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Brighton Business School
Undergraduate Programmes
BSc (Hons) Finance and Investment
Level Five Examination
May/June 2014
EC271: International Financial Economics
______________________________________________________________________________
Instruction to candidates:
Rubric: You are required to answer THREE questions from a total of SIX
All questions are weighted equally (mark allocations within questions are shown in
brackets).
Nature of examination: unseen/closed book
Allowable material: non-programmable calculators
Page 1 of 4
EC271: International Financial Economics
(May/June 2014)
Question 1
a)
Distinguish between Absolute and Comparative Cost Advantage.
(10 marks)
Assume two countries A and B that produce two goods coats and shoes. With constant
returns to scale the labour requirement for each good is shown below
Unit labour requirements
(hours per unit of output)
Coats
Shoes
A
60
30
B
120
40
Suppose that there is no trade between A and B, and each economy has an endowment of
300 workers. Each worker works a 40 hour week. Initially each country devotes half of its
resources to the production of each good.
b)
Which of the countries has an absolute advantage in the production of the two commodities?
(10 marks)
c)
Calculate the opportunity cost of coats in terms of shoes and shoes in terms of coats for
each country.
(10 marks)
d)
Which country has a comparative advantage in the production of coats?
(10 marks)
e)
Trade now takes place under the following conditions: the country with the comparative
advantage in shoe production produces only shoes. The other country produces sufficient
coats to maintain the world ‘no trade’ output devoting the remaining resources to shoe
production. Comment on the gains from trade.
(30 marks)
f)
On a single diagram, plot the production possibility frontier for each country.
of you diagram is indicative of potential gains from trade?
What aspects
(30 marks)
Page 2 of 4
EC271: International Financial Economics
(May/June 2014)
Question 2
a)
What is the ‘interest rate parity’ condition?
(20 marks)
b)
Carefully explain how the foreign exchange market achieves equilibrium if interest rate parity
holds. Use a suitable diagram to explain your reasoning.
(20 marks)
c)
Show, using a suitable diagram, how the following changes will influence the exchange rate.
a.
b.
c.
A rise in the domestic money supply
A rise in foreign income
An expected depreciation of the domestic currency
(60 marks)
Question 3
a)
Using appropriate diagrams assess the effectiveness of fiscal and monetary policy in raising
the level of output and employment under both flexible and floating exchange rate regimes.
(80 marks)
b)
Briefly explain why a government may wish to fix its exchange rate.
(20 marks)
Question 4
a)
Outline how a currency crisis may emerge in the context of Krugman’s first generation model.
(70 marks)
b)
To what extent does this model explain the crisis experienced by South East Asian
economies in the late 1990s?
(30 marks)
Question 5
a)
Under what conditions will it be beneficial for a country to join an optimal currency area? Use
an appropriate diagram to explain your answer.
(60 marks)
b)
To what extent can the EU be described as an optimal currency area?
(40 marks)
Page 3 of 4
EC271: International Financial Economics
(May/June 2014)
Question 6
a)
Briefly outline the key characteristics of Euro-currency and Euro-bond markets.
(20 marks)
b)
What factors have contributed to the rapid growth of the Euro-currency and Euro-bond
markets?
(40 marks)
c)
Assess the impact that the growth in Euro-deposits has had on international debt and its
potential effect on international financial stability.
(40 marks)
Page 4 of 4
EC271: International Financial Economics
(May/June 2014)