For currency deprecation, the following issues could be addressed:
• effect on domestic and international market shares
• the Marshall-Lerner condition, the J-curve and the Balance of Payments
• possible effects on inflation (cost push and demand pull)
• hot money and capital flight
• terms of trade
• debt repayments/debt servicing ratios and the effect of these on
public expenditure and investment
• loss of confidence in the currency
• competitors may devalue to restore competitiveness / possible global instability
• environmental issues
[25 marks] 7. Discuss the possible causes and consequences of a persistent deficit balance in a country’s current account.
(Total 25 marks) 8.This is a broad question that will receive a variety of approaches from
Candidates should demonstrate an understanding of what a current account is
and what a deficit balance means. Other points for explanation may include:
• links to the balance of payments accounts
• the meaning of “persistent deficit balance”
Discussion may include the following:
• reference to the imbalance of credit and debit items, such as imports are
greater than exports or net invisibles may be negative. (Candidates who
limit their answer to this level would not be expected to gain high marks.)
• the nature of exports and imports (both current and over time)
– effect of protection on world prices (such as the Common Agricultural
Policy of the EU on agricultural prices)
• loss of international competitiveness
– comparative rates of inflation
– factor costs
– overvalued currency
• level of foreign debt
– inappropriate use of foreign capital
– debt servicing directly linked to the CAD
– valuation effect of currency depreciation on debt servicing
• currency fluctuations, such as the J-curve effect of a depreciation.
Answers will be less predictable for this part of the question. Candidates
should be rewarded for their depth of understanding rather than the quantity
of points they make.
Points discussed may include:
• recession due to demand management policies designed to reduce the level
of imports, such as higher levels of taxation and lower levels of
government expenditure, and higher interest rates
• social and economic change due to structural adjustment policies designed
to promote exports and encourage import replacement
• capital inflows leading to increased foreign indebtedness
• reliance on MNCs as a source of capital
• depreciation of currency due to the imbalance between current and capital
• intervention by foreign agencies, such as the IMF, that will require
• assistance by aid agencies
[25 marks] 9. (a) Explain the various factors that could cause a change in the terms of trade for a country.
(b) Discuss, with reference to less developed countries, the possible consequences of a deterioration in the terms of trade.
(Total 25 marks) 10. (a) Candidates should define “terms of trade”.
Factors that may be considered include:
• changes in international competitiveness
• competitive advantage
• labour costs
• exchange rate movements
• changes in global demand for and supply of commodities
[10 marks] (b) A variety of approaches may be expected. Deterioration should imply only
negative consequences. A deterioration in terms of trade can be beneficial in
certain circumstances. Discussions may include:
(i) initial consequences
• problem of having to export ever greater quantities of commodities to buy given quantities of imports
• increased export volumes
• decreased import spending
• changes in volumes depend on price elasticities of demand for imports and exports
(ii) longer-term consequences
• balance of payments consequences
• debt and debt servicing
• depreciation of exchange rates
• IMF / World Bank intervention / assistance
• change in standard of living
• change in social spending and infrastructure
• the need for long term structural change
Reference to some real LDC examples is expected although not
necessarily for all points made.
Candidates who rely on generalisations would not expect to score
as highly as those who have made some reference to real examples.
[15 marks] 11. (a) Explain why a country’s balance of payments on current account may at times be in deficit and at other times be in surplus.
(b) To what extent does the existence of a current account deficit represent an economic problem?
(Total 25 marks) 12. (a) Candidates should clearly define the term balance of payments on
current account and explain the terms deficit and surplus on current account.
Explanations of deficits and surpluses might include the following:
• changes in exchange rates which alter the relative prices of imports and exports
• the impact of the level of economic activity in overseas markets on exports
• relative domestic and foreign rates of inflation
• changes in the pattern of comparative advantage and overseas competition
• the impact of changes in barriers to trade
• changes in investment income and transfers
• changes in the terms of trade
• the impact of fiscal and monetary policies
• any reasonable answer.
(b) Reward candidates who are able to discuss circumstances in which a current
account deficit may and may not represent a problem and who are able to
provide an overall evaluation.
Issues and areas for discussion might include:
• not a problem if
– deficit is small and/or temporary
– it is counterbalanced by capital inflows
– other countries are continuously willing to finance the deficit
– it reflects a growing economy and higher living standards
– automatic correction of a deficit under a floating exchange rate system
– any reasonable answer.
• reasons why it may be a problem
– need to finance deficit may lead to depletion of foreign exchange reserves/overseas borrowing/greater indebtedness
– a reflection of trading uncompetitiveness/overvalued exchange rate
– overseas creditors decide to “turn off the taps”
– the impact on the exchange rate and inflation
– the need for domestic deflation and the conflict with the goals of full employment and economic growth
– any reasonable answer.
[13 marks] 13. (a) What might cause a depreciation of a country’s currency?
(b) Discuss whether a country benefits more from a low value of its currency or a high value of its currency.
(Total 25 marks)
14. (a) Responses should begin with a definition of depreciation as a fall in the value of one currency with respect to another in a floating exchange rate system.
Depreciation can come about as a result of an increase in the supply of a currency. This may be caused by
• increased spending on imports (visible and/or invisible)
• capital outflows in response to higher interest rates abroad
• capital outflows caused by speculation
• capital flights in LDCs.
Depreciation can come about as a result of a fall in the demand for a currency. This may be caused by
• decrease in demand for exports (visible and/or invisible) because of relatively higher inflation rates.
• decrease in demand for exports (visible and/or invisible) because of changes in tastes abroad.
Responses should be expected to produce a supply and demand diagram to show depreciation.
(b) Responses should include a discussion of the change in the value of a currency on exporters, importers, consumers, government.
Better responses will carry the argument through to an awareness of the broader macroeconomic issues of inflation (if exchange rate is low) and unemployment (if exchange rate is high) and discuss the implications of these/or government policies.
[15 marks] 15. (a) Explain how changes in a country’s exchange rate may occur under a floating exchange rate system.
(b) Discuss the view that exchange rate changes are the most important factor in determining a country’s export sales.
(Total 25 marks) 16. (a) Answers may include:
· definition of exchange rate
· an explanation of floating exchange rate system
· an explanation of how changes in demand for the currency affect the exchange rate,
e.g. exports, travel and tourism, capital inflows, speculation, inflation etc.
· an explanation of how changes in the supply of the currency affect the exchange rate,
e.g. imports, travel and tourism, capital outflows, speculation, inflation rate, etc.
· a description of how government may intervene to manage the exchange rate eg direct investment, interest rates
· use of correct diagrams to illustrate how changes in demand and supply affect the
(b) Answers may include a discussion of:
· the impact of exchange rate changes on the price of and demand for exports
· the influence of price elasticity of demand on export sales
· importance of other factors affecting exports sales such as:
– non-price factors e.g. quality of products
– efficiency of domestic producers
– comparative advantage
– degree of protectionism
– world economic growth
– membership of a trading bloc
– rate of inflation
For an evaluative approach candidates may discuss
· the relative importance of the different factors affecting export sales
– the short run and long run determinants of export sales
– make a judgment on the importance of the exchange rate affecting export sales compared to other factors.
Examiners should be aware that candidates may take a different approach, which if appropriate should be fully rewarded.
[15 marks] 17. (a) Explain why an improvement in a country’s terms of trade does not always lead to an improvement in its balance of payments on current account.
(b) An economy is currently experiencing a deficit on the current account of its balance of payments. The government is considering either allowing the exchange rate to fall or reducing aggregate demand.
Evaluate the relative advantages and disadvantages of these two policies.
(Total 25 marks) 18. (a) • definition of terms of trade