FOREIGN EXCHANGE RATES-SET-8-QP-MS
MARKSCHEME
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A devaluation will reduce the price of exports (1) raise the price of imports (1).
Up to 5 marks for why it should:
Export revenue may increase (1) and import expenditure may fall (1) improving the current
account position/reducing a current account deficit (1).
May increase total demand (1) causing economic growth (1) reducing unemployment (1).
The currency may initially be overvalued (1) foreign reserves may have to be used to buy the
currency (1).
Some MNCs may be attracted by a lower exchange rate (1) make exports from the country
more competitive (1).
Up to 5 marks for why it should not:
It may cause inflation (1) rise in price of finished imported goods (1) rise in price of imported
raw materials (1) higher costs of production (1) higher total demand (1) because of rise in
net exports (1).
The currency may have initially been undervalued (1) there would have been upward
pressure on the exchange rate (1).
If a large devaluation other countries may retaliate (1) by putting on tariffs (1) making
exports less price competitive (1).
If country is reliant upon imported raw materials (1) may result in imported inflation (1) will
make exports less competitive (1).
If exports are inelastic in demand (1) export revenue may not rise (1).
Higher demand for exports without matching increase in production (1) can result in
demand-pull
inflation (1).
May result in loss of confidence in MNCs (1) resulting in lower FDI and economic growth (1).
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Discuss whether a government should devalue the country’s exchange rate. [8]
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In 2014, global Gross Domestic Product (GDP) stood at US$78 000 billion. A year later it had
increased to US$80 730 billion. In the past, countries such as the USA and Germany might have
been expected to have made the largest contribution to the increase in GDP. China accounted
for 20% of the increase in world output in 2015. China is set to become the largest economy. It is
becoming a stronger competitor in a number of markets. This increased price competitiveness is
the result of a number of factors including maintaining a low exchange rate, providing subsidies
to a number of industries and increased labour productivity. However, in 2015 the Chinese
Government was considering whether to reduce the size of the country’s steel industry, possibly
by cutting the subsidy it received. Fig. 1 shows how the market for steel might be affected by such
a change.
price
of steel
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P2
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Changes in the global balance of economic power
D1
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Q2 Q1
quantity of steel
Fig. 1 The market for steel in China in 2015
Some developed countries have been struggling recently. For example, Australia has seen its
economic growth rate declining. To try to increase domestic economic activity the Reserve Bank
of Australia has cut interest rates.
Developing and emerging economies’ economic growth rates are increasing. In Africa, this is in
part because of the discovery and exploitation of oil and mineral resources. These countries have
different exchange rate systems and have different records of success in attracting multinational
companies. Many African countries use protectionist measures but some are moving towards free
trade.
In most developing and emerging economies the birth rate is falling. The impact of this change is
influenced by the relative size of the fall. For instance, Nauru is one of the smallest countries in the
world having a population of only 10 000. Its birth rate fell from 26 to 25 in 2015.
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Discuss whether a firm would benefit from a fall in its country’s exchange [5] rate.
MARKSCHEME
Lower prices of exports (1) increase demand for its products (1) raise sales / revenue (1)
increase profits (1).
Increase size of market (1) enabling it to take greater advantage of economies of scale (1)
lower average costs of production (1).
Domestic producers can produce goods cheaper than overseas goods (1) resulting in
higher home sales (1).
Up to 3 marks for why it might not:
Increase price of imports (1) raise a firm’s costs of production (1) lower profits (1).
If demand for exports is price-inelastic (1) a fall in price of exports will cause a fall in
revenue (1).
A fall in the exchange rate (1) may create uncertainty making it difficult for a firm to plan
(1)
Maybe recession in other countries (1) will not result in increased sales (1).
Quality of goods may be poor compared with other competitors (1) sales do not rise (1).
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To achieve full marks, benefits to a firm must be discussed.
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[8]
MARKSCHEME
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Up to 5 marks for why it might:
A lower exchange rate will reduce the price of exports (1) raise the price of
imports (1) net exports may rise / exports may rise / imports may fall (1)
current account of the balance of payments may improve (1) total (aggregate)
demand may increase (1) real GDP may increase economic growth (1)
employment may rise (1).
Up to 5 marks for why it might not:
Higher import prices may not reduce spending on imports if demand for
imports is inelastic (1) export revenue may not rise if demand for exports is
inelastic (1) import restrictions imposed on other countries may make it difficult to sell more
exports (1).
Higher import prices may cause inflation (1) imported raw material costs may
rise (1) causing cost-push inflation (1) imported finished products may not be
replaced by domestic products (1) rise in net exports may cause demand – pull inflation (1).
Domestic citizens may be able to purchase fewer imports (1) lower living
standards (1).
If the country is in debt (1) it may increase the cost of repaying the debt (1).
If the country is operating at full employment (1) it may not be possible to produce more
exports / substitutes for imports (1).
Demand for the country’s exports may be low (1) if quality is poor / incomes abroad are
falling abroad (1).
If the fall is used as a way to capture markets abroad / protect domestic
industries (1) there may be retaliation (1).
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Discuss whether or not a fall in its foreign exchange rate will benefit an economy.
Each point may be credited only once, on either side of an argument, but separate
development as to how/why the outcome may differ is expected.
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In June 2016, Nigeria adopted a floating exchange rate after the country’s central bank had spent
months trying to maintain its fixed exchange rate. It had used foreign currency reserves to buy its
currency, imposed tariffs and limited the amount of foreign currency that Nigerians could purchase.
Most economists thought that the value of Nigeria’s currency would depreciate. A lower value of
the Nigerian naira might help increase output and reduce the deficit on the current account of the
country’s balance of payments. In 2015, Nigeria experienced a deficit on its current account for
the first time in 20 years. Countries with a current account deficit often have a higher inflation rate
and a lower economic growth rate than those with a current account surplus. Fig. 1 shows the
inflation rate, economic growth rate and the current account balance of selected countries in 2015.
Fig. 1 The inflation rate, economic growth rate and current account balance
of selected countries in 2015
China
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Economic growth rate
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Current account balance (% of GDP)
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Inflation rate
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Turkey
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A current account deficit can lower the exchange rate and so may increase import prices. A higher
price of imports, including imported food, can accelerate inflation.
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Nigeria adopts a floating exchange rate
In 2015, as well as experiencing a current account deficit, tax revenue fell in Nigeria and was
lower than government expenditure. Some economists predicted that the government would
cut spending on education and healthcare in 2016 to reduce the gap between tax revenue and
government spending.
The Nigerian government has been trying to reduce poverty in the country. In 2015, more than
60% of the population were living in poverty. Among the causes of the high level of absolute
poverty was an unemployment rate of 9.5%. One policy measure proposed to reduce poverty in
Nigeria is for the government to raise the wages of low-paid workers.
The government also wants to diversify the economy because the oil industry accounts for almost
90% of the country’s export earnings. The oil industry pays high wages to some of its workers
and relatively high interest rate payments to local banks. It also creates water pollution and air
pollution.
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Analyse what may cause a depreciation in an exchange rate. [5]
MARKSCHEME
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A deficit on the balance of payments on current account (1) imports are greater than
exports resulting in fall in market price (1).
A fall in demand for the currency (1) a rise in the supply of the currency (1).
A fall in exports/rise in imports (1) due to higher inflation (1) lower quality of goods being
produced (1) higher costs of production (1).
A rise in imports/fall in exports (1) due to increase in demand in the economy/economic
growth (1).
A fall in the rate of interest (1) due to a fall in FDI/speculation (1).
An expansionary government monetary policy (1) to sell currency to encourage exports
(1).
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buyer of Indian cotton textiles, benefited from this. India planned to stop the subsidy by 2019.
This was welcomed by other cotton textile exporters. The USA may not be much affected, in part,
because income usually rises in the country. The value of the Indian rupee against the US dollar
was relatively stable in this period but rose slightly in mid-2017.
Analyse how a rise in a country’s foreign exchange rate may affect its
unemployment rate. [6]
MARKSCHEME
A rise in the exchange rate will make exports more expensive (1) imports cheaper (1)
demand for exports may fall / export revenue may decrease (1) demand for imports
may rise / import expenditure may rise (1) net exports may fall (1) total (aggregate)
demand may fall (1) output may decline (1) demand for labour may fall (1)
unemployment may rise (1) cyclical unemployment (1).
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Reward but do not expect reference to PED.
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The Indian government subsidises the country’s exports of cotton textiles. The USA, the largest
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6
Wage rate growth has increased recently in Kazakhstan, but its economic growth rate has slowed.
This is, in part, due to a fall in exports. To try to increase the economic growth rate, the government
has increased its spending on investment. In August 2015, it adopted a floating foreign exchange
rate system in an attempt to improve the country’s macroeconomic performance.
Discuss whether or not a country should switch from a fixed foreign exchange rate system to a
floating foreign exchange rate system.
[8]
MARKSCHEME
In assessing each answer, use the table opposite.
Why it should:
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• the government will not have to devote time and attention to maintaining the
exchange rate and so may use policy measures to e.g. reduce inflation
• fewer foreign exchange reserves would have to be kept to maintain the exchange
rate. These could be used to stimulate economic activity
• exchange rate may be lower which may increase economic growth, lower
unemployment and improve the current account position.
Why it should not:
• a lower exchange rate may cause inflation
• fluctuations in the exchange rate may create uncertainty. This may discourage
investment and reduce economic growth
• may discourage MNCs from setting up in the country
• a higher exchange rate could reduce economic growth, employment and harm the
current account position.
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