Eduqas A Level Economics
Eduqas A Level Economics Exchange Rates and Exchange Rate Policy Exam Questions
Free Eduqas A Level Economics revision for Exchange Rates and Exchange Rate Policy: what you need to know, common mistakes and exam-style questions with answers. Covers floating and managed exchange rates, appreciation and depreciation, effects on objectives, the terms of trade and Marshall-Lerner.
Practise Exchange Rates and Exchange Rate Policy with past papers
Once you have learnt this topic, find the Exchange Rates and Exchange Rate Policy questions in real Eduqas A Level Economics past papers and mark them with the mark scheme. Doing lots of real questions is the quickest way to learn how examiners ask about each idea.
About Eduqas A Level Economics Exchange Rates and Exchange Rate Policy
Exchange rates and exchange rate policy is a policy instrument area in the Eduqas specification. You learn how a freely floating exchange rate is set by demand for and supply of a currency, what causes appreciation and depreciation, and how managed floats and fixed rates work. You then evaluate the effects of exchange rate changes on growth, inflation, unemployment and the current account, and on households, firms and the terms of trade. The specification states that understanding of the Marshall-Lerner condition is required. Examiners expect accurate currency market diagrams and the idea that a strong pound makes imports cheaper and exports dearer.
What you need to know
- Floating exchange rates In a free float the exchange rate is determined by supply and demand for the currency. Demand for pounds comes from UK exports and capital inflows; supply of pounds comes from UK imports and capital outflows.
- Causes of change Interest rates (hot money flows), QE, relative inflation, trade flows, confidence and safe haven demand, FDI and speculation all shift demand for or supply of a currency.
- Managed and fixed rates In a managed (dirty) float the central bank intervenes by buying or selling currency or changing interest rates. Policies can hold the rate above or below its market level, using foreign currency reserves.
- Effects on objectives A depreciation makes exports cheaper and imports dearer, which can raise AD, growth and employment and improve the current account, but raises import prices and cost-push inflation. An appreciation does the reverse.
- Terms of trade An appreciation improves the terms of trade (each export buys more imports) but worsens price competitiveness.
- Marshall-Lerner condition A depreciation improves the current account only if the sum of the price elasticities of demand for exports and imports is greater than one. In the short run demand is inelastic, so the balance may worsen before it improves (J-curve).
Common mistakes in Exchange Rates and Exchange Rate Policy
- Getting the direction of effects wrong. A strong pound means imports cheaper and exports dearer.
- Labelling a currency diagram with Price and Quantity only. Use the exchange rate (e.g. $ per £) on the vertical axis and the quantity of pounds on the horizontal axis.
- Assuming depreciation always improves the current account. It depends on the Marshall-Lerner condition and on non-price factors such as quality.
- Ignoring the inflation effect of depreciation. Higher import prices raise costs for firms and the price level.
Try three Exchange Rates and Exchange Rate Policy exam-style questions
1. The exchange rate changes from £1 = $1.30 to £1 = $1.20. A UK firm sells a product for £50 in the USA. Calculate the change in its dollar price. (2 marks)
Show the mark scheme answer
Before: 50 x 1.30 = $65; after: 50 x 1.20 = $60; the dollar price falls by $5.
2. Using a diagram, explain how a rise in UK interest rates could affect the value of the pound. (4 marks)
Show the mark scheme answer
Higher UK interest rates increase the return on UK deposits; hot money flows into the UK; demand for pounds increases, shifting D right; the pound appreciates; correct currency market diagram.
3. Explain the Marshall-Lerner condition. (3 marks)
Show the mark scheme answer
A depreciation will improve the current account balance only if the sum of the price elasticities of demand for exports and imports is greater than one (in absolute terms); otherwise spending on imports rises more than export revenue, worsening the balance.
Exchange Rates and Exchange Rate Policy FAQs
What does Eduqas A Level Economics Exchange Rates and Exchange Rate Policy cover?
It covers how floating and managed exchange rates are determined, the causes of appreciation and depreciation, effects on macroeconomic objectives, households, firms and the terms of trade, and the Marshall-Lerner condition.
Is the Marshall-Lerner condition on the Eduqas spec?
Yes. The Eduqas specification states that understanding of the Marshall-Lerner condition is required, so be ready to explain it and the related J-curve effect.
How do I remember exchange rate effects?
Use the phrase Strong Pound Imports Cheap Exports Dear (SPICED). Then reverse it for a weak pound, and always add the effect on inflation and on the current account.
