IB DP Economics: Exchange rates – 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 – the IB holds copyright in its own papers. Use these alongside the official past papers available through your school or the IB store.

This set covers exchange rates, sub-topic 4.5 of Unit 4. It follows the IB Diploma Programme Economics guide (first assessment 2022, published February 2020), the course examined from the 2022 session onwards. Question 11 is HL only; the rest suit SL and HL. All data comes from Kelmark (currency the kel) and Ruvia (currency the ruv), which are invented, so the figures are illustrative. Rates are quoted as ruvs per kel. The study guide and revision notes explain the content; the course page is IB DP Economics. Draw each diagram on paper as you answer, since the answers describe them in words.

Questions

1. Define depreciation of a currency. [2]

2. A hotel night in Kelmark costs 150 kels.

(a) Calculate its price in ruvs when the rate is 0.80 ruvs per kel. [1] (b) The rate falls to 0.72. Calculate the new price in ruvs and the percentage change in that price. [2]

3. The average rate over four periods is 0.80, 0.84, 0.756 and 0.8316 ruvs per kel.

(a) Calculate the percentage change from period 2 to period 3. [2] (b) Calculate the change from period 1 to period 4 and state whether the kel appreciated or depreciated over the whole time. [2]

4. Ruvian shoppers develop a taste for Kelmark’s goods. Explain, with a diagram, the effect on the kel under a floating system. [4]

5. Explain two factors that could cause the kel to depreciate. [4]

6. Kelmark pegs the kel at 0.80 ruvs. In the market for kels (millions per day), demand is Qd = 560 - 250e and supply is Qs = 200 + 250e, where e is the rate in ruvs per kel.

(a) Calculate the rate the market alone would set. [2] (b) State whether the kel is overvalued or undervalued at the peg and calculate the excess quantity. [2] (c) Explain how the central bank could maintain the peg, including the cost of one method in ruvs. [3]

7. The peg in question 6 is cut from 0.80 to 0.72.

(a) Name this change and calculate it as a percentage. [2] (b) Calculate the ruv price of the 150-kel hotel night after the change and explain how it could affect Kelmark’s exports. [2]

8. Later, demand for kels becomes Qd = 620 - 250e, with supply unchanged. Kelmark manages its rate.

(a) Calculate the market rate. [2] (b) The authorities hold the rate at 0.78. Explain whether the kel is overvalued or undervalued, calculate the intervention and state whether the bank buys or sells kels. [3] (c) Suggest one reason the authorities might prefer the lower rate. [1]

9. Explain, with reference to AD/AS curves, the possible effects of a depreciation of the kel on inflation, economic growth and unemployment. [6]

10. The kel appreciates sharply. Evaluate the possible effects on different stakeholders and on the economy. [8]

11. (HL only) Kelmark’s government must choose a fixed or a floating exchange rate system. Evaluate the two systems. [8]

Answers

1. A fall in the market value of a currency [1] against another currency, under a floating system, caused by changes in demand and supply [1]. [2] Examiner insight: Naming the system and the cause separates depreciation from devaluation; “the currency is worth less” alone is vague.

2. (a) 150 x 0.80 = 120 ruvs [1]. [1] (b) 150 x 0.72 = 108 ruvs [1]. Change = (108 - 120) / 120 x 100 = -10% [1]. [2] Examiner insight: Show the formula; a bare percentage hides a slip in the base and leaves nothing to credit.

3. (a) (0.756 - 0.84) / 0.84 x 100 [1] = -10% [1]. [2] (b) (0.8316 - 0.80) / 0.80 x 100 = +3.95% [1]. The kel appreciated over the whole time, despite the fall in the middle [1]. [2] Examiner insight: Use the earlier period as the base each time; dividing by the later value is the usual slip in these calculations.

4. Axes: rate (ruvs per kel) and quantity of kels [1]. Demand for kels shifts right because Ruvians need more kels to buy the goods [1]. At the old rate there is excess demand for kels, so the rate rises to a new equilibrium [1]. The kel appreciates [1]. [4] Examiner insight: Shift only the demand curve and show the old and new equilibrium on the diagram; shifting both curves contradicts the explanation.

5. Any two factors, each with a mark for the factor and one for the link to the rate. Higher inflation in Kelmark than in Ruvia [1]: Kelmark’s exports become dearer and imports relatively cheaper, so demand for kels falls and supply rises, and the kel depreciates [1]. Lower interest rates in Kelmark [1]: portfolio investors move funds to Ruvia, so demand for kels falls and supply rises [1]. (Other valid factors include more imports, outward FDI, remittances sent abroad, speculation and the central bank selling kels.) [4] Examiner insight: Each factor needs a stated effect on demand or supply; naming factors without it is the usual loss on explain questions.

6. (a) 560 - 250e = 200 + 250e [1], so 360 = 500e and e = 0.72 [1]. [2] (b) At 0.80, Qd = 360 and Qs = 400. The peg is above 0.72, so the kel is overvalued [1]. Excess supply = 400 - 360 = 40 million kels [1]. [2] (c) The bank buys 40 million kels using foreign exchange reserves [1]. The cost is 40 x 0.80 = 32 million ruvs [1]. It could also raise interest rates to attract portfolio investment and raise demand for kels [1]. [3] Examiner insight: State the direction of the bank’s trade and give the cost in the other currency; answers that say “intervene” without either gain little.

7. (a) A devaluation [1]. (0.72 - 0.80) / 0.80 x 100 = -10% [1]. [2] (b) 150 x 0.72 = 108 ruvs [1], so Kelmark’s exports are cheaper for Ruvians and the quantity they buy may rise [1]. [2] Examiner insight: Use “devaluation” for an official change and avoid “depreciation” here; the word signals which system you are describing.

8. (a) 620 - 250e = 200 + 250e [1], so 420 = 500e and e = 0.84 [1]. [2] (b) At 0.78 the rate is below the market rate of 0.84, so the kel is undervalued [1]. Qd = 620 - 195 = 425 and Qs = 200 + 195 = 395, so excess demand is 30 million kels [1]. The bank must sell 30 million kels [1]. [3] (c) It keeps Kelmark’s exports price competitive [1]. [1] Examiner insight: Compare the target with the market rate to decide over or undervalued; comparing it with an old peg answers a different question.

9. Cheaper exports and dearer imports raise net exports [1], so AD shifts right [1]. Real GDP rises [1], and unemployment tends to fall as output and jobs increase [1]. Imported inputs cost more in kels, so SRAS shifts left [1]. The price level rises, so inflation increases, while the size of the change in real GDP depends on which shift is larger [1]. [6] Examiner insight: Cover each indicator the question names, with the chain from the rate to AD or SRAS to the indicator; a one-sided AD shift ignores the cost effect.

10. Exporters: Kelmark’s goods cost more in ruvs, so sales may fall [1], and profits and jobs in export firms are at risk [1]. Consumers and importers: imports and foreign holidays are cheaper, which raises living standards [1], and firms using imported inputs face lower costs [1]. The economy: lower net exports shift AD left, slowing growth, with a risk of higher unemployment, and the current account may weaken [1]. Cheaper imports lower inflation [1]. Evaluation: the effects depend on how strongly buyers respond to price, on how large and lasting the change is, and on whether the cause is strong demand for kels [1]. Judgement: for example, an economy reliant on exports would probably lose more than gain, but one reliant on imports could gain [1]. [8] Examiner insight: Weigh the groups against each other and end with a supported judgement; a list of effects alone is only the analysis.

11. (HL only) Fixed: greater certainty for traders and investors if the peg is believed [1], which supports trade [1]. But the bank needs large reserves to defend it [1], and interest rates must serve the peg, limiting domestic policy [1]. Floating: the rate adjusts to imbalances and the central bank is free to target domestic goals [1]. But volatility makes planning harder, and imports may become dearer after a depreciation [1]. Judgement tied to Kelmark: a small, trade-dependent economy with healthy reserves may prefer stability, but one with a weak economy and low reserves may find a peg hard to hold [1] [1]. [8] Examiner insight: Compare the systems on the same criteria and use the facts about Kelmark in the judgement; answers that describe each system separately tend to stay at description.

Where marks are usually lost

• Axes without units or a currency pair.
• Shifting the wrong curve, or shifting both.
• Dividing by the later value in a percentage change.
• Multiplying instead of dividing when converting a foreign price into the home currency.
• Writing depreciation for an official cut, or devaluation for a market fall.
• Describing intervention without saying whether the bank buys or sells.
• Stating that a depreciation always improves the current account.
• Explaining consequences without reaching AD or SRAS.
• Listing points in evaluation questions without weighing them or giving a judgement.
• (HL) Describing fixed and floating systems separately with no comparison.

Next steps

• Review with the revision notes and the study guide.
• Tick off the content on the printable checklist and visit the IB DP Economics course page.
• Take the free 10-minute diagnostics.
• Book a free trial class.

Official syllabus

IB Diploma Programme Economics guide, first assessment 2022, published by the International Baccalaureate Organization, February 2020, sub-topic 4.5.