billion cors [1], costing 12 × 2.20 = 26.4 billion duns [1]. (c) Reserves are finite [1]. Defending the peg may need higher interest rates, which slow growth [1]. [7] Examiner insight: A quantity of currency times a rate gives a cost in the other currency; check that the unit in your answer matches the question.

6. The central bank creates money to buy assets such as bonds [1]. This raises bond prices and lowers yields and interest rates [1]. The lower return on assets in cors leads to less demand for the currency or more supply as funds go abroad [1]. The cor depreciates [1]. [4] Examiner insight: Chains that start from the money creation and reach the currency market through returns usually read as complete; stopping at “more money” does not.

7. (a) Short run: 0.25 + 0.30 = 0.55, below 1, so the condition is not met [1]. Long run: 0.80 + 0.60 = 1.40, above 1, so it is met [1]. (b) In the short run the current account worsens [1], because volumes respond little while import prices in cors rise [1]. In the long run the balance improves as elasticities rise, giving the J-curve [1]. [5] Examiner insight: Add up the two elasticities and compare with 1 explicitly; refer to the time period each time.

8. (a) 0.25 × 12 = 3.0% [1] if all is passed on [1]. (b) 3.0 × 0.5 = 1.5% [1]. A further effect: dearer imported inputs raise firms’ costs [1]. [4] Examiner insight: A specific further effect, such as costs or wage claims, tends to earn more than the general word “inflation”.

9. (a) Multiplier = 1 ÷ 0.6 = 1.667 [1]. GDP rises by 36 × 1.667 = 60 million (5%) [1]. Jobs = 60 ÷ 0.05 = 1,200 [1]. (b) Spare capacity may be limited, so prices rise instead of output [1]. Dearer imported inputs may offset some gains [1]. [5] Examiner insight: The multiplier result holds only with spare capacity; stating that condition shows you know when to stop.

10. (a) 800 × 2.00 = 1,600 million duns, then 800 × 1.60 = 1,280 million [1], a fall of 20% [1]. (b) Investors may expect a further fall [1], and profits in cors are worth fewer duns when sent home [1]. [4] Examiner insight: Linking the exchange rate to the return in the investor’s own currency is a stronger point than listing unrelated factors.

11. The first country to depreciate gains export sales [1], but other countries lose market share and may follow [1], so the gains cancel [1]. Imports become dearer in all the countries [1], which raises costs and prices [1] and reduces real incomes. Uncertainty and trade barriers can follow, harming trade [1]. [6] Examiner insight: Two consequences, each developed through at least two linked steps, usually read better than four listed in a phrase.

12. Current account:

• Cheaper exports and dearer imports [1], but only if the sum of the elasticities exceeds 1 [1].
• J-curve: the deficit may worsen first [1].
• Imported inputs cost more, offsetting some of the gain [1].

Growth:

• Net exports raise AD, multiplied [1], with a gain in output if there is spare capacity [1].
• With full capacity the result is higher inflation [1].
• Retaliation or weak quality limits gains [1].

Evaluation:

• Time period decides the result [1].
• Pass-through and import dependence decide inflation [1].
• Supply-side policies sustain any gain [1].
• Judgement: a depreciation helps most with spare capacity and elastic demand; otherwise it mainly raises prices [1]. [12] Examiner insight: Long answers tend to gain credit for a judgement that names its conditions, rather than a closing summary of earlier points.

Where marks are usually lost

• Reversing the direction of the rate quote and so the direction of the effect.
• Giving the percentage change of one currency for both.
• Quoting units in the wrong currency or omitting them.
• Writing “exports rise” without saying they are cheaper abroad.
• Using Marshall-Lerner without the sum or the time period.
• Describing intervention without saying whether the central bank buys or sells its currency.
• Listing consequences of competitive depreciations without linking them.
• Concluding a long answer without saying when the effect holds.

Next steps

• Re-read the revision notes and the study guide.
• Check coverage on the checklist and see the course hub.
• Try all free 10-minute diagnostics.
• Book a free trial class: /trial/.

Official syllabus

Pearson Edexcel International Advanced Subsidiary/Advanced Level in Economics (YEC11), Specification, Issue 2, June 2018, first teaching September 2018, published by Pearson Education Limited. Section 4.3.3, item 2, points a to g.