WJEC A Level Economics
WJEC A Level Economics Exchange Rates and Exchange Rate Policy Exam Questions
Free WJEC 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 free floating and managed exchange rates, causes of appreciation and depreciation, exchange rate indices, effects 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 WJEC 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 WJEC A Level Economics Exchange Rates and Exchange Rate Policy
Exchange rates and exchange rate policy is AS content in WJEC Economics, extended at A2. At AS you learn how exchange rates are set in a free float, with demand for a currency coming from exports and capital inflows and supply from imports and capital outflows, and the factors that cause appreciation and depreciation, including interest rates, QE, trade flows, confidence, safe haven demand and speculation. You also cover managed floats, exchange rate indices and policies that hold a currency above or below its market level. At A2 you add the effect of exchange rate changes on the terms of trade and the Marshall-Lerner condition. Examiners expect correct currency diagrams.
What you need to know
- Free floating rates The exchange rate is the price of one currency in terms of another, set by demand and supply in the foreign exchange market. Demand for pounds comes from UK exports and capital inflows; supply from UK imports and capital outflows.
- Causes of change Higher UK interest rates, strong export demand, safe haven buying and positive confidence raise demand for pounds (appreciation). QE, rising imports, capital outflows and speculation against the pound tend to cause depreciation.
- Managed floats and policy In a managed (dirty) float the central bank intervenes, buying its own currency with reserves or raising interest rates to support it, or selling it to keep the rate down for competitiveness.
- Exchange rate indices An effective exchange rate index measures a currency's value against a weighted basket of trading partners' currencies, giving a better overall picture than one bilateral rate.
- Effects of changes Depreciation makes exports cheaper and imports dearer, boosting AD and possibly growth and jobs, but raising import costs and inflation. Appreciation helps control inflation and cheapens imported inputs, but hurts exporters.
- Terms of trade and Marshall-Lerner (A2) An appreciation improves the terms of trade but reduces price competitiveness. A depreciation improves the current account only if the combined price elasticities of demand for exports and imports exceed one (Marshall-Lerner); in the short run the balance may worsen first.
Common mistakes in Exchange Rates and Exchange Rate Policy
- Reversing the effect of a strong currency. A strong pound makes UK exports dearer abroad and imports cheaper in the UK.
- Treating appreciation as always good. It can damage exporters and widen a current account deficit.
- Describing exchange rate changes only through trade. Capital flows, such as hot money responding to interest rates, are often more important in the short run.
- Stating Marshall-Lerner without the elasticity condition. Say the sum of the export and import price elasticities must be greater than one.
Try three Exchange Rates and Exchange Rate Policy exam-style questions
1. The exchange rate falls from £1 = €1.20 to £1 = €1.10. A German product costs €330. Calculate the change in its price in pounds for UK consumers. (2 marks)
Show the mark scheme answer
Before: 330 / 1.20 = £275; after: 330 / 1.10 = £300; price rises by £25.
2. Explain two reasons why a central bank might intervene to stop its currency appreciating. (4 marks)
Show the mark scheme answer
To keep exports price competitive, protecting jobs and growth in exporting industries; to avoid a widening current account deficit as imports become cheaper; (or to prevent deflation from cheaper imports).
3. Evaluate the impact of a depreciation of the pound on UK households and firms. (15 marks)
Show the mark scheme answer
A strong answer would analyse higher prices of imported goods and holidays reducing household real incomes, and higher import costs for firms; versus gains for exporters, tourism and import competing firms; consider the Marshall-Lerner condition and J-curve, the share of imported inputs and pass-through to inflation; reach a judgement on who gains and loses.
Exchange Rates and Exchange Rate Policy FAQs
What does WJEC A Level Economics Exchange Rates and Exchange Rate Policy cover?
It covers how exchange rates are set in a free market, causes of appreciation and depreciation, managed floats and exchange rate indices, the effects of changes, and at A2 the terms of trade and the Marshall-Lerner condition.
Which unit is Exchange Rates examined in?
The AS parts are examined in AS Units 1 and 2, and the A2 parts in A2 Units 3 and 4. Unit 4 assesses all A level content.
How do I draw an exchange rate diagram?
Put the exchange rate (for example US dollars per pound) on the vertical axis and the quantity of pounds on the horizontal axis. Shift demand or supply of pounds depending on the cause, and show the new rate.
