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Balance of Payments & Exchange Rates — Exam Questions & Model Answers

Section 4.3.3 — worked exam questions with mark schemes, model answers and examiner commentary.

Economics · WEC14 · Unit 4 · 4.3.3

2 written questions · 12 marks

Time estimates come from one constant per paper — Economics Unit 4 is 2 hours · 80 marks — not from a per-question guess.

This page examines 0 of 42 requirements in 4.3.3 Balance of Payments & Exchange Rates0.0%

Counted over the 2 written questions on this page and nothing else — not the whole question bank, and not the revision notes, which are measured separately and are much better covered. 2 of them carry no spec tag yet, so this number is a floor, not an estimate.

42 requirements in 4.3.3 that no question on this page examines
  • ECON-4.3.3-1a-1 the current account
  • ECON-4.3.3-1a-2 the capital and financial accounts.
  • ECON-4.3.3-1b Causes of deficits and surpluses on the current account.
  • ECON-4.3.3-1c Measures to reduce a country’s imbalance on the current account.
  • ECON-4.3.3-1d The significance of global trade imbalances.
  • ECON-4.3.3-2a The distinction between fixed, managed and floating exchange rates.
  • ECON-4.3.3-2b-1 foreign currency transactions
  • ECON-4.3.3-2b-2 the use of interest rates
  • ECON-4.3.3-2b-3 quantitative easing.
  • ECON-4.3.3-2c-1 relative interest rates
  • ECON-4.3.3-2c-2 relative inflation rates (purchasing power parity theory)
  • ECON-4.3.3-2c-3 current account of the balance of payments
  • ECON-4.3.3-2c-4 strength of the economy
  • ECON-4.3.3-2c-5 capital flight
  • ECON-4.3.3-2c-6 expectations and speculation
  • ECON-4.3.3-2c-7 global factors, e.g. falls in commodity prices.
  • ECON-4.3.3-2d The distinction between revaluation and appreciation of a currency.
  • ECON-4.3.3-2e The distinction between devaluation and depreciation of a currency.
  • ECON-4.3.3-2f-1 the current account of the balance of payments (with reference to Marshall-Lerner condition and to the J-curve effect)
  • ECON-4.3.3-2f-2 the capital and financial accounts of the balance of payments
  • ECON-4.3.3-2f-3 economic growth
  • ECON-4.3.3-2f-4 employment and unemployment
  • ECON-4.3.3-2f-5 rate of inflation
  • ECON-4.3.3-2f-6 FDI flows.
  • ECON-4.3.3-2g Competitive depreciations/devaluations and their consequences. competitiveness (continued)
  • ECON-4.3.3-3a-1 relative productivity rates
  • ECON-4.3.3-3a-2 relative unit labour costs
  • ECON-4.3.3-3a-3 relative export prices.
  • ECON-4.3.3-3b-1 productivity
  • ECON-4.3.3-3b-2 quality of human capital
  • ECON-4.3.3-3b-3 exchange rate
  • ECON-4.3.3-3b-4 wage and non-wage costs
  • ECON-4.3.3-3b-5 regulations
  • ECON-4.3.3-3b-6 quality of infrastructure
  • ECON-4.3.3-3b-7 non-price factors.
  • ECON-4.3.3-3c-1 policies to improve education and training
  • ECON-4.3.3-3c-2 investment incentives
  • ECON-4.3.3-3c-3 privatisation and deregulation
  • ECON-4.3.3-3c-4 measures to reduce the exchange rate of the currency
  • ECON-4.3.3-3c-5 trade liberalisation.
  • ECON-4.3.3-3d-1 advantages for an economy of being internationally competitive
  • ECON-4.3.3-3d-2 problems for an economy of being internationally uncompetitive.

Exam questions

Every question here carries a tariff that exists in IAL Economics. Open the mark scheme before the model answer and you will see what the examiner is paid to look for.

  1. Explain4 marksAO1 · AO26 min

    Explain what is meant by a current account deficit and give one possible cause.

    Mark scheme
    1–2 marks
    Definition: imports exceed exports on the current account
    3–4 marks
    Application: one cause explained (e.g. strong currency, high consumer demand)
    Model answer — 4 / 4
    What the marks in the margin meanKKnowledge/DefinitionAApplication
    A current account deficit occurs when the value of imports of goods and services exceeds the value of exports, plus net primary and secondary income flows are negative overall. K It means the country is spending more on foreign goods and services than it earns from selling to other countries. K

    One possible cause is a strong (overvalued) exchange rate. When the pound is strong, UK exports become more expensive for foreign buyers (reducing export demand) while imports become cheaper for UK consumers (increasing import spending). A This combination of falling exports and rising imports widens the current account deficit. A
    Examiner commentary
    Precise definition covering all current account components. The exchange rate mechanism is clearly developed — strong pound → expensive exports + cheap imports → deficit widens. Avoid saying "the country imports too much" — instead explain the mechanism driving the imbalance.

  2. Examine8 marksAO1 · AO2 · AO3 · AO412 min

    Examine how depreciation of the exchange rate might affect a country's current account balance.

    Mark scheme
    Examine (8)
    Appendix 6: Requires knowledge, understanding, application, analysis and evaluation. Requires an explanation which includes a chain of reasoning, and diagrams where appropriate. Focuses on depth rather than breadth. Any relevant data provided needs to be interpreted. There should be a brief assessment of the arguments/factors/evidence.
    Level 1 — 1–2 marks
    Isolated knowledge and understanding. No application to the context and no chain of reasoning.
    Level 2 — 3–4 marks
    Knowledge applied to the context. A chain of reasoning is begun but not carried through; any data given is described rather than interpreted.
    Level 3 — 5–6 marks
    A developed chain of reasoning in context, with a diagram where one is appropriate. Depth rather than breadth; data interpreted. Assessment is implied rather than made.
    Level 4 — 7–8 marks
    A developed chain of reasoning in context AND a brief assessment of the arguments, factors or evidence — the clause that separates Examine from Analyse.
    Indicative content
    Knowledge: definition of depreciation, current account. Application: mechanism — exports cheaper, imports dearer. Analysis: Marshall-Lerner condition, J-curve effect, time lags.
    Model answer — 7–8 / 8
    What the marks in the margin meanKKnowledgeAApplicationAnAnalysis chain

    Para 1

    Depreciation is a fall in the value of a currency relative to others in a floating exchange rate system. K When the pound depreciates, UK exports become cheaper in foreign currency (more competitive) and imports become more expensive in sterling (less competitive). K

    Para 2

    In theory, this should improve the current account — export volume rises and import volume falls, improving net exports (X – M). An However, this outcome depends on the Marshall-Lerner condition: the current account improves only if the combined PED for exports and imports is greater than 1. K If demand for both is inelastic, depreciation may actually worsen the current account — import spending rises (same volume at higher prices) while export revenue barely increases. An

    Para 3

    Even when the Marshall-Lerner condition holds, there is a time lag explained by the J-curve effect. K In the short run, existing trade contracts are denominated in pre-depreciation prices, and consumers and firms take time to adjust their purchasing decisions. An After the UK pound fell approximately 15% following the 2016 Brexit referendum, the trade balance initially worsened before gradually improving as exporters gained competitiveness. A The J-curve shows the current account initially deteriorating (short-run inelastic demand) before improving as demand adjusts over 12–24 months. An
    Examiner commentary
    Three concepts are integrated rather than listed: the competitiveness mechanism, the Marshall-Lerner condition and the J-curve lag, with sterling's fall after the 2016 referendum as application and a J-curve diagram available for the diagram credit. Level 4 is earned because the improvement is never asserted — it is made conditional on the combined elasticities, the inelastic case in which the current account worsens is stated, and the 12–24 month adjustment is given. That is the brief assessment.
    Why this loses marks — a mid-band attempt at the same question

    Not a real script, and not written for this panel. It is 2 of 3 paragraphs of the model answer above, with “Para 3” removed. Nothing is rewritten. Open the model answer above and the difference is exactly the paragraphs named here.

    What the marks in the margin meanKKnowledgeAnAnalysis chain

    Para 1

    Depreciation is a fall in the value of a currency relative to others in a floating exchange rate system. K When the pound depreciates, UK exports become cheaper in foreign currency (more competitive) and imports become more expensive in sterling (less competitive). K

    Para 2

    In theory, this should improve the current account — export volume rises and import volume falls, improving net exports (X – M). An However, this outcome depends on the Marshall-Lerner condition: the current account improves only if the combined PED for exports and imports is greater than 1. K If demand for both is inelastic, depreciation may actually worsen the current account — import spending rises (same volume at higher prices) while export revenue barely increases. An

    The band this attempt cannot reach

    Level 4 — 7–8 marks
    A developed chain of reasoning in context AND a brief assessment of the arguments, factors or evidence — the clause that separates Examine from Analyse.

    Where it tops out instead

    Level 3 — 5–6 marks
    A developed chain of reasoning in context, with a diagram where one is appropriate. Depth rather than breadth; data interpreted. Assessment is implied rather than made.

    No mark is put on this attempt. The full answer above is marked 7–8 / 8 by its own commentary; what a truncated version scores depends on the script, and inventing a number for it would be the kind of false precision this page exists to avoid.

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