Exchange rates

Question 1

the marshal Lerner condition definition

Answer 1

following a depreciation of an exchange rate the balance of trade will only improve if the sum of price elasticities of demand for export and imports is elastic

Question 2

the marshal Lerner condition calculation

Answer 2

PED x + PED m> 1

Question 3

exchange rates

Answer 3

the price of a currency in terms of another Currency

Question 4

3 factors causing an appreciation of a currency

Answer 4

1. increased interest rates in a domestic country
2. low inflation compared to other countries
3. speculation

Question 5

how can government intervention devalue the exchange rate

Answer 5

China have bought a lot of US assets (US exports) to increase the value of the dollar compared to the yuan.

This keeps the Chinese currency undervalued and their exports become more competitive as a result.

Question 6

purchasing power parity (real exchange rate)

Answer 6

The exchange rate that equalises the purchasing power in two economies

It means at this exchange rate you can buy the exact same basket of goods.

Question 7

3 reasons why can’t ppp be achieved

Answer 7

1. trade barriers
2. transport costs
3. political agreements

Question 8

how can exchange rates be used to control the economy

Answer 8

devaluing the exchange rate= export led growth

revaluing the exchange rate limits growth and inflation

Question 9

how does a country devalue its exchange rate

Answer 9

for example china bought lots of dollars with yuan

Question 10

What does the financial account include

BOP

Answer 10

1. portfolio investments (trading bonds and shares)
2. Foreign direct investment
3. reserves of money

Question 11

What must the balance of payments do

Answer 11

balance

Question 12

What is it called when something money comes into the UK

Answer 12

Credit

Question 13

what is it called when money leaves the UK

Answer 13

Debit

Question 14

why do countries (such as the US) operating on a current account deficit have a Financial account surplus

Answer 14

1. as these countries with a current account surplus (China) have massive reserves of cash which can be used to invest in US portfolio
2. or by issuing bonds and shares to finance current account deficit

Question 15

3 demand side causes of a current account deficit

Answer 15

1. overvalued pound (imports become cheaper)
2. high consumer spending
3. lack of competitiveness

Question 16

3 examples is a current account deficit ok

Answer 16

1. when the current account deficit is financed by FDI in the financial account
2. when the current account deficit is as a result of growth.
3. if the economy is near full capacity and may prevent inflation

Question 17

give an example where the current account deficit was financed by FDI

Answer 17

As incomes were rising in the UK in the 1980’s we bought lots of Japanese electronics such as TV using pounds.

This meant the Japanese had lots of pounds which was invested back into the UK through FDI.

Such as the Toyota factory which was set up in 1989 which employs around 3000

Question 18

industries which have been uncompetitive in the UK

Answer 18

1. bakeries
2. game development
3. car manufacturing.

Question 19

3 supply side causes of a current account deficit

Answer 19

1. low productivity
2. high labour costs
3. low investment
   Which may lower competitiveness causing people to buy abroad

Question 20

problems with a current account deficit

Answer 20

1. falling in ad and reduction in growth

2. causes a depreciation in the exchange rate causing cost push inflation as imports become more expensive

Question 21

problems with using the exchange rate as monetary policy

Answer 21

1. has an asymmetric impact on the economy. those who import (eg tourism) more will better benefit from a weak pound
2. Can cause international trade wars (eg China and the USA)

Question 22

reasons a exchange rate may depreciate

Answer 22

1. reducing export revenues as a result of unattractive exports (high inflation) causes a deterioration in the current account in the balance of payments. As less is exported less domestic currency is demanded.
2. lower interest rates discourage hot money flows

Question 23

what’s the benefit of a fixed exchange rate

Answer 23

if the exchange rate is fixed at a low price is may attract exports and prevent imports.
Export led growth may be caused as result

Question 24

why may the current account deficit be financed by FDI

Answer 24

if US were to buy Chinese toys using dollars. The Chinese must reinvest the dollars back into the US economy as they have no value elsewhere.