OxfordAQA International A Level Economics
OxfordAQA International A Level Economics 3.4.2 The Balance of Payments, Exchange Rates and Financial Markets Exam Questions
Free OxfordAQA International A Level Economics revision for 3.4.2 The Balance of Payments, Exchange Rates and Financial Markets: what you need to know, common mistakes and exam-style questions with answers. Covers current, capital and financial accounts, exchange rate systems, depreciation, marshall-lerner condition, j-curve, money, banks and financial markets.
Practise 3.4.2 The Balance of Payments, Exchange Rates and Financial Markets with past papers
Once you have learnt this topic, find the 3.4.2 The Balance of Payments, Exchange Rates and Financial Markets questions in real OxfordAQA International 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 OxfordAQA International A Level Economics 3.4.2 The Balance of Payments, Exchange Rates and Financial Markets
This section of Unit 4 on the OxfordAQA International A2 Economics course looks at a country's financial links with the rest of the world. You study the structure of the balance of payments, the causes and consequences of imbalances and policies to correct them. You then examine floating, fixed and managed exchange rate systems, what determines exchange rates and how a depreciation or devaluation affects the economy, including the Marshall-Lerner condition and J-curve. Finally you study financial markets and the role of banks and central banks. Examiners often ask you to analyse the effects of an exchange rate change and to evaluate policies to reduce a current account deficit.
What you need to know
- Balance of payments The current account covers trade in goods and services, primary income and secondary income. The capital and financial accounts record flows of investment and other assets. Overall the accounts balance.
- Correcting imbalances Expenditure-switching policies, such as devaluation or tariffs, change the relative price of imports and exports. Expenditure-reducing policies, such as higher taxes or interest rates, cut total demand including imports. Supply-side policies improve competitiveness in the long run.
- Exchange rate systems A floating rate is set by supply and demand for the currency; a fixed rate is maintained by the central bank buying and selling reserves or adjusting interest rates; a managed float combines the two.
- Determinants Exchange rates are affected by relative interest rates, inflation, trade flows, investment flows, speculation and confidence.
- Effects of depreciation A depreciation makes exports cheaper abroad and imports dearer. The current account improves only if the Marshall-Lerner condition holds: the sum of the price elasticities of demand for exports and imports is greater than 1. The J-curve shows it may worsen at first because demand is inelastic in the short run.
- Financial markets Money acts as a medium of exchange, store of value, unit of account and means of deferred payment. Commercial banks create credit; central banks act as lender of last resort and regulate the financial system. Money, capital and foreign exchange markets channel funds between savers and borrowers.
Common mistakes in 3.4.2 The Balance of Payments, Exchange Rates and Financial Markets
- Saying a depreciation always improves the current account. It depends on elasticities (Marshall-Lerner) and timing (the J-curve).
- Confusing depreciation with devaluation. Depreciation occurs in a floating system; devaluation is a deliberate cut in a fixed rate.
- Forgetting the inflationary effect of a weaker currency through higher import prices.
- Explaining a rise in interest rates as weakening the currency. Higher rates attract hot money inflows, increasing demand for the currency.
- Treating a current account deficit as automatically harmful. Its significance depends on its size, cause and how it is financed.
Try three 3.4.2 The Balance of Payments, Exchange Rates and Financial Markets exam-style questions
1. State the Marshall-Lerner condition. (2 marks)
Show the mark scheme answer
A depreciation (devaluation) will improve the current account balance; only if the sum of the price elasticities of demand for exports and imports is greater than one.
2. Explain why a depreciation of a currency may cause the current account to worsen before it improves. (4 marks)
Show the mark scheme answer
In the short run, demand for exports and imports is price inelastic because contracts are fixed and buyers take time to switch; so import spending rises in domestic currency and export volumes barely change; the deficit widens; over time demand becomes more elastic and the balance improves, giving the J-curve shape.
3. Explain two factors that could cause a country's currency to appreciate under a floating exchange rate system. (4 marks)
Show the mark scheme answer
A rise in domestic interest rates relative to other countries attracts financial inflows and raises demand for the currency; strong demand for the country's exports increases demand for the currency; speculation that the currency will rise also increases demand (any two, explained).
3.4.2 The Balance of Payments, Exchange Rates and Financial Markets FAQs
What does OxfordAQA International A Level Economics 3.4.2 The Balance of Payments, Exchange Rates and Financial Markets cover?
It covers the structure of the balance of payments, policies to correct imbalances, exchange rate systems and their determinants, the effects of exchange rate changes, and financial markets and banks.
Which unit is 3.4.2 The Balance of Payments, Exchange Rates and Financial Markets examined in?
It is examined in Unit 4 (EC04), Economic development and the global economy, an A2 unit with multiple choice, short answer, data response and essay sections.
How do I analyse an exchange rate change?
Use a supply and demand diagram for the currency, then trace effects on export and import prices, the current account, inflation and growth. Evaluate with the Marshall-Lerner condition, the J-curve and the cause of the change.
